Financial Daily from THE HINDU group of publications
Friday, Jan 27, 2006
RBI & Other Central Banks
Has the IMF lost its relevance?
DECEMBER should have been the cruellest month for the International Monetary Fund (IMF). On January 13, Brazil's Finance Ministry announced its decision to repay the entire debt of $15.5 billion due to the IMF two years in advance. Two days later, the President of Argentina, Mr Nestor Kirschner decided to repay $9.8 billion ahead of schedule and how Argentina would be "burying a good part of (our) history of indebtedness".
Brazil was the Fund's biggest debtor and Argentina, its second.
Since the days of the "tequila crisis" in Latin America in 2000, the IMF has had a love-hate relationship with them. Do their decisions signal that the Fund is losing relevance? The debate on this is rather old.
In September last, days before the Annual IMF/World Bank Meetings, the Institute for International Economics (IIE), Washington, held a conference covering all aspects of the IMF's governance and work.
Its Director, Mr Fred Bergsten, a renowned economist, argued that, "the IMF has become weak and ineffective".
Around the same time, Mr Mark Weisbrot, wrote, "The IMF has not been reformed, but its power to shape economic policy in developing countries has been enormously reduced." (International Herald Tribune, September 22, 2005.)
The earlier years led to a contentious debate in the US Congress and among economists in the background of the Meltzer Commission Report. Prof. Alan Meltzer and Prof. Calamoris were caustic in reviewing the performance of the IMF and how it bred `moral hazard'. They suggested an advisory role for the IMF. However, the US Treasury was more than aware of the broader interests the IMF served.
The IMF's slide over the years has been precipitous. As described by Walden Bello and Shalmali Guttal, "In 1985 the Fund and the Bank stood at the pinnacle of their power."
By taking advantage of the Third World debt crisis, they instituted "structural adjustment programmes" in more than 70 countries.
By 1995, the IMF stood unchallenged as the centrepiece of the global financial system (the new financial architecture) and had a mission to bring about capital account liberalisation. "By 2005, the credibility of the IMF was in shreds."
The loss of relevance has many roots. Basic was the ever-emerging irrelevance of its policy package or the so-called `Washington Consensus'.
This was further aggravated by the way it operated and its responses to the financial crises over the years. As years passed, there were creeping doubts about the IMF's `surveillance' capability, viz., ability to predict and prevent crisis.
The combined effect was that developing countries hesitate to approach the IMF for succour. The global banking and financial sector move away from it unlike in the 1980s.
It is ironic that the `Washington Consensus', which was put through by J. H. Williams on the basis of experience gained in Latin America in the 1980s, should have led to so much misery, economic turmoil and insecurity in the region.
Prof Dani Rodrik of Harvard University was very perceptive when, as early as in 1999, he predicted that Latin America would need to carve a different path for itself and "develop an alternative vision that articulates how the tension between market forces and the yearning for economic security can be eased." (`Why is there so much economic insecurity in Latin America?', World Bank, October 1999.)
Unfortunately, the Consensus became a magic formula applicable to all countries and for all their ills.
There have been long debates on the Consensus. Facing disturbing evidence to the contrary in Latin America and elsewhere, the IMF experts would raise the bar higher and higher and blame the borrowing countries for lacking in will to push through reforms.
Mr Jose Antonio Ocampo, Under Secretary General for Social and Economic Affairs, UN, narrates the growth and equity frustrations in Latin America in recent years under the Consensus (Journal of Economic Perspectives, December 2004).
Though `reforms' brought down inflation, induced export growth and attracted foreign investment, growth was slow, volatile and exacerbated dualism in the economies. The rich were getting richer and benefits did not reach those at the bottom. Social and ethnic disruptions led to political upheavals.
At present, of a total population of 365 million in the sub-continent, 300 million are ruled by governments that are openly Left or near Left. They have moved away from the US and resist policy prescriptions based on the Consensus. They could combine and wreck the grand vision of a Free Trade Area of the Americas (FTAA),
As analysed in a classic study by Prof. Ha-Joon Chang of the University of Cambridge, "There is a growing concern that, over the last quarter of a century, the "policy space" available for the developing countries has shrunk so much that their ability to achieve economic development is being threatened." (July 2005). His reference is to the enforcement of the Consensus. As long as the IMF is wedded to the Consensus or any of its variants, elected democracies in developing countries are unlikely to approach the IMF.
The IMF has lost relevance and it is no surprise that Brazil and Argentina decided to get `emancipated.'
There is evidence that the IMF is not a reliable ally to help countries in crisis. In the IIE Conference, Mr Martin Redrado, Governor, Central Bank of Argentina, explained, "The fact that a growing number of countries is relying on their own resources to reduce vulnerability definitely shows a lack of credibility in the IMF as a liquidity provider...the reserve building process that is taking place in several countries has been stimulated by the lack of clear rules and transparency in IMF decisions as regards to crisis management and prevention."
As Mr Brad Setser put it in his blog, "The real challenge to the IMF... come from the fact that many emerging markets have far more reserves than they know what to do with." (September 20, 2005.) "China has more than enough hard currency stashed away to lend Brazil $50 billion more than the IMF provided in 2002 should Brazil need it."
Though they are aware of the costs of building reserves, they opt for it, as they are unwilling to be guided by the IMF or subject themselves to conditionality which "often goes beyond narrow monetary and fiscal matters to prescribe policies on privatisation, trade and industrial policy".
There are trends suggesting that countries are moving towards regional currency arrangements, such as the establishment of Chiang Mai Initiative or an Asian Monetary Fund (AMF).
Part of the uncertainty attached to IMF assistance stems from the fact that G7 governments, particularly the US, use the Fund as a vehicle to achieve political ends. There are academic studies by economists such as Graham Bird, Rowlands, Barro and Lee which establish this.
The role and influence of the US, which has virtual veto power on the IMF's lending, have also been well established. Countries friendly to the US, such Turkey and Pakistan, are favoured while others are not. The Fund's conditionality also differentiates between countries, where the `friendly' get away with no bite and the `less friendly' are subject to severe measures.
This was evident in the IMF's dealings with Brazil and Argentina in 2001-02 at the height of their crisis. The Independent Evaluation Organisation (IEO) explained in its `Report on Argentina' (June 2004) how important decisions were "taken outside the Executive Board."
For some years, the Fund has been claiming that its involvement in developing countries would catalyse inflow of private capital. Professors Graham Bird and Dane Rowlands have studied the claim and said, "The justification for this claim is non-compelling. The theory behind it is ambiguous with plenty of reasons to anticipate that catalysis will be limited." Rather, the IMF's reliance on private inflows delayed development of infrastructure in developing countries by a decade leading to serious rethink in recent months.
There is evidence that major banks no longer look to the IMF as in the 1980s and the early 1990s.
In the earlier decades, evidence suggested, "the political status of commercial banks creates compelling incentives for the IMF to direct its resources to developing country governments that are heavily indebted to commercial banks." (`Commercial Banks and the International Monetary Fund: An Empirical Analysis', Thomas Oatley, University of North Carolina, July 2002.)
The intention clearly was to bail out the creditor banks and not the countries. In 1995, the US could bail out its banks in Mexico by pushing a loan package of $50 billion in one working day without approval by the IMF's Executive Board. When the Asian crisis erupted, the US' response was lukewarm as Japanese banks were in trouble. The US could scuttle Japan's initiative to establish an Asian Monetary Fund.
After the Asian crisis, the banks shifted their strategies from syndicated loans to bond or other instruments. This was a measure of self-insurance suggesting lack of trust in the Fund's ability or readiness to foresee crisis or help in time. Banks are now making extraordinary use of derivatives in varied forms, in league with hedge funds, and to hide their liabilities or cushion their losses against default. It is clear that the IMF has lost relevance for them.
When Argentina declared default of its bonds valued at $100 billion, the IMF worked overt time to bring about a Sovereign Debt Restructuring Mechanism (SDRM). It hoped to become the ultimate arbiter in debt disputes while retaining its own `privileged status' as a creditor.
Unfortunately, American banks and the Treasury would not go along and the SDRM teetered. Sadly, even in the eyes of the US Treasury, the IMF has lost relevance. As Robert Skidelsky wrote in his biography, Lord Keynes who conceived the idea of the Fund "would roll in his grave to see the fate of his child."
(The author, a former Finance Ministry official, has extensive experience in international, financial and trade issues.)
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