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Ottawa, September 29, 1996
1996-064

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

Washington, D.C.
September 29, 1996

Delivered text is official version

The Challenge

As we meet today, I am struck by the enormous progress we have made in recent years in addressing a number of key economic policy problems afflicting our economies. Inflation, which dominated the attention of policy-makers through the 1970s and 1980s, has been reduced to low levels in nearly every industrial country. Fiscal deficits, which seemed so intractable for many years, are now on a clear downward trend in many countries, although the same cannot yet be said for public debt. These achievements have created the conditions for lower interest rates and higher sustainable growth rates. Similarly, large current account imbalances among major countries, which threatened in the 1980s the hard-won progress made over the last half century in the area of trade liberalization, have been much reduced.

This progress is not confined to the industrial countries. Indeed, one of the most promising developments of the last several years has been the improvement in the fundamentals of the developing countries. The youth of today in many rapidly growing "emerging markets" may achieve industrial country living standards within their lifetimes, and in some countries before they reach adulthood. A large number of developing countries have escaped the economic stagnation with which they were afflicted for too many years, and are now experiencing growth and improving standards of living as a result of better policies and governance.

At the same time, many important challenges remain. The Executive Board of the IMF has acknowledged the need to address these challenges by proposing that we consider a new declaration on partnership for sustainable growth. I look forward to our discussion on this later today. My remarks today will focus on what we must do to meet the three most important challenges that we face.

One of the foremost issues of concern to me, and indeed to policy makers throughout the industrial countries, is the sluggish pace of economic expansion in our economies, outside of the United States, lagging that of previous business cycles. This, together with structural rigidities in our labour and product markets, has resulted in the unemployment rate remaining unacceptably high.

It is therefore important that we do not simply rest on our laurels. We have made enormous progress over the last several years in strengthening the fundamentals of our economies. It is now time to build on these accomplishments, indeed to go beyond the macroeconomic fundamentals, in order to generate more and better jobs for our citizens.

One area we must address is governments' vulnerability to future spending pressures. In particular, governments must have a clear understanding of what in the business world would be called "off-balance sheet liabilities" -- areas of potential pressure on public finances such as unfunded pension liabilities and the looming cost pressures associated with aging populations.

We must do this while bearing in mind our ultimate objective. This is not deficit reduction for its own sake, but rather a deep concern for the sustainability of the social programs and shared prosperity that we and earlier generations worked so hard to achieve. Governments must govern smarter, preserving the vital social safety net even as we modernise the details of how it works, while ensuring that fiscal problems do not become a drag on the ability of the economy to create jobs and prosperity.

The vulnerability of the international monetary system to crises is the second challenge to which we must respond. The direct effects of the Mexican peso crisis are now largely behind us, due in large part to the timely and effective action taken by the international community, and in particular by the IMF. However, we cannot ignore the possibility that other financial crises will occur in the future. It is important that we take preventative measures to reduce their frequency and have an adequate capacity to respond when they do occur.

Third, the international community must take steps to ensure broadly-based growth among the developing countries. Developing countries also encompass a wide variety of structural conditions. We will need to expend greater effort to understand these varying conditions in order to have policies address their particular circumstances more precisely. The prospects for a number of developing countries are at present limited by heavy external debt levels Last Spring, I endorsed the basic framework for easing the burden on deserving Heavily-Indebted Poor Countries brought forward by the Managing Director and the President. Since that time, we have made progress on all three crucial aspects of this initiative. We have a commitment in place to earmark World Bank resources for a HIPC Trust Fund, we have a commitment from the Paris Club to consider greater debt relief where appropriate and we have a commitment to finance the participation of the IMF through its ESAF program. I am pleased today to be able to participate in the launch of this important initiative.

In the remainder of my remarks I will touch on aspects of these three issues in turn.

Policies to Enhance Prosperity

Let me begin by considering the first of our policy challenges, the disappointing pace of the economic recovery and expansion among most industrial countries.

A wide variety of policy initiatives are proffered every day in the face of these challenges. I remain firmly convinced that the medium-term approach adopted by the Interim Committee two years ago in Madrid has been appropriate. Canada is a good example of a country now reaping the benefits of such an approach.

This approach is based on the recognition that poor economic performance often reflects a complex interaction between macroeconomic and structural problems. Our task is to formulate and implement mutually-reinforcing policies in both the macroeconomic and structural areas that ensure that people have the opportunity and the right incentives to respond to economic disturbances and the changing fortunes of different economic sectors and regions.

The labour market is one area in which the interaction between macroeconomic and structural problems is especially clear. We must improve the efficiency of labour markets by removing regulations that discourage hiring, and improving the ability of people to match their abilities with the skills being demanded by employers.

The priorities for macroeconomic policy in most industrial countries remain those of continuing to cut budget deficits and keeping inflation low, thereby creating the conditions for lower interest rates, stronger investment, and higher growth.

Some have expressed the concern that continued measures to reduce budget deficits in countries where growth is weak will exacerbate the economic slowdown, leading to larger fiscal problems and higher unemployment. However, in too many countries the state of public finances does not allow for any postponement. Indeed, such a move could lead to financial market turmoil and further economic weakness.

Rather, the challenge facing policy-makers in these countries, and indeed in most industrial countries, is to undertake fiscal consolidation in a credible and decisive way, to reap the maximum gains in the form of lower long-term interest rates. Monetary policy in these countries should stand ready to offset any contractionary effect that might occur in the short-term from cuts in budget deficits. Such action is fully consistent with a medium-term objective of achieving and maintaining price stability.

More generally, the role for monetary policy is to safeguard the excellent inflation performance achieved by most industrial countries over the last several years. By keeping inflation at low levels, monetary authorities enhance the ability of firms and individuals to plan for the future, improving the economy's growth and job-creation potential and helping to ensure that we do not again become ensnared in a series of "boom-bust" cycles.

Canada's Policy Approach

The Canadian government is committed to the implementation of sound macroeconomic and structural policies aimed at creating an economic environment in which the private sector can prosper and create high quality jobs. Only in such an environment can we afford the quality social programs that we are equally committed to maintain.

Putting Canada's public finances on a sound footing is the cornerstone of our approach. To accomplish this, we have adopted a sequence of rolling, two-year deficit targets. These short-term targets keep the government's "feet to the fire", allowing no opportunity for decisions to be delayed. Our approach has been very successful -- each year's deficit has come in at or below our projections. Just as important as getting the deficit down is how it is done. Since tax increases reduce incentives to work, save and invest, the bulk of federal government actions to lower the deficit have been on the expenditure side.

In the March 1996 Budget, I announced a new deficit target -- to reduce the federal deficit to 2.0 per cent of GDP by the 1997-98 fiscal year which starts next April. When this target is achieved, the federal government's net debt-to GDP ratio will experience its first meaningful decline since the mid-1970s. We also expect that the government's financial requirements -- the measure of the fiscal deficit directly comparable to that used in many other countries -- will drop to 0.7 per cent of GDP in the 1997-98 fiscal year, the lowest level in almost 30 years, and will be eliminated soon thereafter. Deficit reduction is not a priority only of the federal government: seven of Canada's ten provincial governments achieved balanced budgets or surpluses in the most recent fiscal year (1995-96).

In addition to deficit reduction, getting interest rates down also requires low inflation. 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 within the lower half of this target range, at its lowest sustained level in three decades.

We have also taken steps to address structural problems in the economy. Business subsidies have been slashed and crown corporations have been privatised to foster a more dynamic, competitive economy. With respect to labour markets, we are reforming social programs to meet the twin goals of increasing work incentives and better preparing workers for the job opportunities that arise.

Canada's Economic Performance

Our policy approach is bearing fruit in a number of very tangible ways.

As was the case in many industrial countries, the Canadian economy performed more poorly than expected in 1995 and the first half of 1996. However, the outlook for 1997 and beyond is bright. Our progress toward deficit reduction and in keeping inflation low has translated into sharply lower interest rates. Short-term interest rates have fallen by more than 400 basis points since March, 1995, and are presently some 150 basis points below those in the U.S. Indeed, Canadian bond yields are now below those in the U.S. for maturities out to five years. The spread between Canadian and U.S. ten-year government bond yields has narrowed to about 50 basis points from 160 basis points a year ago. The decline in interest rates will boost domestic demand.

Canada's excellent cost performance has translated in turn into a dramatic improvement in our international competitiveness and a surge in exports. Canada's current account, traditionally in deficit, moved into surplus in the second quarter for the first time since 1984. The current account surplus means that Canada's net borrowing needs are now being met from domestic sources, rather than relying on foreign borrowing as we have done for nearly all of our history. The importance of this development can scarcely be overstated: it has the potential to create a virtuous circle of permanently lower interest rates and stronger long-term economic growth.

Finally, our policy approach is translating into improvements where it matters most -- in creating more and better jobs for Canadians. I am painfully aware that Canada's unemployment rate is still too high. However, Canada's private sector has responded with great dynamism to the lower interest rates and improved confidence brought about by our success in controlling inflation and reducing budget deficits, having created 220,000 new jobs since last November.

Developments in Ireland and the Caribbean

This policy approach is also providing the underpinnings for stronger, sustainable growth in Ireland, and the Caribbean countries that I represent in the Interim Committee.

The long-standing commitment of the Irish authorities to budgetary discipline, exchange rate and price stability, and to a competitive evolution of costs and incomes continues to propel the country forward.

Economic growth will moderate to around 6 per cent in 1996 -- making Ireland the fastest growing OECD country for a third successive year. Employment has been expanding by more than 3 per cent annually during this period. Modest increases in gross incomes, in the context of tax relief made possible by a falling burden of debt and low inflation, have raised standards of living appreciably. At the same time, income restraint has supported growing corporate profitability and this, together with the expectation that Ireland will qualify for participation in European Monetary Union from its outset, has prompted a vigorous expansion of investment. The unemployment rate remains in double digits, however, despite falling by 4 percentage points over the past three years.

To further reduce unemployment and to sustain this exceptional economic performance, the Irish authorities aim to extend the ongoing consensus on incomes moderation after the current pact expires at year-end, in a framework which maintains credibility in financial management and is aligned with the demands of EMU.

The Caribbean countries in our constituency have, for the most part, continued to strive to stabilise domestic financial conditions, or to maintain and consolidate stabilization where this has already been achieved. At the same time, it is a matter of strong concern that growth remains low to modest in most of the countries, and in the notable cases where growth is relatively strong there is a challenge to ensure its sustainability. The urgent social need to increase employment and rapidly reduce the incidence of poverty in Caribbean countries means that stabilization must be accompanied, or closely followed by, a sustained expansion of output. The efforts of the authorities, supported strongly by an advisory and consultative relationship with the Fund, are aimed at reinforcing structural reforms, including in the areas of the public sector, public enterprises, and the composition of government revenue and expenditure.

Several of the countries are striving to improve public savings in order to undertake more infrastructure development supportive of private investment. They are also working toward stronger overall fiscal balances in order to avoid or reduce domestic and external imbalances. Financial system reforms are being promoted at the legislative and supervisory levels, and through institutional development, in order to enhance the soundness of the financial sector. In the eastern Caribbean countries, in particular, a major initiative is underway to develop and bring the several separate minuscule capital markets into one integrated financial system. These efforts in the financial area are expected in due course to increase the efficacy of intermediation, thereby contributing to greater economic flexibility and stronger growth.

The banana exporting countries of the area are continuing with initiatives to restructure production and the institutional arrangements for transportation and marketing of the fruit, as they maintain their efforts to forge a viable transition to the new conditions that will govern the EU market in the future. In the meantime, the small eastern Caribbean countries that are highly dependent on bananas are pursuing the difficult task of diversifying their economies, including through the sustainable development of their tourism sectors.

The Caribbean countries in our constituency do not exert systemic impact. However, as price takers in commodity, services, and financial markets, their prospects are as sensitive to international developments as they are to the quality of domestic policies. They therefore remain supportive of the efforts of the Fund to pursue strong surveillance with the aim of reducing volatility in the global market place.

Developments in the Developing Countries and Countries in Transition

Sound macroeconomic and structural policies are just as important for the developing countries generally and the countries in transition. In most regions of the world, developing countries are experiencing stronger growth as a result of better policies in these areas.

Many Asian countries have maintained impressive growth rates, supported by high domestic savings, and in particular by sound fiscal policies. However, these countries must remain vigilant against overheating, and the high inflation and current account deficits that accompany it. One of the major factors contributing to overheating and current account deficits in some countries has been the macroeconomic policy response to large-scale inflows of foreign capital. In this respect, I welcome the research work that is underway at the Fund toward refining its policy advice in this area.

Growth in Latin America is gradually strengthening again. The priority for many countries in this region is far-reaching reforms to the structure of government finances, including the allocation of revenue and expenditure between federal and local governments, as well as privatisation and measures to strengthen the financial sector.

I am particularly encouraged by the strong growth now being experienced by a number of African countries, which, if sustained, offers the promise of meaningful increases in standards of living for their citizens. This reflects in large measure the benefits of fiscal consolidation and structural reforms, and steps toward better governance. However, the rise in growth has been far from universal. In this respect, the strong performance and improved prospects of those countries that have strengthened their policies illustrates all the more starkly the need for improvement in other countries in the region.

Turning to the countries in transition, it is encouraging to see that many of these countries are now reaping the benefits of financial stabilization and structural reform in terms of growth in output and substantially lower inflation. Many transition countries have now brought inflation under control and eliminated many of the distortions and legacies inherited from central planning.

Their prospects for further growth will depend on the maintenance of prudent macroeconomic and structural policies conducive to savings and investment. In particular, further efforts are needed in four key areas. First, budgetary discipline must be enforced on enterprises to speed-up industrial restructuring and free up resources for use in more productive activities. Second, basic social safety nets must be put in place for workers displaced by reforms. Third, more comprehensive financial sector reforms need to be implemented in most transition countries in order to strengthen confidence in the banking system. Finally, additional far-reaching fiscal reforms are needed to restructure government spending towards the new priorities of a market economy, particularly the strengthening of social policies and the telecommunications and transportation infrastructure. This will in turn require the introduction of a permanent and transparent tax code, which can be effectively enforced and which provides governments with a stable source of revenues.

Avoiding and Managing Crises

I will now turn to the second issue I mentioned at the beginning of my remarks: improving the ability of the international community to foresee and respond to crises.

An effective early warning system will allow the Fund and the international community to act more quickly to prevent or handle financial shocks. A key element of this is better surveillance of national economic policies.

Better data is in turn key to improving surveillance not only by the Fund, but also by the private sector. Over the last year, the Fund has been working to establish standards for the more timely reporting and publication of key economic and financial data. In April, the Fund established a new special data dissemination standard (SDDS) for countries that borrow on international capital markets or aspire to do so.

I welcome the opening earlier this month of the Fund's Dissemination Standards Bulletin Board (DSBB). I am pleased that Canada and Ireland are among a broad range of countries whose data dissemination practices are already described on the DSSB. I encourage other countries to similarly inform the public of the availability and release dates of their data.

The posting on the Internet of information on subscribing countries' statistical practices will greatly assist international capital markets in making their risk assessments. The next step we need to take is to provide direct access to each country's data base. This can be accomplished by linking the information on the bulletin board to the data available at country Internet sites.

I urge the Fund to continue to work on developing a general data dissemination standard for all member countries.

Adequate financial backstop mechanisms are an important complement to improved international surveillance. As co-chair of a G10 Working Group, Canada has played a significant role in efforts over the past year to develop new financing arrangements to supplement the resources available to the IMF to respond to financial emergencies.

I am very pleased that we are close to final agreement between G10 and a number of other countries on the New Arrangements to Borrow (NAB) to double to SDR 34 billion the resources now available to the Fund in a financial emergency.

The new arrangements will give confidence to markets that the Fund has the capacity to respond on an adequate scale to deal with financial emergencies. Underpinning this confidence is the participation in the NAB of a wide range of countries far beyond the G10, with the capacity to support the international monetary system.

It is important that the Fund have adequate resources for its regular lending operations. The Fund's current liquidity position is still reasonably strong. However, strong demand for the Fund's resources is expected to continue beyond 1997. This emphasises the need to make early progress on the size of a quota increase under the Eleventh General Review of Quotas.

I welcome the considerable progress that has been made in discussions at the Fund on options to reduce inequities in present distribution of SDRs. At the heart of the issue, there are a number of new members that did not participate in earlier SDR allocations. A one-time special allocation of SDRs authorised through an amendment of the IMF's Articles of Agreement would ensure that all members receive an equitable share of cumulative SDR allocations. Discussions should continue to try to reach agreement by the time of our next meeting on the size and distribution of a special equity SDR allocation.

Assistance to Heavily-Indebted Countries

I turn now to the proposed Initiative to assist heavily-indebted poor countries. Of all the issues we discuss here today, I believe we will be remembered best for what we have achieved on this front.

We have come a long way over the past two years and I am particularly proud of the role Canada has played in advancing this cause. It was not long ago that we fell short of the broad-based consensus now enjoyed on the need for exceptional action to assist the most heavily-indebted poor countries. And today, it is also widely accepted that such assistance must bring together in a comprehensive and co-ordinated effort all the major creditors, including, for the first time, the full involvement of the international financial institutions.

The fact that we have made it to the point where upwards of $5 billion is to be committed by major creditors arises out of the inherent logic pointing to the need for exceptional debt relief for a number of the poorest, most heavily-indebted countries. Without exceptional actions, excessive debt burdens, which lead to the perverse spectre of large net negative transfers from the IFIs for some of the poorest countries in the world, will continue to undermine development prospects by creating a disincentive for investment and by crowding out productive public spending on much-needed infrastructure, education and health care. Clearly, any effective development and growth strategy for a these countries must include debt relief and expenditure on new projects and programs, tied to appropriate reform. Any strategy that does not include all these elements will fail to foster adequate development in the most serious cases.

Last Spring, I endorsed the basic framework brought forward by the Managing Director and the President and today I am pleased to be able to extend that support and participate in the launch of this initiative. We are clearly ready to begin to make available to those heavily-indebted poor countries with a proven record of reform the exceptional levels of debt relief necessary to enable them to move forward with their development efforts. This action has been a long time coming. I am honoured to have played a role in bringing it to fruition.

In welcoming our success in launching this initiative, it is important not to minimise a number of pitfalls which still remain in the way of the effective implementation of the strategy.

For example, in seeking to assist deserving countries with a clear need for exceptional assistance and with a proven commitment to reform, it is essential we ensure that all major creditors co-ordinate their actions closely. In so doing, no single creditor should be able to insist on action by others before it participates in this Initiative. The need for a high degree of simultaneity, however, underlines the importance of close and early co-operation between the major players -- the IMF, the World Bank and the Paris Club, in particular -- in determining the sustainability of a country's debt burden and in setting the performance benchmarks and reform measures which will determine ongoing eligibility for the Initiative.

Another key challenge is to ensure that resources freed up from debt service by this Initiative are not squandered and are, instead, used productively by recipient nations. While an essential part of this is the adoption of sound macroeconomic policies, I am pleased to note the explicit inclusion of criteria which focus on the delivery of social services and the quality of public expenditure. The focus on basic human needs -- including primary education and health care -- is one that I have insisted upon and is particularly welcome. While the World Bank is clearly in the best position to monitor such benchmarks, I would hope that all major creditors view compliance with the social-sector criteria as an integral part of the overall conditionality associated with eligibility for this Initiative.

On burden-sharing, and on the relative financial contributions from bilaterals versus multilaterals, we must acknowledge the massive effort already undertaken by bilateral creditors. The Paris Club alone has written off more than $8 billion in debt to developing countries since 1989 -- and much of this has been to the poorest countries. A number of countries have also written off virtually all of the ODA debt owed to them by the poorest countries. In Canada's case, this has amounted to almost $1 billion. These are impressive numbers and do not even include the costs associated with extending full Naples Terms to the many heavily-indebted poor countries which have not yet received treatment under these terms.

And we are ready to go even further. Canada will support an increase in the amount of debt reduction the Paris Club can provide to those heavily-indebted poor countries which become eligible for the HIPC debt Initiative. We are prepared to support reductions in the stock of eligible debt of up to 80 per cent on a case-by-case basis. This, combined with previous actions, represents a fair and generous contributions from bilateral creditors. The remainder of the costs associated with this Initiative must, therefore, come predominantly from multilateral resources.

Finally, with respect to the issue of how to finance the IMF's participation in the initiative, and consistent with the Managing Director's Summing-Up, I would like to see the IMF Executive Board endorse the sale of 5 million ounces of gold sooner rather than later. The sale of such a modest amount of gold makes clear sense. Gold is a non-performing asset and, at a time when other sources of financing are under enormous pressure, we must make the most efficient use of all resources.

I welcome indications from a number of countries, both industrial and developing, of their intention to contribute bilateral resources to this initiative. Canada will take the necessary steps to allow use of our SCA-2 resources to support ESAF. I believe, however, that the bulk of the financing must come from the IMF's own resources if we are to ensure that financing for the IMF's participation is to represent real additional resources for the poorest countries and not simply the reallocation of aid resources from other important uses.

Clearly, any sale of IMF gold will be undertaken in a gradual and transparent manner. This will ensure that the impact on world gold markets is negligible given the vastly larger flows of supply and demand transacted there today. Further, every effort should be made to begin the sale as early as is prudent. This will ensure the maximum possible investment return for ESAF and will minimise the impact on other resources available to all ESAF borrowers.

I am delighted that we are ready to finally launch the Debt Initiative. This Initiative is a major success, not only for the poor of the world, but for the effectiveness of the international institutional community. The time is right to launch it now.