Sustained and consistent reforms are critical to restoring confidence by tgj38769


                                                                                                                                    Monetary Fund
                                                                                                                                    VOLUME 32
                                                                                                                                    NUMBER 8
                                                                                                                                    May 5, 2003

                                                                                                                                    In this issue
Sustained and consistent reforms are critical                                                                                       Köhler on Latin
                                                                                                                                    America’ prospects
to restoring confidence in Latin America                                                                                            121
                                                                                                                                    Politics of

S    peaking at the Thirty-Third Washington
     Conference of the Council of the Americas on
April 29, IMF Managing Director Horst Köhler
                                                                                                                                    IMF lending

                                                                                                                                    Comments sought
expressed optimism about Latin America’s growth                                                                                     on draft financial
prospects. Despite difficult economic times, he said, the                                                                           indicators guide
people have indicated no desire to return to past                                                                                   126
authoritarian regimes, and several countries have                                                                                   Following up
recently reaffirmed their commitment to a market-                                                                                   on Monterrey
based system. A summary of Köhler’s address, delivered
at the U.S. Department of State, follows.                                                                                           128
                                                                                                                                    Public policies
                                                                                                                                    and poverty
   Latin America is beginning to recover from a diffi-              Horst Köhler: The IMF is fully engaged in supporting
cult year, Köhler said. In 2002, the region experienced                                                                             132
                                                                    economic reform in Latin America.
                                                                                                                                    Stock market
its worst downturn in 20 years, although there were                                                                                 volatility
significant differences between countries. Growth                   Countries with stronger policies, such as Chile and
slowed in many countries, particularly Argentina and                Mexico, weathered the crisis better.                            134
                                                                                                                                    African stock
Venezuela, but picked up in Mexico and Peru. The                                                                                    markets
adverse global environment affected many Latin                      Agenda for success
American countries, especially those that relied on                                                                                 and…
                                                                    The first quarter of 2003 brought additional signs of
financing from international capital markets.                       improvement, Köhler said, (Please turn to the following page)   124
                                                                                                                                    Selected IMF rates
IMF Institute seminar                                                                                                               130
Politics of IMF lending:                                                                                                            New on the web

who borrows from the IMF and why?                                                                                                   Recent publications

A     t a March 28 IMF Institute seminar, a trio of
      political economists attempted to “make sense of
IMF lending.” They made a case for looking beyond
                                                                    James Vreeland (Yale), and Erica Gould (University of
                                                                    Virginia) highlighted in their presentations.

old-style economics, which ignores political factors, in               Why do countries that have or could conceivably
favor of new-style economics, which incorporates all of             have access to external financing turn to the IMF for
politics into a single vari-                                                                    a loan? Why is there an
able. This new approach,                                                                        IMF? It has been said that
they said, can provide a                                                                        if the IMF did not exist,
more nuanced economic pic-
                                                                                                it would be necessary to
ture because it focuses on the
                                                                                                invent it. Jeffrey Frieden
conflicts of interest that are
inherent in the political                                                                       reiterated that view, dip-
environment. Factoring poli-                                                                    ping into history to
tics into economic decisions                                                                    describe the international
also has implications for                                                                       creditor committees that
both the IMF and the coun-                                                                      have existed since the
tries that borrow from it, as    Left to right: IMF Institute Director Mohsin Khan with         development of modern
Jeffrey Frieden (Harvard),       Jeffrey Frieden, Erica Gould, and James Vreeland.                      (Please turn to page 123)    121
                         Restoring confidence in Latin America
                        (Continued from front page)including export growth in        resources to support national economic programs.
                        several countries and improved market perceptions.           Outstanding IMF resources to the region are about
                        In Brazil, the new government’s macroeconomic poli-          $42 billion, more than half of the IMF’s total lending.
                        cies are beginning to bear fruit, and he welcomed            And, increasingly, he said, the IMF is helping coun-
                        Brazil’s successful return to international capital mar-     tries meet international standards and codes in the
                        kets for the first time in over a year. He also wel-         economic and financial areas, an objective that is par-
                                                    comed Uruguay’s recent           ticularly important for restoring investor confidence.
                                                    debt exchange offer, which       As for the poorest countries in the region—for exam-
                                                    will help achieve a more sus-    ple, Nicaragua—the IMF is extending financial sup-
                                                    tainable medium-term debt        port for their reform programs through its Poverty
                                                    profile for the country. On      Reduction and Growth Facility.
                                                    Argentina, Köhler noted that
                                                    the IMF stands ready to          Challenges for the region
                                                    work with the new leader-        Köhler agreed with Mexico’s former president,
                                                    ship on a comprehensive          Ernesto Zedillo, that the main problem in much of
                                                    reform program, which will       Latin America had been too little reform and, in par-
                                                    be needed to build on the        ticular, inconsistent reform. “Sustained and cons-
                                                    current stabilization gains      istent reforms are critical to restoring confidence—
                                                    and establish a firm basis for   confidence needed for more investment and better
                                                    sustained strong growth,         access to financial markets.” Thus, Latin America’s key
                                                    commensurate with the            challenge will be to keep good policies on track.
William R.              country’s considerable potential. It is these develop-          But, Köhler said, Latin America also needs, and
Rhodes (right),
Chairman of
                        ments, Köhler said, that give him grounds for                deserves, support from the rest of the world. The
the Council of          optimism.                                                    first priority, he said, should be to strengthen trade,
the Americas,              In addition, he noted that new leaders in the             which offers significant potential for economic
confers with            region were formulating agendas for increasing long-         growth and for reducing countries’ vulnerability to
                        term sustainable growth while improving social               external shocks stemming from swings in capital
                        equity. He pointed to three elements that he consid-         flows. For Brazil alone, Köhler said, the liberaliza-
                        ered particularly important:                                 tion of market access under free trade agreements
                           • increasing the economy’s resilience to crisis by        with the European Union and the Americas could
                        achieving low inflation, which will require, first and       boost exports by $18 billion, or 32 percent, primar-
                        foremost, placing public financing on a solid footing;       ily for agricultural products. In that connection, he
                           • strengthening the institutions that underpin            welcomed the initiative to establish a free trade area
                        a market economy and implementing structural                 of the Americas. However, in moving ahead with the
                        reforms to raise economic growth potential; and              free trade area, he cautioned that it would be imper-
                           • addressing issues of social equity and governance       ative to ensure consistency with the multilateral
                        to buttress popular support for reform.                      trade discussions being held under the Doha Round.
                           Köhler noted that there was no single model for           Trade is critical to restoring confidence to the world
                        success. In many cases, he said, national traditions         economy, and the United States and Europe bear
                        would shape individual approaches. But he was cer-           primary responsibility for ensuring that the Doha
                        tain that the common agenda held much promise                Round is brought to a successful conclusion. And,
                        for the region. “Promoting sound institutions and            by supporting higher economic growth and poverty
                        strengthening the culture of accountability and trust        reduction, it will also enable developing countries to
                        are critical to ensuring sustainable long-term growth        participate more fully in the benefits of globaliza-
                        and social equity. Without social equity, there can be       tion. Regional and multilateral trade initiatives share
                        no social peace, and without social peace, long-term         the same objective: raising economic growth and
                        investment and sustainable economic growth will              prosperity by promoting trade and cross-border
                        remain elusive.”                                             investment.
                           The IMF is fully engaged in supporting economic              Latin America has enormous potential for growth,
                        reform in Latin America, Köhler said. It is helping its      Köhler concluded. And it now has leaders who know
          May 5, 2003   members make their economies more crisis-proof by            the way forward: through investment in better inte-
                  122   providing policy advice, technical assistance, and           gration with the global economy.
Why countries borrow from the IMF                                                                                                  It is valuable
                                                                                                                                   to try to
(Continued from front page)   sovereign lending 150 or            credit and adopting economic reforms. Another                    understand
so years ago. Their IMF-like function was to deal with            group strongly opposes reform but is indifferent to              IMF lending
the difficult cross-border and jurisdictional property            access to credit. A group in the middle wants access to          as a signal
right issues that accompanied sovereign lending. For              credit but is ambivalent to, or opposes, reform. This            to private
example, the Ottoman Public Debt Administration                   third, pivotal group functions as a “veto player” and            markets.
was set up in 1881 and functioned for about 50 years:             must be won over if reform is to take place.                        —Jeffrey Frieden
in its heyday, it controlled about one-fourth of the                 According to Frieden, this situation offers scope for
revenue of the Ottoman Empire. Between the two                    Pareto improvements (when a reallocation of resources
World Wars, creditor committees coexisted with the                makes at least one group better off without making
League of Nations and eventually led to the Bank for              any group worse off) because the first group could
International Settlements, established to deal with               compensate the others for the costs of reform out of
German reparations and debt payments. In the                      the benefits it gains from acquiring access to external
absence of an international bankruptcy court, those               credit and implementing policy reforms. However,
institutions, Frieden said, like the IMF today, moni-             such outcomes are politically difficult to achieve.
tored and supervised debtor country policy and con-
ditional lending.                                                 Value of IMF conditionality
                                                                  When the special interest groups are unable to strike a
Debtor-country scenario                                           political bargain, a country neither reforms nor gains
Like their historical counterparts, modern debtor                 access to external credit. But an IMF-supported pro-
countries are often unable to pull themselves out of              gram, according to Frieden, can help untie this knot.
debt, partly because of conflicts within governments              For one thing, it serves as a country’s seal of approval
about what changes need to be made. Jeffrey Frieden               and a commitment device for undertaking reform,
presented a debtor-country scenario to illustrate a               which signal private markets that the country’s
conflict between the desirability of access to external           domestic policies are credible. These features allow
credit and the desirability of policy change. Suppose,            private creditors to extract what they need to know
he said, a country has three special interest groups.             about a country’s creditworthiness from a plethora of
One interest group strongly favors gaining access to              information, much of it incomplete and asymmetric.

 Comments sought on financial
 soundness indicators guide                                       securities and real estate markets. The encouraged indica-
                                                                  tors are designed to add depth to financial soundness
To encourage countries to develop stronger and more effec-        assessments but may be relevant at the present time for
tive financial sectors, the IMF is preparing the Guide on         only a limited number of countries.
Financial Soundness Indicators. The IMF recognizes that              Experts from international statistical organizations, stan-
analytically sound and readily understood indicators can          dard setters, and IMF member countries provided com-
give policymakers and the markets a good quantitative pic-        ments on an earlier draft; the current version incorporates
ture of the stability and soundness of a country’s financial      their comments. Beginning in April, the draft guide has
system. The guide, currently in draft form, will provide          been the subject of a series of regional outreach seminars,
background information on concepts, definitions, and data         in which the guide’s major themes and issues have been
sources and offer techniques for compiling and disseminat-        discussed, and comments elicited from a wider range of
ing core and encouraged indicators.                               users. In addition, the current draft has been posted on the
   Core indicators seek to assess the banks’ (deposit-taking      IMF’s website for public review and comment.
institutions’) capital adequacy, asset quality, earnings and         Once comments have been received, the draft will
profitability, liquidity, and sensitivity to market risk. These   undergo another round of revisions. The guide is expected
indicators are likely to be useful in all countries, regardless   to be finalized by the end of 2003.
of their institutional characteristics or stage of develop-          The text of the draft guide is available on the IMF’s
ment, and are feasible to collect without excessive extra         website at
resources.                                                        Comments, which must be received by June 20, can be
   Encouraged indicators seek more detailed data for              e-mailed (, faxed (1 (202) 623-5411), or
deposit-taking institutions and go beyond these institutions      mailed, addressed to: Director, Statistics Department,
to other key sources of vulnerability, such as nonbanks, cor-     International Monetary Fund, 700 19th Street NW,
porations, households, and relevant markets, including            Washington, DC 20431, U.S.A.                                     May 5, 2003
                         But the most important characteristic of an IMF-          debt rescheduling; and loss of investment, as failure
                      supported program is that it can change a country’s          would send a negative signal to investors.
                      domestic political balance by addressing its conflicts          To illustrate, he described Uruguay’s situation in
                      of interest. Through its conditionality, an IMF-             1990, when an unpopular president (Luis Alberto
                      supported program can offer compensation with an             Lacalle de Herrera) sought to push through reforms
                      international component. That is, it links access to         but faced multiple obstacles: a legislature in which
                      IMF lending, hence external credit, to domestic policy       a different party held the majority, a coalition govern-
                      change. The veto players acquiesce because the com-          ment that fell apart, and a system with a national
                      pensation carries an international component. But, he        referendum involving, potentially, a further veto.
                      noted, the impact of conditionality depends on two           So Lacalle negotiated an IMF program (a Stand-By
                      things: the character of the veto players and the char-      Arrangement, approved in 1990), and the outcome
                      acter of a country’s political institutions. With regard     was considered a success overall. Uruguay ended up
                      to the veto players, at what price are they willing to       with a budget surplus of 0.37 percent of GDP in 1990
                      reduce their opposition to reform in exchange for            and of 0.91 percent in 1991. Moreover, the state
                      access to external credit? As for institutions, do they      monopoly on insurance was eliminated, and four
                      have other available commitment devices and com-             banks were privatized.
                      pensation mechanisms, and how responsive are they               Switching perspectives, Vreeland suggested that
                      to special interest groups?                                  increasing the number of veto players could have the
                         But the ultimate question, Frieden said, is, what         opposite effect on the IMF. Executives hindered by
                      motivates politicians to broker trades with broad            many checks and balances would probably require
                      long-term effects? The longer a politician’s time hori-      more assistance to push through unpopular reforms
                      zon, the more likely he or she is to internalize the         and, at the same time, be less able to commit to signif-
                      positive effects of the deal. The larger the politician’s    icant policy changes. Thus, if the IMF sought agree-
                      constituency, the more likely it is, again, that he or she   ments with countries that were likely to bring about
                      will internalize the positive effects of the policy.         the most reform, it could prefer countries with fewer
                         It is valuable, Frieden concluded, to try to under-       veto players. Vreeland noted that this political econ-
                      stand IMF lending as a signal to private markets. The        omy perspective of IMF lending had implications for
Although              signal is credible and valuable because of the IMF’s         IMF reform. Whereas “the IMF claims it prefers not to
countries often       ability to catalyze the reworking of domestic political      get involved in domestic politics,” he said, it becomes
complain that         coalitions by linking access to credit to policy change.     involved the moment it attaches conditions to its
the IMF               And political economy? It might be relevant even for         resources that entail raising taxes and cutting spend-
imposes               apolitical economists, Frieden said, because it can          ing. Vreeland concluded that the IMF could perhaps
conditions            open up areas for new understanding.                         make it an official policy to seek out and assist
on them,                                                                           reform-minded governments or, in some other way,
conditionality        Why do countries turn to the IMF?                            make its role in countries’ domestic politics explicit.
could make            In exploring debtor countries’ motivations, James
reform more           Vreeland also looked at the role of veto players. He
likely.               argued that the more veto players a country’s political
                                                                                     Selected IMF rates
 —James Vreeland
                      system had, the more likely it was that the executive
                      would enter into an IMF arrangement.
                                                                                       Week                SDR interest         Rate of           Rate of
                         Although countries often complain that the IMF              beginning                rate           remuneration         charge
                      imposes conditions on them, Vreeland suggested                April 21                  1.77                1.77              2.27
                      that conditionality could make reform more likely.            April 28                  1.75                1.75              2.24
                      A reform-minded executive may be unable to push               The SDR interest rate and the rate of remuneration are equal to a
                                                                                    weighted average of interest rates on specified short-term domestic
                      through unpopular reforms without the approval of             obligations in the money markets of the five countries whose cur-
                      other actors—for example, the congress or coalition           rencies constitute the SDR valuation basket. The rate of remunera-
                                                                                    tion is the rate of return on members’ remunerated reserve tranche
                      partners, depending on the system—who represent               positions. The rate of charge, a proportion of the SDR interest rate,
                      veto players. But the executive does not necessarily          is the cost of using the IMF’s financial resources. All three rates are
                                                                                    computed each Friday for the following week. The basic rates of
                      need approval to enter into an IMF arrangement,               remuneration and charge are further adjusted to reflect burden-
                      which may call for the very measures the executive            sharing arrangements. For the latest rates, call (202) 623-7171 or
                                                                                    check the IMF website (
                      favors. Once an agreement with the IMF is signed,
                                                                                    General information on IMF finances, including rates, may be accessed
                      Vreeland said, a country’s failure to meet program            at
        May 5, 2003   commitments incurs “rejection” costs: restricted              Data: IMF Finance Department
              124     access to IMF credit; postponement or cancellation of
How IMF lending has changed                                      must meet to continue receiving IMF financing.
Focusing on the political factors that influence IMF             Her findings included
lending, Erica Gould began by reviewing the work of                 • a relatively gradual increase in the number of
scholars who have modeled the IMF to explain lend-               conditions in IMF programs (although her data for
ing patterns (see box, below). The three models may              the 1990s, she said, are less complete);
offer some useful insights into the politics of the IMF,            • relative stability in the length of IMF programs
she said, but they have missed a key dynamic.                    through the mid-1970s, after which their length shot            Which actors
   According to Gould, the dramatic changes that                 up and became more variable; and                                should be
have occurred in IMF conditionality over the past                   • increased phasing over time, with loans being              influencing the
50 years have been driven by financiers that supple-             released in a larger number of tranches.                        IMF and its
ment IMF loans, as well as by changes in the sources                Gould said her quantitative research and case stud-          activities
of state financing. The financiers are crucial to the            ies provide initial support for her argument. Each              depends on
success of IMF programs and, for that reason, have               group has systematically different reasons for provid-          what one
some leverage over program design. Change occurs                 ing supplementary financing to IMF borrowers.                   thinks the IMF’s
because the three types of financier—creditor states,            Thus, as the sources of financing have shifted and              role should be.
private financial institutions, and other multilateral           diversified over the years, Gould argued, so, too, have                —Erica Gould

organizations—have different reasons for lending                 the demands on the IMF and the institution’s activi-
and different preferences as to what should be in-               ties. For example, lending was initially dominated by
cluded in an IMF program. Creditor states provide                a small number of creditor states, but their number
finance for political ends and favor relatively few con-         has risen since World War II. The other two types of
ditions so that their allies are not destabilized by a           financier, meanwhile, have become more active.
program; private financial institutions are profit ori-             Many outsiders are studying the IMF and trying to
ented and prefer conditions that will enable them to             understand the reasons for changes in its activities.
be repaid; other multilateral institutions are moti-             Some, Gould observed, would argue that her work
vated by policy objectives and prefer specific, detailed         supports the contention that the IMF is an agent for
conditions related to their areas of expertise.                  multinational corporations and banks and should be
   Gould used material from the IMF’s archives to                further reformed. Others would argue that one of the
test the plausibility of her argument. Her data set              IMF’s primary purposes is to facilitate supplementary
included 249 loans (all Stand-By, Extended Fund                  financing for borrowers and that, as a result, the
Facility, Structural Adjustment Facility, and Enhanced           influence of supplementary financiers on IMF condi-
Structural Adjustment Facility Arrangements)                     tionality is neither surprising nor problematic. In the
between 1952 and 1995, coded according to the tar-               end, she said, which actors should be influencing the
geted conditions. She focused on binding conditions,             IMF and its activities depends on what one thinks the
or performance criteria, which program countries                 IMF’s role should be.

                                                                    (1) The IMF is viewed as an actor in itself with some
 Models of IMF lending
                                                                 autonomy to pursue its own interest and is not simply a
                                                                 conduit for state preferences. The IMF derives some auton-
Erica Gould outlined the perspectives of three competing         omy through development of expert knowledge, which in
models of the IMF.                                               turn has driven changes in conditionality.
                                                                    (2) The IMF is trying to maximize its budget, staff, and
   Realist. Powerful states control IMF lending. The United      independence. Changes reflect the bureaucracy’s drive for
States, the largest shareholder, controls IMF decisions, and     greater power.
lending thus reflects U.S. interests. The IMF is more likely     Sources: Michael Barnett and Martha Finnemore, “Expertise
to lend to a U.S. ally, determined by its voting record in the   and Bureaucratic Power at the International Monetary Fund”
United Nations relative to the U.S. voting record.               (unpublished), and Roland Vaubel, 1996, “Bureaucracy at
   But, Gould says, this measure of alliance may be captur-      the IMF and the World Bank,” World Economy, Vol. 19,
ing something different. For example, countries voting           pp. 195–210.
increasingly like the United States may be reforming or             Liberal. States direct activity of international organiza-
democratizing and are thus most likely to receive loans.         tions, which are seen as serving the collective interests of
Source: Strom Thacker, 1999, “The High Politics of IMF           states rather than the narrow interests of the powerful.
Lending,” World Politics, Vol. 52, pp. 38–75.                    Changes in these organizations’ activities are often attrib-
   Bureaucratic. IMF staff and management determine              uted to objective changes in the nature of the problems
IMF activities and lending, with changes in conditionality       they are trying to address.
                                                                                                                                 May 5, 2003
being driven internally by organizational actors.                Source: IMF staff.
                        ECOSOC dialogue with Bretton Woods institutions
                        Improved coordination sought
                        in Monterrey Consensus follow-up
                        O      n April 14, the United Nations Economic and
                              Social Council (ECOSOC) gathered for the sixth
                        annual high-level dialogue with the Bretton Woods insti-
                                                                                       Eduardo Aninat, IMF Deputy Managing Director—
                                                                                    representing both IMF Managing Director Horst Köhler
                                                                                    and the Chair of the International Monetary and
                        tutions. The meeting, which took place in New York City,    Financial Committee (IMFC), Gordon Brown––
                        focused on improving coordination in implementing the       focused on the conclusions coming out of the April 12
                        Monterrey Consensus and on tracking progress toward         IMFC meeting. He reaffirmed the IMF’s commitment to
                        achieving the UN Millennium Development Goals               helping countries achieve the MDGs and encouraged
                        (MDGs).                                                     stakeholders to build on the historic compact for devel-
                                                                                    opment reflected in the Monterrey Consensus between
                           Before heading home after the spring meetings of         developed and developing countries.
                        the IMF and the World Bank, ministers of finance and           Aninat also highlighted the IMF’s work on surveil-
                        development stopped in New York City for a day-long         lance and financial assistance, noting that the IMF was
                        session with ministers of foreign affairs, UN delegates,    doing its part by working with the World Bank to
                        senior officials from international organizations           monitor policies and actions needed to make progress
                        (including the UN, the IMF, the World Bank, and the         toward reaching the MDGs. The IMF was also align-
                        World Trade Organization (WTO)), and representa-            ing its concessional financing (the Poverty Reduction
                        tives from civil society and the private sector. This       and Growth Facility) with the priorities outlined in
                        year’s top issue was how to increase coherence, coordi-     domestically generated and owned Poverty Reduction
                        nation, and cooperation between multilateral organi-        Strategy Papers (PRSPs), which play a central role in
                        zations in following up on commitments made at the          bringing together domestic policies and international
                        March 2002 International Conference on Financing            support in reaching the MDGs at the country level.
                        for Development in Monterrey, Mexico.                          Clearly, the IMF’s efforts to reach out to the UN
                           The other priority was identifying the actions and       in recent years, in particular its support for the
                        policies needed to help countries achieve the MDGs,         Monterrey Consensus and the MDGs, have con-
                        with an emphasis on ensuring sound domestic poli-           tributed greatly to a better understanding between
                                           cies, reducing distorting agricultural   officials in New York and Washington. While many
                                           subsidies and increasing market          people on both sides of the fence have contributed to
                                           access for developing countries,         this outcome, Aninat was specially commended for his
                                           ramping up official development          constructive role. As Nitin Desai, UN Under-
                                           assistance, securing debt sustainabil-   Secretary-General for Economic and Social Affairs,
                                           ity for heavily indebted poor coun-      noted, by now people understood that “not everyone
                                           tries, and enhancing the voice and       in Washington had red tails and not everyone in New
                                           vote of developing countries in inter-   York had white wings.”
                                           national organizations.                     On a more serious note, there appeared to be
                                              Deputy Secretary-General Louise       widespread support for the PRSPs as the most
                                           Fréchette, opening the meeting on        promising framework for implementing the MDGs
                                           behalf of the UN Secretary-General,      and recognition of the value added in reaching out to
                                           recalled that political leaders had      a wide range of actors, including parliamentarians.
Eduardo Aninat: The
                        pledged in Monterrey to remain engaged and to use           There was also broad recognition of the emerging
IMF is working with
the World Bank to       the UN as a forum for dialogue, in particular to bring      consensus on the need for institution building and
monitor policies and    together the key specialized multilateral institutions in   enhanced capacity, including the capacity of develop-
actions needed to       finance, trade, and development. In a statement that        ing country officials to negotiate trade agreements.
make progress
                        resonated in many subsequent interventions, she             All of these initiatives are likely, in turn, to facilitate
toward reaching
the Millennium          pointed out that developing countries had long been         medium-term progress toward the MDGs.
Development Goals.      encouraged to eliminate subsidies to improve their fis-        Fathallah Oualalou, Morocco’s Minister of Finance,
                        cal positions and create conditions necessary for           noted that many participants identified a lack of
                        growth but that advanced economies persisted with           coherence in developed country policies, underscoring
          May 5, 2003   agricultural subsidies and tariffs that hurt developing     the need to address this problem. Developing countries
                126     countries’ exports.                                         were also urged to recognize that their policies lacked
coherence at the domestic level. They could not be            reinforcing. PRSPs were widely seen as a useful vehi-
sure, for example, that their finance, trade, and plan-       cle to promote more coherent domestic development
ning ministers were always on the same wavelength.            policies. A number of speakers agreed with Morocco’s
                                                              Oualalou that regional groupings, such as the New
Priorities for the future                                     Partnership for Africa’s Development, could also help
Several broad themes emerged from the meeting’s pre-          countries improve the effectiveness of policies. Gert
sentations, with participants acknowledging the con-          Rosenthal, Guatemala’s
sensus on what domestic policies are needed, the desir-       Ambassador and
ability of faster progress in reaching goals, the key role    President of ECOSOC,
of trade, the need for policy coherence, the importance       spoke for the entire
of more and better-quality aid, and the key issue of          gathering when he
improving the voice of developing countries in the            concluded that, on the
deliberations of the IMF and the World Bank.                  international level, the
   Faster progress in implementing the MDGs and the           current dialogue
objectives of the Monterrey Consensus. Concerted and          between ECOSOC, the
strong political will is needed if countries are to realize   Bretton Woods institu-
their commitments. Trevor Manuel, Finance Minister            tions, and the WTO
of South Africa and Chair of the joint World Bank–            could also enhance
IMF Development Committee, noted that, at the                 coherence, as this dia-
spring meetings, the committee had welcomed prog-             logue spanned the different cultures of finance, trade,        Louise Fréchette:
                                                                                                                             Developing countries
ress in developing a global monitoring framework              development, and foreign affairs ministries.                   have long been
that would permit regular assessment of progress                 The quantity and quality of official development            encouraged to
toward development goals. Monitoring will reinforce           assistance (ODA) must be substantially increased.              eliminate subsidies to
accountabilities in the developing and developed              In addition to a call for countries to meet their ODA          improve their fiscal
                                                                                                                             positions and create
countries, as well as in their institutional partners.        commitments, many speakers concurred with Hilde                conditions necessary
   Consensus on the domestic policies that developing         Frafjord Johnson, Norway’s Minister of International           for growth, while
countries need to pursue to achieve the MDGs. There           Development, that the regulations and reporting                advanced economies
exists broad agreement that prudent macroeconomic             requirements demanded from recipient countries                 persist with agricultural
                                                                                                                             subsidies and tariffs
and structural policies are essential, particularly to        should be streamlined and harmonized to enhance
                                                                                                                             that hurt developing
increase savings and investment opportunities. Also           the effectiveness of aid.                                      countries’ exports.
critical are good governance, strong institutions, peace         It will be important to improve the voice and repre-
and political stability, active and effective human devel-    sentation of developing countries in the decision-
opment policies, and infrastructure development.              making processes of the IMF and the World Bank.
Aninat, in particular, stressed that such policies would      Manuel noted that many participants indicated that
help underpin sustainable growth and strengthen               strengthening the capacity of developing countries
countries’ resilience to adverse global developments.         would enhance their voice and improve the account-
   A successful Doha Round of trade negotiations is           ability and legitimacy of international institutions.
essential. Many delegates agreed with WTO Deputy              Some participants agreed with Fouad Siniora,
Director-General Francisco Thompson-Flôres that the           Lebanon’s Minister of Finance and the chair of the
Doha Round incorporated ambitious goals that, if              Group of 24 that the voting power in the IMF and the
successful, would go a long way toward strengthening          World Bank should be redistributed to reflect develop-
confidence in the world economy and helping coun-             ments in the global economy. These issues are sched-
tries fight against poverty. He noted that the Septem-        uled for further discussion in the two institutions.
ber 2003 Cancun ministerial meeting would be a key
opportunity to provide the momentum needed to                 Preview for October meeting
ensure that the round is completed on schedule by             While the April 14 dialogue did not conclude with
end-2004. Many delegates stressed that areas of critical      formal agreements, its ideas will feed into a General
importance for developing countries—especially agri-          Assembly discussion on progress on the Monterrey
culture—required urgent attention.                            Consensus in October. That meeting will also evalu-
   There must be policy coherence at the national,            ate where the world is in terms of achieving the
regional, and international levels. As implementation         MDGs.
occurs at the country level, domestic policymaking
processes will need to be coordinated so that policies                        Patrick Cirillo, IMF Secretary’s Department,   May 5, 2003
emanating from different ministries are mutually                                      and Axel Palmason, IMF UN Office       127
                     Do public policies play a role
                     in reducing poverty?
                                                                                      Measuring poverty
                     P     overty reduction is today the central objective of
                           the IMF’s policy design and advice for low-income
                     economies, along with the institution’s more traditional
                                                                                      A major challenge for research in this area stems from
                                                                                      the scarcity of poverty-related data for low-income
                     emphasis on correcting financial imbalances and pro-             countries. There are several ways of measuring
                     moting the development of productive resources and               poverty. For example, the United Nations, in setting
                     economic growth. In a recent IMF Working Paper, “Is              its Millennium Development Goals, defines as poor
                     Growth Enough? Macroeconomic Policy and Poverty                  those who live on less than $1 a day. In this study,
                     Reduction,” Dhaneshwar Ghura, Carlos Leite, and                  poverty is defined as the average income of the lowest
                     Charalambos Tsangarides find that some public policies           20 percent of the population in the income distribu-
                     are “super pro poor”—that is, they appear to directly            tion—a measure used by other researchers for econo-
                     influence the incomes of the poor.                               metric analysis. We used data from a large set of
                                                                                      developed and developing countries during 1950–99.
                        The renewed sense of urgency for faster, deeper
                     poverty reduction has spawned a growing debate on                Main findings
                     the determinants of poverty and strategies for allevi-           An initial, simple exercise of identifying correlations
                     ating it. A key point of reference in the literature has         between variables (see box, below, for a summary of
                     been the impact of rapid economic growth on                      methodology and variables; see the Working Paper
                     poverty reduction in East Asia. Indeed, recent empiri-           for details) indicates that, on average, countries in
                     cal work has found that economic growth is a key                 which the poor have incomes higher than those of
                     driver of poverty reduction, with little or no direct            their counterparts in other countries are character-
                     role for economic policies (once account is taken of             ized by higher macroeconomic stability, lower income
                     the effects of economic growth). The fact that recent            inequality, better internal environments, more demo-
                     research finds that public policies play only a small            cratic political institutions and better governance, a
                     role, or no role, in directly lowering poverty moti-             better-educated population, more open trade
                     vated this study.                                                regimes, and higher levels of financial development.

                        Methodology and variables
                                                                                         The 18 potential explanatory variables accounted for
                       Econometric work with data for several countries spanning         • overall average income (which was kept in all the
                       a number of years faces some daunting challenges: country-           regressions);
                       and time-specific effects, endogeneity of explanatory vari-       • the internal environment or resources (including
                       ables, omission of relevant variables, and uncertainty about         natural resources and ethnicity);
                       the effectiveness of the underlying statistical model, among      • institutions / governance (including rule of law and
                       other things. In this study, we used two methodologies.              level of democracy);
The IMF has
                          The first is a traditional framework to reproduce some of      • human capital (including educational outcomes and
a key role
                       the existing results in the literature and to show that the          life expectancy);
to play in             methodology is perhaps inadequate for such analysis. In           • physical capital (including private and public
helping to             particular, while correcting for a number of the economet-           investment);
alleviate              ric problems noted, this framework cannot address model           • macroeconomic stability (including inflation and
poverty.               uncertainty, which arises because of the lack of clear theo-         fiscal balance);
                       retical guidance on the choice of explanatory variables.          • government size (ratio of government consumption
                          The second methodology—a check for robustness—                    to GDP);
                       corrected for this problem along with the others. In simple       • the trade regime (including share of exports and
                       terms, it attempts to account for all possible combinations          imports in GDP);
                       of explanatory variables in the statistical regressions. We       • the external environment (including changes in the
                       used 18 potential explanatory variables, basing the robust-          terms of trade); and
                       ness check inferences on the results of a very large number       • financial development (including the ratio of broad
       May 5, 2003     of regressions.                                                      money to GDP).
   The econometric analysis confirmed the impor-           basic education, health, and nutrition, this result
tance of economic growth in raising the incomes of         points to the importance of the quality of investment
the poor, although the elasticity of the incomes of the    in human capital in poverty reduction efforts.
poor with respect to average income is sensitive to the       Some of the statistically nonsignificant results are
variables that are included in the statistical regres-     also noteworthy. For example, a number of vari-
sions (an elasticity of one implies that a 1 percent       ables—such as trade openness, the investment rate,
increase in overall average income raises the average      the extent of democracy, life expectancy at birth, and
income of the poor by 1 percent). We also found that       the extent of civil
the econometric estimates derived from the tradi-          wars—that have been
tional statistical regression framework were not           shown in the empiri-
robust. In particular, the traditional framework was       cal literature to affect
unable to say anything about the direct impact of          economic growth do
public policies on the incomes of the poor. As a           not directly influence
result, one would tend to conclude that such policies      the incomes of the
may have no independent effect and alleviate poverty       poor (once the level
only through their influence on economic growth.           of overall average
   But, using a second framework to check for robust-      income has been
ness (see box, page 128), we found that the data con-      accounted for). A
tained other interesting information, especially about     corollary is that, to
the role of public policies. The findings confirmed the    the extent that it is
relationship between economic growth and poverty           closely related to
reduction, although the relationship is less than one to   globalization, trade                                       Schoolchildren in
one. More specifically, for a given target for poverty     openness does not appear to hurt the incomes of the        Guinea.
reduction over a certain period of time, the economic      poor but, instead, has a positive effect by boosting
growth rates required could exceed what can reason-        overall economic growth.
ably be expected (compared with what would be
required if an increase in economic growth resulted in     Policy implications
an increase of one to one or greater in the incomes of     We found that raising overall economic growth is
the poor). We also found that certain public policies      indeed key to poverty reduction. The bottom line is
have a direct impact on the incomes of the poor, even      that growth—and lots of it—is needed so that the
after controlling for the effect of economic growth.       extra income generated can also benefit the poor.
These include policies that lower inflation, shrink the    But, while growth is a necessary condition for poverty
size of the government, promote financial develop-         reduction, it is by no means sufficient. Countries        Public policies
ment, and raise the educational level. The policy-         need to implement policies that focus on creating an      that raise the
related variables are considered “super pro poor”          enabling environment for the poor to participate in,      educational
because they raise the incomes of the poor directly,       and benefit from, the growth process.                     level of a
as well as indirectly, through economic growth. The           Our results also suggest that the IMF has a key role   population
direct and indirect effects are mutually reinforcing,      to play in helping to alleviate poverty. The IMF’s pri-   also raise the
and there are thus no identified trade-offs between        mary mandates include assisting countries in the          incomes of the
growth promotion and poverty alleviation. The results      design of policies that lead to low and predictable       poor.
also indicate that the poor are significantly vulnerable   inflation; reorienting government resources to pro-
to adverse movements in the terms of trade.                ductive outlays (including health and education) by,
   Another interesting result relates to the importance    for example, lowering unproductive government con-
of secondary school (and not primary school) enroll-       sumption; and deepening the financial sector. In pro-
ment in directly raising the incomes of the poor. This     moting such policies successfully, the IMF can do a
result appears puzzling in view of the notion that pri-    lot to lower poverty in the world, and it needs to con-
mary education plays a central role in lowering            tinue focusing on this issue in sub-Saharan Africa,
poverty. Our finding does not contradict this view;        Latin America and the Caribbean, and parts of
instead, given that social indicators for health and       Europe and Asia where large segments of the popula-
education are highly correlated, this result tends to      tions live in absolute poverty. Coordination with the
highlight the importance of public policies that           World Bank and other development agencies is
enhance social outcomes. In addition, to the extent        important, as they also have a key role in focusing on,
that the secondary school enrollment ratio represents      for example, social policies that lead to higher social   May 5, 2003
the quality of the accumulation of investment in           outcomes in low-income countries, as well as on           129
                       strategies to help these countries diversify their export    empirical relevance. It would also be important for
                       bases (to lower their vulnerability to adverse terms of      more empirical work to be undertaken on policies
                       trade shocks).                                               that allow the poor to participate fully in, and benefit
                          The pro-poor public policies described in this paper      from, the economic growth process.
                       enable the poor to participate in the growth process             Second, it is not clear how relevant the recom-
                       through the labor market or self-employment and              mendations derived from cross-country regression
                       to safeguard the purchasing power of their incomes.          studies are for individual countries. There is, there-
                       A stable macroeconomic environment, characterized            fore, a need for more country-specific studies of
Pro-poor               by low and predictable inflation, makes it possible for      experiences with poverty reduction, despite the
public policies        the poor to do the latter. One argument in the eco-          dearth of data. Third, the impact of economic
enable the             nomic literature is that inflation is a “harsh tax” on the   growth and the “super pro poor” policies on the
poor to                poor because they are less likely than the rich to have      incomes of the poor does not necessarily imply cau-
participate in         access to financial hedging instruments protecting the       sation from one to the other. An examination of the
the growth             real value of their wealth. Financial sector development     issue of causation would require continuous data
process                also benefits the poor by facilitating access to credit      over long periods of time for a given country—but
through the            and improving risk sharing and resource allocation.          such data rarely exist.
labor market           Educational achievement, facilitated by government              Finally, the issue of how long it takes for public
or self-               investment in health and education, allows the poor to       policies to make a significant dent in poverty needs
employment             participate in the economic growth process through           careful consideration. Again, more poverty-related
and to                 employment. The reduction of government consump-             data are needed. An important challenge for the
safeguard the          tion (used as a proxy for government size in this study)     international community is to finance the collection
purchasing             allows more scarce resources to be devoted to invest-        and dissemination of more household-level poverty
power of their         ment in health and education.                                data over time in low-income countries.
                       Unresolved questions                                                                  Dhaneshwar Ghura and Carlos Leite
                                                                                                                      (IMF African Department)
                       The existing empirical literature on poverty reduction                                     and Charalambos Tsangarides
                       leaves a number of questions unresolved. First, how                                      (George Washington University)
                       can public policies have an independent effect on the
                       incomes of the poor when the underlying framework
                                                                                     Copies of Working Paper No. 02/118, “Is Growth Enough?
                       controls for overall income as an explanatory vari-           Macroeconomic Policy and Poverty Reduction,” by
                       able, which itself incorporates the poor’s income? We         Dhaneshwar Ghura, Carlos Leite, and Charalambos
                       believe that the independent effect occurs through a          Tsangarides, are available for $15.00 each from IMF Publica-
                                                                                     tion Services. See page 131 for ordering information. The full
                       distributional channel, but how exactly? For such an          text of the Working Paper is also available on the IMF’s web-
                       evaluation, it would be necessary to specify relevant         site (
                       transmission mechanisms and to rigorously test their

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Recent publications

IMF Working Papers ($15.00)                                          03/61: “The Impact of External Indebtedness on Poverty
03/43: “Poverty and Social Impact Analysis—Linking                      in Low-Income Countries,” Boileau Loko, Montfort P.
   Macroeconomic Policies to Poverty Outcomes:                          Mlachila, Raj Nallari, and Kadima D. Kalonji
   Summary of Early Experiences,” Caroline M. Robb                   03/62: “Factors Underlying the Definition of Broad
03/44: “Estimation of the Equilibrium Real Exchange                     Money: An Examination of Recent U.S. Monetary
   Rate for South Africa,” Ronald Macdonald and                         Statistics and Practices of Other Countries,”
   Luca A. Ricci                                                        Ewe-Ghee Lim and Subramanian S. Sriram
03/45: “Primary Dealers in Government Securities:                    03/63: “Interest Rates, Credit Rationing, and Investment
   Policy Issues and Selected Countries Experience,”                    in Developing Countries,” Mwanza Nkusu
   Marco Arnone and George R. Iden                                   03/64: “How to Fight Deflation in a Liquidity Trap:
03/46: “Are They All in the Same Boat? The 2000–2001                    Committing to Being Irresponsible,” Gauti B.
   Growth Slowdown and the G-7 Business Cycle                           Eggertsson
   Linkages,” Thomas F. Helbling and                                 03/65: “Fiscal Deficits and Inflation,” Luis A. Catão and
   Tamim A. Bayoumi                                                     Marco E. Terrones Silva
03/47: “Market Volatility as a Financial Soundness
   Indicator: An Application to Israel,” Armando                     IMF Country Reports ($15.00)
   Morales and Liliana B. Schumacher                                 (A country name indicates the report is the country’s
03/48: “Did Output Recover from the Asian Crisis?”                      Article IV consultation.)
   Valerie Cerra and Sweta C. Saxena                                 03/93: Republic of Armenia: Third Review Under the
03/49: “Would ‘Cold Turkey’ Work in Turkey?”                            PRGF and Request for Waiver of Performance
   Oya Celasun, R. Gaston Gelos, and Alessandro Prati                   Criterion
03/50: “Financial Integration and Macroeconomic                      03/94: Paraguay
   Volatility,” Ayhan Kose, Eswar S. Prasad, and                     03/95: Paraguay: Statistical Appendix
   Marco E. Terrones Silva                                           03/96: Tanzania: Poverty Reduction Strategy Paper
 03/51: “Does Insider Trading Raise Market Volatility?”                 Progress Report
   Julan Du and Shang-Jin Wei                                        03/97: Uganda: Financial System Stability Assessment,
03/52: “Country and Industry Dynamics in Stock                          including Reports on the Observance of Standards
   Returns,” Luis A. Catão and Allan Timmerman                          and Codes
03/53: “Inflation Performance and Constitutional                     03/98: Republic of Mozambique: Poverty Reduction
   Central Bank Independence: Evidence From Latin                       Strategy Paper Progress Report
   America and the Caribbean,” Eva M. Gutierrez Garcia               03/99: Portugal
03/54: “Trade Costs, Market Integration, and                         03/100: Republic of Kazakhstan: Report on the
   Macroeconomic Volatility,” Allan D. Brunner                          Observance of Standards and Codes
   and Kanda Naknoi                                                  03/101: Argentina: Request for Stand-By Arrangement
03/55: “Firm-Level Evidence on International Stock                   03/102: Pakistan: Joint Staff Assessment of Poverty
   Market Comovement,” Robin J. Brooks and                              Reduction Strategy Paper Progress Report
   Marco Del Negro
03/56: “Current Issues in the Design and Conduct of                  Other
   Monetary Policy,” Mohsin S. Khan                                  World Economic Outlook: Growth and Institutions,
03/57: “Do Elections Always Motivate Incumbents?                       April 2003 ($49; academic rate, $46)
   Experimentation vs. Career Concerns,” Eric Le Borgne              Managing Financial Crises: Recent Experience and
   and Ben Lockwood                                                    Lessons for Latin America, Charles V. Collyns and
03/58: “Availability of Financial Soundness Indicators,”               G. Russell Kincaid (Occasional Paper No. 217; $25;
   Graham L. Slack                                                     academic rate, $22)
03/59: “Determinants of the Choice of Exchange                       “Large and Complex Financial Institutions: Challenges
   Rate Regimes in Six Central American Countries:                     and Policy Responses—Lessons from Sweden,”
   An Empirical Analysis,” Michael G. Papaioannou                      R.B. Johnston, Balazs Horvath, Luca Errico, and
03/60: “Exchange Rate Policy and Debt Crises in Emerging               Jingqing Chai (Policy Discussion Paper No. 03/01;
   Economies,” Samir Jahjah and Peter J. Montiel                       free)

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                                                                                                                                     May 5, 2003
                               IMF Working Paper
                               Deciphering the determinants
                               of stock market volatility
                                                                                                 Nature of volatility
                               S    ince the dawn of modern stock exchanges in early
                                    seventeenth-century Europe, periodic bouts of stock
                               price volatility have puzzled economists and nonecono-
                                                                                                 Applying their methodology to a global data set of
                                                                                                 monthly returns for about 4,000 firms from 1973 to
                               mists alike. Commenting on one such episode—the                   2002, Catão and Timmerman find overwhelming evi-
                               boom and bust of the famed South Sea company shares               dence of two distinct and well-defined “states” of high
                               in 1720 England—Sir Isaac Newton is said to have                  and low volatility. Overall market volatility (country-
                               remarked, “I can measure the motion of bodies, but I              and industry-specific volatilities plus a “global”
                               cannot measure human folly.” An important strand of               volatility component common to all firms) is highest
                               current research focuses on the role of country location          around the time of the first oil shock (1973–75),
                               and industry affiliation in determining stock price               the second oil shock (1979–81), the debt crisis of
                               movements. In a new IMF Working Paper, Luis Catão                 the early 1980s, the 1987 stock market crash, and the
                               of the IMF’s Research Department and Allan                        1991 Gulf War (see chart, left). After a dramatic
                               Timmerman of the University of California, San Diego,             decline during 1992–96, volatility rose and remained
                               gauge these effects.                                              persistently above its historical average through 2002.
                                                                                                 Despite its dramatic rise in recent years, volatility has
                                                                        The extent to which      moved up and down over the past 30 years: periods
Overall stock market volatility
                                                                     country and industry        of high volatility have been followed by periods of
has been highly cyclical                                                                         low volatility. This evidence dispels the notion, held
                                                                     factors influence stock
(percent a month)
                                                                     returns has important       by some, that stock market volatility has been trend-
6                                                                    practical implications.     ing upward as financial markets become more
                                                                     If stock returns are pri-   globalized.
5                                                                                                   The country component of volatility has histori-
                                                                     marily determined by
                                                                     country location,           cally accounted for about two-thirds of overall mar-
4                                                                                                ket volatility (see chart, below). In contrast, the
                                                                     investment risk can be
                                                                     reduced by holding an       industry contribution was, for most of the time,
                                                                     internationally diversi-    much lower (see chart, page 133). Since 1997, how-
2                                                                    fied portfolio. If indus-   ever, the contribution of the industry factor has
1973          78         83           88       93       98    2002 try factors are para-         nearly tripled, to the point of standing at par with
                                                                     mount, crossing             that of the country factor, each accounting for nearly
   Data: IMF, Working Paper No. 03/52
                                                                     national borders will       one-third of overall market volatility. A similar phe-
                                    yield meager gains, and risk diversification can more        nomenon was observed during periods of industry-
                                    easily be accomplished by investing in different             specific global shocks, such as the oil crises of
                                    industries in a given country. Catão and Timmerman           1973–75 and 1979–81. However, the recent rise of
                                    use a new methodology (see box, page 133) to exam-           the industry factor has been far more persistent.
                                    ine these relationships and find that the benefit of
                                    exiting from national stock markets and buying for-
                                    eign stocks declines dramatically during periods of
                                                                                                 Country factors have historically
                                    high global volatility, such as the current one.             driven stock market volatility
                                                                                                 (percent of overall stock market volatility)
                                       Their study also supports the so-called geography
                                    or cultural view of financial markets—that is, that
                                    stocks tend to move together more tightly across             60
                                    English-speaking countries (and notably so between
                                    the United Kingdom and the United States) and                50
                                    much of continental Europe, but much less so
                                    between, say, Japan and the United States. This is true      40
                                    during periods of both high and low volatility and
                                    implies that being purely Anglophile or Europhile is         30
                                                                                                 1973           78          83             88   93   98   2002
              May 5, 2003           not beneficial, at least when it comes to diversifying
                       132          equity risk.                                                      Data: IMF, Working Paper No. 03/52
   Another salient finding is that the volatilities of             important macroeconomic implications. For
country and industry factors often move in opposite                instance, the more synchronized the movement
directions, both absolutely and in terms of their con-             of stock returns, the
tribution to overall stock market volatility, as in the            less diversifiable the      Industry factors have played a
post-1997 period. Also, several periods of high overall            equity risk. This           relatively small role historically
market volatility have been associated with high                   raises the equity risk       (percent of overall stock market volatility)

industry volatility, such as the early 1970s, 1979–81,             premium and, hence,         50
and 1997–2002. On the one hand, this suggests that                 the cost of capital for
major industry shocks effectively become global                    firms, which, in turn,      40
shocks. On the other hand, the diverging patterns of               tends to choke aggre-
country and industry volatilities pose interesting pos-            gate investment.            30
sibilities for risk diversification.                                  The main question
                                                                   then becomes: what
Implications for risk diversification                              happens to the vari-
An important practical spin-off of their analysis,                 ous relationships
Catão and Timmerman say, is the feasibility of                     between industry and          0
reducing overall investment risk by diversifying port-             country portfolios           1973          78         83           88     93 98 2002

folios along country or industry lines. They point                 when the global mar-            Data: IMF, Working Paper No. 03/52
out that, given that overall market returns display                ket is characterized
distinct patterns of volatility, as do country and                 by high or low volatility, and when industry and
industry factors, a crucial question for risk diversifi-           country factors themselves experience high or low
cation is how these components move together dur-                  volatility?
ing different periods of volatility. This question is not             Catão and Timmerman’s analysis leads to four
only relevant for the individual investor but also has             conclusions:

 New model incorporates dynamics of
 country and industry factors                                          To overcome these drawbacks, Catão and Timmerman
                                                                   developed a new two-stage model. In the first stage, cross-
Traditionally, a standard method has been used to identify         sectional regressions of individual firms’ stock returns are
the relationship between stock returns and country and             run on a set of country and industry dummy variables to
industry factors. A simple cross-sectional regression of           form country-specific and industry-specific portfolios.
                                                                   Each of these portfolios measures excess returns (positive
stock returns is run for a large number of firms and coun-
                                                                   or negative) associated with investing in a specific country
tries on a set of dummy variables that capture a variety of
                                                                   or industry as opposed to investing globally. In the second
country and industry characteristics. Then monthly varia-
                                                                   stage, the dynamic evolution of such excess returns is
tions in these dummy variable coefficients are averaged over       jointly modeled as a regime-switching process—that is,
time, and their respective contribution in explaining total        it is allowed to undergo an alternating sequence of high-
stock return volatility is computed.                               and low-volatility states.
    While appealingly simple, this methodology has signifi-            The new method has two main advantages. First, using
cant drawbacks, say Catão and Timmerman. First, to com-            stock return data for individual firms to form country and
pute country and industry contributions, the traditional           industry portfolios allows the model to deal with “unbal-
model uses either arbitrary fixed subperiods—an approach           anced” panels where not all firms survive through the
that invariably introduces sample-selection biases—or rolling      period under review. This is important because any real
moving averages that may result in artificial U-shapes or          world data set will include firms that come to life and die
                                                                   within the selected time period. In contrast, other methods
curves. Second, this procedure implicitly assumes that
                                                                   that are based on full panel estimators of very large data
changes in country and industry factors are very gradual. In
                                                                   sets that are artificially balanced for computational ease
reality, policies that influence country risk often display dis-
                                                                   will have biased results insofar as relevant information is
tinct changes, and the emergence of new technologies, such         lost by excluding firms that do not live throughout the
as information technology, can rapidly and drastically alter       whole period. Second, the construction of country and
the dynamics of industry factors. Third, the linear structure      industry portfolios reduces the number of time series to
of the standard model simply cannot account for periods of         a manageable dimension, allowing the model to focus on
sustained increases in volatility.                                 the dynamics of the relevant portfolios.
                                                                                                                                  May 5, 2003
                           • Diversification gains vary significantly depend-        • Finally, while overall diversification gains are
                        ing on the level of volatility underlying the global,     more meager when global and industry-specific
                        country, and industry factors. In particular, the bene-   volatility both rise (as in the post-1997 period), in
                        fits of investing abroad tend to be much more mea-        such periods investors benefit somewhat more by
                        ger when global volatility is high.                       diversifying across industries rather than along
                           • Given the correlations between various country       country lines.
                        portfolios, the benefits of investing abroad are even
                        smaller when international diversification is confined
                        to Anglo-Saxon countries or continental Europe.             Copies of IMF Working Paper No. 03/52, “Country and
                           • When global volatility is low, it makes sense to       Industry Dynamics in Stock Returns,” by Luis Catão and Allan
                        diversify equity holdings across national borders.          Timmerman, are available for $15.00 each from IMF Publi-
                                                                                    cation Services. See page 131 for ordering information. The
                        One practical manifestation of this was the massive
                                                                                    full text is also available on the IMF’s website (
                        wave of foreign investment in the years prior to the
                        1997 Asian crisis.

                        Forum showcases region’s stock exchanges
                        Africa is “more than ready”
                        for foreign portfolio investment

                        G    iven the “striking absence” of local capital in
                             Africa, noted Mark Malloch Brown,
                        Administrator of the United Nations Development
                                                                                  Stock markets—new and old
                                                                                  Ndi Okereke-Onyiuke, Chair of ASEA and Chief
                                                                                  Executive Officer of the Nigerian Stock Exchange,
                        Program (UNDP), stock markets have a potentially          noted that both the ASEA and most stock markets
                                                 vital role to play in helping    in Africa have a short history. The ASEA, she said,
                                                 develop local capital markets    was founded in 1993 chiefly to promote the develop-
                                                 and encouraging foreign          ment of African capital markets and to highlight the
                                                 investment inflows. A two-       largely untapped investment opportunities in the
                                                 day forum provided an            sub-Saharan region. The ASEA-UNDP-NYSE forum
                                                 opportunity to showcase some     represents a relative high point because it has been
                                                 of the high-performing com-      difficult, thus far, to give African exchanges a high
                                                 panies listed on African         profile in the West. Okereke-Onyiuke expressed the
                                                 exchanges and the consider-      hope that if Africa could build strong regional
                                                 able scope for future invest-    exchanges, “perhaps the world will talk to us.”
                                                 ment opportunities.                 Neither ASEA nor its member exchanges are “ask-
Ndi Okereke-                                                                      ing for handouts,” she stressed. They are extending
Onyiuke: If Africa                                  On April 14–15, more than     an invitation to developed countries—particularly
could build strong      500 Wall Street analysts, institutional investors,        their private sectors—to become partners in creating
regional exchanges,     African finance ministers, and high-level representa-     the wealth needed for Africa’s long-term develop-
“perhaps the world
will talk to us.”       tives from African stock exchanges gathered in New        ment and poverty reduction. This is a potential win-
                        York City to exchange information and explore the         win endeavor since increased investment in Africa’s
                        potential investment opportunities in Africa and its      exchanges can benefit all parties, she added, noting
                        18 active stock exchanges. The first African Capital      that five African exchanges were among the top per-
                        Markets Development Forum, jointly sponsored by           formers worldwide in 2002.
                        the UNDP and the African Stock Exchanges                     Bryant W. Seaman III, Vice President,
                        Association (ASEA), in collaboration with the New         International, New York Stock Exchange, provided
                        York Stock Exchange (NYSE), is part of a broader          the perspective of a major developed country
                        effort by the UNDP to boost foreign investment in         exchange. He noted that Africa offers an “unparal-
                        Africa—an effort that includes organizing invest-         leled opportunity” for high-growth equity invest-
                        ment dialogues in African countries and providing         ment. The NYSE wants to be a “good partner” with
          May 5, 2003   grant financing to help them secure sovereign credit      Africa’s leading companies and with the home mar-
                134     ratings.                                                  kets of these companies. Dual listings by African
companies on their home exchanges and on the                information and an electronic brokerage infrastruc-
NYSE can benefit the home markets of African com-           ture for African markets. He cited the ability of many
panies, he explained, pointing out that 56 percent of       African stock markets to offer high dividend yields
the total average daily trading volume for the seven        (even in U.S. dollar terms); the emergence of “pan-
African companies currently listed on the NYSE              African plays” in the 1990s, especially in telecommu-
takes place on the home market. Two additional              nications; listed subsidiaries of multinational firms
African companies have listed on the NYSE so far            that trade at a significant discount to their parent
this year, and African listings now make up 28 per-         firms, even though the sub-
cent of the exchange’s new foreign listings. Moreover,      sidiaries are often more prof-
more African companies have plans to have dual list-        itable and growing at higher
ings on the NYSE in the coming year.                        rates; and risk strategy diversifi-
                                                            cation offered by African mar-
Attracting financing for development                        kets, which are largely uncorre-
“It takes money to make money,” acknowledged                lated with major world markets.
Walter H. Kansteiner, U.S. Assistant Secretary of               And the prospects for these
State for African Affairs, as he outlined U.S. govern-      stock exchanges look even
ment programs to make financing available in devel-         brighter. Nkontchou predicted
oping African private and capital markets. Africa,          that three major trends will sig-
for its part, is eager. “To ask if Africa is ready for      nificantly transform these stock
                                                                                                                       Zéphirin Diabre (left)
portfolio investment is to ask a starving man if he         markets: improved trading infrastructure, increased        UNDP Associate
is ready for food,” declared Yaw Osafo-Maafo,               participation by local institutions, and increased         Administrator, confers
Ghana’s Minister of Finance. Wealth creation is cru-        market liquidity combined with promising future            with Mark Malloch
cial for development, and Africa is, he said, “more         listings.                                                  Brown, UNDP
than ready” for foreign portfolio inflows.                      Osafo-Maafo called on Western exchanges and
   Like many forum participants, Osafo-Maafo                investors around the globe to join African exchanges
lamented the negative media images and lack of              in holding annual meetings like this one; provide
information that have hampered Africa’s 53 coun-            technical support to African exchanges and help
tries in their efforts to attract private foreign invest-   them modernize, develop the necessary financial
ment. A sovereign credit rating, he suggested, can          instruments, and avoid the pitfalls that developed
help counter this. “It is better to be rated low than       country exchanges encountered in the past; and
not at all,” he said, and added that Ghana plans to         encourage more listings of African companies on
secure a sovereign credit rating in the third quarter       developed countries’ exchanges. Thahane joined
of this year. Timothy Thahane, Lesotho’s Minister of        Okereke-Onyiuke and Osafo-Maafo in noting the
Finance, also spoke strongly in favor of independent        importance of developing information and commu-
sovereign credit ratings. Attaining such a rating, he       nications technology and other aspects of stock mar-
observed, is critical for African countries’ policies       ket infrastructure so that, among other things, com-
and would be essential for borrowing on the interna-        munication could be improved between African
tional capital markets.                                     exchanges and more developed exchanges.

Strong early showing                                        Benefits of regional integration
The performance of many of Africa’s stock markets           Nkontchou noted the striking contrast between the
to date suggests considerable promise. Osafo-Maafo          trend toward regionalization and globalization in
reported that 11 exchanges achieved positive returns        major developed country markets and a proliferation
in U.S. dollar terms in 2002, with the exchanges of         of new national exchanges in Africa over the past
Botswana, Ghana, Mauritius, and the West African            decade. For African countries, a stock exchange is
Economic and Monetary Union countries posting               still perceived as a symbol of national sovereignty,
very strong returns ranging from 27 percent to              he observed.
42 percent. These compared with returns of 24 per-              But, as Kansteiner and several other forum partici-
cent and 19 percent in the U.S. and U.K. capital            pants underscored, regional integration—together
markets, respectively.                                      with further macroeconomic and structural
   There are several reasons for this relatively strong     reforms—could help African capital markets develop
performance, suggested Cyrille Nkontchou,                   and overcome some of the impediments that cur-
Managing Director of LiquidAfrica, an innovative            rently constrain them, notably small market size and       May 5, 2003
private enterprise providing Internet-based financial       illiquidity. Integrated financial markets give investors   135
                                    a trusted “signal,” Kansteiner
                                    said, pointing to how dozens
                                    of U.S. stock markets eventu-
                                    ally consolidated into three
                                    highly successful ones.
                                       Charles Konan Banny,
                                    Governor of the Central
                                    Bank of West African States,
       Laura Wallace
         Editor-in-Chief            reviewed the achievements of
       Sheila Meehan                the eight member countries
        Managing Editor
                                    of the West African
         Elisa Diehl
         Assistant Editor           Economic and Monetary                From left, Ghana’s Minister of Finance Yaw Osafo-Maafo, U.S. Assistant Secretary
                                                                         of State for African Affairs Walter Kansteiner, and Chair of the African Capital
Christine Ebrahim-zadeh             Union. He cited, in particu-
         Assistant Editor                                                Markets Development Forum Claude Bébéar (chair of AXA).
      Natalie Hairfield
                                    lar, harmonized business laws
         Assistant Editor           and indirect taxes, standard-                                     inadequacies in basic skills and management train-
      Maureen Burke                 ized banking practices, a free trade area, and a                  ing, and onerous registration procedures and other
       Editorial Assistant
     Kelley McCollum                regional stock exchange (the Bourse régionale des                 administrative barriers.
       Editorial Assistant          valeurs mobilières, founded in 1998). But challenges                  James Harmon, a former chair of the U.S. Export-
       Philip Torsani
    Art Editor/Graphic Artist
                                    remain, and he emphasized the private sector’s key                Import Bank and vice chair of the CCA-IIE commis-
         Julio Prego                role in promoting regional integration, economic                  sion, shared Patricof’s view that efforts to attract
         Graphic Artist
                                    growth, and stability.                                            increased capital to Africa would be most successful
     Prakash Loungani
                                                                                                      if driven by the private sector, in partnership with the
       Contributing Editor          More public-private partnerships                                  public sector and international donors. He termed the
The IMF Survey (ISSN 0047-          Stressing that the “seed core” of African stock                   Ex-Im Bank “one of the best public-private partner
083X) is published in English,      exchanges’ business is small and midsized firms, Alan
French, and Spanish by the IMF
                                                                                                      it was doing little business in Africa. Even today, he
22 times a year, plus an annual     Patricof, chair of Apax Partners, shared impressions              said, all of the OECD’s export credit agencies together
Supplement on the IMF and an
annual index. Opinions and
                                    of visits he made to 10 African countries last year.              provide a relatively tiny amount of export credit to
materials in the IMF Survey do      While financing for very large projects and for micro-            sub-Saharan Africa. There is clearly scope for these
not necessarily reflect official
views of the IMF. Any maps          credit projects is plentiful, he said, there is a crucial         agencies, together with agencies such as the U.S.
used are for the convenience of     shortage of capital for small and midsized firms,                 Overseas Private Investment Corporation (OPIC), to
readers, based on National
Geographic’s Atlas of the World,    whose financing needs fall in the $200,000–$500,000               serve as large financing sources.
Sixth Edition; the denomina-        range. Africa’s biggest challenge, Patricof indicated,                To help redress Africa’s needs, Harmon proposed
tions used and the boundaries
shown do not imply any judg-        would be to nurture this key group of firms, which                that all OECD export credit agencies be mandated,
ment by the IMF on the legal        have great potential to expand and create jobs, con-
status of any territory or any
                                                                                                      or at least aim, to lend 2.5–3 percent of their total
endorsement or acceptance           tribute to economic growth, and eventually seek list-             credits to sub-Saharan Africa. He also provided a
of such boundaries. Text from
the IMF Survey may be
                                    ings on exchanges.                                                preview of some of the recommendations the
reprinted, with due credit given,      To meet their needs, he recommended increased                  CCA-IIE commission would present to the U.S.
but photographs and illustra-
tions cannot be reproduced in
                                    linkages between large international companies and                government in June: a 10-year tax holiday for U.S.
any form. Address editorial         small and medium-sized enterprises. This would                    businesses that invest in Africa and maintain their
correspondence to Current
Publications Division, Room         allow large companies to take on a mentoring role                 operations for at least 10 years; liberalization of the
IS7-1100, IMF, Washington, DC       and share their skills and knowledge, as well as their            African Growth and Opportunity Act to increase
20431 U.S.A. Tel.: (202) 623-
8585; or e-mail any comments        capital. While conceding that there was still a great             trade flows; more OPIC money for African coun-
to The IMF       need for donor aid, Patricof stressed that this partic-           tries; and a more aggressive stance on debt
Survey is mailed first class in
Canada, Mexico, and the United      ular effort should be driven by the private sector,               forgiveness.
States, and by airspeed else-       perhaps in partnership with the public sector and                                                             Jacqueline Irving
where. Private firms and indi-                                                                                                            IMF African Department
viduals are charged $79.00          international donors.
annually. Apply for subscrip-
tions to Publication Services,
                                       Patricof currently chairs a commission of private
Box X2003, IMF, Washington,         sector and African leaders and practitioners, con-
DC 20431 U.S.A. Tel.: (202)
623-7430; fax: (202) 623-7201;
                                    vened by the Corporate Council on Africa (CCA)
e-mail:       in partnership with the Institute for International                  Photo credits: Pedro Márquez and Michael Spilotro
                                    Economics (IIE). Based on his discussions with pri-                  for the IMF, pages 121–25; UN/DPI, pages 126–27;
                                    vate sector firms in the region over the past year,                  USAID, pages 128–29; and Dennis Yeandle for UNDP,
                                                                                                         pages 134–36.
                 May 5, 2003        Patricof urged African countries to address corrup-
                             136    tion, poor infrastructure, poor corporate governance

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