There is a widespread feeling at the level of both governments and experts that the existing monetary and financial arrangements need extensive reforms to enable the international economy to sustain growth at a respectable rate in a milieu of stability; there is also an acute realisation now about maintaining the quality of growth.

While monetary stability, macro-economic discipline and efficiently working market mechanisms are essential for countries that embrace globalisation, these are not sufficient. These have to be supplemented by policies that promote equity. In many countries the quality of growth is suffering from widening distributional inequalities, high unemployment and stagnant real wages for unskilled workers. A large number of countries are also suffering from poor governance, corruption and crime.

The issues relating to global financial and monetary reforms can be broadly classified as follows:

(1) The exchange rate system

(2) The management of the global capital market

(3) The role of the Special Drawing Rights (SDRs)

(4) Development finance for low income countries

(1) The exchange rate system

After the breakdown of the Bretton Woods regime based on a par value system linked to the United States dollar in 1971, most countries of the world have settled for floating exchange rates.

In reality so far as exchange rate management by leading industrial countries is concerned, the period since August, 1971 has been one of muddling through. It has, however, become quite obvious that the present non-system carries considerable cost in the form of excessive volatility of floating rates, particularly as between the United States dollar, the Euro and the Japanese yen.

The character of the exchange rate regime has special significance for developing countries and transition economy countries where exchange rate management has an important role in the fight against inflation.

It remains to be seen whether in the foreseeable future, despite a strong desire for a more stable exchange rate regime, the leading industrial countries will have the will and the skill to fashion such a system. In a world in which monetary power is more widely dispersed, the management of a more stable regime of exchange rates will depend not only on the preferences of a dominant power but on the negotiations of several powers, primarily the United States, the European Union and Japan.

(2) Management of the Global capital market

The elimination of capital controls by industrial countries and a large number of developing countries as well as revolution in information and computer technologies have completely transformed the global capital market.

The management of private capital flows is one of the crucial issues of the international financial system.

The vulnerability of economies to outflows and speculative inflows of hot money has also increased considerably as a result of liberalisation and greater integration of the global financial system.

The Mexican, East Asian, Russian, Argentinean and Brazilian crises have provided vivid examples of this danger. Policy autonomy in a de-regulated and open financial system is also greatly circumscribed. It can only respond passively to sudden inflows and outflows of external funds. Stock markets too, are prone to shocks that stem from the sudden movements of a large volume of funds. The recent experience of equity markets in many developed as well in developing countries has highlighted the de-stabilising aspect of this risk.

It has been proposed that the resources available to the International Monetary Fund (IMF) should be sufficiently enlarged to enable it to help countries overcome the speculative pressures on their balance of payments stemming from unexpected developments.

The IMF while performing its surveillance function is now, inter-alia, focusing on the appropriate sequencing of capital account liberalisation and helping countries to ensure the resilience of the economy particularly of the financial sector to possible shocks.

The IMF is also trying to improve the reporting and monitoring of capital flows, particularly with respect to inter-bank credit lines.

(3) The role of the SDRs

In 1969, the IMF created the SDR as an international reserve asset -- official holdings of gold, foreign exchange and reserve positions in the IMF. The IMF allocates SDRs to its members in proportion to their IMF quotas. A member that acquires SDRs in excess of its allocation receives interest.

After the second amendment to the Articles of Agreement in 1978, the SDR has become an international unit of account. Agreement to allocate SDRs has been reached on only two occasions; the first was in 1970, the second was in January 1981 when SDRs 12.1 billion were allocated to the IMF’s then 141 members, bring the total allocations to SDRs 21.4 billion.

The SDR value is based on the value of a basket of currencies. Movements in the exchange rate of any one component currency will tend to be partly or fully offset by movements in the exchange rate of other currencies. Thus the value to the SDR tends to be more stable than that of any single currency in the basket, which makes the SDR a useful unit of account.

The case in favour of fresh SDR allocation is quite strong and is based on the following considerations:

(i) The demand for reserves will grow significantly in the future in line with the expansion of world trade and international transactions.

(ii) A significant proportion of the increased demand for reserves will arise on account of the need of developing countries and countries in transition. About 30 per cent of developing and transition countries have reserve holdings equivalent to less than eight weeks of imports of goods and services. To acquire the additional reserves to reach their desired level, the countries have to follow policies such as import compression that damage the world economy and their growth prospects.

(iii) The element of stability in the supply of reserves provided by a SDR allocation reduces the vulnerability of economies that rely heavily on private sources of credit when their reserve needs increase unexpectedly.

(iv) A fresh SDR allocation would help in achieving the objective of making the SDR the principal reserve asset of the international monetary system as mandated by the Articles of Agreement of the IMF.

The rich industrial countries comprising the United States, Germany, Japan, the United Kingdom, Canada, Italy and Australia, however, have opposed a fresh SDR allocation on the grounds that it world be inflationary and that there is no longer global liquidity need to supplement international reserves.

(4) Development finance for low-income countries:

The joint Fund–Bank Ministerial Group known as the Development Committee has been considering issues connected with the provision of development assistance to low income countries. Unfortunately so far as Official Development Assistance (ODA) is concerned, its magnitude is only around one-third of the desired target of 0.7 per cent of GNP of rich industrial countries. A great portion of ODA is politically motivated.

The funds provided by the IMF, World Bank and regional development banks have often conditionalities attached to them which generate political resistance in the recipient countries; there has also been an unfortunate tendency on the part of international financial institutions to expand the scope of their conditionalities to such sensitive issues as defence expenditures and legal reforms.

The developing countries also feel that their participation in the decision-making process of the Bretton Woods institutions should be enhanced.