[Title] November 23, 2003

Crisis Prevention and Resolution

I. Crisis Prevention

The international financial system has experienced chronic financial crises. Inrecent years, we have seen a currency crisis in Mexico in 1994, financial crisisin Asia in 1997 and crises in Russia and Brazil in 1998. The crises in Argentinaand Turkey since last year are still fresh in our memories.

In order to prevent such financial crises from occurring, it is essentialthat we strengthen the surveillance functions of the IMF and other multilateralinstitutions. Particularly important is appropriate policy management, whichincludes the adoption of an appropriate exchange rate system and prudent debtmanagement, as well as the proper surveillance of such policies by theinternational community.

Adoption of exchange rate regime

There is a variety of exchange rate regimes: they include a strict fixedexchange rate system, such as dollarization and currency board systems; afloating exchange rate system; and various intermediate systems between thesetwo.

With regard to a fixed exchange rate regime, one option is to fix a currencyto a basket of currencies rather than to a single currency, when trade andinvestment partners are diversified. As in the case of the introduction of asingle currency in Europe, adopting a single currency could be anotheralternative, depending on the degree of labor mobility and integration ofintra-regional trade and the degree of similarities of economic structureswithin the region.

In adopting an exchange rate regime, it is important to take into account thepros and cons of each regime as well as economic fundamentals which support sucha regime, for example, the level of foreign exchange reserves, trade structure,and the degree of capital account liberalization. It is particularly importantthat each country implement appropriate macroeconomic policy and adopt anexchange rate regime that is consistent with its economic policy.

For example, in the case of Argentina, the Argentine government implemented amacroeconomic policy that was not compatible with its currency board system,forcing the system to be abandoned in the end. To implement a macroeconomicpolicy that is consistently compatible with the currency board system is verydifficult to achieve, but this example shows that proper surveillance ofmacroeconomic policy is of particular importance.

Debt management

In addition to adopting an appropriate exchange rate regime, it is alsoimperative that each country implement prudent debt management policy. As wasclearly pointed out in the Asian Financial Crisis, it is essential for agovernment to know precisely the maturity structure of its assets andliabilities and to have a firm grasp of risks of debt increase associated withthe movement of exchange rates. We have to be mindful of the point, forinstance, that sharp depreciation of a currency can drastically increase thelevel of real debt owed by domestic corporations and banks.

It is also important to make careful analysis of the economic parameterswhich tend to precede crises, taking advantage of our past experiences. Forinstance, it is important to closely monitor the ratio of short-term debt toforeign exchange reserves. It is also necessary to sharpen our methods ofanalysis, while making use of "debt sustainability analysis" now beingdiscussed at the IMF.

Capital account liberalization

Further, in crisis prevention we should pay further consideration to capitalaccount policy. Although liberalization of long-term capital transactions suchas FDI needs to be expeditiously pursued, due consideration has to be paid tothe risk of currency and financial crises which might arise from abrupt inflowsand outflows of short-term capital. It is also important to pursue capitalaccount liberalization while taking into consideration the fragility of domesticfinancial systems.

Surveillance

In view of the large volume of cross-border capital movements in recent years,the probability of currency crisis and financial crisis looms ever larger.Against such backdrop, we need to strengthen economic surveillance on such itemsas sound macroeconomic policy management, compatible exchange rate regime anddebt sustainability. The importance of forums like the G20 will ever increase inthe future.

II. Crisis Resolution

To resolve an international financial crisis three pillars are essential: (i)official sector lending from the IMF and other international financialinstitutions; (ii) policy adjustment by the government facing the crisis; and(iii) private sector involvement (PSI). The IMF, the G7, and other forums arecurrently discussing these issues, and steady implementation is called for.

Official sector lending

With regard to the IMF's lending, it is important that lending exceeding thenormal access limits be restricted to exceptional cases, based on a thoroughexamination of debt sustainability and the catalytic effect for private capitalflow.

As for the IMF's quotas, which constitute the basis for the volume of IMFlending, we are now approaching the final phase of the general review which isdone once every five years. The recent increase in cross-border movements ofcapital requires that sufficient financial resources be available to resolvefinancial crises and I believe that the current level of the IMF resources isnot adequate. I strongly hope that an agreement will be reached on the increaseof the quotas before the deadline of end-January 2003. Further, the currentallocation of quotas does not reflect recent international developments,particularly the growth of the Asian economy. It is therefore necessary toreview the quotas so as to realize more appropriate allocation.

Policy adjustment

In crisis resolution, it is essential that an IMF program, including policyadjustment by the country in the crisis, be formulated and implemented in asteady manner and with ownership. In September, new guidelines on conditionalityfor IMF programs were drawn upon with a strong emphasis on this point. We expectthat streamlined and appropriate IMF programs will be formulated and implementedbased on these new guidelines.

Private sector involvement

In the process of crisis resolution, the restructuring of sovereign debt issometimes unavoidable. In order to change the terms of repayment of sovereigndebt, (i) a contractual approach with collective action clauses (CACs) and (ii)a statutory approach called the sovereign debt restructuring mechanism (SDRM),which involves an international legal framework, are now being examined at theIMF and other forums. These two approaches are complementary and, therefore, wesupport a two-track approach, by which we study the two approaches at the sametime.

With regard to collective action clauses, the G7 Finance Ministers agreed attheir last meeting that G7 countries should include such clauses when they issuebonds outside their own jurisdiction. In the markets of the UK and Japan, suchclauses are already introduced in the bonds contracts. I hope that emergingmarket economies will include collective action clauses based on the modelclauses now being examined by the G10, with close consultation with the privatesector when they issue bonds in the United States.

On the statutory approach, as it was agreed at the September meeting of theIMFC, the IMF will develop a concrete proposal by the next IMFC meeting in May,and I look forward progress being made on this issue.