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Ottawa, April 22, 1996
1996-032

Notes for an Address by the Minister of Finance of Canada, Paul Martin, to the IMF Interim Committee

Washington, D.C.
April 22, 1996

Delivered text is official version

Global Economic Situation and Policy Challenges

Policy Priorities in the Recovery

Over the last six months, growth has slowed markedly across most industrial countries. While there are encouraging signs that growth in Japan and North America is picking up, the economies of many European countries remain weak.

In some countries, this slowdown has occurred at a time in which recovery from the last recession is still incomplete. In nearly all countries it is exacerbating concerns among our citizens about the ability of our economies to create jobs and prosperity. These concerns have become all the more acute owing to the accelerating pace of economic and technological change, which is contributing to a pervasive sense of insecurity.

We all agree that governments have a responsibility to address these concerns. Our challenge is to do this in a way that is responsible and sustainable.

In these remarks, I will focus first on the policy measures that industrial countries can take to improve our prospects for steady, strong growth. Then, I will turn to the measures that other countries can, and are, taking collectively through the IMF to further this same end, particularly the poorer countries of the world.

What can we in the industrial countries do to strengthen the prospects for sustained growth? The general policy prescriptions that the Interim Committee endorsed 18 months ago in Madrid -- sound public finances, price stability, and structural reforms -- are still the best way to strengthen recovery where it is weak, and sustain it where it is already mature.

With respect to fiscal policy, deficit reduction must remain a top policy priority. Although considerable progress has been made, much remains to be done in this area if we are to reap the benefits in the form of lower world interest rates and higher standards of living. Here, I think we must all bear in mind that it took many years for our fiscal problems to mount. Similarly, addressing these problems will require a committed, approach.

In my view, there is simply no other option; in an environment of excessive public debt, governments have limited scope to address the problems of real interest, of either an economic or social nature, until they get their public finances in order.

The actions that governments take to put their finances on solid footing must be complemented by appropriate monetary policy. The over-riding goal of monetary policy must remain price stability. We must continue to safeguard the hard-won gains that we have achieved over the last several years in reducing inflation, and perhaps, more importantly, in wringing inflationary expectations out of our economies.

Experience shows that the successes that countries achieve in reducing budget deficits and in maintaining price stability can be mutually reinforcing. Canada and Ireland are examples of the benefits that come from building policy credibility in these areas. Later in my remarks I will elaborate on the concrete benefits that have resulted from this policy approach.

Structural reform is another area in which we must act to improve the prospects for sustained growth and higher living standards. In particular, we must improve the efficiency of labour markets by removing laws and regulations that discourage hiring and embed disincentives to work. We must also redirect our existing social and labour market programs toward measures that help equip workers to prosper in today's dynamic, technology-driven environment, and that foster adaptability rather than dependency. The Fund has an important role to play in advising industrial countries on such structural issues, since poor structural policies can offset some of the benefits of even the best macroeconomic policies. In developing countries, it should work with the World Bank to the same end.

Canada's Policy Approach

These priorities - restoring public finances, price stability, and structural reform - are at the heart of the approach we have adopted in Canada.

Our overriding policy objective since the very beginning of our mandate in 1993 has been to create more and better jobs for Canadians. However, we realized that simply throwing money at the economy is no durable solution to the problem of unemployment. So, in Canada we have acted to create the necessary conditions for strong economic growth and job creation. This has meant reducing our budget deficits while keeping inflation low, which, in turn, helps get interest rates down and keep them down.

Putting Canada's public finances on a sound footing is the first step in generating better, sustained economic growth and job creation.

In the Budget that I tabled last month, I announced a new deficit target -- to reduce the federal deficit to 2.0 per cent of GDP by the 1997-98 fiscal year, from 3.0 per cent this year. When this target is achieved, Canada's debt-to GDP ratio will experience its first significant decline since the mid-1970s. By the 1997-98 fiscal year, the government's financial requirements -- a measure of fiscal performance more comparable to that used in other countries, such as the U.S. and the U.K., will be the lowest among the major industrial countries. By the 1998-99 fiscal year, the Government of Canada's financial requirements will be well under 1 per cent of GDP. The sharp reduction in the federal deficit is not the complete story, however -- eight of ten provincial jurisdictions were in fiscal balance or surplus in the most recent fiscal year (1995-96), a very considerable turnaround.

In addition to deficit reduction, getting interest rates down also requires keeping inflation low. The Government and Bank of Canada have jointly established targets of 1 to 3 per cent for inflation that extend through to the end of 1998. Currently, inflation remains well within the target range and at its lowest sustained level in three decades. The Government and the Bank of Canada are committed to ensuring that this excellent performance continues. The Bank of Canada has also been increasing its efforts to make monetary policy formulation and implementation more transparent. This has been achieved, in part, through the semi-annual publication of its Monetary Policy Report, which explains its policy objectives, its views on the economy, and the nature of its actions.

Our success on the fiscal and inflation fronts, however, must be complemented by measures to reduce structural problems if our goal of stronger growth and job creation is to be achieved. For this reason, we are also taking actions to remove impediments to growth and to ensure a more productive economy. Business subsidies have been slashed and Crown corporations have been privatised. On the labour front, we have acted to improve work incentives and better prepare workers for the job opportunities that will be created by a more dynamic economy.

Canada's Economic Performance

This policy approach is clearly bearing fruit.

Although, like many industrial countries, the Canadian economy performed less well than expected in 1995, the outlook for 1996 is more promising. Our success in reducing the budget deficit and keeping inflation low has reduced short-term interest rates through 1995 and into this year, with the exception of a temporary run-up in rates during last October's referendum in Quebec. In fact, for the first time in many years, the differential between Canadian and U.S. short-term interest rates has been eliminated, without downward pressure on the Canadian dollar.

Low interest rates are expected to provide a boost to domestic demand, and there are indeed some signs that a pick-up in activity is already underway. The strong growth in employment that has occurred since October, particularly in the private sector, is a sign that our policies are paying off, one which will provide a further boost to domestic demand by raising household incomes and consumer confidence. Export growth, which has been our principal source of growth over the past several years, should also be strong in 1996, since growth in the U.S. economy is picking up once again.

Most importantly of all, the Canadian economy is creating jobs. Since 1993, the Canadian economy has created and sustained nearly half a million new jobs. In contrast, in the four European G-7 countries taken as a group employment has actually shrank.

Economic Developments in Ireland

Developments in Ireland and the Caribbean countries I represent in this Committee also show the wisdom of the economic policy approach I have outlined.

In Ireland, economic growth in 1996 may be among the fastest in the industrial world, following robust expansion over the last two years accompanied by rapid employment growth. Nonetheless, inflation is expected to remain low, at about 2 1/4 per cent. This performance reflects the strong commitment of the Irish authorities to sound public finance, to price stability through a stable exchange rate, and to moderate wage developments. Despite these impressive achievements, the major policy challenge facing Ireland remains that of making further inroads into unemployment, which has fallen from 15.6 per cent in 1993 to under 13 per cent in 1995 and is expected to fall further in 1996.

Economic Developments in the Caribbean

The Caribbean countries I represent are also continuing to work towards the consolidation of sound policies. In this respect, they recognise the value of the Executive Board's consideration of bilateral and multilateral surveillance issues since last fall.

Those eastern Caribbean countries hit by last September's hurricane have made important progress in recovering from the damage. The authorities in a number of small countries in this region have demonstrated their commitment to strong policies, and have been ready to draw upon IMF advice in improving their policies further, including in cases where they do not contemplate using Fund financing. The Jamaican authorities have achieved their objective of ending their use of IMF credit and, reflecting their commitment to sustaining strong policies, are entering into a close informal monitoring arrangement with the Fund.

Prospects for the Developing Countries
and the Economies in Transition

I will conclude my remarks about the world economic situation with a few words about the developing countries and countries in transition.

The developing countries as a group have made a great deal of progress in recent years and have the opportunity to realize more robust growth in the future, provided that they continue to pursue appropriate policies. This was certainly the impression that I took back to Canada from my recent visit to Thailand and Vietnam, countries that are reaping the benefits of good policies.

Naturally, policy priorities differ to some extent across countries. In Latin America, for example, the top priorities are sound public finances and structural reform, including privatization and measures to strengthen financial sectors. For many Asian countries it is the need to be vigilant against overheating and the high inflation and current account deficits that accompany it. African countries must work toward achieving the long-term gains to be had by reducing their budget deficits, and by more fundamentally improving governance.

At the same time, there are also come considerations and approaches that apply across the range of developing countries. Some of these do not fall neatly into our standard categories like "macroeconomic policies", or "structural reforms". For example, at the recent APEC Ministerial in Kyoto, there was general agreement among countries in the region on the need to consider carefully the social dimensions of growth, such as income distribution. There is also a need for countries to carefully review their government spending, to ensure that it reflects the true needs of their economies and citizens.

Lastly, in my own conversations with businessmen from Canada and elsewhere active in developing countries, I have been struck by the number of these people who have stressed the importance of a well-defined and predictable legal framework. Improvements in this area will contribute enormously to countries' abilities to attract investment and boost their growth prospects.

Turning to the countries in transition, the experience of the most successful transition countries demonstrate clearly that strong macroeconomic adjustment and structural, even system-wide, reform programs are both essential to a resurgence of economic growth.

The evidence shows that one of the most important aspects of successful macroeconomic adjustment in transition countries is sound public finances. The reining in of fiscal deficits financed by money creation is critical to bringing about a lasting decline in inflation and improved macroeconomic performance.

There is also an overriding need to continue on the difficult, but essential, path of restructuring uncompetitive industries and enterprises, allowing competition to take root and to create adequate social safety nets. Fundamental tax reform is a priority in many countries in transition. Otherwise, weak economic activity early in the reform process, tax evasion and weak enforcement, and the granting of numerous tax exemptions, contribute to shrinking tax bases and could derail fiscal progress. In this environment, even strong gains in reducing fiscal deficits can be easily reversed.

Countries that act boldly in these areas will minimise the output losses which appear to be an unavoidable part of the transition to market economies, and accelerate their return to growth.

Institutional Challenges

At the last Interim Committee meeting, I outlined the proposals endorsed by G-7 Leaders at the Halifax Summit to improve the ability of the IFIs to respond to future challenges to the international monetary system. We have made considerable progress since then.

(i) the Fund has strengthened its surveillance through stronger and more candid analysis of members' economic policies;

(ii) the Fund can respond more promptly to serious financial crises through the recently established emergency financing mechanism;

(iii) new data standards are being established to better inform markets of financial and economic developments;

(iv) discussions have advanced on strengthening the Fund's financial resources under the Eleventh Quota Review and through the establishment of new financing arrangements to complement the resources available from General Arrangements to Borrow;

(v) the G-10 has been engaged with the issue of sovereign liquidity crises and [recently] released a report on orderly work out arrangements.

Work is ongoing for a number of these initiatives. Let me now comment on the specific issues that are on our agenda today.

Data Dissemination Standards

Last year, I stressed the importance of timely and reliable economic and financial data. I am glad to see that the Fund has moved quickly to establish a new special data dissemination standard for capital market borrowers. The standard is challenging and consistent with the overall objective of ensuring timely public access to high quality data. I am pleased to confirm that Canada and Ireland are fully committed to meeting this higher special data dissemination standard.

Early implementation of the Fund's electronic Dissemination Standards Bulletin Board will provide information on subscribing countries' statistical practices to the widest possible audience. As a result, international capital markets will be able to make risk assessments on the basis of the best information available. This should help reduce the risk of adverse market movements which are based on rumoured developments rather than solid facts.

The development of common data standards is a major achievement. For my part, however, I believe that parallel progress to harmonise public and private-sector accounting standards is also critically important. In line with progress on common data standards, I would also encourage greater transparency in the Fund's own operations through the regular release of Article IV documents.

In proceeding on this issue, however, we must remain mindful that many developing countries including the Caribbean countries in this Constituency, recognise that they will need to make further efforts to develop their data systems. In this connection, there should be adequate provision for continued technical assistance from the Fund for this purpose.

New Arrangements to Borrow

Even with improved international surveillance, adequate backstop mechanisms are still required to deal with major financial crises when these occur. In line with this, Canada chaired the G-10 Working Group which was tasked to develop a proposal for new financing arrangements to double the resources currently available to the IMF under the General Arrangements to Borrow (GAB).

A key feature is the involvement of new participants which have the financial capacity to support the international financial system. In addition, such arrangements will need to:

• give confidence to markets that the Fund has the capacity to respond on the scale that is required to deal with financial emergencies, and
• ensure that new participating countries have rights and responsibilities that are commensurate with their relative standing in the world economy.

I am confident that current discussions between the G-10 and potential new participants can reach a positive outcome in the coming months.

Eleventh General Review of Quotas

The Fund must also have adequate resources for its regular lending operations. This underlines the importance of continuing discussions on the size of a quota increase under the Eleventh General Review of Quotas.

It is critical that substantive progress be made to better align the quotas of individual members with their relative positions in the world economy. This would strengthen the Fund by allowing it access to the largest possible pool of usable resources. It would also have the advantage of giving those countries that have grown more rapidly since the last review, a voice in Fund decision-making that is more in line with their economic status.

The Caribbean countries in the Constituency that I represent also look forward to a timely and satisfactory conclusion of the Eleventh Quota Review. In their view, this should avoid a precipitous erosion of the voting position of developing countries, particularly small developing countries. They believe that this can be achieved by an appropriate balance between selective and equiproportional increases and by adequate adjustments of the level of the basic votes in the system.

Allocation of SDRs

The role of the SDR in light of changes in the world financial system is of continuing interest to all of us, even if there is no clear consensus on how to proceed with a new allocation. This was behind last year's call by the Interim Committee for outside experts and policy-makers from around the world come together to exchange views on this issue. I would like to extend my thanks to the Fund for responding to the request and organising the recent seminar on the Future of the SDR. I hope that we are able to build on this important exchange and come to an understanding on this thorny issue.

I understand that there is no broad support for expanding the role of the SDR. I would reiterate, however, that Canada continues to see value in a new allocation which would ensure equitable treatment of new members who did not participate in earlier SDR allocations. Let me also state that the Caribbean countries that I represent believe that there should be renewed effort to advance the matter of a fresh allocation of SDRs.

Regulatory Co-operation

At last year's Summit, the G-7 Leaders identified regulatory and supervisory co-operation as an important area for future attention. I am encouraged by the co-operative efforts that have been undertaken by the Basle Committee on Banking Supervision and the International Organisation of Security Commissions (IOSCO) and look forward to their formal reports.

Special Problems of Low-Income Countries

I turn now to the question of the special problems of low-income countries, in particular, those that are facing unsustainable debt burdens. On this issue, there are two fundamental questions to address. The first pertains to the design of a strategy to assist the most heavily-indebted poor countries. The second concerns the appropriate role for the IMF in such a strategy.

I would like to begin by expressing my appreciation to both IMF and World Bank staff for their work over the past few months in developing a very helpful analytical framework for dealing with this question. However, I am concerned that discussions on the proposal are getting bogged down and that we are losing some of the positive momentum of recent months. At this point, it is clear that, for a small but significant number of low-income countries, debt is a serious problem. We all agree that a comprehensive strategy is required to ensure a real solution to the problems of the heavily-indebted poor countries and that an appropriate treatment of multilateral debt is the missing link in this strategy. I also believe that there is a sincere desire to address this challenge. Our job today is to provide clear direction to bring about a lasting solution to this problem.

Let me begin by declaring my support for the basic framework developed by the Fund and the Bank. The proposal draws together the commercial banks, official bilateral creditors, and multilateral institutions and sets out a comprehensive approach that offers the hope of real progress. I am also encouraged by the clear link between the provision of exceptional multilateral assistance and the need to enhance the delivery of social services and improve the quality of public expenditures. A sharper focus on reducing unproductive expenditures, particularly excessive military spending, is a necessary complement to progress on debt. That being said, I believe a number of elements in this basic framework need to be significantly strengthened.

There is no question that donor countries have made, and continue to make, significant contributions to debt relief. What is called for at this point is for the international financial institutions to make better and more creative use of their own resources if this overall framework is to be workable. A burden-sharing arrangement which requires bilateral creditors to virtually write off debts owed them and contribute to a Multilateral Debt Trust Fund before multilateral institutions provide any debt relief is unrealistic.

In addition, under the current proposal, exceptional multilateral assistance would not be available until fairly late in the process. While a track record of commitment to reform must be established, I firmly believe that multilateral assistance needs to be provided as early as possible if we are to break these countries out of their unsustainable debt trajectories. For example, the three-year track record established for an exit stock treatment under Naples Terms strikes me as acceptable evidence of performance if complemented by forward-looking commitments, particularly those regarding the quality of public expenditures.

This brings me to the second question, the appropriate role for the IMF in such a strategy. At a minimum, the Fund must be in a position to continue to finance an adequately-funded Enhanced Structural Adjustment Facility (ESAF). Clearly, as the IMF's only concessional arrangement, ESAF remains essential in addressing the special problems of the poorest countries.

The lack of agreement on the role of the IMF centres on the financing of such an initiative. As we are all aware, donor aid budgets today are shrinking under the pressure to reduce overall expenditures. Clearly, in this environment, there would be significant opportunity costs in using bilateral resources to finance ESAF in terms of their alternative uses for development.

For my part, let me reiterate that I see the use of IMF gold as the key source of interim ESAF financing. My position on this is well known and I have yet to see any other viable source of financing identified by opponents of this proposal. I would also note that some shareholders take comfort in the fact that ESAF is projected to be adequately funded for several more years. Sadly, the debt problems of some of the poor countries will outlast this interval unless a viable strategy is put in place, moreover, it is true that existing resources will last for a few more years, we should also be aware that the longer we put off this decision regarding ESAF, the more we limit our options for financing.

Therefore, I believe it essential that this issue be resolved quickly if we are to move ahead on a comprehensive approach to not only the multilateral debt problem, but to the broader debt problem of the heavily-indebted poor countries.