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Discussion paper by Montek S. Ahluwalia, 2000

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What: The purpose of this discussion paper is to evaluate the impact of developments on the relative roles of the International Monetary Fund and the World Bank in the future. Initially the paper provides a brief overview of the changing roles of the Fund and the Bank and it then summarizes why the crises of the 1990s are fundamentally different from earlier episodes of balance-of-payments difficulties and therefore calls for very different responses. It also discusses some of the main elements which have been proposed as part of the new financial architecture and examines their implications for the roles of the Fund and the Bank. Finally the paper presents a summary assessment of various proposals for improving coordination between the Fund and the Bank. Who: For a lecturer or research work on the roles of the international financial institutions. How: Can be used as a background reading material on the relative roles and overlaps of IMF and the World Bank.

1International Monetary and Financial Issues for the 1990s, Vol. XI


Montek S. Ahluwalia*

* The views expressed are those of author and do not necessarily reflect the views of the Government of India. Acknowledgements
are due to Yilmaz Akyüz, Gerry Helleiner, Deena Khatkhate, Sarwar Latif and Narendra Jadhav for useful comments on an earlier


The frequency of crises in recent years has drawn attention to the weaknesses in the
international financial system and rekindled interest in its reform. At first, the crisis in East
Asia, followed by the collapse in the Russian Federation, with spillover effects on Wall Street,
created a widespread perception that the existing system was hopelessly inadequate and a radical
reform was needed. This was the spirit of Prime Minister Blair’s impassioned call for “building
a Bretton Woods for the new millennium”, which raised expectations of a major institutional
restructuring. More recently, as financial markets have stabilized, the initial enthusiasm for
radical reform has subsided and the ongoing discussions on the new financial architecture have
a more limited scope. They focus on ways of improving surveillance in international financial
markets, strengthening the financial system in developing countries, and increasing transparency
and the flow of information to private markets to allow them to function better. Talk of
restructuring the Bretton Woods institutions for the new millennium has given way to a more
modest objective of strengthening cooperation between the International Monetary Fund and
the World Bank to increase their effectiveness in crisis prevention and crisis management.

The Fund and the Bank have a long history of cooperation, and one can certainly build on
this tradition to improve their capacity to meet future challenges. However, the nature of
cooperation in the future need not be a simple extrapolation of the past. The challenges facing
the international financial system today are quite different from those of the past, and it is
precisely because of these differences that there is a need for a new financial architecture. The
purpose of this paper is to evaluate the impact of developments on the relative roles of the Fund
and the Bank in the future. The paper is divided into four sections. Section I provides a brief
overview of the changing roles of the Fund and the Bank in the past which led to a considerable
overlap in their activities in the 1980s. Section II summarizes why the crises of the 1990s are
fundamentally different from earlier episodes of balance-of-payments difficulties and therefore
call for very different responses. Section III discusses some of the main elements which have
been proposed as part of the new financial architecture and examines their implications for the
roles of the Fund and the Bank. Section IV presents a summary assessment of various proposals
for improving coordination between the Fund and the Bank currently under consideration and
evaluates their relevance in the light of the larger reforms needed in the system.

2 Ahluwalia: The IMF and the World Bank in the New Financial Architecture

I. Evolution of the overlap between
the Fund and the Bank

The Fund and the Bank were originally established
as part of the international financial architecture cre-
ated at Bretton Woods, based on the system of “fixed
but adjustable par values”. Under this system coun-
tries undertook two critical commitments: (i) to
maintain their exchange rates within a very narrow
range of the declared par values, to be changed only
with the prior approval of the Fund; and (ii) to eschew
restrictions on current payments. These commitments
reflected the determination of participating countries
at the time to avoid the debilitating experience of the
inter-war years when competitive devaluations and
exchange restrictions produced a downward spiral
in world trade. Restrictions on current payments were
seen to be antithetical to the expansion of trade and
were therefore to be avoided, but the system did not
seek to eliminate or even regulate restrictions on capi-
tal account transactions which were in place in most
countries and were expected to continue.

A. The first phase: distinct identities

The Bretton Woods architecture envisaged very
different roles for the International Monetary Fund
and the World Bank. The Fund was established to be
the guardian of the par value system and was expected
to oversee its operation, ensuring that countries com-
plied with the commitments undertaken by them.
It also stood ready to provide short-term finance, sub-
ject to appropriate macroeconomic conditionality,
to help countries deal with temporary balance-of-
payments problems in a manner which would not be
“destructive of national and international prosper-
ity”. As supervisor of the system as well as a finan-
cier, the Fund dealt with both industrialized and
developing countries and its approach to managing
balance-of-payments problems was very similar in
both cases.

The World Bank’s original function was the fi-
nancing of reconstruction in war-torn countries and
development in developing countries. The former
was quickly taken over by Marshall Aid and the Bank
settled down at a very early stage to the task of fi-
nancing projects in developing countries. It was
expected to finance projects which were economi-
cally viable but which otherwise might not be
financed because of the scarcity of domestic re-
sources and the difficulty in obtaining external

finance since international capital markets were rela-
tively undeveloped at the time. Bank financing was
generally accompanied by project-level condition-
ality which occasionally also extended to sector-level
policies, but it did not involve macroeconomic
conditionality. The Bank did make regular assess-
ments of development policies and prospects of
individual borrowing countries, but this was prima-
rily to establish the creditworthiness of the borrower
and not with a view to specifying conditionalities
for its lending.1 Unlike in the case of the Fund, the
Bank’s membership was asymmetric, distinguishing
between borrowing and non-borrowing members,
with the Bank lending only to the former.

The two institutions functioned with very little
overlap for the first 25 years of their existence, as
each provided finance which was for different pur-
poses and was linked to very different types of policy
conditionality. However, development finance can
never be completely divorced from macroeconomic
policy and there were some jurisdictional overlaps
in the early years.2 Recognition of the possibility of
overlapping activities led to the issuance in 1966 of
formal guidelines for Fund-Bank collaboration, de-
marcating areas of primary responsibility for each
institution. The Fund was assigned primary respon-
sibility for “exchange rates and restrictive systems,
for adjustment of temporary balance-of-payments
disequilibria, and for evaluating and assisting mem-
bers to work out stabilization programmes as a sound
basis for economic advance”. The Bank was assigned
primary responsibility for “the composition and
appropriateness of development programmes and
project evaluation including development priorities”.

The 1966 guidelines recognized that between
these two “clear cut areas of responsibility” there
were other areas of interest to both institutions, e.g.
the structure and functioning of financial institutions,
the adequacy of money and capital markets, the
capacity to generate domestic savings, external fi-
nancing and external debt, and that in these areas
each institution would form its own view and differ-
ences were implicitly accepted. However, in the event
of a conflict of views in an area within the primary
responsibility of one institution, the view of that in-
stitution would prevail over that of the other. These
issues could be discussed between the two institu-
tions, but the guidelines explicitly ruled out any
critical review by one institution with a member coun-
try on issues within the primary responsibility of the
other institution, except with the latters’ prior con-

3International Monetary and Financial Issues for the 1990s, Vol. XI

B. The overlap in the 1980s

Changes in the world economy in the 1970s
forced both the Fund and the Bank to reorient their
activities in a manner which considerably increased
the overlap between the two institutions in the 1980s.
The role of the Fund changed dramatically after the
collapse of the par value system in 1973. The shift
by major currencies to floating rates, combined with
the growth of capital markets, made the Fund irrele-
vant as a source of finance for industrialized countries.
No major industrialized country borrowed from the
Fund after 1976 and its financing role thereafter fo-
cused only on developing countries, with countries
in transition being added in due course. The Fund
responded to the needs of its exclusively developing
country clientele by introducing several new facili-
ties tailored to their special requirements, which had
the effect of moving Fund financing closer to devel-
opment financing of the type provided by the Bank.

The critical factor driving the change was the
recognition that the balance-of-payments problems
of many developing countries were of a structural
nature and therefore very different from the tradi-
tional Fund conception in which balance-of-payments
deficits were seen as a reflection of excess aggre-
gate demand. Deficits caused by excess demand were
obviously best handled by demand restraint, supple-
mented by exchange rate changes whenever it was
felt necessary to stimulate the production of trade-
ables relative to non-tradeables. Adjustment was
expected to be accomplished in a relatively short
period of time, which is why IMF standby arrange-
ments typically provided finance for a period of
between one year and18 months, to be repaid be-
tween three to five years after each drawing. This
approach was inappropriate for developing countries
suffering from structural constraints which limited
their capacity to expand the production of tradeable
goods. Reducing aggregate demand to reduce the
current account deficit in this situation often led to
underutilization of capacity and unemployment,
which could not be countered by depreciating the
exchange rate to stimulate the production of trade-
ables. Expanded production of tradeable goods could
be achieved only by removing structural bottlenecks,
which often required a period of increased invest-
ment, a process which would take time. This meant
that current account deficits had to be financed over
a longer period and the period of repayment also had
to be extended. These considerations led to the es-
tablishment of the Extended Fund Facility (EFF) in
1974, which enabled developing countries to receive
assistance over a three-year period (and therefore also

in a larger total amount) and extended the repayment
period to between four and eight years, which was
later extended to between four and 10 years.

Fund financing also moved closer to Bank
financing because of the introduction of conces-
sionality for low-income countries. In 1976 the Trust
Fund was established, financed by profits on the sale
of a part of the Fund’s gold, to make medium-term
loans (repayable over a period of between five and
10 years) to low-income countries at near zero inter-
est rates and with weak conditionality.3 Ten years
later another concessional facility was introduced
responding to the problems of low-income countries
in Africa suffering from persistent economic stag-
nation after the oil shocks of the 1970s. It was
recognized that revival of growth in these countries
was possible only if larger balance-of-payments defi-
cits could be financed, and that the financing had to
be on concessional terms because their debt-servic-
ing capacity was severely constrained. In 1986 the
Fund established the Structural Adjustment Facility
(SAF) to make loans to IDA-eligible countries at
0.5 per cent interest repayable between the fifth and
tenth year after each drawing. This was followed a
year later by the Enhanced Structural Adjustment Fa-
cility (ESAF), designed to provide a larger volume
of resources on the same terms, but with more strin-
gent conditions.4

The Bank also moved closer to Fund-type ac-
tivity by shifting from its earlier exclusive focus on
project financing to providing balance-of-payments
support. Most developing countries experienced a
mounting burden of debt following the oil crisis
which created serious macroeconomic imbalances
and led to a slowdown in growth by the end of the
1970s. The Bank’s management came to the conclu-
sion that it could make little impact on development
in this situation if it continued to focus only on project
lending. Weaknesses in macroeconomic and sectoral
policies in the developing countries were seen to be
at the root of their poor performance and unless these
policy weaknesses were corrected it was felt that
continued project lending could make little differ-
ence.5 The Bank therefore introduced Structural
Adjustment Loans (SALs) in 1980 to provide non-
project tied assistance in support of wide-ranging
policy reforms aimed at increasing the efficiency of
resource use. The package of reforms typically
covered tax policy, price decontrol, trade policy, pri-
vatization of public enterprises and reforms in the
financial sector. In 1982 Sector Adjustment Loans
(SECALs) were introduced with policy conditionality
being more narrowly focused on a particular sector.

4 Ahluwalia: The IMF and the World Bank in the New Financial Architecture

Since adjustment lending resembled balance-
of-payments financing it created an obvious overlap
with the Fund, with the possibility of conflict be-
tween the two institutions. To avoid conflict, it was
clarified that SALs would deal with policy issues
other than fiscal policy and exchange rates, which
were the core areas of the Fund. Since fiscal and
exchange rate issues could not be entirely avoided
in formulating SALs, the Bank undertook to coordi-
nate with the Fund on these issues in order to ensure
that adjustment lending did not become a means of
sustaining an unviable macroeconomic position. In
fact, the expectation was that in practice SALs would
generally be used in cases where a Fund programme
was already in place.

For its part, the Fund recognized that its ESAF
programmes for low income countries had to be
firmly grounded in appropriate structural policies
which could bring about sustainable growth. ESAF
programmes were therefore preceded by considera-
tion by the Board of a Policy Framework Paper (PFP),
prepared jointly by country authorities and the staffs
of the Bank and the Fund, which was expected to lay
out the medium-term policy agenda to be followed
by the country. Joint preparation of the PFP was in-
tended to ensure full coordination with the Bank and
also to ensure “ownership” by the country. In prac-
tice, it did achieve coordination between the two
institutions, but for a variety of reasons, including
the lack of capacity in many low-income countries,
the success achieved as regards ownership is ques-

Adjustment lending proved to be a useful inno-
vation partly because it responded to developing
country demands for more flexible conditionality
than that usually associated with Fund programmes.
Fund conditionality was typically limited to a few
(at most 10) key macroeconomic policy variables and
focused heavily on fiscal discipline and restraint on
domestic credit expansion. Targets for each perform-
ance variable were precisely quantified by specifying
particular levels of domestic credit, credit to the gov-
ernment, or reserves to be met at the end of each
quarter, and failure to meet any one target could lead
to drawings being interrupted. SAL conditionality
was much broader, often covering as many as 30-50
policy actions in different areas!6 Instead of fixing
specific compliance dates for policy action, SALs
were tranched so that disbursement under each
tranche could be effected once the agreed set of policy
actions relating to that tranche had been taken. The
Bank was generally also more flexible in determin-
ing compliance, relying on a broad assessment of

whether the programme was on track. SECALs added
a new dimension of flexibility since developing coun-
tries were able to obtain financing based on reforms
in only one sector, where they might be more easily
acceptable for domestic reasons. Adjustment lend-
ing increased rapidly, reaching about 25 per cent of
Bank lending in the second half of the 1980s; and
this is a measure of the extent of overlap between
the two institutions.

A by-product of the overlap was the emergence
of the so-called Washington Consensus, which sought
to integrate the approaches of the Fund and the Bank.
Sound development policy was sought to be defined
as a combination of (i) macroeconomic balance (ba-
sically a low fiscal deficit), which was the traditional
concern of the Fund, and was viewed as an essential
precondition for growth, and (ii) efficiency-enhanc-
ing reforms (e.g. decontrolling private sector activity,
opening the economy to trade and foreign investment,
and privatizing the public sector as much as possi-
ble), which was the focus of the structural reform
effort spearheaded by the Bank. The consensus was
modified over time in response to criticism on some
important points, e.g. the possibly negative effect of
fiscal discipline, and sometimes also market-oriented
reforms, on the poor. This led to a redefinition of the
consensus to recognize that structural reforms must
be supplemented by direct efforts at poverty allevia-
tion by protecting certain types of government
expenditure, e.g. in the social sectors, which were
especially important for the poor and also by increas-
ing expenditure on poverty alleviation programmes.

Developing countries were particularly con-
cerned that a consensus on broad directions of policy
should not degenerate into a “one size fits all” ap-
proach, and they consistently emphasized the need
to tailor programmes to suit the circumstances and
constraints of individual countries. Differences across
countries could arise on issues of pace and sequencing,
and also on the strategic importance of concentrat-
ing on particular areas. The Fund and the Bank also
differed on these issues. The Fund typically placed
much greater emphasis on fiscal balance, calling for
relatively quick reductions in the fiscal deficit irre-
spective of how they were achieved, while the Bank
focused much more on efficiency-enhancing reforms
some of which could involve trade-offs with deficit
reduction. The emphasis to be placed on tariff re-
duction as a structural reform measure at a time of
fiscal stringency is an obvious example where the
Bank was often in favour of a faster reduction in tar-
iffs to reduce trade distortions even at the cost of a
higher fiscal deficit, while the Fund tended to be

5International Monetary and Financial Issues for the 1990s, Vol. XI

much more concerned about the impact of such re-
ductions on fiscal balance.

Conflict over Argentina and the Concordat of 1989

Despite the overlap there was no overt conflict
between the Fund and the Bank until the celebrated
case of Argentina in 1988, when the Bank decided
to go ahead with adjustment lending even though
negotiations with the IMF for an Extended Fund
Facility had recently collapsed. In the Bank’s view,
the Fund was insisting on too strong a fiscal correc-
tion because of its traditional focus on aggregate
demand, whereas the Bank, being more concerned
about structural reforms, was willing to accept a less
ambitious fiscal target. It is well known that the
Bank’s management was under pressure from the
United States Treasury to go ahead with the loan.7 In
the event, the Fund’s judgement was vindicated when
it became clear, shortly after the approval of the ad-
justment loans by the Bank’s Board, that Argentina
would not be able to meet the expected criteria of
fiscal performance and disbursements had to be in-

The Argentina fiasco, as it has been described
by Polak (1997), generated concern in several quar-
ters. It was the first case where the Bank proceeded
with adjustment lending despite a clear finding of
macroeconomic unsustainability by the Fund staff.
The Fund was understandably concerned that it might
create a precedent which would encourage countries
in difficulty to postpone or avoid taking necessary
corrective steps, and seek support from the Bank as
an easier alternative. This would undermine the cred-
ibility of the Fund as the established arbiter of what
was needed to achieve macroeconomic stabilization
and devalue its good housekeeping seal of approval.
Also, the G-10 deputies were concerned about lack
of coordination between the two institutions leading
to the possibility of conflicting policy advice to the
country concerned.

Intensive consultations ensued between the two
institutions to resolve these problems and culminated
in the so-called Bank-Fund Concordat of 1989, which
superseded the earlier guidelines on Bank-Fund
collaboration. The main features of the Concordat
are summarized in box 1. It is significant that the
Concordat did not seek to eliminate, or even reduce,
the overlap between the Bank and the Fund. On the
contrary, the overlap was accepted as a natural de-
velopment given the changed circumstances of the
world economy and the difficulties being experienced

by so many developing countries. The Concordat
focused instead on the limited objective of improv-
ing coordination between the Bank and the Fund and
avoiding conflicting advice if possible, while pre-
serving the independence of action of each institution.

In the event of a disagreement, the Concordat
prescribed an extensive process of consultation but
the final decision was left to be taken by the Execu-
tive Board of the institution concerned after hearing
the view of the other institution. What this meant
was that the management of one institution could not
be vetoed by the management of the other, even if it
differed on issues within the primary responsibility
of the other institution. In such cases the Executive
Board of the lending institution would have the right,
after having heard the view of the other institution,
to act independently.

II. The crises of the 1990s: new sources
of fragility

Issues of coordination between the Fund and
the Bank surfaced again at the time of the East Asian
crisis as both institutions worked together to help
crisis-hit countries. Each institution also introduced
innovations in its lending policies to respond to the
new situation. At first glance this can be viewed as a
logical continuation of the overlap which had devel-
oped over the 1980s. However, there are significant
differences between the crises of the 1990s and earlier
payments problems suffered by developing countries,
and these differences have important implications for
the role of the two institutions in the future. A brief
digression on the distinctive features of the new type
of crisis is therefore appropriate.

A. Crises of confidence

Each of the major crises in the 1990s –
Mexico in 1994, East Asia in 1997, the Russian
Federation in 1998 and Brazil in 1999 – had fea-
tures peculiar to itself, but they all shared an
important common characteristic. They were cri-
ses of confidence originating in the capital account
and therefore very different from earlier episodes
of payments problems in developing countries
which typically arose in the current account.8 The
vulnerability of developing countries to such cri-
ses has increased in the 1990s because many
countries have liberalized restrictions on capital

6 Ahluwalia: The IMF and the World Bank in the New Financial Architecture

movements in order to integrate more fully into glo-
bal financial markets and improve their access to
international capital flows. While access has defi-
nitely improved, this has been achieved at the risk
of greater volatility and instability. Financial mar-
kets have long been known to suffer from euphoria
and panics which can create boom-bust cycles, and

this applies to the international capital market also.
Inflows can exceed the level warranted by underly-
ing fundamentals when perceptions are favourable,
as was clearly the case in East Asia before the crisis,
but outflows can also be disproportionately large
when perceptions change and there is a loss of con-

Box 1


The Concordat of 1989 defined each institution’s area of “primary responsibility” more elabo-
rately than in the 1966 guidelines.

• The Fund’s areas of primary responsibility were “the aggregate aspects of macroeconomic
policies and their related instruments – including public sector spending and revenues, aggre-
gate wage and price policies, money and credit, interest rates and the exchange rate”.

• The Bank’s areas of primary responsibility were development strategies, sector and project
investments, structural adjustment problems, policies dealing with the efficient allocation of
resources, priorities in government expenditure, reforms of the administrative system, the
production trade and financial sectors, the restructuring of state enterprises and issues related
to creditworthiness. The mandate of the Bank specifically excluded the aggregate aspects of
economic policies, which were the exclusive preserve of the Fund.

• It was recognized that both the Fund and the Bank had legitimate concerns with regard to
macroeconomic and structural issues, and that each institution would need to undertake inde-
pendent analysis of these issues and take the results into account in their policy advice and
lending operations.

• Elaborate procedures were laid down to enhance coordination between the Bank and the Fund
through periodic meetings at various official levels, including sharing of information between
the two institutions. These procedures were designed to keep each institution aware of the
views of the other on a more continuous basis. The Bank was expected to ascertain the view
of the Fund on the adequacy of macroeconomic policies, before formulating its own opinion,
even in cases where there was no Fund programme. Similar obligations were imposed on the
Fund vis-à-vis the Bank with regard to developmental and structural policies.

• In the event of irreconcilable differences on a matter within the primary responsibility of one
institution, the Concordat stipulated that “the institution which does not have primary respon-
sibility would, except in ‘exceptional circumstances’, yield to the judgement of the other
institution”. Polak (1997) reports that the original draft prepared by the Fund had made it
mandatory to yield in such cases but this was not acceptable to the Bank, and the present
version with the exception clause was finally agreed. Exceptional circumstances were “ex-
pected to be rare”, but when they did arise the managements were expected to consult their
respective executive boards before proceeding.

• Each institution was also allowed to lend to a member in arrears to the other institution sub-
ject to appropriate consultation. The key consideration was that each institution would con-
sider whether the arrears to the other were an indication that its own resources would not be

7International Monetary and Financial Issues for the 1990s, Vol. XI

It is important to appreciate that the risks faced
by developing countries integrating with global fi-
nancial markets are substantially greater than for in-
dustrialized countries. One reason for this is that
developing countries are objectively more vulner-
able to changes in external economic circumstances
and this is bound to be reflected in greater instabil-
ity in investor perceptions. However, this “objec-
tively justifiable” instability is magnified by infor-
mation deficiencies. Investors, especially portfolio
investors, typically have much less information about
conditions in developing countries than in industri-
alized countries and this can exaggerate the response
to negative developments, leading to greater vola-
tility. Lack of information also increases the likeli-
hood of herd behaviour and the risk of contagion,
both of which intensify volatility. Developing coun-
tries not only face greater volatility, but they are also
more vulnerable to any given level of volatility be-
cause of the thinness of their markets compared with
the size of resources that can be moved by global
investors. The same degree of volatility in capital
flows therefore has a much greater impact on prices
in developing country markets (both forex and equi-
ties) than in industrialized countries.

Instability is heightened by the fact that it is
not easy to predict what can cause a crisis of confi-
dence in a particular situation. One can be fairly sure
that economies that are fundamentally strong on all
counts are unlikely to become victims of panic behav-
iour. At the opposite end of the spectrum, economies
that are visibly weak will invariably have problems,
though such economies are more likely to suffer from
chronic external payments difficulties rather than the
danger of a sudden crisis. Between these extremes,
however, there will be many countries where an
otherwise strong economic performance may be sud-
denly clouded by the emergence of some weaknesses.
If investor perceptions always changed as a continu-
ous response to changes in economic fundamentals,
inflows would dry up gradually as weaknesses
emerged, giving clear warning signals and ample
time to take corrective action. However, investor per-
ceptions often change in a discontinuous fashion. A
build-up of negative factors may be ignored for some
time by investors in the belief that it is either tempo-
rary or will be corrected by appropriate policies, but
if this does not happen perceptions can change sud-
denly, triggering a sudden reversal of capital flows.
This can easily turn into a self-fulfilling panic in
which the financial markets may fail to play a stabi-
lizing role. Instead, the system is pushed from an
initial equilibrium to another equilibrium which is

much less favourable and from which recovery is
not easy.9

What triggers a panic will vary from situation
to situation. In Mexico, for example, vulnerability
had built up over time with a steady deterioration in
the current account, reaching 8 per cent of GDP in
1994, and a substantial real appreciation in the peso
in the years preceding the crisis. The large current
account deficit was not seen to be a problem at the
time because it was financed by strong private in-
flows.10 Perceptions changed in the course of the year
because of a series of negative developments includ-
ing a shift to a more expansionary macroeconomic
policy, the assassination of a presidential candidate
and the rebellion in the Chiappas region. Lack of
transparency in disclosing the extent of reserve use
in the course of the year intensified the strength of
the negative investor reaction, which led to a large
withdrawal of funds towards the end of the year.

East Asia’s vulnerability arose from what we
now know was a pervasive weakness in the financial
sector, though this was completely missed by Fund
surveillance and also by the World Bank, which had
an extensive involvement in Indonesia and some in-
volvement in Thailand. It was also missed by the
international credit rating agencies which are an im-
portant source of information for financial markets.
The only warning signals spotted by Fund surveil-
lance in 1996 were the size of the current account
deficit in Thailand and the real appreciation of the
baht, and these were discussed by the Fund with the
Thai authorities.11 However, the depth of the crisis
in Thailand and its spread to other countries as
investors concluded that similar weaknesses were en-
demic, was certainly not anticipated.

The major factors which contributed to fragil-
ity in East Asia varied across countries and are
summarized in box 2. They are clearly linked to
weaknesses in the financial sector in the sense that a
stronger financial system would have avoided many
of the problems. Banks would not have lent so ex-
tensively to highly leveraged corporations, especially
those with large volumes of unhedged foreign debt.
They would also have avoided large unhedged ex-
posure to foreign borrowing on their own account.
This would have moderated foreign inflows in the
earlier years by creating a more realistic perception
of the returns on investment and the risks involved.
It would also have avoided the very large build-up
of short-term loans from international commercial
banks which was an important source of vulnerabil-
ity in all the affected countries.

8 Ahluwalia: The IMF and the World Bank in the New Financial Architecture

B. Managing the new type of crises
Managing the new type of crisis poses special

problems. A loss of confidence, whatever its cause,
can be highly destabilizing because of the possibil-
ity of a large reversal of capital flows. Net positive
inflows on which a country depended in order to
finance the current account deficit may cease alto-
gether, as new lending is held back. It may also
become negative as short-term loans are not rolled
over. The open capital account also makes it easier
for domestic capital to flow out in anticipation of
exchange rate depreciation.12 Unlike the traditional

Box 2


Many of the factors which contributed to the currency crisis in East Asia reflect weaknesses in
the financial sectors of the countries of the region. There were variations from country to coun-
try, but the following factors were relevant over most of the region.

• Large private inflows, attracted by favourable investor perceptions, were channelled into un-
productive domestic investments by banks and other financial intermediaries which were ei-
ther too weak to undertake proper credit appraisal or were knowingly engaged in cronyism, or

• The financial system tolerated high debt-equity ratios which made corporations, and also the
banks lending to them, highly vulnerable in the event of a downturn.

• Exchange risk was underestimated by both banks and corporations, possibly because of the
experience of nominal exchange rate stability. This encouraged an excessive unhedged expo-
sure to foreign borrowing, often short term.

• Total external debt was not high (except perhaps in Indonesia) but the ratio of short-term debt
to foreign exchange reserves increased sharply in the years preceding the crisis. Banks in the
Republic of Korea were actually encouraged to borrow short term as this segment was liber-
alized, while longer-term borrowing remained restricted. The offshore banking facilities in
Thailand had the same effect. The build up of short-term debt added to vulnerability in the
event of non-renewal of such loans.

• Lack of transparency also made surveillance ineffective and may have delayed adjustment.
Thailand’s intervention in forward exchange markets pre-committed much of Thailand’s avail-
able reserves without this being known to the market. Similarly, the Republic of Korea’s
foreign exchange reserves were not effectively available because they had been lent to branches
of the country’s banks abroad to meet their short-term obligations. Earlier public disclosure
of these actions would have led markets to change perception earlier, in which case the change
may have been more gradual.

• Foreign banks lent excessively to East Asian banks possibly because of the perception that
governments would ultimately guarantee these loans. Critics have argued that the Fund’s Mexico
bailout contributed to the perception that such loans were effectively government-guaran-

balance-of-payments crises originating in the current
account, in which pressure typically built up gradu-
ally, crises originating in the capital account can
explode quite suddenly, creating a sudden need for
financing with very little time to negotiate a pro-
gramme. The volume of finance needed is much
larger than earlier, and most of the financing is also
generally needed up front if confidence is to be re-
stored. If credible corrective policies are quickly put
in place and enough financing is made available to
calm markets, it may be possible to restore confi-
dence relatively quickly, in which case capital flows
may return relatively quickly to normal levels. In such

9International Monetary and Financial Issues for the 1990s, Vol. XI

with their reliance on fiscal restraint and interest rate
policy in the face of crises originating in the capital
account. The Fund has been widely criticized for
insisting on a traditional dose of fiscal restraint in
East Asia even though none of the East Asian coun-
tries suffered from fiscal imbalances at the time of
the crisis. It has argued that even if a fiscal imbal-
ance was not the cause of the problem, some fiscal
restraint had to be part of the solution because an
increase in government savings was necessary in
order to bring about the improvement needed in the
current account to ensure external balance. However,
this argument ignores the special nature of the East
Asian situation where capital outflows had pre-
cipitated excessive currency depreciation, which had
strongly negative balance-sheet effects on banks and
corporations, which in turn depressed domestic
demand. Fiscal tightening is normally part of a tra-
ditional Fund adjustment package, especially one
involving depreciation of the exchange rate, because
depreciation is normally expected to have a stimu-
lating effect on the demand for tradeables and
aggregate demand restraint is needed to maintain
macroeconomic balance while allowing the current
account to improve. In East Asia, however, any de-
mand-stimulating effects of currency depreciation,
working through the relative price of tradeables, were
completely swamped by the negative balance-sheet
effects of the large currency depreciation. This nega-
tive effect was not taken into account in the Fund’s
programmes, perhaps because the extent of the de-
preciation was not anticipated. The initially tight
fiscal targets were of course loosened very consider-
ably when it became evident that the economies were
undergoing an exceptionally sharp economic contrac-
tion (see table 1). Nevertheless, the initial tightness
calls into question the appropriateness of the macr-
oeconomic policy design.

situations it may not be necessary for the financing
package mobilized to be fully disbursed and, even if
it is, repayments can be made very rapidly from the
restoration of normal capital flows. Unlike in the case
of structural balance-of-payments problems, the fi-
nancing needed for a crisis of confidence does not
have to be long term and, in any case, certainly not

Restoration of confidence must obviously be
the prime objective of policy in such crises, but it is
often not clear what is needed to achieve this objec-
tive. In Mexico in 1994 the crisis was quickly
contained and Mexico made a relatively quick re-
covery. East Asia, on the other hand, was very
different. The Fund was able to put together rescue
packages for Thailand, Indonesia and the Republic
of Korea in a commendably short time, and it re-
ceived full cooperation from the World Bank and the
Asian Development Bank, both of which contributed
to the rescue packages in the form of structural ad-
justment loans to supplement Fund financing.
However, unlike in the case in Mexico, the Fund’s
East Asia programmes did not succeed in stabilizing
the situation; in fact, the currency collapse actually
intensified after the programmes were put in place
and all three countries suffered an exceptionally sharp
economic contraction. Growth forecasts for the pro-
gramme countries were revised downwards on
several occasions in quick succession, giving rise to
criticism in some quarters that the Fund’s pro-
grammes were not only inadequate but also may have
actually worsened the situation. These developments
clearly eroded the credibility of the Fund as a crisis

The East Asian experience illustrates the inef-
fectiveness of traditional stabilization programmes,

Table 1


Actual Initial First Second Third
1997 package revision revision revision

Indonesia 0.2 1.0 -1.0 -3.0 -8.5
Malaysia 2.6 2.5 0.5 -3.5 --
Philippines -0.9 0.0 -1.0 -3.0 --
Republic of Korea 0.3 0-0.3 -- -0.8 -1.8
Thailand -0.9 1.0 1.0 -1.6 -2.4

Source: World Bank (1999).

10 Ahluwalia: The IMF and the World Bank in the New Financial Architecture

The Fund also relied heavily on interest rate
policy in its East Asian programmes, and again in
Brazil, but this policy failed to prevent an exchange
rate collapse in all these cases while imposing se-
vere economic costs in the short run. The World Bank
(1999) has implicitly criticized the Fund’s approach
by arguing that the empirical evidence that high in-
terest rates help restrain currency depreciation is
inconclusive, whereas there is strong evidence that
they damage economic growth. The limitations of
interest rate policy in handling a currency crisis origi-
nating from the capital account certainly need to be
studied carefully, especially because the financial
community tends to regard high interest rates as an
essential element in any stabilization package.

One can be reasonably certain that high inter-
est rates will succeed in reducing pressure on the
currency when this pressure arises from a widening
of the current account deficit in a situation of excess
aggregate demand. In such a situation high interest
rates help to reduce aggregate demand, which auto-
matically moderates the pressure on the exchange
rate. However, where exchange rate depreciation is
being driven by capital outflows, higher interest rates
are presumably expected to help by increasing the
return on domestic assets and encouraging an inflow
of capital. This relationship may not work quite as
expected. The interest rate level needed to offset the
perception of an imminent depreciation is very high
and such high rates, if maintained for any length of
time, can depress the real economy. Stiglitz and
Furman (1998) point out that if the disruptive effect
of raising interest rates on the real economy leads to
a sufficient increase in the default risk it could theo-
retically counter the incentive effect of high interest
rates on capital flows and thus actually worsen the
situation. East Asia was particularly vulnerable to
the negative effects of high interest rates because
corporations were highly leveraged and commercial
banks were also extensively exposed to the property
sector against collateral of real estate, the value of
which is highly sensitive to interest rates.

Critics of the Fund have argued that lower in-
terest rates would have avoided some financial
distress without necessarily worsening the extent of
exchange rate depreciation, and might even have
helped achieve an earlier recovery because the real
economy would have performed better, encouraging
an earlier return of confidence. Fund spokesmen point
to the gradual recovery in exchange rates which has
since taken place in the Republic of Korea and Thailand,
with a parallel decline in interest rates in those coun-
tries, as evidence that the policy was basically sound

though painful in the short run.14 This is clearly an
area where further research is necessary.

III. The new financial architecture:
some key elements

The new type of crisis witnessed in the 1990s
has important implications for the functioning of the
Fund and the Bank in the future. These institutions
had evolved mechanisms for cooperating in handling
the older types of payments problems, but the crises
of the 1990s pose new challenges and possibly also
call for somewhat different policy responses. In this
section we focus on some of the key elements cur-
rently being discussed in the context of the new
international financial architecture to help deal with
these problems. These are:

• Strengthening the financial sector in develop-
ing countries;

• Improving bilateral and multilateral surveil-

• Making the Fund a genuine lender of last re-

• Introducing mechanisms for orderly negotia-
tions with private creditors;

• Managing the social consequences of crisis;
• Creating an internationally agreed regime for

restrictions on the capital account.

The future role of the IMF and the World Bank
should be defined in the light of decisions made on
these issues.

A. Strengthening the financial sector

The most commonly discussed lesson from East
Asia is that it is necessary to strengthen the financial
sector in developing countries, especially for coun-
tries integrating with international financial markets.
This is ultimately a process of institutional develop-
ment which can be achieved only over several years,
but the first step is to improve the regulatory frame-
work governing various parts of the financial sector.
The discussions on the new financial architecture
have outlined the action needed on several fronts.
Reforms in the banking system must obviously have
top priority, given the special importance of banks
in the financial system. This calls for improvement
in the prudential norms and standards applied to com-

11International Monetary and Financial Issues for the 1990s, Vol. XI

mercial banks and also in the supervisory system for
monitoring and enforcing them. Regulatory reform
is also needed in the operation of securities markets
and the functioning of the insurance sector. These
reforms need to be underpinned by reform of the
substructure. Accounting practices and standards
need to be upgraded in most developing countries as
an essential precondition for improving the allocative
efficiency of both the banking system and the capi-
tal market. Also, experience in East Asia has shown
that domestic bankruptcy laws are often inadequate
for private creditors and domestic banks wishing to
take legal action to recover loans. Finally, improve-
ments in corporate governance are also needed.

It is also recognized that the need for reforms is
not limited to developing countries and that improve-
ments are needed as well in financial markets in
industrialized countries. The international operations
of institutions such as hedge funds and other invest-
ment institutions operating from offshore banking
systems are inadequately regulated at present.
Leveraged trading in particular needs better regula-
tion, at least in terms of disclosure, so that lending
institutions can be better informed about the risks
involved.15 Some features of bank regulation in in-
dustrialized countries actually encourage short-term
flows to developing countries by ascribing lower risk
weights to short-term loans, thus creating a regula-
tory incentive for short-run lending which increases
the potential volatility of flows to developing coun-

The broad coverage of the reforms needed for
the new financial architecture reflects the fact that
financial markets are highly interconnected and regu-
lation of one segment of the market will not serve
the purpose. It is necessary to take an integrated view
of the functioning of the international financial sys-
tem and all its sub-sectors instead of the present
segmented approach in which regulatory issues re-
lating to individual sectors are discussed in separate
organizations, e.g. banking issues are discussed in
the Basle Committee while issues related to the func-
tioning of the securities markets are discussed in the
International Organization of Securities Commis-
sions (IOSCO).

The United Nations Committee on Develop-
ment Planning suggested the creation of a World
Financial Organization as a sort of supranational body
exercising supervisory powers over the financial sec-
tor as a whole.16 The G-7 countries have opted for a
more modest alternative of bringing together national
authorities of the G-7 countries and the major inter-

national institutions and other concerned interna-
tional bodies in a Financial Stability Forum which
will act as a consultative group rather than a supra-
national supervisor. The forum consists of two
representatives from the IMF, the World Bank, the
Basle Committee, the Bank for International Settle-
ments (BIS), IOSCO and the International Association
of Insurance Supervisors (IAIS) respectively, and
three representatives from each of the G-7 countries.
The 33-member forum will be chaired by the Gen-
eral Manager of the BIS for a three-year period and
will be serviced by a small secretariat based in the
BIS. No developing countries are included in the
forum at present, although it has been reported that
it may be expanded to include some emerging mar-
ket countries “at a later stage”. Inclusion of major
developing countries in this forum is surely essen-
tial to ensure even a minimal degree of participation
and representation.

It is important to recognize that there are prac-
tical problems in establishing international regulatory
standards for various parts of the financial sector. It
is necessary to distinguish between those areas where
standards already exist, which have gained wide ac-
ceptability among industrialized countries, and other
areas where this has yet to be achieved. Examples of
the former are the standards relating to prudential
norms and supervision of banks evolved by the Basle
Committee, the standards relating to the operation
of securities markets evolved by IOSCO and stand-
ards for regulating insurance evolved by IAIS.
Considerable homogenization of standards has taken
place across industrialized countries, but there are
important differences. Prudential standards applied
in the Japanese banking system, for example, did not
fully meet international expectations.

A practical problem in applying international
standards of financial regulation to developing coun-
tries is that these standards may require some
modifications to take account of developing country
characteristics. For example, the Basle Committee
standards for prudential norms and supervision of
commercial banks were designed for banks operat-
ing in industrialized countries with fully developed
financial markets and very efficient legal systems,
and could pose problems if applied in countries which
do not have similar well-developed financial mar-
kets. For example, mark-to-market practices for
valuing securities can present problems when secu-
rities markets are illiquid. Similar problems will arise
in other areas where standards already exist, such as
in the operation of securities markets and in in-
surance. The existing standard-setting bodies are

12 Ahluwalia: The IMF and the World Bank in the New Financial Architecture

dominated by industrialized countries and are not
likely to identify modifications of international stand-
ards for developing countries. There is an area where
the Fund and the Bank could play a useful role by
defining modifications appropriate for developing
countries and also by determining phased transition
paths for achieving full compliance with international
standards. Transition paths defined by the Fund and
the Bank are more likely to acquire international re-
spectability and will provide developing countries
with operational guidance in moving to higher
standards. Progress by individual countries could be
monitored by the Fund in the course of bilateral
surveillance. In addition, the Fund and the Bank could
offer technical assistance to countries needing such
assistance to achieve compliance in individual areas.

Establishing common standards in some of the
other areas will be much more difficult. Account-
ancy standards, for example, are much stricter in the
United States than in Europe and although the Inter-
national Accounting Standards Committee is working
to evolve common standards, it is not clear whether
the United States would accept any dilution of the
Generally Accepted Accounting Principles. Corpo-
rate governance is a relatively new concern even in
industrialized countries and there are considerable
differences in corporate governance practices,
depending on whether the country follows the Anglo-
Saxon model, the German model or the Japanese
model. The OECD is currently working on an inter-
national standard for corporate governance, but it is
unlikely to go much beyond stating some very broad
principles, the practical application of which would
be very different in different countries. Common
standards for bankruptcy laws are perhaps furthest
in the future. Here again, practice varies consider-
ably across industrialized countries, with the balance
between debtor and creditor interest being struck
differently from country to country.

To summarize, the effort to upgrade regulatory
and supervisory systems in different parts of the fi-
nancial system in developing countries will certainly
increase the transparency of, and flow of informa-
tion from, emerging country markets, and this should
help financial markets to function more effectively
vis-à-vis these countries. However, some caveats are
important. First, the introduction of regulatory struc-
tures is no guarantee against a financial crisis – there
are numerous examples of crises occurring in regu-
lated financial markets in developed countries. The
effectiveness of regulation depends on how the sys-
tem is implemented in practice, and this depends
heavily on the quality of supervision. It will take sev-

eral years for supervisory institutions in developing
countries to build the supervisory skills needed. An-
other caveat relates to the nature of regulation itself.
There is a growing body of opinion that the focus of
supervision in banking should move away from en-
forcement of standard norms relating to capital
adequacy, asset classification by risk category, pro-
visioning etc. to a comprehensive assessment of the
risk management system in each bank. Supervision
would then focus on assessing the adequacy of the
risk management system in each bank and checking
whether the system is actually being followed. It is
obviously impossible to define common international
standards in this type of approach. Nor would it be
appropriate for developing countries to be judged by
adherence to traditional mechanical norms while in-
dustrialized country institutions switch to more
sophisticated systems of risk assessment, which give
their financial institutions much greater flexibility.

All this underscores the fact that conventional
wisdom on financial regulation is itself evolving and
it is important for the developing country constraints
and perspectives to be taken into account in evolv-
ing standards in future. The expansion of the Financial
Stability Forum to include developing countries and
the role of the Fund and the Bank as spokesmen for
the developing countries are particularly important
in this context.

B. Improved surveillance

Surveillance is a core activity of the Fund, which
conducts bilateral surveillance of individual coun-
tries through its annual Article IV consultations and
multilateral surveillance through periodic reviews of
the international economic situation in the form of
the World Economic Outlook. Both types of surveil-
lance need to be strengthened so that vulnerabilities
are identified at an earlier stage in future.

Bilateral surveillance needs to be strengthened
to address the various information deficiencies which
contribute to instability in financial markets facing
developing countries. Timely availability of infor-
mation and transparency are critical in this context.
The establishment of the IMF’s Special Data Dis-
semination Standard in 1996 is an important advance.
For its part, the Fund has published a Code of Good
Practices on Fiscal Transparency and is currently
working on a Code of Conduct on Monetary and Fi-
nancial Policy. Implementation of these codes will
help present a much more reliable picture of the fis-

13International Monetary and Financial Issues for the 1990s, Vol. XI

cal and monetary conditions in member countries on
a comparable basis.

Particular attention will have to be paid to fi-
nancial sector weaknesses, especially in developing
countries which are more integrated with global fi-
nancial markets. Since both the Fund and the Bank
are actively involved in work on the financial sector
there is scope for greater cooperation between the
two, and we will return to this subject in section IV.
However, effective surveillance requires the Fund to
cooperate not only with the World Bank but also with
other important players, including in particular BIS
and IOSCO. The recently established Financial Sta-
bility Forum will help the Fund in this context.

In the past, surveillance was designed prima-
rily to keep the Fund and member governments
informed of developments in individual countries.
In future it must play a much larger role in feeding
information to financial markets to improve market
efficiency. This raises problems because of the con-
straints of confidentiality associated with Article IV
consultations. The Fund has recently introduced the
practice of releasing Public Information Notices
(PINs) summarizing the outcome of Board discus-
sions of Article IV consultation reports, where the
country under review requests such release. This is
clearly a step in the right direction. However, out of
138 Article IV consultations concluded in 1997/98
countries chose to have PINs released in only 77
cases, a fact which indicates that many countries wish
to retain confidentiality. This may be partly because
countries which do not have and are not seeking sub-
stantial access to international financial markets do
not see any advantage in releasing PINs. However,
countries seeking access to financial markets are
likely to take a different stand and in any case will
be pushed towards greater disclosure by market pres-

If surveillance is expected to improve the func-
tioning of financial markets it must also pay greater
attention to market perceptions than is done at
present. It is not easy for the Fund to incorporate
market perceptions in formal surveillance activity
since governments can always downplay such assess-
ments as being subjective. But greater use of market
sources can often add useful information. For exam-
ple, the build-up of non-performing assets in some
of the East Asian banking systems was not docu-
mented in official circles but was definitely suspected
by market circles, which routinely discounted the low
officially reported figures (Khatkhate and Dalla,

Multilateral surveillance also needs to be im-
proved. It must focus more sharply on developments
which could add to instability in the external envi-
ronment facing developing countries. The impact of
industrialized countries’ policies on developing coun-
tries through their impact on world trade has been
the focus of attention for some time. Their impact
on capital flows to developing countries is equally
important. For example, low interest rates in indus-
trialized countries created conditions which favoured
a heavy flow of capital to developing countries and
also made them vulnerable to a reversal, but this
vulnerability was not sufficiently highlighted in mul-
tilateral surveillance. These linkages need more
attention in future. Multilateral surveillance does not
of course imply an ability to achieve policy correc-
tion. The Fund has not played a significant role in
policy coordination among the G-7 countries in the
past and this situation is unlikely to change.17 How-
ever, it could try to become a more vocal spokesman
for developing countries, which are not represented
in G-7 deliberations at all, and yet are highly vulner-
able to G-7 policy decisions.

The Bank can play an independent supplemen-
tary role in multilateral surveillance by highlighting
longer-term problems of particular interest to de-
veloping countries. The recent practice of issuing an
anual publication on global economic prospects for
developing countries is a useful step in this direc-
tion; it is not necessary to achieve close coordina-
tion between this publication and the World Economic
Outlook. Differences in perspective between the Fund
and the Bank can legitimately exist in view of the
Bank’s special focus on development issues, and
transparency requires that these differences be fully

C. The Fund as lender of last resort

A major issue in the discussions on the new
financial architecture is whether there should be an
international lender of last resort to deal with situa-
tions where otherwise well-managed economies are
hit by panic outflows of capital. The analogy is drawn
with the domestic banking system, where the central
bank acts as a lender of last resort to prevent a sol-
vent bank from falling victim to a run on deposits.
Since countries with open capital accounts are po-
tentially vulnerable in the same way to a loss of
confidence which may not reflect any weakness in
fundamentals, it is argued that the new financial ar-
chitecture should include an international lender of

14 Ahluwalia: The IMF and the World Bank in the New Financial Architecture

last resort to help countries deal with such situations.
There are several practical problems which have to
be resolved before this idea can be put into practice.

One set of problems relates to the availability
of resources on the scale required. The Supplemen-
tal Reserve Facility (SRF) introduced by the Fund in
December 1997, is an important new instrument
which allows the Fund to provide short-term finance
without limit in the event of exceptional balance-of-
payments difficulties attributable to a sudden and
disruptive loss of market confidence.18 However, the
Fund’s total resources are not sufficient, even after
the implementation of the last quota increase and the
activation of the New Arrangements to Borrow
(NAB), to enable it to meet all the financing needs
that could arise in this context. Keynes’ original vi-
sion of a Fund empowered to create its own liquidity
without limit is too radical to be accepted. A less
radical but feasible alternative would be to amend
the Articles to allow the Fund to issue SDRs to itself
for use in lender-of-last-resort operations, subject to
a cumulative limit on the total volume of SDRs that
could be created by the Fund for this purpose. The
limit could be determined by an 85 per cent major-
ity, as is the case for a general allocation of SDRs.
Within this limit the Fund should be empowered to
issue SDRs to itself to finance lender-of-last-resort
operations approved by the Board. SDRs created for
this purpose should be extinguished on repurchase
by the borrowing country, to be reactivated again only
in similar circumstances. This arrangement has sev-
eral advantages. It would not amount to a permanent
increase in unconditional liquidity as in the case of a
general allocation of SDRs. The additional liquidity
would be activated only in the context of lender-of-
last-resort programmes and would be linked with
appropriate conditionality and subject to majority
support in the Board, which in practice requires sub-
stantial support from the G-7 countries. The liquidity
created would be only for the duration of the crisis
since the SDRs would be extinguished on repurchase.

In the absence of such an arrangement, the only
alternative is the one proposed by Fischer (1999),
who argues that while an international lender of last
resort is definitely needed it is not necessary that it
must be able to create its own liquidity. That func-
tion could be just as effectively performed by the
Fund “arranging” finance from different sources. The
credibility of this alternative obviously depends on
the ability of the Fund to mobilize resources on a
sufficient scale when needed. The East Asian expe-
rience is not encouraging in this context. The Fund
was able to mobilize a total of $117 billion for Indo-

nesia, the Republic of Korea and Thailand, consist-
ing of its own resources and contributions from the
World Bank and the Asian Development Bank and
from bilateral sources (see table 2). However, the
bilateral contributions for Indonesia and the Repub-
lic of Korea, which were almost half of the total
package for these countries, were only a “second
stage back-up” with considerable uncertainty about
the circumstances under which they would become
available.19 The programmes of Indonesia and the
Republic of Korea were clearly inferior to the Mexi-
can programme in 1995, in which there was a large
bilateral United States contribution ($21 billion). If
the bilateral contributions for Indonesia and the Re-
public of Korea are excluded, the total volume of
resources mobilized for East Asia was only $76 bil-
lion compared with $ 49 billion for Mexico, whereas
a comparable figure for the three East Asian coun-
tries, using GDP as the scaling factor, would be close
to $200 billion! The inadequacy of the financing pro-
vided in East Asia has been identified by the World
Bank (1999) as one of the reasons why the Fund pro-
grammes did not succeed in stabilizing the situation
in the initial stages.20

We also need to consider whether it is desir-
able to draw on the resources of the World Bank and
the relevant regional development bank to meet the
needs of crisis financing. This may have been una-
voidable in the East Asian case because there was
no other source from which resources could have
been mobilized, but the discussions on the new fi-
nancial architecture should consider whether this is
an ideal arrangement. As pointed out earlier, the fi-
nancing needed to deal with crises of confidence is
quite different from that normally provided by mul-
tilateral development banks, and this would suggest
that the appropriate longer-term response is to
strengthen the capacity of the Fund to meet all the
requirements. Direct involvement of the World Bank
and the relevant regional development bank in crisis
lending operations only distracts these organizations
from their primary function, which is to provide long-
term development finance, a distraction which is
particularly undesirable in an environment where the
flow of such lending has been declining in real terms
over the past decade. The Bank should of course be
free to negotiate adjustment lending separately for
crisis-hit countries, and such lending may well be
needed as part of structural reforms in the post-crisis
phase, but this should be a separate activity with no
compulsion to complete the process in time to in-
clude resources as part of the total financing package.
Structural adjustment lending requires time in order
to design an appropriate policy framework, and this

15International Monetary and Financial Issues for the 1990s, Vol. XI

process should not be hurried to fit within the time-
frame in which a crisis management package has to
be finalized.

These considerations suggest that there is a need
to strengthen the Fund’s ability to provide finance in
crisis situations. One way of doing this is through a
greater expansion of quotas. Industrialized countries
have been reluctant to agree to large quota increases
in the past on the ground that such increases are not
necessary because creditworthy countries have am-
ple access to liquidity under normal conditions in
global capital markets. However, crises originating
in the capital account exemplify cases of market fail-
ure and since these cases can multiply rapidly because
of contagion, there may be a need for Fund financ-
ing on a large scale in such situations. It can still be
argued that a large increase in Fund quotas is not the
best way of empowering the Fund to deal with crisis
situations since quotas increase the general financ-
ing capability of the Fund. This concern can be met
by giving the Fund access to special borrowing
facilities available only for lender-of-last-resort
programmes. The General Arrangements to Borrow
(GAB) and the NAB provide such backup, but the
availability of these resources is subject to the spe-
cific consent of the contributing countries for each
call, in effect giving each contributing country a veto
on the use of its resources for each particular pur-

pose. What is needed are pre-arranged lines of credit
from the major central banks, which could be coordi-
nated through the BIS and be available automatically
for use by the Fund in lender-of-last-resort pro-
grammes approved by the Fund’s Board. The major
developing countries, which are members of the BIS,
could join in contributing to these lines of credit on
an appropriate-burden sharing basis. If becomes nec-
essary to access resources from the World Bank or
the relevant regional development bank, this should
be in the form of bridge finance to the Fund, which
can be repaid by the Fund in a short time.

The conditionality to be attached to last-resort
financing also poses formidable problems. One view
is that such a facility must be very different from the
present arrangement whereby countries negotiate
programmes with the Fund after a crisis has arisen
and access to resources therefore depends on the
outcome of negotiations undertaken in situations
where the country is in a weak position and can be
pressured into accepting unnecessarily tough condi-
tionality.21 Since central banks acting as lenders of
last resort lend freely (i.e. in large amounts) to solvent
banks facing liquidity problems, with no conditions
except a penal interest rate, it is sometimes argued
that countries facing panic outflows should have simi-
lar access to large volumes of finance to calm markets
without having to negotiate on conditionality at that

Table 2


($ billion)

World Regional
IMF Bank dev. bank Bilateral Total

Brazil, 1998 18.1 4.5 4.5 14.5 b 41.6
Indonesia, 1997 11.2 5.5 4.5 21.1 42.3
Mexico, 1995 17.7 -- -- 31.1 c 48.8
Republic of Korea, 1997 21.1 10.0 4.2 23.1 58.4
Russian Federation, 1998 d 15.1 6.0 -- 1.5 22.6
Thailand, 1997 4.0 1.5 1.2 10.5 17.2

a The rescue packages for each country represent resources available over different periods for each case.
b From industrial countries, including direct assistance from Japan and from others through BIS.
c Comprises $20 billion from the United States, $1.1 billion from Canada and a $10 billion credit line from the BIS.
d Conditional commitments to the end of 1999. Of these, $1.5 billion shown under “bilateral” consists of Japanese support

co-financing the World Bank.

16 Ahluwalia: The IMF and the World Bank in the New Financial Architecture

time (see, for example, Griffith-Jones, 1999). This
ignores the fact that central banks provide last-re-
sort financing only to banks which face liquidity
problems but are otherwise solvent and that central
banks are particularly well placed to judge the sol-
vency of banks in distress because of intensive
supervision. The existence of supervision reduces the
moral hazard that could otherwise arise with last-
resort financing. Since similar intrusive supervision
does not exist for countries, automatic extension of
low-conditionality financing would attract the charge
of moral hazard. Conditionality in this situation be-
comes the only basis for ensuring solvency.

One way out of the dilemma would be estab-
lish a precautionary or contingency financing
arrangement under which a country could pre-qualify
for future assistance by complying with performance
conditions agreed with the Fund before there is any
crisis, in exchange for which it would obtain assured
access to short-term financing on a large scale in the
event of a crisis. The knowledge that such an arrange-
ment is in place can be expected to calm markets
and reduce the likelihood of a panic-induced crisis.
A proposal of this type was considered by the IMF
at the time of the Mexican crisis but was not found
practical. It is being considered again in the wake of
the East Asian crisis. There is considerable support
for such an arrangement, but designing a precaution-
ary facility poses several problems.

The major difficulty with a contingency financ-
ing facility is that performance criteria thought to be
appropriate prior to a crisis cannot continue to be
the only performance requirements if a crisis does
occur. This is because crises rarely take the form of
a purely irrational panic arising in an otherwise com-
pletely normal situation. What is much more likely
is that countries face a crisis because they are sud-
denly perceived to have become vulnerable because
of some adverse external or internal development,
or because of belated recognition of a weakness
which existed earlier but was not known to the mar-
ket. In such situations there is a need for some
adjustment in policy to reflect the new development.22
A partial solution lies in treating pre-qualification as
a basis for releasing at least a first tranche of the
crisis package, with relatively minimal conditionality,
while simultaneously initiating negotiations to de-
termine appropriate conditionality for additional
support. Such an arrangement could help to stabilize
markets if pre-qualification is seen to increase the
probability that Fund resources will be made avail-
able in the event of a crisis.23

Pre-qualification could also pose some difficult
problems in the pre-crisis period. Any departure from
agreed performance criteria would either require
prompt corrective action or withdrawal of cover.
Since the effectiveness of the pre-qualification safety
net depends upon its availability being publicly
known, any withdrawal of cover would also have to
be made public, and this could generate controversy
because the withdrawal of cover could itself precipi-
tate a loss of confidence. Performance requirements
in the pre-crisis period could also change as a result
of a change in external circumstances which in the
view of the Fund might warrant intensification of
policy parameters for continued eligibility for cover.
If the required change in those parameters is not ac-
cepted by the country, the Fund may have to withdraw
cover, which again is bound to attract controversy.

D. Orderly debt restructuring

A lacuna in the existing system, which makes
it difficult to handle crises of confidence, is that credi-
tors have an incentive to exit at the first sign of trouble
in the hope of escaping before the crisis gets out of
hand, which in turn intensifies the crisis. It is argued
that the system would be more stable if countries
facing panic outflows could have recourse to an in-
ternationally sanctioned mechanism for invoking a
temporary standstill during which the government
could initiate discussions with major private credi-
tors, inform them of measures being taken to deal
with the crisis and, where relevant, of the extent of
Fund support available, and negotiate a restructur-
ing of payment obligations so that the country could
meet them without a disruptive depreciation of the
currency.24 Such an arrangement would ensure that
the burden of adjustment is shared more fairly be-
tween lenders and the debtor country and would avoid
the moral hazard in the present system whereby Fund
resources are used to repay private creditors who get
away scot free.25 It could also be used to encourage
new private sector lending if new flows could be
given seniority over pre-crisis debt, thus creating
incentives to “bail in” the private sector.

Debt negotiations with private creditors have
taken place in the past, but they have had no formal
legal sanction and creditors have been technically
free to treat suspensions of payment as a default. In
practice, the outcome has depended upon the degree
of support a country can mobilize from official quar-
ters. In the 1980s the Managing Director of the Fund
took the initiative to persuade the New York banks

17International Monetary and Financial Issues for the 1990s, Vol. XI

to provide a fresh infusion of funds as a condition
for Fund financing of debt-burdened Latin Ameri-
can countries. More recently in the Republic of
Korea, the United States Treasury Secretary is re-
ported to have intervened personally to encourage
the New York banks to cooperate in restructuring the
short-term obligations of banks from the Republic
of Korea. However, these cases involve a high de-
gree of non-transparency and it is doubtful whether
similar support would be extended to other countries,
especially those which do not pose systemic risk.
Establishing an internationally agreed procedure
whereby countries could introduce a temporary stand-
still with IMF approval, and perhaps also involve
the IMF in the restructuring negotiations, would make
the process more transparent and even-handed.26

Several practical problems have to be resolved
before debt restructuring can be implemented. First,
there is the problem of determining which debts
should be covered by the standstill and the subse-
quent restructuring negotiations. Clearly, trade credit
should be completely excluded to avoid disruption
in current payments. Other debts can be categorized
into (a) sovereign debt owed to government or other
official sources; (b) sovereign or semi-sovereign debt
owed to private creditors, i.e. banks or bondholders;
(c) commercial bank debt owed to other banks or
bondholders; and (d) private sector debt. Attempt-
ing to restructure debt in all these categories is
impractical and it is therefore necessary to focus on
some important categories. Sovereign debt owed to
governments is covered by the Paris Club. Private
sector debt is best left to normal market forces and
bankruptcy procedures. Debts in (a) and (c) above
are perhaps the most suitable for negotiated restruc-
turing. Since the context in which the restructuring
may be considered is a crisis of confidence, the fo-
cus of the negotiation must be on short-term debt in
these categories. This could be defined as debt with
original or residual maturity of one year to 18 months,
leaving other debts in these categories outside the
restructuring. Even if debt restructuring is limited to
some categories, it is relevant to consider whether
the standstill provisions should be applied to all cat-
egories pending the outcome of negotiations.

More generally, it is necessary to consider
whether the standstill should extend beyond debt-
related payments to cover other capital outflows as
well. It is difficult to justify unilaterally freezing
payments due to foreign creditors while an open capi-
tal account allows domestic capital to exit freely and
intensify the crisis, which could lead to demands for
more drastic debt restructuring to ensure viability.

Special problems arise where foreign residents hold
bonds denominated in domestic currency. It is not
practical to seek to restructure repayment obligations
to foreign holders of domestic bonds but not to oth-
ers. If payments are allowed in domestic currency
but it is sought to block repatriation, this becomes a
restriction on repatriation of capital. Should such
repatriation be restricted while other repatriation
(e.g. by direct foreign investors) is not? There is no
consensus as yet on these issues.

Another set of issues relates to the practical
problem of conducting negotiations with a large
number of creditors. In the Latin American debt cri-
sis of the 1980s, most of the debt was sovereign debt
owed to a handful of commercial banks and it was
easy to identify and negotiate with few major credi-
tors. Today, commercial bank debt is much less
concentrated than it was earlier, and so the number
of commercial banks involved is much larger. This
creates a possible free-rider problem in which smaller
banks have an incentive to act as free-riders, refus-
ing to accept restructuring. It is not clear how this
can be eliminated. The proportion of debt in the form
of bonds has also increased substantially, and it is
impossible to negotiate with large numbers of bond-
holders in the absence of legal provisions in bond
contracts providing for collective representation and
specifying the extent of majority consent needed to
apply the restructuring terms to all bondholders.

Perhaps the most difficult issue is the extent to
which the IMF should be directly involved in pro-
viding some sort of official sanction to the standstill
and possibly also assisting the country concerned in
debt negotiations. Involvement of the IMF has ad-
vantages because it would help to evolve uniform
practices which can be followed in all cases. It could
also link the availability of additional Fund support
to an agreement on restructuring, incentivizing both
the debtor and the creditor to come to a reasonable
agreement, and also ensuring effective burden-shar-
ing. However, there is resistance to getting the IMF
directly involved in sanctioning departures from debt
contracts and in determining the terms of renegotia-

The current state of the consensus on debt re-
structuring in official circles is perhaps best reflected
in the report of the G-22 Working Group on Finan-
cial Crises. The report emphasizes the high cost of
even a temporary suspension of payments and there-
fore urges the need “to make the strongest possible
efforts to meet the terms and conditions of all debt
contracts in full and on time”. It recognizes that a

18 Ahluwalia: The IMF and the World Bank in the New Financial Architecture

temporary suspension may become unavoidable in
certain circumstances, but it stipulates that this op-
tion should be considered only when it is clear, from
consultations with the Fund and other international
financial institutions, that even with appropriately
strong policy adjustments the country will experience
an exceptionally severe financial and balance-of-
payments crisis. The report specifically warns against
“disruptive unilateral action” – an implicit criticism
of the Russian unilateral repudiation in 1998 – and
recommends trying to achieve a cooperative solu-
tion. The report goes on to recommend facilitative
measures which would make it legally possible to
renegotiate with creditors should this become nec-
essary, such as the inclusion of various types of
collective representation clauses in bond contracts.

To summarize, the G-22 Working Group stops
short of endorsing an internationally approved proc-
ess for invoking a standstill with IMF approval. The
requirement of prior consultation with the Fund and
examination of alternative policy options implies that
debt restructuring is not a “first resort” instrument in
crisis containment and that countries must first try
to stabilize the situation through conventional meth-
ods. In practice, this means that there could be a
period during which the system will be under pres-
sure and outflows could continue to occur. In the
absence of financing of the lender-of-last-resort type,
efforts to contain these outflows may not be very
successful and may force resort to restrictive high
interest rate policies which may have very high short-
term economic costs. This illustrates the basic
dilemma with debt restructuring proposals. There are
strong moral hazard grounds for discouraging debt
restructuring except as a last-resort option. However,
if debt restructuring can be resorted to only after
conventional means have been exhausted, there is a
danger that it will be used only after most of the dam-
age has been done, and not to forestall damage as its
proponents would like.

E. Managing the social consequences of

An important feature of recent crises is that the
impact on the poor can be very severe. Estimates
provided for Indonesia, Mexico, the Republic of
Korea and Thailand by the World Bank (1999) show
a sharp decline in real wages and an increase in un-
employment rates between the pre-crisis year and the
post-crisis year in all these cases. Estimates of
changes in poverty in East Asia are more tentative

because they depend on the change in income dis-
tribution, which is not easy to predict, but large
increases in poverty are expected in all the crisis-
affected countries.

Crisis management strategies must therefore try
to ensure that the negative impact on the poor is mini-
mized. Although fiscal discipline may require a
reduction in total real government expenditure, this
should be achieved while protecting those expendi-
tures which are of particular importance for the poor.
For example, a reduction in total subsidies may be
unavoidable but the focus should be on cutting sub-
sidies which are not effectively targeted, of which
there are usually many, while preserving those sub-
sidies which are effectively targeted at the poor. There
may even be a case for increasing targeted subsidies
in certain circumstances. Similarly, it is necessary to
protect expenditure on social services, especially
health and education, which are crucial inputs into
the welfare and human capital of the poor. These
expenditures often suffer during periods of fiscal
tightening and this is typically at the expense of the
poor. The effort to preserve or perhaps even increase
pro-poor expenditures while reducing total expendi-
ture can succeed only if other expenditures can be
subjected to even deeper cuts. This is not easy, but
that only reveals the nature of the difficult choices
involved in achieving adjustment with a human face.

Special efforts can also be made to provide so-
cial safety nets which would help to maintain income
levels of the poor and those affected by unem-
ployment. Special public works programmes for
providing wage employment could be introduced, or
expanded where they already exist. The cost-effec-
tiveness of these programmes, however, depends
critically on the extent of leakage to non-target groups
and also on the productivity of the resulting assets
created. International experience suggests that leak-
ages to non-target groups can be very large unless
programmes are very carefully designed and moni-
tored. Efforts to achieve quick results will lead only
to projects which have high public visibility but low

This is clearly an important area for Fund-Bank
collaboration. The Bank can help in formulating ap-
propriate performance criteria for Fund programmes
which would ensure that the pro-poor components
of expenditures in the government budget are not
reduced. The Bank can also directly finance social
safety net programmes which can be very useful in
the post-crisis phase, provided that they are designed
in a manner which maximizes effectiveness. How-

19International Monetary and Financial Issues for the 1990s, Vol. XI

ever, as pointed out earlier, these programmes should
be separate from financing provided in the context
of crisis management which should ideally be sourced
from the Fund.

F. Capital account liberalization

Prior to the East Asian crisis, industrialized
countries were pressing for broadening the mandate
of the Fund to include liberalization of capital
movements, and this was reflected in the Interim
Committee’s statement in Hong Kong (China) in
October 1997 calling for consideration of an amend-
ment to the Fund’s Articles to make liberalization of
capital movements one of the purposes of the Fund.
Although many developing countries have liberal-
ized the capital account to varying degrees, most still
retain substantial capital controls and many devel-
oping countries have reservations about giving the
Fund an expanded mandate in this area for fear that
it might create pressure to liberalize capital account
transactions at a faster pace. The crises in East Asia
and Brazil have highlighted the problems which can
arise if the capital account is liberalized prematurely
and the pressure for rapid movement in this area has
therefore diminished, but the issue remains on the
agenda of the Fund’s Board and will have to be ad-
dressed as part of the new architecture for the global
financial system.

Given the increased importance of capital flows
in the global economy, and the fact that many devel-
oping countries are progressively integrating with the
global financial market, it is somewhat incongruous
that the Fund has no mandate at all in this area. If the
Fund is to function effectively as the principal inter-
national overseer of the international financial
system, it can be argued that it must have some man-
date for monitoring, and perhaps even regulating,
restrictions on capital account transactions. It is im-
portant that this should not become an instrument
for pushing developing countries prematurely into
liberalization of the capital account, denying them
the flexibility to impose controls on capital flows if
they feel these are needed for macroeconomic man-
agement. One way of giving the Fund a limited
mandate would be to abandon the approach of in-
cluding the liberalization of capital movements as
one of the purposes of the Fund and focus instead on
the limited objective of enabling the Fund to super-
vise capital restrictions with a view to creating more
orderly conditions in international capital markets.

The only obligation on members should be to inform
the Fund of the restrictions they impose on capital
account transactions and also any changes made
therein. Countries would then be free to adopt any
regime they liked, and also change it at will, but the
subject would become a legitimate issue for discus-
sion by the Fund, and countries would be under some
pressure to justify their actions in the course of sur-

A regime of this sort could also evolve into one
whereby developing countries may, of their own vo-
lition, accept binding obligations to avoid imposing
restrictions on certain types of capital transactions
except in consultation with the Fund. Restrictions
imposed in emergency conditions could be made
subject to review, with a presumption of return to
normal conditions within a predetermined period.
This would give the Fund a role in supervising obli-
gations accepted by developing countries of their own
volition and help to increase transparency and in-
vestor confidence in emerging markets. The incentive
for developing countries to accept obligations vol-
untarily would depend on whether financial markets
viewed such discipline with favour as reflected in
credit ratings and yield spreads.

From the perspective of developing countries
there will be the lurking suspicion that even a lim-
ited mandate is likely to generate pressure on them
to liberalize their capital account at a faster pace and
could also be reflected in Fund conditionalities at
times when Fund financing is needed. This is a le-
gitimate concern which cannot be lightly dismissed.
To some extent it can be addressed by suitable draft-
ing of the mandate. More substantively, developing
countries could insist that such arrangements should
only be considered as part of a package where the
Fund’s ability to act as a lender of last resort is
strengthened, and it is also given some authority to
provide legal sanction to restrictions on capital
payments which may have to be imposed in an emer-
gency. Industrialized countries have so far shown
little inclination to support proposals which increase
the financing available to the Fund or put the Fund
in a position where it may legitimize new restric-
tions imposed on capital movements by a developing
country. However, a one-sided use of the Fund to
push for liberalization of capital markets, without also
strengthening it in ways that would help contain vola-
tility and instability is clearly unbalanced. Progress
in this aspect of the new financial architecture may
require balanced movement on both fronts.

20 Ahluwalia: The IMF and the World Bank in the New Financial Architecture

IV. The Fund and the Bank in the new

In this section we examine various proposals
relating to the future role of the IMF and the World
Bank which are being considered as part of the dis-
cussions on the new financial architecture. These
proposals reflect the state of the current consensus
on architecture issues, which emphasizes the need
to make financial markets work more effectively
rather than supplant them. The role envisaged for
the Fund and the Bank in this framework is one of
improving surveillance and contributing to strength-
ening the financial sector in developing countries to
prevent crises from occurring. It also envisages
strengthening the capacity of these institutions to deal
with crises if they occur, and this is to be achieved
not by radical restructuring but by improvements in
their existing capacities and better cooperation.

The existing arrangements for cooperation be-
tween the two institutions have been reviewed on
the basis of the experience in handling the East Asian
crisis. Both institutions have concluded that the
Concordat of 1989 continues to provide an accept-
able framework for Fund-Bank cooperation, but
additional arrangements for cooperation are needed
in some areas.

A. Cooperation in financial sector work

There is general agreement that Fund-Bank co-
operation needs to be greatly enhanced in work
related to the financial sector. Strengthening the fi-
nancial sector in developing countries is necessary
both from the point of view of macroeconomic sta-
bility and from the point of view of allocative
efficiency. Both institutions therefore have a strong
interest in this area with somewhat different empha-
ses. The Fund is concerned with financial sector
issues which affect macroeconomic balance, are rel-
evant for the effectiveness of macroeconomic policy
instruments, or concern problems which can gener-
ate systemic risk. The Bank is concerned with
developing and implementing strategies for the me-
dium-term development of the financial sector,
including restructuring of banks and financial insti-
tutions, improving systems of prudential regulations
and supervision, and related capacity-building. This
broad division of responsibilities necessarily leaves
a substantial area of overlap.

The United Kingdom recommended the estab-
lishment of a common department for financial sector
issues to service both institutions. This has not found
favour and instead each institution plans to strengthen
its own capability with elaborate arrangements for
consultations at various levels, including field-level
coordination in financial sector work, participation
in each other’s missions and even joint missions. A
Financial Sector Liaison Committee has been estab-
lished comprising senior staff of the Monetary Affairs
and Exchange and the Policy Development and Re-
view Departments of the Fund and of the Financial
Sector Board and the Poverty Reduction and Eco-
nomic Management Network of the Bank. The
committee will help coordinate the work of the two
institutions in this area and delineate respective roles
for the two institutions reflecting their mandates and
comparative strengths.

The effectiveness of these arrangements can
only be judged on the basis of actual experience in
the future. However, it is important to emphasize that
while mechanisms for consultation aimed at elimi-
nating disagreements to the extent possible are
desirable, the achievement of a common Bank Fund
position on all financial sector policy issues should
not be viewed as an overriding objective. Financial
sector development in developing countries in an
environment of global financial integration is a com-
plex process in which perceptions of best practice
are still evolving. There may be room for different
views on many points and it is more important for
the Fund and the Bank to remain open to ideas from
outside in this area, including the views of market
participants and national regulators, than to reach
common positions on all issues.

An important area where the Fund and the Bank
can cooperate is in ensuring that the concerns of de-
veloping countries are appropriately taken into
account in the development of international regula-
tory standards for the financial sector. As participants
in the G-7 Financial Stability Forum, they can help
shape the evolution of an international consensus on
the application of standards in different areas to de-
veloping country situations. Once standards are
agreed in the relevant international forum they can
help to evolve guidelines for applying these standards
in developing countries, including the determination
of appropriate transition paths which take account
of country-specific constraints. They can also pro-
vide technical assistance to developing countries
seeking assistance in attempting to comply with
agreed standards. Finally, the two institutions can
cooperate to enhance the effectiveness of Fund sur-

21International Monetary and Financial Issues for the 1990s, Vol. XI

veillance in monitoring implementation of these
standards in individual developing countries.

B. Coordination in crisis management

While existing mechanisms for coordination
between the two institutions for their normal lend-
ing operations are broadly acceptable, they are not
adequate in crisis situations, as the East Asian expe-
rience shows. The suddenness with which the crisis
broke in East Asia left very little time for consulta-
tion and, as it happened, the Bank differed from the
Fund on many aspects of crisis management. Some
of these differences relate to differences on struc-
tural policies which are within the domain of the
Bank. For example, the Fund programme involved
closure of 16 insolvent banks. Because of the severe
time constraints within which the Indonesian pro-
gramme was formulated, the Bank was not adequately
consulted. We now know that the Bank had reserva-
tions about the Fund’s approach. The closure of the
banks was announced in a manner which created
uncertainty about the security of deposits in the other
banks, leading to a run on deposits and a flight of
capital which worsened the currency collapse. The
Bank also appears to have had a different view on
the extent of fiscal restraint and the interest rate poli-
cies advocated by the Fund, both of which are within
the Fund’s area of primary responsibility. However,
this division of responsibility should not make the
Bank’s views irrelevant. Since short-term stabilization
measures can disrupt the development process, or
conflict with longer-term structural policy objectives,
it is necessary for the Bank’s views to be adequately
reflected in formulating crisis management pro-

Recognizing these difficulties, the two institu-
tions have reached agreement on new procedures to
ensure effective coordination between them in fu-
ture crisis management operations. The responsibility
for the overall stabilization programme, including the
adoption of urgent structural measures which may
have to be taken in the initial stage of stabilization,
rests squarely with the Fund. However, in future the
Bank will be fully involved in programme formula-
tion in the early stages through participation by Bank
staff in Fund missions or through parallel missions.
The Bank’s involvement is obviously especially nec-
essary in order to deal with structural issues where it
has primary responsibility, and where it may later
even engage in direct lending. The proposed proce-

dure will also allow the Bank to contribute to the
formulation of other parts of the programme as well.
If the Bank was not in a position to make firm rec-
ommendations on structural issues within the
time-frame in which the crisis management package
has to be finalized, the Fund would take the necessary
decisions, on the basis of preliminary understandings
with Bank staff, to be modified later on the basis of
more in-depth work. The introduction of ex post
flexibility in this way is a definite improvement. Fol-
low-up activity on the structural side would be
undertaken by the Bank, with Fund staff participat-
ing in Bank-led missions.

The Bank’s contribution to programme formu-
lation would obviously be most useful in situations
where it has an ongoing involvement in the crisis-hit
country, but this cannot be taken for granted. The
Fund and the Bank therefore propose to identify a
group of key emerging countries where significant
financial sector reforms are under way, or are likely
to be required, and to assist the authorities in evolv-
ing appropriately sequenced plans for financial sector
reform. By focusing Fund surveillance and Bank sec-
tor work on structural issues in the financial sector
in these countries in this way, both institutions ex-
pect to develop an improved understanding of the
financial system and to identify possible problems
for corrective action, which will help in formulating
crisis management programmes should this become

The current consensus on Fund-Bank coopera-
tion also appears to favour direct financing by the
Bank to supplement Fund financing at times of cri-
sis. The Emergency Structural Adjustment Lending
(ESAL) procedure recently approved by the Bank is
designed to enable the Bank to play this role.28 The
approach adopted in this paper is different. We have
argued that Bank financing should not be part of the
crisis management package, although the Bank may
well involve itself in adjustment lending as part of
post-crisis restructuring.

In addition, the Bank could play an even more
important role in the post-crisis recovery phase by
helping countries regain access to international capi-
tal markets. Given the information asymmetries from
which developing countries suffer, and the market
failures associated with contagion, it is quite possi-
ble that crisis-hit developing countries may find it
difficult to access commercial markets even though
policy correctives have been put in place which jus-
tify fresh access. The World Bank could play a
market-compatible role, bringing developing coun-

22 Ahluwalia: The IMF and the World Bank in the New Financial Architecture

try borrowers back to the market earlier rather than
later through the use of its guarantee facility. Since
market access is likely to be needed by the private
sector, the Bank’s insistence upon a government
counter-guarantee is not an ideal arrangement. Di-
luting this requirement will require legal changes in
the Bank’s Articles, but it is time that the Bank con-
sidered such changes to allow it to use suitably priced
guarantees to help private sector borrowers to re-
enter international capital markets in the post-crisis

C. Should the Fund be merged with the

An issue which needs to be addressed is
whether, in view of the perceived need for coopera-
tion and coordination between the Fund and the Bank
in so many areas, there is a case for merging the two
institutions. Proposals for merger have surfaced in
the past because the overlap between the two insti-
tutions made it difficult to distinguish the Fund’s
activities from those of the Bank and merger was
seen as a logical way of avoiding duplication of work
and possible conflicting advice (see Crook, 1991).
The suggestion for a merger has been advanced again
– in the aftermath of East Asia – by former Secretary
of the Treasury, George Schultz.29

A merger would be logical only if one were to
conclude that there is no distinctive role for the Fund
in the new financial architecture which cannot be
performed just as efficiently by the Bank. This is
clearly not the case. On the contrary, the distinctive
features of latter-day crises imply that the Fund’s role,
both in surveillance and as a financing institution,
has become more distinct from that of the Bank. Sur-
veillance in future must focus much more on market
perceptions and short-term factors which could af-
fect confidence, and these areas are outside the
special expertise of the Bank. Surveillance by the
Fund in future must therefore involve more exten-
sive consultation between the Fund and many other
participants in the international financial system in
addition to the Bank. The financing requirements for
handling latter-day crises are also very different from
what they used to be. The Fund has to be able to
provide large volumes of finance to support pro-
grammes aimed at restoring confidence, but unlike
in 1980s such financing does not have to be long-
term and certainly not concessional.

These developments suggest that instead of a
merger of the two institutions the role of the Fund in

the future should actually become more distinct from
that of the Bank. The Fund should focus more sharply
on sources of instability in the international finan-
cial system and on handling balance-of-payments
problems which are either short-term or systemic in
nature. It could even be argued that financing op-
erations related to chronic balance-of-payments
problems of low-income countries, e.g. the ESAF and
the Heavily Indebted Poor Countries (HIPC) Initia-
tive, are much closer to structural adjustment lending
where corrective policies focus heavily on extensive
structural reform, and should perhaps be shifted to
the Bank, with cooperation from the Fund being made
available on technical matters. The problem of trans-
ferring the resources involved, which are currently
located in the Fund, will present legal difficulties,
but this problem could be overcome provided that
the principle is accepted.

D. Reform of the Interim and Development

A common complaint about the present system
is the lack of a high-level political forum which takes
a unified look at interrelated issues such as the
functioning of the international financial system,
macroeconomic stability and policy coordination in
the major industrialized countries, special problems
of vulnerability of emerging market economies, and
the impact of international trends on the develop-
ment process. The Fund-Bank annual meeting of
Governors is largely ceremonial, and given its size it
cannot be anything else.

The Interim Committee and the Development
Committee are more compact political-level bodies
which meet twice a year. Though they have a sub-
stantially overlapping membership, they function as
separate committees with Fund-related issues being
dealt with in the Interim Committee and Bank issues
in the Development Committee. Their functioning
leaves a great deal to be desired. Until recently, both
committees operated with procedures in which most
of the time was devoted to prepared speeches with
little opportunity for substantive interaction between
Ministers. The procedure has been greatly improved
in this respect in recent years, but the objective of
creating a forum capable of taking an integrated view
of the interrelated issues of international finance,
trade and development, with substantive discussions
at a high political level, has yet to be achieved.

The principal reason why the two committees
have not served as forums for substantive discussions

23International Monetary and Financial Issues for the 1990s, Vol. XI

is simply that the industrialized countries have not
found it necessary to use them for this purpose. They
engage in fairly extensive interaction among them-
selves in the G-7, based on detailed preparatory work
at the official level by deputies from capitals, and
positions arrived at through this process are often
presented in the meetings of the two committees more
or less as faits accomplis. Industrialized countries
do not perceive the need for a substantive discussion
with developing countries at a political level before
formulating their own position, because the consent
of the developing countries is not actually needed in
order to push policy in the Fund and the Bank in the
direction they want. On rare occasions developing
countries have used their voting power to block an
initiative by industrialized countries, as happened in
Madrid in 1994, when the industrialized countries
had a strong interest in pushing through a special
allocation of SDRs in favour of transition countries
but were unwilling to concede a significant general
increase. Since the decision required an 85 per cent
majority, the developing countries were in a posi-
tion to block the proposal, which they did, but they
did not succeed in extracting agreement on a general

The need to consult developing countries was
seen to be more compelling in the wake of the East
Asian crisis in order to secure agreement on the broad
outline of the new financial architecture. However,
the United States, which took the initiative on this
issue, bypassed the Interim Committee and invited
an ad hoc collection of 22 countries (the G-22, which
has since been expanded to G-33) to discuss the is-
sue. The group included a number of emerging
market economies which were judged to be “systemi-
cally” important, many of which would not have been
included if the discussions had taken place in the
Interim Committee, which reflects the constituency
structure of the IMF Board. It is more representative
of the diversity of developing countries, but it does
not include all the economically significant emerg-
ing market economies, and involvement of significant
“stakeholders” was obviously felt to be necessary.

Various proposals for reform of the Interim and
Development Committees have been made in the
recent past. A long-standing proposal to convert the
Interim Committee into a council with decision mak-
ing powers, which was provided for in the Second
Amendment, was recently considered by the IMF
Board but did not meet with approval. Two propos-
als for restructuring the Interim and Development
Committees are currently under consideration.

(i) The first is to retain the present two-committee
structure but make the committees more sym-
metric by making the Bank a full partner in the
Interim Committee and enforcing a clear de-
lineation of responsibilities between the two
committees to avoid overlaps. In this case, glo-
bal economic issues, including their implica-
tions for development, would be discussed only
in the Interim Committee while the Develop-
ment Committee would focus on specific de-
velopment-related initiatives, including those in
which they Fund is involved such as ESAF and

(ii) The second alternative involves the creation of
a single overarching group at Ministerial level
to address global economic issues, with the In-
terim Committee and the Development Com-
mittee continuing to address specific Fund and
Bank issues as at present. The Fund and the
Bank would be full partners in the new group,
while other institutions such as the WTO,
UNCTAD, BIS and IOSCO could be permanent
observers and could be involved in the prepara-
tory work for agenda items in these areas. The
group could meet twice a year as the Interim
and Development Committees do at present,
with a plenary session in the morning for the
overarching group followed by separate Interim
and Development Committee meetings as at
present. The new group could also meet on other
occasions if circumstances warranted without
being linked to meetings of the two commit-

The first alternative clearly reflects a minimalist
approach and is unlikely to achieve any significant
improvement on present practice other than giving
the Bank a more elevated position in the Interim
Committee in the event that the committee is not
converted into a council. The second alternative is
clearly more ambitious and involves a substantive
change in the present arrangements. Its main advan-
tage is that it would create a new international forum
at which major industrialized countries and devel-
oping countries, including all the emerging market
countries, could interact with each other and also with
the major players in the global financial system, such
as the BIS, UNCTAD, IOSCO and WTO, in order to
evolve a consensus on critical issues facing the global
economy from the perspective of both industrialized
and developing countries.

The country composition of the new forum
could be made wider than that of the Interim Com-

24 Ahluwalia: The IMF and the World Bank in the New Financial Architecture

mittee by including the top 10 industrialized coun-
tries by size of quota in the Fund, plus the top 10
among the other members, which include oil-export-
ing countries, transition countries and developing
countries, plus all those countries not already cov-
ered by this criterion but which represent their
constituencies on the IMF Board.30 This formula is
likely to produce a group of around 30 countries
which would include all the major “stakeholders”
defined in terms of economic potential, and would
ensure a degree of representativeness based on ob-
jective selection criteria.

This would create a credible international fo-
rum which could take an integrated view of the
functioning of the global economic system in which
operational issues related to the Fund and the Bank
would be only part of the agenda. The forum would
include some of the major non-government partici-
pants in the international financial system, which is
necessary given the enormously increased role of
private markets. The proposal also has the advan-
tage of continuing the Interim and Development
Committees in more or less their present forms, which
is useful for providing operational guidance for the
Fund and the Bank respectively. A potential prob-
lem in this proposal will be the pressure to expand
the new international forum to include various inter-
national agencies connected with one or other aspect
of development. Too broad a definition of develop-
ment will widen the net too much and dilute the
effectiveness of the forum if it is ever established.
This should obviously be avoided.


1 Both the quality of its project portfolio and the credit-
worthiness of its borrowers were important considerations
for an organization dependent on the markets for its funds.

2 In the 1960s, for example, the Bank adopted a “programme
of projects” approach in some Latin American countries,
linking disbursements for a group of projects to the pursuit
of macroeconomic policies to control inflation. In the mid-
1960s the Bank also engaged in non-project lending for
India to provide much needed balance-of-payments
support (see Kapur et al., 1997).

3 The Trust Fund was included in the package at the time of
the Second Amendment to the Articles in 1976 in order to
obtain the consent of the developing countries to the
amendment. These countries had participated in the
discussions on international monetary reforms in the
Committee of Twenty in the hope of securing some link
between the provision of liquidity through SDRs and the
expansion of development assistance. No such link was
accepted, however, and the Trust Fund was offered instead
as a sop.

4 ESAF interest rates were subsidized by grants from the
aid budgets of some aid donors. This introduced an overlap

(admittedly very small) on the resources side between the
Fund and the Bank/IDA, since interest subsidies came from
the same pool of resources from which IDA contributions
were made.

5 Fiscal problems in borrowing countries also made it
difficult for many developing countries to maintain a
pipeline of new projects, because they could not always
find the counterpart domestic resources needed to add to
the projects already under way.

6 Many of these policy initiatives involved regulatory, legal
and institutional changes which could not be reduced to
precise quantitative targeting. Some of the multitude of
actions were in the nature of consequential action within
the same areas to bring about institutional reform.

7 It is relevant to note that the Bank’s Vice President for
Development Policy at the time, Stanley Fischer, who is
now First Deputy Managing Director of the Fund, had
expressed reservations on proceeding with the Argentine
loan in view of the fiscal problems identified by the Fund
(see Kapur et al., 1997).

8 Balance-of-payments problems in the past typically arose
from a deterioration in the current account caused either
by domestic policy misalignments or a change in external
circumstances or, in the case of developing countries, by
structural constraints on the supply side. The structural
nature of balance-of-payments problems in developing
countries has long been recognized and it calls for a longer
period of adjustment, and therefore a larger cumulative
amount of financing, but the annual financing need in such
cases is still defined by the degree of pressure on the current

9 The theoretical literature on panics and bank runs treats
such cases as examples of multiple equilibria (see, for
example, Diamond and Dybvig, 1983).

10 The conventional wisdom at the time was that if a current
account deficit was not a reflection of public sector deficits,
and was being financed by private flows, the market had
clearly judged it to be sustainable and there was no cause
to worry. This obviously ignored the potential instability
in private flows, a lesson which has been learned since

11 The Thai current account deficit had reached 8 per cent of
GDP, the same level as in Mexico before the crisis, and
there was also a real appreciation of the baht, though not
as much as in the case of the peso. Fund surveillance clearly
picked up signals which had preceded the crisis in Mexico,
but it did not pick up financial sector weakness which had
not been identified as a cause of crises earlier.

12 This is not to deny that capital flight can take place even
without capital account liberalization. However, while a
regulated system has leakages, the speed at which outflows
can take place in the face of restrictions is obviously much

13 See, for example, Radelet and Sachs (1998). The failure
of the Fund’s programmes in the Russian Federation and
Brazil was less damaging to the Fund’s credibility, because
in those cases the failure was due to non-performance of
the requirements under the programme. This is most
glaring in the case of the Russian Federation, but it was
also true in Brazil, where fiscal commitments under the
programme were called into question in the legislature,
thus creating doubts about the government’s ability to
implement the programme.

14 A Fund Staff study (Lane et al., 1999) has defended the
high interest rate policy followed in East Asia by arguing
that it was not associated with an excessive contraction in
money supply. Real growth in money supply and domestic

25International Monetary and Financial Issues for the 1990s, Vol. XI

credit in all three countries was adequate to accommodate
growth, and it was particularly accommodative in
Indonesia. A lower interest rate policy would have meant
an even faster growth in money supply, with the risk of
intensifying the inflation-depreciation cycle.

15 Disclosure alone may not be much help because the com-
plexity of many derivative instruments makes it very dif-
ficult to determine the net exposure to risk of institutions
extensively involved in derivatives trading. The whole
issue of the management of risks associated with deriva-
tives is one which needs greater attention from regulators
not only in developing countries but also in industrialized

16 The relationship between such a body and the national
regulators was never clarified, although it is clearly an
important issue which cannot be avoided.

17 The marginalization of the Fund in substantive policy
coordination among G-7 countries was most evident at
the time of the Plaza Accord and the Lourre Accord.

18 SRF resources are made available over a period of one
year and carry an interest rate 300 basis points above the
normal Fund charges. They are expected to be repaid
between one and one and a half years after withdrawal,
but the repayment period can be extended by a year. In the
latter case the interest spread increases to 500 basis points.

19 It was relatively clear that the bilateral package for Thailand
was to be disbursed pari passu with Fund financing. No
part of the bilateral package for Indonesia or the Republic
of Korea was disbursed.

20 The Fund staff study of the East Asian experience (Lane
et al., 1999) admits that the resources made available under
the programmes were deemed to be sufficient only on the
assumption that the programmes would lead to a quick
restoration of confidence reversing the capital outflow. This
did not happen, however.

21 The recent Brazilian package is an example of a Fund
arrangement negotiated in anticipation of a crisis, but even
that negotiation was carried out at a stage when the crisis
was looming and conditionality was therefore fairly stiff.

22 If all possible types of adverse developments could be
fully anticipated, the appropriate policy response in each
hypothetical case could also be defined and agreed in
advance, and financing could be extended automatically
in the event of a crisis, subject to the pre-agreed policy
corrections being adopted. However, it is clearly im-
possible to anticipate all the circumstances in which a crisis
would be triggered and agreement, reached in advance on
the corrective action needed. In the absence of such
agreement, some negotiation of suitable conditionality after
the crisis occurs appears unavoidable.

23 Since pre-qualification implies a substantial convergence
of perceptions between the government and the Fund be-
fore the crisis, it could be argued that it increases the prob-
ability that a mutually acceptable adjustment programme
to deal with the crisis will be negotiated.

24 This process is mutually beneficial for both debtors and
creditors just as domestic bankruptcy laws are designed
to prevent creditors from engaging in a “grab race” for
assets, which would only push the debtor into liquidating.
Since the value of the firm as a going concern is generally
greater than the value of its assets in liquidation, bank-
ruptcy laws provide opportunities for firms to bring in
fresh capital and restructure their debts in a mutually ben-
eficial manner for both debtors and creditors.

25 Exiting creditors would not be seen to benefit if Fund
programmes actually succeeded in stabilizing exchange
rates. However, when these fail to do so, as in East Asia,

the Russian Federation and Brazil, creditors able to exit
because of Fund financing do benefit. The benefit is evi-
dent where the debt is denominated in domestic currency
and the exit enables them to avoid the loss of confidence,
but it is also present where the debt is denominated in
foreign currency, since exiting creditors avoid the increase
in default risk associated with an exchange crisis.

26 This is not to suggest that it would ensure identical terms
of debt restructuring. That would necessarily depend on
the circumstances of each case.

27 This is effectively the formula that was used for exchange
rate regimes in the Second Amendment after the collapse
of the Bretton Woods system. Members can choose
whatever regime they wish, but they must inform the Fund
of their choice.

28 SALs are specifically designed to allow the Bank to lend
in conjunction with a Fund programme to countries facing
a crisis where there is a presumption that the country will
need structural adjustment lending in the post-crisis phase.
ESALs have a much shorter repayment period (between
three and five years) and carry an interest rate at least 400
basis points higher than the Bank’s normal lending rate.

29 Schultz, writing jointly with William Simon and Walter
Wriston (Schultz et al., 1998), first criticized the Fund for
imprudent lending and adding to moral hazard in East Asia,
and argued that it should be abolished. Subsequently, he
suggested the alternative of merging it with the World Bank
(Schultz, 1998).

30 The 20 countries that would qualify on this basis in the
first two categories are the United States, Germany, Japan,
France, the United Kingdom, Italy, Canada, Belgium, the
Netherlands and Switzerland among the industrialized
countries, and Saudi Arabia, the Russian Federation,
China, India, Brazil, Venezuela, Mexico, Argentina,
Indonesia and South Africa among the others. All the G-22
participants would be included except Australia, Hong
Kong (China), the Republic of Korea, Malaysia, Poland
and Thailand. Some of these, e.g. Australia, would be likely
to be included as constituency representatives.


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