Reforming the IMF: Will the G20 Miss a Chance?

Posted by on 14 March 2009

From Graham Bird and Dane Rowlands.
 
 
As the meeting of the G 20 on 2nd April in London gets closer, negotiations are proceeding behind the scenes about reforming the International Monetary Fund. Political leaders, and as host of the meeting Gordon Brown in particular, want to have something to show for their deliberations and their endeavours to ‘save the world’ from economic meltdown. Reforming the IMF may appear to be a feasible and visible option.
 
Just one year ago things were radically different. IMF lending was close to an all time low. The seemingly relentless expansion of international financial markets and surging exports allowed many traditional clients to build up their own foreign reserves, allowing them to by-pass the Fund altogether. The only potential danger in an otherwise benign global economic environment was the massive imbalance associated with the current account deficit of the United States, which the IMF had proven powerless to resolve. Somewhat ironically, the era of economic globalization seemed inhospitable to one of its premier champions. Unable to influence the economic policy outside of a dwindling number of poor, small and weak states, one of the world’s key global institutions appeared to be fading into obscurity.
 
Declining international relevance was accompanied by problems of governance. A shrunken lending portfolio reduced the Fund’s own income stream, forcing it to swallow the bitter medicine of austerity that it had so often prescribed for others. The under-representation of emerging economies and the lop-sided and backward nature of its decision-making processes increasingly called into question its legitimacy. Economically irrelevant and politically indefensible, why did the world need the IMF? 
 
How things have changed. If the financial crisis has been good news for anyone, it must surely be for the IMF. It has been convenient for national politicians to present the crisis as a global phenomenon, accentuating the network of financial arteries that tie countries together. With a global financial crisis one needs a global financial institution, and the IMF has sought to grasp the opportunity to reinvent itself. It has happily proffered advice to advanced economies about the design of economic and financial policy, and has stood ready to provide financial assistance to emerging and low-income countries. The Fund’s clientele has suddenly expanded to include the likes of Iceland, Hungary, Ukraine and Pakistan, and plenty of others seem to be queuing up. It would have been difficult to have imagined this even a few short months ago. Indeed, the IMF’s own predictions in early 2008 were that its lending would stay close to the low level to which it had then fallen.
 
But there is a problem in taking on an expanded lending role, and it is one that the Fund has been quick to emphasise. Does it have the resources needed to meet the increased demand for its assistance? Certainly its First Deputy Managing Director, John Lipsky, has argued that the Fund needs a significant infusion of additional resources, probably doubling its lending capacity; some observers see this as an underestimate. Where is the money going to come from?
 
The front running idea is that Saudi Arabia and China, countries with balance of payments surpluses and high levels of reserves, should step up to the plate. Japan has already offered to make a sizable contribution. It seems likely that a package of such arrangements will be put together before April, allowing the G 20 to claim at least one small victory in the battle against global recession. After all, borrowing from well-positioned member countries or increasing subscriptions by raising members’ quotas have been the traditional means of resolving problems of insufficient liquidity at the Fund. However, such a solution would actually squander an opportunity for more meaningful reform. These ad hoc arrangements have consistently proven unequal to the challenges of subsequent crises, and they increase the exposure of the Fund to external political pressure while leaving unaddressed the sources of institutional illegitimacy. Is there a better way forward?
 
One option for the G 20 to consider is to recognize that the Fund has two types of clients, and to prescribe a treatment for each of the associated resourcing ills. For the low income countries that have been regular users of IMF resources, the Fund could sanction an additional allocation of Special Drawing Rights – the Fund-based international reserve asset that can be created when there is a global need. At a stroke, the Fund could do something to bolster the diminishing international reserves of poor countries while offsetting any decline in development assistance that accompanies the global economic crisis. The allocations could be tied to the adoption of IMF-endorsed economic policies, which in turn could be modified to focus on those conditions under which aid has been shown to be most effective. The old fashioned arguments against this so- called SDR-aid link are precisely that; old fashioned. Under current circumstances there is little risk that allocating SDRs to poor countries would generate global inflation. Since the 1970s vintage vision of the SDR as the principal reserve asset has long been abandoned, there is also no threat to the reserve structure of the international monetary system. By addressing the frequent but modest claims of poor countries on the IMF’s resources, a concessionary SDR allocation would do some good for a large proportion of the world’s population and would do nobody any harm.
 
In contrast to low-income countries, emerging economies generally make less frequent use of IMF resources but, when they borrow, they tend to borrow relatively large amounts. To meet these more volatile demands a second prescription is required to cure the IMF’s resource ills. Borrowing from private capital markets would permit the Fund to raise resources as and when needed, providing the degree of flexibility required to deal with the uncertainties surrounding the future demand for IMF loans. While this policy has been rejected in the past, the arguments against it seem misplaced and irrelevant to contemporary economic circumstances. For example, the claim that the Fund would crowd out emerging economies from the market sound hollow when the defining feature of recent crises has been the drying up of private lending to these countries. Instead the IMF would be assisting countries to regain lost access to capital markets.  
Another criticism is that in the apparent absence of financial constraints, the Fund’s management would expand unwisely its portfolio of loans. However, the need to maintain credibility in private capital markets will impose its own discipline on the IMF, which may be both more effective and preferable to the current situation that sees its operations vulnerable to unpredictable and opaque political influence. The Fund’s Independent Evaluation Office could also take on an expanded role of auditing the IMF’s borrowing and lending activities. With its stock of gold as collateral, and with default risks reduced by the stipulation of economic policy conditions, the IMF will almost certainly be able to borrow at favourable interest rates. It may even be welcomed by private lenders as a reasonably safe place to lend money in turbulent financial times. 
 
No doubt some reforms to the IMF will be cobbled together by the beginning of April and will be trumpeted by the G 20 as an important step forward. By recycling more quickly the international reserves held in surplus countries, the reforms being contemplated may indeed help to stimulate the world economy. Borrowing from member countries offers a relatively quick and easy solution to the liquidity problems that the IMF may soon face. However, at the same time, it would be a pity not to grasp the chance to undertake superior reform. The reforms we are proposing here would be in step with those being adopted within national economies. An issue of SDRs would reinforce the expansionary monetary policy being adopted by governments and central banks. And just as many governments are now taking on the role of orchestrating the lending that banks are not prepared to do, and are going into debt to do it, so too could the IMF. Essentially the reforms proposed here would see the IMF doing at a global level what many governments are doing at a national level.
 
While crises motivate reform, the danger is that they motivate a modest ‘band aid’ approach to it. If the Fund’s liquidity problem is effectively patched up, then the question is raised as to why more fundamental reform is needed. The G 20 seem to be heading in the direction of pulling out the band aid when a little more thought, imagination and ambition could result in much better systemic reform. While there are no real technical problems to implementing the reforms proposed here, political leaders will undoubtedly be seduced by the attractions of a temporary solution that is quick and easy. Such a temptation will play to the advantage of those who are reluctant to loosen the leash that they have on the IMF, and to those who see an enhanced role and expanded resources of multilateral institutions as a threat to national interests. But if we continue to let ‘he who pays the piper calls the tune’ be the basis for global cooperation, how can we expect to achieve a more harmonious global economic system?
 

Graham Bird is Professor of Economics and Director of the Surrey Centre for International Economic Studies at the University of Surrey. 

Dane Rowlands is Professor at the Norman Paterson School of International Affairs, Carleton University.