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Ottawa, September 21, 1998
1997-080

Statement prepared for the Interim Committee of the International Monetary Fund

The Honourable Paul Martin, Minister of Finance for Canada

Hong Kong
September 21, 1997

Delivered text is official version

Canada's Policy Approach and Outlook

The outlook for the world economy continues in the main to be promising. Output, trade and employment prospects have generally improved over the past year and further robust gains are expected next year. Moreover, the remarkable degree of policy convergence around the world -- in particular the strong commitment to maintaining a healthy fiscal climate and low inflation -- suggests that the current global expansion can be sustained.

The macroeconomic policy framework we have adopted in Canada --which focuses on putting the public finances on a sound basis and keeping inflation low --is clearly now paying off in the form of stronger growth and improved job creation. The Canadian economy expanded at a robust annual rate of 4.9 per cent in the second quarter of 1997, following growth of 3.7 per cent in the first quarter. This represents a significant strengthening of the pace of activity from the 1.5 per cent observed in 1996. Indeed, the strong growth observed in the first half of the year has prompted the IMF to raise its forecast for 1997 as a whole to 3.7 per cent.

Improved growth and job creation reflects in large part the impact of the steep declines in interest rates that have taken place over the last 2½ years: since early 1995, short-term interest rates have declined by some 500 basis points, to their lowest sustained levels in more than 20 years. Canadian short-term interest rates are now below comparable U.S. rates by about 200 basis points. Canadian rates are equal to or below U.S. rates across all maturities. Exchange rate developments have also contributed to an easing in monetary conditions.

The improvement in the Canadian economy's growth prospects is far from being entirely the result of developments in financial markets. Business confidence remains at a record high, while consumer confidence has reached its highest level in almost nine years. Most importantly, this confidence, combined with lower interest rates, is translating into stronger demand by both households and firms. Household spending has posted strong gains in recent months. Business investment has grown at a robust pace since mid-1996, a development that both stimulates growth in the short term and adds to the economy's long-term growth potential.

Stronger growth is translating into healthy job creation, with the Canadian economy generating more than 260,000 jobs from the end of 1996 through to August, pushing the unemployment rate down to 9 per cent. The Canadian economy is clearly well on the way to bettering the 300,000 jobs expected during the year by private-sector forecasters surveyed in February before the 1997 Budget. Most importantly, there is every indication that this improvement in labour market conditions is helping to establish a "virtuous circle" of stronger employment growth leading to increased confidence, higher household incomes, and continued overall economic growth.

The decline in interest rates and improved confidence that are the most direct contributors to stronger growth has in large measure been made possible by the remarkable progress made by Canada's federal and provincial governments in deficit reduction. Federal financial requirements, a measure of the government's cash flow position, were in a surplus in 1996-97, the first such surplus in over 15 years. Financial requirements correspond more closely with the deficit measures used in other G-7 countries. Based on this measure, Canada will have the best budgetary performance of all G-7 countries.

Developments in Ireland and the Caribbean

Sound economic policies are also being pursued in Ireland and the Caribbean countries that I represent on the Interim Committee. All the indications are that 1997 is turning out to be a fourth successive good year for the Irish economy, with GNP likely to expand by about 6.5 per cent and employment by some 4 per cent. Moreover, inflation has been lower than expected -- averaging about 1.5 per cent so far this year. With strong economic and employment growth boosting tax revenues, the budget deficit is likely to be well below the 1.5 per cent of GDP target adopted at the beginning of 1997. Competitive developments in wages and other costs are continuing to facilitate export growth and a balance of payments surplus, to boost corporate profitability, and to motivate ever-stronger business investment. This, in turn, is laying the basis for further economic expansion. The critical challenge ahead, as Ireland moves towards the closer integration which European Monetary Union represents, is to maintain the wage moderation and fiscal discipline which have figured so prominently in its success to date. The auguries are good. Ireland's social partners have committed to a responsible wage pact for the period to 1999, while the new government which took office during the summer aims to achieve fiscal balance within two to three years, if current conditions continue.

In the Caribbean countries, the pursuit of stable macroeconomic conditions remains paramount, despite an increasingly difficult external environment, as protected markets for bananas and other traditional commodities are under challenge. This has been exacerbated in recent times with the adverse WTO ruling concerning bananas and these countries will require both time and assistance in combating the attendant external shocks. On average, countries in the region achieved only mediocre growth in 1996, while at least one country recorded a negative outturn. The challenge of expanding output, while diversifying and liberalising their economies from monocrop industries (mainly agriculture or tourism), combined with a fast-growing labour force, is key to long-run economic potential in the region. In this vein, efforts to restructure public sector management, state-owned enterprises, labour markets and financial systems are vigorously being promoted. My Caribbean authorities continue to support and benefit from the Fund's efforts of strong surveillance aimed at minimising the incidence of systemic risk in the world economy.

The Global Policy Environment

In terms of the broader international picture, as I mentioned, the world economic outlook is generally positive. There are, however, risks and fragilities that could undermine this sanguine outlook. Timely and appropriate policy responses, on the part of the advanced, developing and transition countries, will be required to ensure the expansion's continuance.

While much has recently been made of the destabilising nature of global capital flows, we should not lose sight of the fact that they also convey critical benefits. An open and liberal system of capital movements is beneficial to the world economy, improving the allocation of financial resources and contributing to global economic growth. However, to ensure that the benefits of international capital flows outweigh the potential costs, national authorities must continue to pursue prudent macroeconomic polices, reinforced by structural reforms which enhance a country's ability to deal with significant capital flows. In particular, careful attention must be paid to addressing fragilities in the financial sector, through adequate supervision standards and prudential regulations. More flexible exchange rate arrangements may also be beneficial. Only when these policies are in place, will countries be able to reap the full benefits of globalization.

IMF Policy Issues

While the Fund has been active in promoting the orderly liberalisation of capital flows, it lacks explicit authority in this area . Broadening the Fund's mandate to cover capital flows would be a logical extension of its current mandate. For this reason, I support amending the Articles to make the promotion of capital account liberalisation a "specific purpose" of the Fund.

Preliminary understandings have been reached on the general thrust of an enhanced role for the Fund in promoting capital account liberalisation, but substantial work remains to identify the specific scope of the Fund's jurisdiction and appropriate transitional provisions and approval policies. Cooperation with other international institutions, such as the World Bank, the OECD and the WTO, is essential to ensure that the Fund's jurisdiction is consistent with the work underway in these fora. In our view, this would exclude the regulation of inward direct investment, which would more usefully be taken up by other institutions and arrangements.

An important lesson of the recent experience in South East Asia is that the Fund still has an important role to play in the international economy. The Fund had the resources, knowledge and credibility to develop a package that will stabilise the situation in the short term and provide national authorities with time to introduce needed reforms. It is essential that the Fund continues to have the resources to fulfil this important role.

In this regard, I am pleased with the agreement reached yesterday on an increase in IMF quotas. I also welcome the agreement that has been reached on a special one-time SDR allocation of SDR 21. 4 billion. This agreement ensures that all members will receive equitable treatment under all previous allocations.

Finally, on other Fund issues, let me say that Canada is pleased with recent progress that has been made to broaden eligibility criteria and significantly increase the size of the debt initiative for the heavily-indebted poor countries (HIPCs). These changes will allow an even greater number of countries to benefit from this exceptional assistance. The next challenge is to ensure that this initiative is adequately funded. For our part, I am pleased to announce that Canada will convert its share of the SCA-a refund into an unconditional grant of about SDR12 million to support this initiative. We urge others to firm up their pledges. For the IMF, the issue of funding will entail early discussions on the importance of "optimizing" the use of its resources. It is also essential that the Fund and the Bank continue their efforts to aggressively implement the initiative. For our part, we remain convinced of the need to continue to provide flexible and generous assistance which will enable a growing number of HIPCs to reach sustainable debt levels and become fully integrated into the global economy.