Challenges for Rato’s successor

Within hours of the announcement of Rodrigo de Rato’s surprise resignation from the International Monetary Fund (IMF), pundits and officials started speculating about his successor. Since it is customary for the Fund to be headed by a European, the only question seems to be whether he (she is unlikely) will be British, Italian or French. However, Rato’s legacy raises more important issues for the IMF... and for Europe.

When Rato took over in 2004, the IMF’s core business was indisputably the prevention and resolution of financial crises in developing countries. From the Asian crises of 1997-1998 to the Argentinean debacle of 2002, the Fund had been busy the world over assisting countries in crisis and helping them to restructure their debt; the main discussion about the Fund’s role had been whether to transform it into some sort of court for the settlement of sovereign debt defaults, as proposed in 2001 by Rato’s future deputy Anne Krueger.

Rato had to deal with very different issues during his mandate. There has been no significant financial crisis in recent years. On the contrary,  the IMF had to begin looking for ways of earning revenues other than by charging interest on the credits it extended to countries such as Argentina. More importantly, the Fund has been looking for a new purpose, and global macroeconomics has gained increased prominence. Last year, the Fund served as a venue for consultations between the US, the euro area, China, Japan, and Saudi Arabia. A few days ago, it announced the first revision in 30 years of its bilateral surveillance over the member countries’ policies. It now intends to assess ‘external stability’ (a new, broad concept meaning that the balance of payments does not risk giving rise to disruptive adjustments in exchange rates) and to determine whether member countries are engaging in currency manipulation, especially ‘for the purpose of securing an undervalued exchange rate’ in order ‘to increase net exports’.

A major reason for this move is that the US government has requested that the IMF get serious about the exchange rate of the renminbi, to tell the Chinese that the time has come to let their currency appreciate and, if Beijing does not bow to pressure, to state officially that its currency is manipulated.

For several years, the US Treasury has been trying to persuade Beijing to accept a significant appreciation of the renminbi and the transition to a more flexible exchange rate regime. In December 2006, Ben Bernanke, Chairman of the Federal Reserve, famously suggested that exchange rate intervention by the Chinese central bank amounted to an export subsidy. Now Congress is increasingly receptive to suggestions that it should retaliate against Chinese currency manipulation. For the US, the advantages of IMF involvement are clear. Washington is torn between its currency dispute with Beijing and its desire not to damage what Treasury secretary Henry Paulson has called America’s “most important economic relationship”. The Fund is not part of the bilateral monetary quarrel between the US and China and can therefore be expected to be authoritative. Also, the IMF has real clout, because a pronouncement that the Chinese currency is manipulated would open the way to the filing of a complaint at the World Trade Organisation.

From a global standpoint, there are also advantages in an enhancement of the Fund’s surveillance. A ‘disorderly adjustment’ of the international imbalances (to use the standard euphemism) would involve significant economic and trade risks. It is wise to make sure that the world’s premier financial institution is equipped to deal with exchange rate matters at the multilateral level as well as vis-à-vis particular countries. However, the challenge is a significant one for both technical and political reasons.

First, the Fund will need, if not to tell, at least to hint at what an appropriate exchange rate for the Chinese currency would be. This is risky business politically, and there will be a need to persuade the Chinese government that a move is in the country’s best interest. But this is also risky technically: estimates of the renminbi equilibrium exchange rate are notoriously imprecise, as recognised in Fund research by Dunnaway, Leigh and Li.  Second, the Fund is still looked at with suspicion in Asia. At the time of the 1997-1998 crisis, it was widely perceived in the region as an instrument of the US (which holds 17% of the voting rights, see http://www.imf.org/external/np/sec/memdir/eds.htm) and the Europeans (who jointly hold about a third of them). Already, China’s central bank has expressed reservations about the Fund’s decision, and has called for a strengthening of policy surveillance ‘over those members who issue major reserve currencies’ – meaning the US.

The issue goes beyond policies and raises a problem of governance. An institution whose main role is to lend and monitor the borrowers’ policies may be dominated by creditor countries. But an institution whose main role is to serve as a facilitator for global consultations, and as an arbitrator in currency disputes, needs a more balanced shareholders’ structure. From the US point of view, a straightforward way to convince the Chinese and other emerging countries that the IMF’s newly defined role is not directed against them would be to increase further their voice on its board, at the expense of the Europeans, and to float that Europe’s privilege to appoint the head of the institution will not be eternal. 

This is where the Europeans have a direct stake in the debate. They also have something to gain from an adjustment of the renminbi and from a more legitimate IMF. They should, first, insist that the US obsession with China is excessive, and that while it is right to push for a revaluation of the renminbi, Japan also holds the key to an adjustment of Asian currencies. Second, they should get serious about a consolidation of European chairs on the IMF board, and trade some of the vast nominal power they enjoy for some more real influence on the institution, as advocated in Ahearne et al. (2006). Third, if they want to retain their privilege, they should at least demonstrate that they are able to pick the best suitable candidate for Rato’s succession, and instead of leaving it to financial diplomats’ negotiations behind closed doors, put in place a transparent and proper process for his selection.  

Reference

Ahearne, Alan, Jean Pisani-Ferry, André Sapir and Nicolas Véron (2006), “Global Governance: An Agenda for Europe”, Bruegel Policy Brief n°2006/07, December, www.bruegel.org