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4 October 2005 Committee on Economics and Monetary Affairs European Parliament October 2005 Hearing by Lorenzo Bini Smaghi I. Introduction Madam Chair, honourable Committee Members, I would first like to thank Chairwoman Pervenche Berès for giving me the opportunity to share some thoughts on the strategic review of the International Monetary Fund (IMF). The IMF, with its nearly universal membership of 184 countries and its cooperative structure, is a unique international institution to promote global macroeconomic and financial stability and to address related economic challenges. It is in the interest of Europe to ensure that the IMF is a well-functioning institution with full legitimacy. As you know, the strategic review of the IMF covers a broad range of issues, including its role in surveillance, in providing technical and financial assistance to vulnerable member countries, and its governance. I would like to focus today on the governance of the IMF. Before I turn to the issue at hand, I would like to note that I speak here today in a personal capacity. I would also like to point out that the IMF is a country-based institution. It is, therefore, primarily a matter for EU countries to decide on how to improve IMF governance and how they want to be represented in the IMF. 1 In addressing the issue of the European representation, three areas are of particular relevance: (i) the rising global challenges to IMF representation and governance; (ii) the EU rationale and interest to reform its representation; (iii) the options for reform to strengthen EU cooperation and to increase the EU’s influence. I will conclude with an overall personal assessment. II. Global challenges to IMF representation and governance To start with, it is important to recall that the IMF is a cooperative institution, which aims at promoting macroeconomic stability and preventing and resolving financial crises. To fulfil its mandate, the IMF performs three main functions: surveillance, lending, and technical assistance. The IMF’s resources are provided by its member countries, primarily through the payment of quotas, which determine countries’ voting shares. These quotas are currently calculated on the basis of four criteria: (i) GDP, (ii) foreign exchange reserves, (iii) the degree of openness of the economies and (iv) the variability of trade and capital flows of member countries. This formula is intended to capture countries’ relative importance in the world economy, as well as their vulnerability to external shocks. The 184 countries that are member of the IMF are represented in the Executive Board by 24 Executive Directors. Most countries are grouped in constituencies (Table 1). Decisions are taken in the Executive Board according to three majority systems, depending on the issues under consideration, 50%, 70% and 85% of total votes. Very seldom a formal vote is taken as decisions are made by consensus. Over the last few years, the IMF governance has become an issue of discussion. At the last Annual Meetings of the IMF, a few days ago, the Fund’s Managing Director stated that governance has become subject to major imbalance. Three factors are behind these developments: 2 1. Quota and voting share calculations: The current voting shares of some member countries do not reflect their relative importance in the world economy (see Table 2 for a comparison of voting share and quota share). This is mostly true for some countries in emerging Asia, which request a significantly higher quota in light of their recent rapid growth, expanding trade and rising foreign exchange reserves. Moreover, the gap is expected to rise over time if the recent trends continue in the future. Just to give an example, the share in world GDP of China, which is already under-represented, is expected to double in 10 – 15 years. Over the same period, the EU’s share is projected to decrease by one third (see Table 2 for projections of countries shares in the world economy in 2020). Within Europe, based on the current formulas, there is a balance between underrepresented and over-represented countries. On the basis of the current formula, Europe as a whole does not seem to be over-represented. The formula currently used to calculate quotas is considered by many as not anymore relevant to measure countries’ relative importance in the current economic and financial environment. In particular, the emphasis on the stock of foreign exchange reserves or on the degree of trade openness are considered not to take the increasing importance of capital flows in international payments duly into account. 2. Influence: Another issue that has emerged in IMF and WB governance arises from the fact that in recent years some members of the Fund do not feel that they have enough voice to represent their problems and interests. This is the case in particular for African countries in spite of the fact that the IMF is deeply engaged in Africa (95% of the IMF programmes concern low-income countries). While Africa is not under-represented on the quota formulas, only two Executive Directors have to represent over 40 countries. There are also calls for a change in the actual organisation of the Executive Board. Some constituencies, especially the Asian, feel that they should have a stronger voice. 3 3. Effectiveness: The governance of the IMF is felt by some as not ensuring full effectiveness. The IMF’s role in the resolution of recent financial crises has led its members, especially creditors, to increase their scrutiny of the decision making process. As a result, the IMF has been criticized as being ineffective, because of the large size of its Executive Board and the slowness of its financial support to countries experiencing financial crisis. These problems are not new. In the past, the number of EDs has been increased to meet the concerns of under representation. Quota misalignments have been corrected with ad hoc quota changes. Some countries, in particular Europeans, have indicated that these traditional recipes, i.e. ad hoc quota increase, increase in basic votes and possibly increase in the number of Executive Directors, could be used again to address the most recent problems. It’s important to realise that the solutions that have been followed in the past may not be viable anymore. For instance, ad hoc increases to adjust the quotas of some underrepresented countries reduce equiproportionally the quotas of all other countries, including those that are under-represented. The increase in basic votes, also, tend to reduce the quotas of the larger shareholders. Several countries, in particular the US, Japan and other Asians have indicated that these solutions cannot be repeated in the future. There have also been various attempts to change the quota formulas in order to take into account changes in the world economy, but so far it has been impossible to reach agreement on these issues (see Table 2 for countries’ shares in the world economy). To sum up, there are many issues at stake for the IMF governance. At the IMF Annual Meetings a few days ago, the issue of quotas and representation was raised on several occasions. This discussion will continue towards next year’s Annual Meetings in Singapore. Moreover, the IMF’s 13th quota review provides an opportunity to address the issue of quotas and representation. 4 III. Europe’s rationale and interest for reform It is in Europe’s interest that the IMF preserves its legitimacy and remains at the center of the international financial system. It is also in its interest to preserve and strengthen its overall influence in the IMF. Europe has also to realise that most other countries and constituencies outside Europe, in particular the US, Japan, Asia, consider that part of the solution for the IMF’s governance lies in a redefinition of Europe’s role and way in which it is represented. Although Europeans do not necessarily need to share this broad consensus outside Europe, it is important to try to understand the reasons for this. As a matter of fact, when EU countries do coordinate and cooperate, the outcome can be powerful and the EU’s voice is highly influential. A coalition of European constituencies represents one of the larger coalitions, with over 30 per cent of the votes, more than the G11, or the US. The more EU countries coordinate and act as a coalition, the more the rest of the world considers them as a single entity. And this is why they consider their 8 chairs and over 30 per cent of the votes as excessive. Given these challenges, we should ask how the EU could contribute to find a solution with a view to maximize its interests while at the same time preserving the legitimacy of the IMF. A. Current settings of EU coordination on IMF issues EU countries indeed coordinate their positions on IMF issues, as decided in the Copenhagen ECOFIN meeting in 2002. There are two main fora through which this coordination takes place. In Europe, EU countries coordinate in the EFC and the EFC’s Sub-Committee on IMF and Related Issues (SCIMF). In Washington, the Executive Directors representing EU countries at the IMF get together regularly in the so-called EURIMF. The EFC concentrates more on long-term policy issues relevant for the EU, while the EURIMF is a forum for ongoing exchange of information and coordination. Its agenda follows closely the agenda of the IMF Executive Board. 5 This model has been effective in fostering common views on issues such as private sector involvement in crisis prevention and resolution, access limits to IMF resources, IMF conditionality, etc. On other areas where the EU has common interests such as trade, financial sector issues, development aid, there is some coordination. For example, the EU Presidency always holds a speech at the IMFC meetings and this speech is agreed among EU countries. At the latest IMFC meeting a few weeks ago, the EU Presidency speech included, for instance, a commonly agreed text on debt relief and development finance. While EU countries coordinate among themselves, it is fair to say that their overall influence on IMF decisions does not correspond to their overall voting share. This is a well-agreed fact, although not everybody agrees on the reason for this underinfluence. One hypothesis, which might not be shared by others, is that a source of weakness derives from the fact that the European countries are spread over ten constituencies. Euro area countries are spread over eight constituencies. In three of these, non-EU countries preside the constituency. What is important to recognize is that decision-making in the IMF requires the building of coalitions between constituencies, in order to achieve the desired majority of votes (even if in the end decisions are taken by consensus). Several groupings have been created. One example is the G7, which groups the seven largest industrial countries and holds nearly 50 percent of the votes. Another grouping is the G11, which consists of emerging market economies and has around 30 percent of the votes. In none of these groupings do all EU or euro area countries participate. On issues that are of relevance to monetary union, the euro area has a clear decision making process and a clear representation to express common positions. However, the euro area is not yet always fully represented when such issues are discussed at the IMF, as the Eurogroup does not always have a joint position. For example, there is no single euro area statement at the IMF Executive Board meeting on the World Economic Outlook. 6 B. Options Reform of IMF governance entails several aspects, in particular, the issue of quotas and shares and that of representation. The two are not necessarily linked, except for one aspect. Concerning quotas and shares, long-term trends in growth rates will inevitably lead to a progressive reduction in most EU countries’ quotas. This is unavoidable if quotas have to reflect the relative size in the world economy. According to some calculations, by 2020 the GDP of developing Asia (excluding Japan) could be as large as that of the current euro area countries. At present, it is less than half. These trends will have somehow to be reflected in the calculation of the IMF’s quotas and shares. How can EU’s influence be maintained or even increased if over time its quota is bound to decrease? One way to maintain or strengthen influence as the relative shares decrease could be to strengthen coordination between EU or euro area constituencies. There are different ways to achieve this. As a benchmark, it may be useful to examine the extreme case of a single chair of the European Union, as a long-term solution to EU representation. I called it a benchmark because this solution has not been endorsed by EU countries. This option has the following features: - It would consolidate the EU Member States’ voting share by regrouping all Member States into one constituency; - The EU would have to speak with a single voice, in line with developments in the foreign policy area, and would mirror the draft constitutional Treaty’s aim to streamline the EU’s representation in international fora; A sub-option would be to form a single constituency of euro area countries only. Like the first option, this would reduce the size of the Executive Board, while regrouping euro area countries. 7 C. Possible challenges for a unified European representation Regrouping EU countries in one constituency would be challenging. - First, it requires an amendment of the Articles of Agreement and hence an 85% majority vote by the Board of Governors. The EU would obtain a veto power even, with a lower overall quota share than the sum of the current shares. This could create some room to meet demands from emerging markets and developing countries for enhanced representation and to address the problem of quota shares. - Second, there is the fear that a single European chair may create a risk of polarisation in the IMF Board between developed economies, on the one hand, and emerging market and developing economies, on the other hand. However, a careful analysis of the current situation shows that the IMF is much more polarized at present, the G7 having a major influence on decisions taken by the Executive Board. In the G7, the US have a major role as they are the only country which can from alternative coalitions, either with the other G7 countries or with the G11 countries. No European country can have such a role, unless the EU countries unite. - Third, a single EU seat would eliminate mixed constituencies, where the views of creditor and debtor countries are tentatively balanced. IMF experience suggests in any case that when divergence of views emerge between debtors and creditors, these give rise to direct negotiations, in particular between the G7 and the G11. - Fourth, a single seat would imply a single position on all issues. This would require parallel progress in the implementation of an EU foreign policy. EU countries would need to design clear rules to ensure effective decisionmaking. As most IMF issues fall under the competence of the Member States, there would also be a need for mechanisms to ensure political 8 accountability. There would be a need to clarify the roles that the national parliaments and the European Parliament would be expected to play. - Fifth, a single seat would not eliminate the need for creating coalitions with other countries or constituencies to ensure that sufficient guidance is given to the IMF management. In such coalition-building, however, EU countries, speaking with one voice and acting jointly, would have a major leadership role. To sum up, a single EU or euro area seat would be quite a challenging endeavour. It would certainly call for a step forward towards political unification. V. Overall assessment EU countries face the issue of IMF governance in a rather peculiar and paradoxical situation. They see themselves as under-influential, as the IMF is largely influenced by the US. On the other hand, the non-Europeans see EU countries as coordinating more and more and acting jointly, and they consider 8 or more seats as excessive. Pressure to reform the IMF governance and representation will intensify going forward, mainly at the initiative of non-Europeans. The governance of the IMF is bound to be discussed also in many other fora, like the G20. Unless this problem is satisfactorily solved, the IMF may lose its legitimacy and be replaced by other fora. This is not in the interest of EU countries. EU countries do not have yet a common position. A EU/euro area single seat appears to be a desirable solution, but only in the long term, and in parallel with progress in other areas of political integration. For the short to medium term, it is essential to further improve coordination and cooperation on IMF issues, so as to maximise the EU influence. The risk that I see, personally, is that in the coming discussions on reforming IMF Governance Europe is isolated and divided, defending rearguard positions, not being 9 able to agree on a common proposal. Time, as well as demographic and growth trends, play against Europe. I personally believe that the EU and EU countries can gain significantly from a reform of IMF governance, which can at the same time secure EU countries’ interest, strengthen EU cohesion as well as the influence of our continent in the global economy, while serving the interest of other IMF members. To achieve this, leadership is needed. Madam Chair, honourable Committee Members, I thank you for your attention. 10 Table 1: Constituencies’ voting shares and EU countries (shaded) in the IMF Executive Board Constituencies 1 2 3 4 Voting share (%) 17.08 6.13 5.99 5.13 5 6 7 4.95 4.95 4.85 8 4.27 9 4.18 10 3.71 11 3.51 12 3.33 13 3.26 14 15 3.22 3.19 16 3.00 17 18 2.94 2.84 19 20 2.74 2.47 21 2.47 22 23 24 2.40 1.99 1.41 Executive director Alternate director US Japan Germany Belgium Austria Belarus Luxembourg France UK Netherlands Ukraine Armenia Cyprus Moldova Mexico Venezuela Costa Rica Nicaragua Italy Greece Albania Timor-Leste Canada Ireland Antigua Dominica St. Lucia Norway Sweden Denmark Latvia South Korea Australia Kiribati New Zealand Samoa Egypt Bahrain Lebanon Qatar Saudi Arabia Malaysia Indonesia Brunei Myanmar Tonga Tanzania Kenya Angola Ethiopia Mozambique South Africa Zambia China Switzerland Poland Azerbaijan Turkmenistan Russia Iran Morocco Afghanistan Tunisia Brazil Colombia Dominican Rep. Panama India Sri Lanka Bangladesh Argentina Peru Bolivia Equatorial Guinea Rwanda Benin C.A.R. Congo, R. Guinea Mauritania Senegal Czech Rep. Slovak Rep. Hungary Slovenia Kazakhstan Turkey Bosnia Georgia Romania El Salvador Spain Malta Bulgaria Israel Croatia Macedonia Guatemala Honduras Portugal San Marino Bahamas Grenada St. Vincent Estonia Lithuania Marshall Isl. Palau Seychelles Iraq Libya Syrian Barbados Jamaica Belize St. Kitts Finland Iceland Micronesia, Papua N.G. Solomon Isl. Jordan Maldives UAE Mongolia Philippines Vanuatu Kuwait Oman Yemen Cambodia Nepal Vietnam Botswana Gambia Namibia Sudan Fiji Singapore Tonga Burundi Lesotho Nigeria Swaziland Lao Thailand Kyrgyz Rep. Uzbekistan Serbia Tajikistan Algeria Ghana Pakistan Ecuador Suriname Bhutan Chile Burkina Faso Chad Côte d'Ivoire Guinea-Bissau Mauritius Togo Guyana Trinidad Haiti Paraguay Cameroon Comoros Djibouti Madagascar Niger Uruguay Cape Verde Congo, D. R. Gabon Mali São Tomé Eritrea Malawi Sierra Leone Uganda Source: IMF (some countries' names shortened due to limited space) 11 Table 2: Voting and quota shares at the IMF and shares in the world economy of selected IMF members Share at the IMF Share in World economy Current voting share (1999) Voting share (proj 2020) Cooper Formula Germany 6.0 6.3 8.0 7.0 France 5.0 4.1 5.1 4.4 United Kingdom 5.0 5.4 3.9 Italy 3.3 3.1 Netherlands 2.4 Belgium Existing formulas Excluding intra(updated 2002) EU trade Trade share (exports 2002) PPP GDP share (2002) GDP share (2002) GDP share (proj 2020) 6.0 9.8 4.4 6.7 3.8 3.7 4.9 3.1 5.0 3.2 5.7 3.4 4.4 3.1 5.3 4.1 4.0 3.4 2.9 4.0 3.0 4.1 2.3 2.5 1.4 2.8 1.3 3.3 0.9 1.4 0.8 2.1 1.7 1.3 2.0 0.8 2.7 0.6 0.8 0.6 Spain 1.4 2.0 1.9 2.0 1.4 2.0 1.8 2.4 1.8 Sweden 1.1 1.1 0.9 1.2 0.8 1.3 0.5 0.8 0.6 Austria 0.9 1.0 0.8 1.1 0.6 1.2 0.5 0.7 0.5 Denmark 0.8 0.9 0.6 1.0 0.5 0.9 0.3 0.6 0.4 Poland 0.6 0.6 0.4 0.6 0.3 0.7 0.8 0.6 0.6 Finland 0.6 0.5 0.5 0.5 0.4 0.7 0.3 0.4 0.4 Hungary 0.5 0.4 0.2 0.4 0.2 0.6 0.3 0.2 0.2 Portugal 0.4 0.5 0.4 0.5 0.3 0.7 0.4 0.4 0.2 Ireland 0.4 1.4 0.2 1.7 0.3 1.3 0.3 0.4 0.5 Greece 0.4 0.4 0.3 0.4 0.3 0.2 0.4 0.5 0.5 Czech Rep. 0.4 0.4 0.3 0.5 0.1 0.6 0.3 0.3 0.2 Slovak Rep. 0.2 0.2 0.1 0.2 0.1 0.2 0.1 0.1 0.1 Luxembourg 0.1 1.1 0.1 1.8 0.1 0.2 0.1 0.1 0.1 Slovenia 0.1 0.1 0.1 0.1 0.1 0.2 0.1 0.1 0.1 Lithuania 0.1 0.1 0.1 0.1 0.0 0.1 0.1 0.1 0.1 Cyprus 0.1 0.1 0.0 0.1 0.0 0.0 0.0 0.0 0.0 Latvia 0.1 0.1 0.0 0.0 0.0 0.0 0.0 0.0 0.1 Malta 0.1 0.1 0.0 0.1 0.0 0.0 0.0 0.0 0.0 Estonia Aggregate Euro Area (12) 0.0 32.0 23.0 0.1 33.7 24.4 0.0 30.9 24.1 0.1 37.7 27.7 0.0 23.4 17.9 0.1 40.1 31.0 0.0 21.3 15.5 0.0 31.1 23.0 0.0 21.1 14.5 United States 17.1 21.3 22.5 17.8 19.3 10.8 21.0 29.3 32.0 Japan 6.2 7.0 13.2 7.3 6.9 6.3 6.8 11.5 8.4 Canada 2.9 2.8 2.9 3.2 3.3 4.2 1.9 2.4 2.1 Switzerland 1.6 1.4 1.0 1.6 1.8 1.4 0.4 0.9 0.5 Australia 1.5 1.1 1.3 1.1 1.7 1.0 1.1 1.5 1.2 Norway 0.8 0.7 0.7 0.8 0.9 0.9 0.3 0.6 0.5 Israel 0.4 0.5 0.3 0.6 0.5 0.4 0.3 0.3 0.3 New Zealand 0.4 0.2 0.2 0.2 0.5 0.2 0.2 0.2 0.2 Iceland Aggregate 0.1 31.1 0.0 35.1 0.0 42.0 0.0 32.6 0.1 35.0 0.0 25.2 0.0 32.0 0.0 46.8 0.0 45.1 Saudi Arabia 3.2 0.8 1.1 1.0 3.6 1.1 0.5 0.6 0.7 China 2.9 7.2 1.8 4.6 3.3 5.2 13.4 4.4 11.1 Russia 2.8 1.4 2.0 1.3 3.1 1.7 2.6 1.4 1.8 India 1.9 1.6 1.0 1.0 2.2 0.8 5.8 1.6 2.6 Brazil 1.4 1.1 1.9 1.0 1.6 1.0 2.7 1.4 1.3 Venezuela 1.2 0.4 0.6 0.4 1.4 0.4 0.2 0.3 0.2 Mexico 1.2 1.9 1.7 1.9 1.4 1.6 1.8 1.7 1.8 Argentina 1.0 0.4 0.9 0.4 1.1 0.4 0.8 0.4 0.3 Indonesia 1.0 0.7 0.8 0.8 1.1 0.9 1.4 0.6 0.7 Korea 0.8 2.1 1.4 2.1 0.9 2.6 1.7 1.7 2.1 Malaysia 0.7 1.0 0.5 1.3 0.8 1.5 0.5 0.3 0.4 Thailand 0.5 0.8 0.5 0.9 0.6 1.0 0.9 0.4 0.6 Turkey 0.5 0.8 0.6 0.7 0.5 0.6 0.9 0.8 1.0 Singapore 0.4 1.9 0.5 2.9 0.5 2.2 0.2 0.3 0.3 Chile 0.4 0.3 0.2 0.3 0.5 0.3 0.3 0.2 0.3 Colombia Aggregate 0.4 20.3 0.2 22.5 0.2 15.5 0.2 20.8 0.4 22.9 0.2 21.5 0.6 34.4 0.2 16.2 0.3 25.5 Developing countries (134) Aggregate 16.7 8.8 11.6 8.9 18.8 13.2 12.3 6.0 8.3 EU (25) Advanced economies (9) Non-EU Emerging Markets (16) 12