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IMF is half-heartedly wooing emerging markets

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8-9/2006
  

[ IMF ]

Half-heartedly wooing emerging economies

The International Monetary Fund does not make many headlines anymore. This once-dreaded instrument of rich nations has lost its predominance because aspiring emerging-market countries have accumulated large foreign-exchange reserves. The IMF leadership is now promoting reform to bring these countries into its fold – but the chances of success do not look too good.


[ By Barbara Unmüssig and Liane Schalatek ]

Never before in its 60 year history has the International Monetary Fund (IMF) faced such a legitimacy crisis as it does today. A growing chorus of critics is chanting the refrain “reform or die”. The message has finally got through to the IMF management in the organisation’s concrete and glass headquarters in Washington. The reform that IMF Managing Director Rodrigo de Rato has announced is intended to save the organisation from impending irrelevance in the 21st century.

The main tenor of the new strategy is that the IMF, which has 184 member states, should increase its multilateral activities, focus on an updated mandate for global surveillance and, above all, represent the economically-strong emerging markets more fairly in its decision-making. De Rato has the mandate to present a reform plan to the International Monetary and Finance Committee (IMFC) at the IMF’s annual meeting in Singapore in September. Implementation is meant to follow without delay.


Unaccustomed weakness

Things have become quiet around the IMF in recent years. There have not been any major financial crises. Technocratic discussion on how to better supervise financial markets has been less than sensational. For most of the major emerging-market countries, the IMF no longer has economic or political appeal as the lender of last resort. In Asia in particular, these countries have been accumulating substantial foreign-exchange reserves after having had painful experiences with IMF conditionalities during the Asian Crisis of 1997. Currently, their reserves stand at about $ 2,500 billion. Last year, two other major borrowers, Brazil and Argentina, even repaid their billions of liabilities to the IMF early. They did so in order to escape the policy restrictions set by the Washington-based institution, which, in their view, is excessively influenced by the US administration. Similarly, Indonesia, which has outstanding debts to the IMF of $ 8 billion, announced recently that it will make early repayment within two years.

Latin America and Asia, moreover, are relying on regional financial agreements. The Chiang Mai Initiative was established in 2000 with 13 Asian countries (including China, Japan and South Korea). It is something like an “Asian Monetary Fund”. The fund for Latin American reserves also plays a significant part in challenging the IMF’s traditional role of supporting and advising governments in the case of exchange-rate and balance-of-payment difficulties. Turkey, which has debts of $ 13 billion, is the only client remaining of the IMF’s formerly important debtor countries.

This is, in itself, quite positive news. Nonetheless, it has spelt real trouble for the IMF. Ironically, the one-time guardian of smooth balance of payments now finds itself in financial straights. The reason is that major emerging markets no longer need it – and consequently take out fewer loans. Without help, the Fund will soon have to go into debt itself. It is funded by fees (spreads) on its structural adjustment loans. The Fund’s capacity building and surveillance activities are also paid for by such means. Thus, in effect, the borrowers have been funding this multilateral body. Industrial nations pushed through this model in the 1970s because they did not want to pay periodic contributions.

This year, the IMF already faces a budget shortfall of some $ 110 million. The sum might rise to $ 300 million by 2009. The options are to levy fees for IMF advice, to sell its gold holdings, to invest its foreign-exchange reserves in the capital market, or to revert to grants from wealthy nations.

De Ratos’ medium-term strategy is aimed at regaining relevance and systemic influence. However, neither goal will be achieved without a radically different mandate supported by the advanced nations. In principle, the management’s proposal to boost the IMF’s multilateral surveillance role makes sense. To this end, the Fund is proposing a multilateral consultation procedure with important member nations and even regional groupings such as the EU and ASEAN. Such talks are to complement the conventional bilateral talks. This approach would make sense because imbalances in the global economy are of course not the result of individual countries acting in isolation.


Proposed reform does not go far enough

But the basic problem remains that the IMF does not have the ability to assert itself and to impose sanctions. Multilateral consultations will not have any clout if this shortcoming is not addressed. The IMF may well denounce systemic misbehaviour – such as the unsustainable twin deficit in the USA’s current account and budget, or the non-productive accumulation of foreign-exchange reserves in Asia. It can also call for better international cooperation. It normally does so in technically-abstract jargon. However, the IMF does not have the means to force transgressors who jeopardise the stability of the global economy to change their selfish financial and economic policies.

The IMF is also proposing to improve monitoring (and technical analysis) of exchange rates, financial markets, macroeconomic risks and the challenges of globalisation. Again, these proposals deserve support in principle. However, reform would presuppose the political will of the powerful members to be subjected to surveillance and to be held accountable. Both seem doubtful.

In any event, the macroeconomic criteria the IMF applies need to be reviewed. The IMF’s neo-liberal doctrine, which does not allow for any alternative proposals, must not remain its base for action. The Fund’s stubborn and unpragmatic approach to the crises of the late 1990s was one of the main reasons for the emerging giants from Brazil to China turning away. The IMF is feared because of its prescriptions, which outrule capital controls – but encourage rigid stabilisation policies, even to the detriment of welfare programmes and political stability. Germany is one of the most influential IMF members. Therefore, the Federal Government and the Bundestag (lower house of the German Parliament) should debate the tasks of the IMF in public.

De Ratos’ medium-term strategy recognises the reality that emerging markets adapt differently to global financial market risks today than they once did. De Rato wants to make the IMF’s large-scale loans to emerging markets more predictable and more flexible, concerning terms and conditions (not only in the case of crises). In addition, he is proposing financial incentives for rapid repayment. A new type of arrangement could offer high-access contingent financing, designed for macro-economically stable emerging markets. It would allow them rapid access to three times their IMF quota in the event of a crisis – with relatively few conditions.

It remains to be seen how attractive this instrument will be to emerging markets. Its predecessor, the Contingent Credit Line (CCL), lapsed after a few years without any country ever having applied for it. Emerging market countries did not make use of it because they did not want to signal any weakness to the global financial markets. In any event, it is still unclear whether the developed nations are prepared to support the funding of such an instrument through general quota increases.

There is no doubt, however, that the most important (and symbolically most meaningful) step for any IMF reform meant to engage emerging markets would be to give them fairer representation and greater weight in the IMF. The developed nations agree on doing so in principle and are prepared to decide in September to immediately increase the voting shares of the important emerging-market economies of China, Turkey, South Korea, Mexico and possibly Singapore. However, such a step would be hardly altruistic, but purely self-serving. Today, their exclusive Club of Seven can only control global risks to a limited extent. The promise to increase the IMF shares of those countries that are most obviously under-represented acknowledges this fact. Furthermore, only by giving emerging markets more influence within the IMF can their future cooperation be secured – and consequently the IMF’s survival. For the G7, the IMF was always one of the most important instruments of pursuing interests globally.

Nonetheless, it remains to be seen whether simply increasing the IMF voting shares can secure the commitment of emerging-market countries. The first phase of de Ratos’ two-step plan does not even give scope to India and Brazil. Nor has it been decided yet by how much the voting shares of the four or five countries mentioned above should increase from their present, absurdly low level. China currently holds only three percent of the voting shares, India less than two percent and South Korea only 0.75. In comparison, Austria’s share is 0.87.

Even if de Rato were to receive consent in September for the second stage of reform (to overhaul the IMF’s obsolete quota formula), there would still be a long way to go to really reduce the industrial nations’ dominance in the IMF. From its very outset, the IMF reflected power relations in political – rather than purely economic – terms. It will make no difference whether gross domestic product or purchasing-power parity will be used to calculate shares in future (the latter option being preferred by emerging markets). Whichever way the formula is redesigned in an attempt to reflect economic power, the USA – with its share of the world economy of around 30 percent – would keep its current stake of 17 percent of IMF shares, giving it veto power. It takes agreement among the nations holding 85 percent of the IMF shares in order to change the Articles of Agreement, the IMF constitution.

It is therefore doubtful whether the proposed reforms are adequate for the IMF to regain its lost credibility in the eyes of increasingly self-assured emerging markets. Likewise, it remains to be seen whether the Fund, with its weak mandate and its self-image as an “apolitical” organisation, will gain the necessary powers and self-assertion to fight global imbalances. Obviously, the IMF will remain dependent on the member states with regard both to policy guidelines and finances.

The proposed reform must also be looked at in the context of the reform of the World Bank, its sister organisation, which is facing a similar crisis of legitimacy and finance, even if it is less obvious. The World Bank, too, is of declining interest for major clients and exposed to legitimate criticism for its macroeconomic recipes hardly ever succeeding.

De Ratos’ medium-term strategy is geared towards initial reform steps, but rather hesitantly so. Many of the core questions remain unaddressed. So far, there is no sign of a clear break with the past and a radically new beginning, beyond some half-hearted courting of emerging-market governments.


No concern for the poorest

Sadly, low-income developing countries are completely overlooked in the internal debate on IMF reform. Their voting share is miniscule. Taken together, 43 sub-Saharan countries make up only 4.4 %. For economically weak countries – that is, the majority of IMF members – it would be most important to increase the basic votes to which every country is entitled, irrespective of their share in the world economy. Whereas these voting rights amounted to 11 % for all developing countries at the time of the IMF’s founding, their share has fallen to only 1.7 % today. In other words, the developing countries have been progressively weakened since the IMF was established. Those in the know suggest that the USA would at most agree to double the basic quota. Any step of that kind would have a merely cosmetic effect – if the matter gets on to the Singapore agenda at all.

In any event, what would be of greater importance for the least developed countries would be to reform the allocation of seats on the IMF Executive Board. Here, Europe is extremely over-represented, with eight out of 24 seats. (If one includes the mixed constituencies of developing and developed countries, Europe actually has ten seats). Creating a single seat for the countries of the Euro zone, as a resolution by the European Parliament recently demanded, would free some seats on the Executive Board for developing countries. However, that goal remains purely hypothetical for the time being. The weakest point of de Ratos’ strategy paper is how it regards developing countries. It does not envisage any reform of the Executive Board in the foreseeable future.

According to de Rato’s plan, the IMF suggests to mainly strengthen its surveillance functions over developing countries. It would have a greater custodial function than in the past, advising developed countries (and signalling to the donor countries) whether their official development assistance can be correctly absorbed and applied (in the neo-liberal sense), for example, to reach the Millennium Development Goals. At any rate, the Fund continues to rely specifically on achieving poverty reduction through private-sector led trade and growth and would put an even higher focus on it under the new plan – as if its ideological rigidity over the last 20 years had proved successful and not actually increased poverty and disparities in Africa and Latin America. What the poor countries really need is less dogma and more policy space. This is also the case for emerging markets, and their leaders are well aware of this. However, none of this is addressed by the current reform proposals.


Barbara Unmüssig
is a board member of the Heinrich Böll Foundation, which is connected to Germany’s Green party. unmuessig@boell.de
http://www.boell.de/asp/frameset_en.html

Liane Schalatek
is Associate Director
of the Foundation’s Washington office.
liane@boell.org
http://www.boell.org