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[Financial Post G7 Record]

Financial Post, Weekly edition, Tue 07 Feb 95, page 5

Keywords: International finance Economic conditions Mexico International Monetary Fund

CRISIS HAD PERFECT TIMING: The Mexican meltdown prompts G-7 ministers to discuss reform of the international financial services at long-planned Toronto meeting

Greg Ip

As financial crises go, the timing of Mexico's was perfect.

Coming weeks before the Group of Seven finance ministers were to meet in Toronto, it galvanized discussions on reforming the international financial system.

At their gathering in Naples last year, the G-7 heads of government promised to examine the systems of "global governance" at their summit in Halifax this June.

The decision was motivated solely by the 50th anniversary of the Bretton Woods agreements of 1944, which led to creation of the International Monetary Fund, the World Bank and the General Agreement on Tariffs and Trade.

But the financial crisis provoked by Mexico's devaluation of the peso in December has kick-started the agenda.

IMF managing director Michel Camdessus, who attended the Toronto summit, described Mexico's crisis as the first of the new economic order of massive, rapid capital movements.

The IMF was set up to finance members' temporary balance-of-payments difficulties - usually caused by a jump in import prices or a fall in export earnings. That lasted as long as the system of partly fixed exchange rates - until 1971. Since then, the IMF's main role has been policing the economic restructuring of countries who were cut off from the world financial system when they defaulted on their bank debt in the early 1980s.

But its key role in supplying US$17.8 billion in credit to Mexico to refinance maturing short-term paper and prop up the peso is fundamentally different.

It is the first time it has helped to rescue a country rocked by a massive outflow of "hot money" - portfolio capital that, unlike bank loans, is sensitive to loss of confidence, and can flee a market en masse in days. The magnitude of such outflows dwarfs anything the IMF has previously dealt with.

Peter Kenen, economics professor at Princeton University and an authority on the international financial system, said the world had no choice but to help Mexico.

"We've got to the point with some developing countries where the notion of 'Too big to fail' holds." Had Mexico defaulted, the same sort of crisis would soon have engulfed other countries.

That said, "the precedent of using the IMF resources to the extent they were is a bad one."

Countries can call on the IMF's resources several ways.

Each member has a quota that it can draw on, with the fund's approval, to meet temporary balance-of-payments needs. (These drawings in practice come from the hard-currency contributions of developed countries.)

In addition, the IMF can lend out of "special facilities," which have different conditions for access, such as a sudden plunge in commodity export prices or adoption of an economic restructuring package.

Mexico's package was seven times its quota, and contrary to IMF practice, 44% of it has been handed over already.

"It is unprecedented in size," Kenen said. "You couldn't do three or four of those without a serious problem for the fund. It would have rapidly depleted its liquidity."

But, he said, it is politically impossible to ask IMF members to increase their support sevenfold to meet the global requirements implied by Mexico's bailout.

Instead, Kenen proposes that countries experiencing large-scale capital inflows deposit part of those inflows in a special facility with the IMF. Each dollar deposited would be matched with the right to draw an additional dollar, doubling the country's resources in the event of a sudden capital outflow.

But resistance to such reforms is strong. Last year, Camdessus proposed a facility for dealing with capital outflows and got nowhere with the industrialized countries that dominate the IMF's voting. This weekend's G-7 meeting of finance ministers suggests that has not changed.

"The G-7 ministers . . . expressed their total satisfaction with the international efforts to assist Mexico, which have helped ease its financial crisis," Canadian Finance Minister Paul Martin said after the meeting.

In response to reporters' questions about the need to reform the IMF, Martin said, "there is very great support for reforming the international financial institutions and for putting even greater emphasis on surveillance. But at the same time there was a very clear recognition that the institutions had, in fact, worked very well. We're not looking for the need for fundamental restructuring, but constant improvements."

Increasing IMF quotas, expanding global liquidity through the issuance of additional Special Drawing Rights (an IMF-specific currency) or creating a new facility for dealing with capital flows were not even discussed, Martin added. German Bundesbank president Hans Tietmeyer worried that bailouts like Mexico's reduce the pressure on countries to alter the reckless policies that trigger crises.

Yet the grumbling of the Europeans, especially the Germans, at how the U.S. rammed the rescue package through last week with minimal consultation shows how tenuous ad-hoc arrangements can be.

As the Halifax summit approaches, the clamor for reform is likely to increase. Canada claims to be at the forefront of the "global governance" reform movement. As host it is well-placed to keep this high on the agenda.

Last summer it was the aid agencies and the United Nations that were the focus of reform. The Canadians want to examine the overlap between the many multilateral aid agencies - the World Bank, Asian Development Bank, Interamerican Development Bank, European Bank for Reconstruction and Development - and see if they can be transformed from disbursors of official government aid to motivators of private investment.

Mexico had been a textbook case of how economic reform encouraged private capital to take the place of official aid. The crisis that ensued when that capital abruptly turned tail has helped push the world monetary system ahead of official aid on the reform agenda.

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Revised: June 3, 1995

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