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Finance Ministers' Meetings

Report of G7 Finance Ministers to the Köln Economic Summit

Cologne, Germany, 18 - 20 June , 1999


1. A well-functioning international financial system is essential to allow an efficient allocation of global savings and investment, and provide the conditions needed to improve world-wide growth and living standards in all countries. Recent events in the world economy have demonstrated that a strengthening of the system is needed to maximise the benefits of, and reduce the risks posed by, global economic and financial integration.

2. Reform of the international financial architecture will also reinforce the open multilateral trading system. Keeping markets open for goods and capital will make the global economy more resilient to shocks. The benefits and economic opportunities derived from open markets have led to a significant improvement in living standards in industrialised and emerging economies. We believe the process of globalisation offers great additional potential to create wealth and employment.

3. As Finance Ministers of the major economies, we are aware of our special responsibility for improving the conditions for a proper functioning of the international financial and monetary system and, in particular, enhancing sound fundamentals necessary for exchange rate stability. To this end we will maintain strong cooperation to promote stability of the international monetary system and exchange rates among major currencies that are in line with fundamentals.

4. Following the remit from last year’s Birmingham Summit, we have proposed in co-operation with other countries a number of important reforms to the architecture of the international financial system. We believe the initiatives and reforms that have been agreed will make a significant contribution to the stability of the world financial system.

5. In this increasingly integrated global economy, in which policy responsibility still lies mainly with sovereign states, the challenge is to promote global financial stability through national action as well as through enhanced international cooperation. All countries, together with the international financial institutions and private sector financial institutions, must share this responsibility.

6. This does not require new international organisations. It requires that all countries assume their responsibility for global stability by pursuing sound macroeconomic and sustainable exchange rate policies and establishing strong and resilient financial systems. It requires the adoption and implementation of internationally-agreed standards and rules in these and other areas. It requires the existing institutions to adapt their roles to meet the demands of today's global financial system: in particular to put in place effective mechanisms for devising standards, monitoring their implementation and making public the results; to have the right tools to help countries to manage crises; and to take steps to enhance their effectiveness, accountability and legitimacy. It also requires the right structure of incentives for all participants in the international financial system Ö national authorities as well as the private sector.

7. Our overall strategy is to identify and put in place policies to help markets work properly and to provide the public goods necessary to achieve this objective. This requires public authorities to provide for enhanced transparency and disclosure, improved regulation and supervision of financial institutions and markets, and policies to protect the most vulnerable. It also requires that private creditors and investors bear responsibility for the risks that they take, and are involved appropriately in crisis prevention and crisis management. In these respects, the establishment of internationally-agreed codes and standards for policy-makers serves both as an incentive for better governance and as a yardstick against which to measure country risk.

8. Last autumn, we identified for our Leaders the need for concrete actions to strengthen the international financial architecture. This report recommends specific reforms in six priority areas:

a. Strengthening and reforming the international financial institutions and arrangements;
b. Enhancing transparency and promoting best practices;
c. Strengthening financial regulation in industrialised countries;
d. Strengthening macroeconomic policies and financial systems in emerging markets;
e. Improving crisis prevention and management, and involving the private sector;
f. Promoting social policies to protect the poor and most vulnerable.

9. We believe these proposals will reduce the risk of, and help better manage, future financial crises. We are committed to, and will monitor closely, their implementation, and will continue to report on progress as necessary. Of course, financial markets will continue to evolve and this is likely to require further adaptations of the international financial system in the years ahead.

A. Strengthening and reforming the international financial institutions and arrangements

10. The development of global economic and financial arrangements to reflect the changing nature of the world economy is a continuous process. Our aim is to promote more efficient international financial institutions and arrangements, in which all relevant interests can be effectively represented.

11. We agree on a set of principles which should guide this process:

a. The IMF and the World Bank have the central role in the international economic and financial system, and in facilitating cooperation among countries in these fields.

b. The international supervisory and regulatory bodies have a crucial role to play in making the international financial system more robust.

c. The accountability and transparency of these bodies and of the IFIs should be strengthened.

d. A broad range of countries should be involved in discussions on how to adapt the international financial system to the changing global environment.

e. A system based on constituencies is appropriate for the governance of the institutions.

12. A number of steps have been taken to widen the ongoing dialogue on the international financial system to a broader range of countries, including the establishment of the New Arrangements to Borrow (NAB) comprising 25 participants; the special meetings involving Ministers and Governors of systemically significant economies that occurred during 1998; the seminars involving 33 industrial and emerging economies held this Spring in Bonn and Washington; and this year’s Spring meeting of the IMF Interim Committee which was prepared for the first time by a special meeting of deputies.

13. The new Financial Stability Forum was created to enhance international cooperation and coordination in the area of financial market supervision and surveillance. The Forum met for the first time in April, and agreed to focus initially on three issues: the implications of highly leveraged institutions, off-shore centres and short-term capital flows. This process will include participants from other industrial and emerging economies. We agree that the Forum should, by the time of the September meeting, be broadened to include significant financial centres, in a format that provides for effective dialogue.

14. A number of proposals have been discussed for institutional reform, including the proposal for transformation of the Interim Committee into a Council. At this time, recognising our special responsibility as major shareholders in the Bretton Woods institutions we have agreed to support the following important steps towards institutional reform.

a. The Interim Committee would be given a permanent standing Ö as the "International Financial and Monetary Committee". The Committee’s mandate should be consistent with the principle, which we reaffirm, that the IMF must play a prominent role in facilitating cooperation among all countries, especially in the area of macroeconomic and monetary issues that are at the center of the IMF’s mandate, as stated in Article 1 of its Articles of Agreement.

- Deputy-level meetings of the new Committee would be held twice a year shortly before the Ministerial meetings, building on the successful meeting of the Interim Committee Deputies this April.

- The President of the World Bank would play a privileged role in the new Committee; the Chairman of the Financial Stability Forum would be given observer status.

- Joint sessions of the International Financial and Monetary Committee and the Development Committee would be held when appropriate on issues where there is a clear overlap of responsibilities.

b. We will work together to establish an informal mechanism for dialogue among systemically important countries within the framework of the Bretton Woods institutional system.

We continue to review these arrangements, taking account of the proposals which have been put forward to strengthen the institutional arrangements, including the proposal to transform the Interim Committee into a Council.

15. We have also agreed to take steps to improve the effectiveness of the IMF and other IFIs, including by:

a. pursuing enhanced monitoring of policy commitments while drawings on the Fund remain outstanding but after program conditionality has ended, in order to reinforce incentives for good performance;

b. sharpening the focus of the IFIs on sectors where they have a comparative advantage, and broadening their dialogue with other international fora and with the private sector. Special attention needs to be paid to the specific circumstances of the country concerned aiming at encouraging direct ownership of the programs;

c. building upon the experience of IMF-supported programmes in the financial crisis, the IMF should explore ways further to improve IMF surveillance and programmes so that they better reflect the changes in the world economy, in particular potentially abrupt large-scale cross border capital movements.

d. enhancing the accountability of the IMF by improving transparency, the decision-making procedures and the timely flow of information.

e. encouraging the IMF to continue undertaking systematic evaluations both internal and external of the effectiveness of selected operations programmes, policies and procedures.

B. Enhancing transparency and promoting best practices

16. The availability of accurate and timely information is an essential ingredient for well-functioning financial markets and market economies. Such information is necessary for market participants and should be used by them to make good decisions. It also provides greater incentives for policy-makers to implement sound economic policies. Improved information will help markets to adjust more smoothly to economic developments, minimise contagion and reduce volatility.

17. Significant progress has been achieved in a number of areas. The IMF has made substantial progress in promoting enhanced disclosure of economic statistics and indicators, and in developing voluntary codes of good practice and standards to ensure appropriate transparency of the processes by which governments formulate macroeconomic and financial policies:

a. The IMF Executive Board approved in March 1999 an expansion of the Special Data Dissemination Standard (SDDS) to provide for a more comprehensive and timely disclosure of data on countries’ international reserve positions. The expanded SDDS, which will go into effect in April 2000, addresses gaps in the original standard established in 1996. Efforts are also being taken through the Inter-Agency Task Force on Financial Statistics to harmonize the statistics published on developing and transition countries’ external debt by the BIS, IMF, OECD, and the World Bank, and quarterly publication has begun.

b. The IMF’ s Code of Good Practices on Fiscal Transparency has been approved by the Executive Board and was endorsed by the Interim Committee in April 1998. An implementation manual, questionnaire, and self-evaluation report have been prepared and are being disseminated.

c. A draft Code of Good Practices on Transparency in Monetary and Financial Policies has been published for comment and should be completed by the 1999 IMF Annual Meetings.

18. The IMF has also approved a number of measures to increase transparency in member countries’ economic policies as well as its own operations, including: (i) greater use of Public Information Notices to provide information on IMF policy issues; (ii) procedures for the release of Letters of Intent, Memoranda of Economic and Financial Policies, and Policy Framework Papers that underpin IMF-supported programs; (iii) publication of the Chairman's statement following Board approval or review of members' programs; and (iv) a pilot project for the voluntary public release of Article IV staff reports. In the World Bank, Country Assistance Strategies, which set out the major development challenges of individual countries and guide the Bank’s lending programme, will in principle be made public as of July 1999.

19. Transparency of the private sector is of particular importance to the orderly and efficient functioning of financial markets. The Basle Committee, IOSCO, and the IAIS have established Core Principles for supervision in their respective areas of responsibility. Valuable actions in this area also include IOSCO’s issuance of Disclosure Standards to Facilitate Cross-Border Offerings and Initial Listings by Multinational Issuers. The BIS-Committee on the Global Financial System (CGFS) is reviewing ways to improve market disclosure, including a model template for public disclosure of their exposures and risk profile by institutions engaged in trading, investment and lending activity, both regulated and unregulated. Further work on this issue, involving other relevant authorities, was supported in the Financial Stability Forum.

20. We support and commend the efforts being taken by private sector bodies to enhance transparency. We welcome the completion by the International Accounting Standards Committee of its core set of international accounting standards, and we look forward to IOSCO, IAIS and the Basle Committee completing their reviews. We urge all those involved in setting accounting standards to work together so that high quality accounting standards can continue to be developed and agreed internationally.

21. With considerable progress already having been made in the development of standards and codes of good practice, the key challenge now facing the international community is to encourage implementation. We attach high priority to the following steps:

a. Wider compliance with the SDDS by countries with access to the international capital markets, wider agreement on specific SDDS standards for reporting of external debt, addition of indicators of financial sector soundness, and efforts to promote greater public awareness of, and use of, the information conveyed by the SDDS.

b. Steps further to increase transparency in the IMF’s own operation and its member countries’ economic policies, including the greater release of Board documents.

c. Developing a system for surveillance of implementation of the codes and standards, built on the Article IV process of the IMF, involving close collaboration with the World Bank and the standard setting bodies. To this end, we call on the Fund to develop a mechanism for coordinating this liaison, and to report on the effectiveness of the Article IV process as a means of monitoring and encouraging adherence to standards. Country adherence to standards should also be used in determining Fund conditionality.

d. Systematic incorporation of information on a country’s observance of transparency standards in the Fund’s regular Article IV surveillance reports, as well as in special reports on country transparency practices prepared by the staff. We are encouraged in this respect that experimental transparency reports have already been prepared by the Fund staff, and that countries have engaged in pilot self-assessments of their own transparency practices. We look to these reports to be extended to form an integral part of the Article IV surveillance process.

e. Continued efforts towards implementation of the Core Principles established by the Basle Committee, IOSCO, and IAIS, including in the context of the Core Principles Methodology Working Group and with appropriate involvement by the IMF and World Bank.

f. Moves by our regulators to consider a country’s adherence to the range of relevant international standards, including international standards for banking supervision, as part of the prudential criteria used when considering market entry by foreign banks.

g. Recognising the importance of providing a sufficient degree of transparency by all market participants, steps should be taken to improve transparency by all market participants, including steps to improve the quality and timeliness of public disclosure of direct material exposure to highly leveraged financial institutions, and of relevant information by highly leveraged institutions. We look forward to the work of the Financial Stability Forum on this issue.

h. The ongoing efforts by IOSCO to review the advisability and feasibility of imposing transparency and disclosure requirements on highly leveraged institutions.

i. Completion of the work of the CGFS on reporting of aggregate positions and transactions in foreign exchange markets.

j. Measures to induce off-shore centres to comply with internationally agreed standards and codes in the area of transparency and supervision. We look forward to the work of the Financial Stability Forum on this issue.

k. The OECD's recently-approved core principles on corporate governance, and the World Bank’s continuing work with the OECD and other international institutions to encourage their broadest possible adoption and implementation in emerging market and industrial countries.

l. Compilation of the various financial and economic policy standards and best practices into a common reference such as a compendium on international financial and economic policy standards, through which countries could articulate their intention to implement the various standards and best practices.

C. Strengthening financial regulation in industrial countries

22. The past two years have reminded us that investors and creditors often tend to underestimate risks as they reach for higher yields. In periods of market euphoria, market participants can make credit and investment decisions that might not otherwise have been made. In hindsight, the failures on the part of lenders and supervisors in the major countries include poor risk management practices, inadequate information as well as inadequate attention to available information, and capital standards that provide unintended incentives to lend to risky borrowers. Such excessive risk taking, combined with high degrees of leverage, can magnify the negative effects of any event or series of events.

23. Measures to induce creditors and investors to act with greater discipline (i.e., to analyse and weigh risks appropriately in their lending and investment decisions), should aim at avoiding excessive leverage and encouraging more prudent assessment of the risks associated with lending to emerging markets. In addition to the measures on transparency set out above, we have identified three critical areas that should be addressed by industrial countries:

a. Improving risk assessment and risk management. Measures to induce creditors and investors in industrial countries to act with greater discipline can dampen investors’ tendency to underestimate risks in good times and exaggerate them in bad times. These measures can take the form of increased supervisory oversight of firms’ risk management practices, and strengthened capital adequacy.

b. Assessing the implications for supervisors and regulators of Highly Leveraged Institutions (HLIs). Leverage can play a positive role, but problems can arise when excessive leverage is accompanied by excessive concentration of risk. In addition, concerns have been expressed about the activities of HLIs with respect to their impact on market dynamics generally and vulnerable economies in particular.

c. Encouraging offshore financial centres (OFCs) to comply with international standards. Financial market participants need to compete on a level playing field. Therefore, as we continue to strengthen our own regulatory standards, it will be important for OFCs to strengthen their supervisory systems and standards.

24. A substantial amount of work has already been undertaken. In particular, in January 1999, the Basle Committee promulgated guidance on sound practices for banks in relation to HLIs, including credit analysis practices, and the development of more accurate exposure measures. The sound practices also include setting meaningful overall credit limits for HLIs, and monitoring credit exposures relating to HLIs.

25. Special requirements are demanded by the supervision of complex, internationally active financial organisations. The Joint Forum on Financial Conglomerates has done valuable work on the development of principles, regulatory techniques and other guidance for meet-ing some of the most significant regulatory challenges arising from the emergence of inter-nationally active financial conglomerates. In February 1999 its parent organisations, the Basle Committee, IOSCO and IAIS endorsed and released a package of papers dealing with, among other things, techniques for:

a. assessing the capital adequacy of conglomerates,
b. facilitating the exchange of information among supervisors, including the identification of co-ordinators,
c. facilitating co-ordination among supervisors, and
d. testing the fitness and propriety of managers, directors and major shareholders of con-glomerates.

26. On risk assessment and risk management, the existing work of the Basle Committee provides a useful start for further work in this area. More work is now required:

a. We welcome the Basle Committee’s recent agreement on proposed revisions to the Capital Accord to make it more sensitive to risk, including credit risk involved in lending to emerging markets and in short-term lending, and reflecting compliance with international standards such as the SDDS and Basle Core Principles. We welcome the Basle Committee's intention to consider broader revisions to the existing system of risk-based capital regulation, taking into account changing market practices.

b. We encourage private firms to strengthen their own risk management practices. In this regard, we note that the Counterparty Risk Management Policy Group will soon issue a report on strengthened risk management practices. Once issued, we call on national authorities to consider whether to endorse these recommendations.

c. National authorities should ensure that banking institutions in their countries implement adequate risk management practices in accordance with the recommendations set forth in the Basle Committee’s January 1999 papers on HLIs.

d. We welcome the efforts of IOSCO to strengthen risk management practices for securities firms in relation to HLIs and to consider other measures to limit counterparty risk in dealings with HLIs.

27. On Highly Lleveraged Institutions, we look forward to the work of the new Financial Stability Forum on a number of issues, including systemic issues relating to market dynamics generally and vulnerable economies in particular. Considerations should be broadly based and encompass the whole range of available measures, including of the pros and cons of indirect and direct supervisory approaches as well as of enhancing transparency by improving reporting and disclosure.

28. Some offshore centres have already taken measures to enhance home country supervision. However, not all countries have yet taken such measures. Moving forward, we hope the following will occur:

a. Countries with close relations with OFCs should exert pressure on those jurisdictions to comply with international standards.

b. As noted above, the Basle Committee should link risk weights to compliance with international standards.

c. IOSCO and Basle-sponsored working groups should make membership in their bodies contingent on progress towards implementation of international standards.

d. The Financial Action Task Force should take concrete steps to bring OFCs, and under Ö regulated and non-cooperating jurisdictions, into compliance with the 40 recommendations against money laundering and to protect the international financial community from the adverse impact of those that do not comply.

e. More generally, we look forward to the work of the Financial Stability Forum on OFCs.

29. In writing this report we took account of the reports of the G7 Financial Experts Group on Supervision and Regulation in the Financial Sector and the G7 Working Group on Financial Crime.

D. Strengthening macroeconomic policies and financial systems in emerging markets

30. Recent financial crises have demonstrated the need to strengthen economic fundamentals and financial systems in emerging economies. This is essential not only to improve economic welfare in these countries, but also to help create an environment conducive to international economic and financial stability. While large-scale international capital flows have provided an important contribution to the development of emerging economies, they have also changed the nature of risks facing those countries: weak macro-economic policies and financial infrastructures can be penalised more severely and more suddenly by investors. A broad international consensus has recently been formed on a number of issues:

a. Countries need to pursue sound macroeconomic policies, including sustainable exchange rate regimes and prudent fiscal policies. They should adhere to sound principles of debt management. A high priority should also be given to strengthening emerging economies’ financial sectors and supervisory regimes.

b. Some emerging economies have sought to achieve exchange rate stability by adopting peg regimes against a single currency or a basket of currencies, often in the same region, of countries with which they have the closest trade and investment links. Countries choosing fixed rates must be willing, as necessary, to subordinate other policy goals to that of fixing the exchange rate. If countries choose fixed rates, recent history suggests that arrangements institutionalising that policy can be useful to sustaining a credible commitment to fixed rates.

c. There are particular risks and vulnerabilities associated with excessive short-term borrowing, particularly in foreign currencies. Where problems have developed, there have often been important and unwise policy biases in favour of short term capital flows. Countries should avoid excessive accumulation of short-term debt, maintain an appropriate structure of liabilities, and seek to eliminate biases in favour of short-term borrowing.

d. Capital account liberalisation should be carried out in a careful and well-sequenced manner, accompanied by a sound and well-regulated financial sector and by a consistent macroeconomic policy framework.

e. The use of controls on capital inflows may be justified for a transitional period as countries strengthen the institutional and regulatory environment in their domestic financial systems. Where financial sectors and supervisory regimes are weak, safeguards may be appropriate to limit foreign currency exposure of the banking system. More comprehensive controls on inflows have been employed by some countries as a means to shield themselves from market pressures. Such steps may carry costs and should not in any case be used as a substitute for reform. In addition to these considerations, controls on capital outflows can carry even greater long term costs. They have not been a very effective policy instrument and should not be a substitute for policy reform, although they may be necessary in certain exceptional circumstances.

31. We agree that emerging economies themselves must take the lead in strengthening their economies and financial systems. In addition:

a. It is our objective to help emerging economies adapt their policies and organisations to those required to participate fully in the world economy.

b. The IFIs and other international bodies should enhance their cooperation in terms of giving useful advice and assistance to emerging economies.

32. Numerous countries will need technical assistance if standards of best practice are to be implemented without delay and effective supervision is to be achieved. As there is only a limited number of experts available both in national authorities and in international organisations, we call on the Financial Stability Forum to consider methods to improve the coordination of technical assistance, including the possibility of establishing a clearing mechanism for this purpose at the international level to ensure that technical assistance is co-ordinated and to make best use of all available resources.

Exchange rate regimes in emerging economies

33. Further work is needed on appropriate exchange rate regimes for emerging market economies. The choice of exchange rate regime is critical for emerging economies to achieve sustainable economic development, and also has important implications for the world economy, including in the context of large-scale official financing. In this context:

a. We agree that the most appropriate regime for any given economy may differ, depending on particular economic circumstances, such as the degree of integration with its trading partners. Since economic circumstances vary over time, the most appropriate regime for any given country may also vary. In any case, stability depends on the exchange rate regime being backed by consistent macroeconomic policies and supported by robust financial systems.

b. We agree that the international community should not provide large-scale official financing for a country intervening heavily to support a particular exchange rate level, except where that level is judged sustainable and certain conditions have been met, such as where the exchange rate policy is backed by a strong and credible commitment with supporting arrangements, and by consistent domestic policies.

c. We encourage the IMF to continue its work in this area and to enhance the attention it gives to exchange rate sustainability in the context of its surveillance activities. The IMF should encourage countries to adapt their policies by giving them advice, and support when appropriate, in order to help avoid moves towards unsustainable positions.

Financial systems

34. Further efforts are needed to strengthen financial systems in emerging markets:

a. We commit ourselves to enhancing our cooperation, together with the IFIs and relevant international regulatory bodies, to promote improved financial supervision in emerging economies.

b. The IMF and the World Bank should coordinate their advice to emerging economies, in particular in the area of financial sector reforms. As part of policy reviews, they should enhance surveillance over the broad range of policies now understood to be crucial to financial stability. Countries should be encouraged to demonstrate their commitment to making rapid progress towards full compliance with existing international codes as part of IMF and World Bank conditionality when the IFIs extend loans or credits.

c. We welcome the establishment of the Financial Sector Liaison Committee (FSLC) in September 1998, and the IMF-World Bank Financial Sector Assessment Programme (FSAP), to enhance effective collaboration between the Fund and Bank in this area. The breadth and pace of these efforts need to be increased, by more effectively integrating the efforts and operations of the two institutions in the financial sector, also drawing on relevant expertise in national and international regulatory and supervisory bodies. We call upon the Fund and the Bank to prepare a joint report on their progress and on proposals to meet these objectives by the time of the Annual Meetings in September. These proposals should aim to provide more effective organisation and deployment of resources to improve crisis response, the design and delivery of financial-sector programmes, and technical assistance for member countries.

d. We welcome commitments given by the emerging economies of Asia and Latin America in various fora to take the necessary steps towards implementation of the Basle Core Principles for effective banking supervision. We call upon the governments of other countries to make every effort to ensure that by 2001 plans are in place to implement the Core Principles. The core principles of IOSCO and IAIS should also be implemented by all countries without delay.

e. Governments should narrow the scope of their guarantees of private obligations so as to make sure that creditors do not lend to private entities with the expectation that they will be protected from adverse outcomes. Those guarantees that are provided should be clear and transparent: non-bank financial institutions that fall outside the scope of such regulation should not be covered by explicit or implicit government guarantees created for the banking sector.

Capital flows

35. We encourage the IMF to continue its work on the appropriate pace and sequencing of capital account liberalisation, and to explore further issues related to the Fund’s role in facilitating an orderly approach to such liberalisation. In this context, particular attention should be paid to eliminating policy biases in favour of short-term capital flows, particularly in foreign currencies, and promoting sound debt management policies. The IMF should also further refine its analysis of the experience of countries with the use of capital controls. In this regard, there is a strong case for further studying the benefits and costs of market-based prudential measures aimed at curbing excessive capital inflows, including those used by the Chilean authorities in the recent past.

36. We call on the IMF and other relevant institutions to cooperate with national authorities to create a better system for monitoring cross-border capital flows:

a. We note the importance of timely and comprehensive data on capital flows, and encourage the IMF and national authorities, with the assistance of relevant institutions such as the BIS, to create more detailed data on inflows and outflows of capital by maturity, currency, type, and borrower. In this context, we welcome the agreement to improve data on short-term liabilities of the official sector in the context of strengthening the Special Data Dissemination Standard (SDDS).

b. We encourage the use of high-frequency debt monitoring systems which can be used to verify the sustainability of debt structures, especially of foreign short-term exposures, and encourage the IMF to intensify its work with member governments in this area.

c. We look forward to the work of the Financial Stability Forum on short-term capital flows.

Debt managment

37. We will work with emerging market economies and the IFIs to promote best practices in debt management, which should:

a. encourage greater reliance on long-maturity, and if possible domestic-currency denominated, debt to maintain a debt profile that provides substantial protection against temporary market disruption; avoid transforming long-term debt into short-term debt;

b. remove biases which encourage short-term private borrowing;

c. encourage the creation of deeper domestic bond markets to facilitate long-term domestic currency debt financing;

d. encourage governments that are heavily dependent on commodities revenue to hedge their exposure to commodity price volatility, and promote arrangements that provide greater contractual risk-sharing between creditors and debtors;

e. promote debt management that minimises exposure to liquidity risk, including rollover risk, rather than minimises short-term borrowing costs. Provisions in sovereign debt contracts that can augment balance of payments pressure in a crisis should be avoided; and

f. promote the use of contractual provisions in offshore sovereign bond documentation that facilitate orderly restructuring, as described in section E below.

E. Improving crisis prevention and management, and involving the private sector

38. Recent crises have emphasised the need to improve the approach of the international community to financial crisis prevention and resolution, and adapt it to a world of open capital markets. We need to shape expectations so that private creditors know that they will bear the consequences of their investment decisions, and to identify ways to reduce the risk of contagion.

Crisis prevention

39. Prevention of financial crises is key. The measures that we have outlined in the sections above provide important ways to improve crisis prevention. In addition, new clear principles and new tools are needed to limit contagion and to fully recognise the crucial role private investors play in today’s integrated financial markets.

40. The new IMF contingent credit line (CCL) will play an important part in promoting international financial stability. This facility aims at protecting from contagion countries with reasonable debt structures, sound macro-economic and structural policies, and which are also engaged in an appropriate process of consultation with private creditors. The facility should encourage the IMF towards an increasing focus on crisis prevention, and will provide further incentives for countries to take early measures to avoid the risk of financial crisis. The CCL provides an additional mechanism for encouraging countries to implement standards.

41. Countries should take ex ante steps to strengthen the framework for the market-based, cooperative and orderly resolution of the debt payment difficulties that do arise. We have agreed on the following measures:

a. Appropriate communication between debtors and creditors is important in both crisis prevention and resolution. We encourage emerging economies to develop mechanisms for more systematic dialogue with their main creditors. We also support strengthened contacts between the international financial institutions, notably the IMF, and the private sector.

b. We encourage the use of market based tools aimed at preventing crises and facilitating adjustment to shocks, including through the use of innovative financial arrangements, including private market-based contingent credit lines in emerging countries and roll-over options in debt instruments. These measures would facilitate access to the international markets in times of instability for emerging countries, and, in the context of a sound debt management framework, can thus help prevent liquidity crises and give countries a breathing space to make decisive macro-economic or structural adjustments.

42. We have agreed on the importance of stronger efforts to encourage progress in broadening the use of collective action clauses in sovereign debt contracts, along with other provisions that facilitate creditor coordination and discourage disruptive legal action. We recommend:

a. making the use of such provisions a component of international best practices in debt management, and a consideration in determining access to the IMF’s Contingent Credit Line;

b. focusing attention on the use of these provisions in international surveillance, and making such provisions a consideration in IMF conditionality, as appropriate;

c. considering incorporating these provisions into sovereign debt that is enhanced by the multilateral development banks;

d. Further considering the possible inclusion of such provisions in our own debt instruments, and otherwise encouraging the use of such provisions in the debt instruments issued by other sovereigns in our markets.

43. We also encourage efforts to establish sound and efficient bankruptcy procedures and strong judicial systems. We support the work of the international financial institutions to help countries to improve the transparency, predictability, and equity of their insolvency and debtor-creditor regimes.

A framework for private sector involvement in crisis resolution

44. In addition to crisis prevention measures addressed above, we are agreed that the international financial community needs to set out in advance a broad framework of principles and tools for involving the private sector in the resolution of crises. The following framework should help to promote more orderly crisis resolution and therefore be of mutual benefit to debtors and creditors in finding cooperative solutions. It should also help to promote cooperative solutions between borrowing countries and the private sector and to shape expectations in a way which reduces the risk that investors believe they will be protected from adverse outcomes. Developing a framework of this kind which facilitates debtor/creditor cooperation should minimise the incidence and intensity of crises and also minimise the time before debtor countries can expect to regain market access.


45. We agree that this framework should comprise the following key principles:

a. The approach to crisis resolution must not undermine the obligation of countries to meet their debts in full and on time. Otherwise, private investment and financial flows that are crucial for growth could be adversely affected and the risk of contagion increase.

b. Market discipline will work only if creditors bear the consequences of the risks that they take. Private credit decisions need to be based on an assessment of the potential risk and return associated with a particular investment, not on the expectation that creditors will be protected from adverse outcomes by the official sector.

c. In a crisis, reducing net debt payments to the private sector can potentially contribute to meeting a country’s immediate financing needs and reducing the amount of finance to be provided by the official sector. It can also contribute to maintaining appropriate incentives for prudent credit and investment decisions going forward. These potential gains must be balanced against the impact that such measures may have on the country’s own ability to attract new private capital flows, as well as the potential impact on other countries and the system in general through contagion.

d. No one category of private creditors should be regarded as inherently privileged relative to others in a similar position. When both are material, claims of bondholders should not be viewed as senior to claims of banks.

e. The aim of crisis management wherever possible should be to achieve co-operative solutions negotiated between the debtor country and its creditors, building on effective dialogues established in advance.


46. The principles outlined above, and the tools we propose below, should help establish a broad framework for making judgements about the policy response appropriate to a given case. The appropriate role for private creditors, if any, and the policy approaches needed to induce private creditors to play this role will vary depending on the circumstances of the particular case. There are advantages to making clear in advance the basic considerations that will guide our actions and specific approaches we will employ. The principles and tools we propose should help provide a degree of predictability for investors, without sacrificing the flexibility required to address effectively each particular financial crisis.

47. There is a variety of circumstances where countries might face external financing pressures There are circumstances where we believe emphasis might best be placed on market-based, voluntary solutions to resolve the country’s financial difficulties. There are also cases where more comprehensive approaches may be appropriate to provide a more sustainable future payments path. In practice, there will be a spectrum of cases between these two extremes. Where a country falls on this spectrum, will help to determine the policy approach best suited to its particular circumstances. Relevant considerations include the country’s underlying capacity to pay and its access to the markets.

48. In addition, the feasibility of different policy approaches will depend on the nature of outstanding debt instruments. These will influence assessments of which claims need to be addressed to resolve the country’s financing difficulties, the magnitude of possible concerns about equitable treatment among various categories of creditors, and the scope for voluntary versus more coercive solutions. The nature of the relevant debt obligations can differ along many axes, including whether the debt obligations are principally private or public; foreign or local currency; short-term or long-term; payment of principal or interest; offshore or onshore; secured or unsecured; held narrowly or held by a diffuse group of creditors.

49. It is important to put into place incentives that would encourage a country to take strong steps at the early stages of its financial difficulties to prevent a deepening crisis.


50. To address effectively a wide range of potential cases, the international community needs to have a broader range of tools available to promote appropriate private sector involvement. The tools available to the international community should comprise the following:

a. Linking the provision of official support to efforts by the country to initiate discussions with its creditors to explain its policy program.

b. Linking the provision of official support to efforts by the country to seek voluntary commitments of support, as appropriate, and/or to commit to raise new funds from private markets.

c. Linking the provision of official support to the country’s efforts to seek specific commitments by private creditors to maintain exposure levels.

d. Linking the provision of official support to the country’s efforts to restructure or refinance outstanding obligations.

e. In cases where a country’s official debt needs to be restructured in the Paris Club, the Paris Club principle of comparability of treatment applies to all categories of creditors other than the international financial institutions. The Paris Club should adopt a flexible approach to comparability, taking into account factors including the relative size and importance of different categories of claims.

f. Imposing a reserve floor that effectively ensures that the private sector makes an adequate contribution, such as through debt restructuring, alongside official resources in the resolution of crises.

g. In exceptional cases, it may not be possible for the country to avoid the accumulation of arrears. IMF lending into arrears may be appropriate if the country is seeking a cooperative solution to its payment difficulties with its creditors.

h. In exceptional cases, countries may impose capital or exchange controls as part of payments suspensions or standstills, in conjunction with IMF support for their policies and programmes, to provide time for an orderly debt restructuring.

51. We call on the IMF further to develop and define the legal and technical questions involved in implementing the specific approaches identified in the framework agreed here. We look forward to its conclusions by the autumn Annual Meetings.

52. In order to guide expectations more effectively, we agree that we will seek to provide a clear and timely explanation of the policy approaches, adopted in individual cases, in relation to the principles and considerations that we have laid out above.

F. Promoting social policies to protect the poor and most vulnerable

53. Recent events in the world economy have underlined the important link between economic and social issues; and that good economies depend both on stable relationships between governments and their citizens, and strong social cohesion. An efficient social system, by equipping people for change, builds trust and encourages people to take the risks which are a necessary part of a competitive modern market. This in turn helps to mitigate the risks and spread the benefits of globalisation.

54. Effective social policy can in particular ease the task of adjustment during times of crisis, helping build support for necessary reforms and ensuring that the burden of adjustment does not fall disproportionately on the poorest and most vulnerable groups in society.

55. Action in these areas can be subject to a number of constraints. In general, the resources available for social programmes are limited, other priorities are pressing and institutional capacity can be stretched. In times of downturn, policy makers may face particularly difficult choices between safeguarding immediate social welfare, and ensuring the adjustment necessary to restore confidence and promote stable growth, which provides the best way of reducing poverty and supporting social welfare. We believe there are strong benefits for all countries and the IFIs in working together to develop and promote practices in social policies which most effectively support economic development.

56. Countries, each with their different culture and traditions, have developed their own systems and practices for addressing social issues. There is likely to be mutual benefit for countries in sharing experiences of policies which work best at different stages of development. Experiences were discussed at the seminar involving 33 economies held this spring in Washington. The seminar:

a. considered the most important areas of social spending, the ways in which public expenditure can be effectively targeted to the neediest, and the trade-offs which are involved when levels of social spending are determined;

b. underlined the importance of monitoring social developments and operating social policy in a transparent way, so that both governments and their populations can be more aware, at the earliest possible stage, of areas of particular need, and plan on that basis.

57. Moreover, since countries operating in the modern globalised economy are likely to face similar pressures, there is a case for identifying principles, policies and best practices, and for their promulgation through international organisations. We note with approval the principles of good practice in social policy which have been prepared by the World Bank, in collaboration with the United Nations. At the last meeting of the Development Committee, Ministers asked the World Bank to report back at the 1999 Annual Meetings on its work on policies and best practice to protect the poorest groups and maintain the momentum for development.

58. Further work is needed to identify and promulgate principles, policies and best practices in social policy. We call on:

a. the UN to make rapid progress in developing the basic social principles as part of the follow-up on the Copenhagen Declaration of the World Summit for Social Development;

b. the World Bank, with full participation from the IMF, to report back to the 1999 Annual Meetings on identifying policies and best practice to support the process of economic development. In times of crisis, these can be drawn upon in the design of adjustment programmes to ensure protection of the most vulnerable;

c. the IMF and the World Bank, in their work on transparency and good governance to consider more explicitly the way in which this can be geared to ensuring implementation of social programmes which minimises waste and maximises efficiency;

d. the World Bank and the IMF to strengthen collaboration in the preparation of public expenditure reviews of individual countries which analyse the composition and efficiency of public expenditure;

e. the IMF, in assisting countries to develop macroeconomic frameworks in times of crisis, to take into consideration the degree to which the adjustment programmes provide for adequate spending in the social sector;

f. the World Bank to work with countries, the Fund and Regional Development Banks on drawing up and monitoring implementation and follow up of social indicators;

g. the Fund and Bank to increase the attention they give to these issues in the design of adjustment and sector programmes, and to develop further their cooperation in this area. In addition, we call on all countries to consider what more can be done to encourage the pursuit of sound social policies both inside and outside of crisis situations.

59. Effective social policy will help provide a foundation for sustainable development, by ensuring that the benefits of globalisation are widely shared, equipping people for change and ensuring that economies are more robust.

60. Sustainable development at a global level, enabling all countries to share the benefits of economic growth, also depends on measures to reduce the unsustainable debt burdens on the poorest countries and alleviate poverty. The initiatives on social policy must therefore be taken forward together with initiatives on debt relief and poverty reduction, on which we have presented separate proposals to our Heads.

Source: Released at the Köln 1999 Summit

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