The Hindu Business Line : How ‘reformed’ is the IMF?

The IMF has greatly profited from the global economic crisis by being given another chance to be influential in developing economies. In this edition of Macroscan, C. P. Chandrasekhar and Jayati Ghosh investigate whether the claims that the IMF has changed its lending strategy to be more flexible and responsive to the needs of its debtors, are actually valid.

Only recently, the International Monetary Fund was a shunned institution on life support. Its credibility was battered by its consistent inability to predict crises or deal with them effectively.

Criticism of its functioning was no longer confined to dissident economists and leftwing activists.

Even the rightwing economist Robert Barro concluded that “the typical country would be better off if it could commit itself not to be involved with IMF loan programmes”, while Jeffrey Sachs called the IMF the “Typhoid Mary” of emerging markets, spreading economic recession wherever it went.

Its lending programme was in tatters, rendered irrelevant by the expansion of private finance and the developing world’s increasing dislike of being subject to IMF conditionalities, and it was a net recipient of dues repaid by developing countries.

To add insult to injury, its own fund management was criticised as incompetent by the IMF’s external auditors. The organisation had to shed staff and office space, and was on the verge of irrelevance.

Extraordinary as it may seem, however, the current global financial crisis has given the IMF a new lease of life. In April, G-20 leaders agreed to triple the IMF’s own capital to $750 billion, and to create an additional $250 billion by issuing Special Drawing Rights (SDRs), the institution’s own reserve asset or quasi-currency that borrowing nations can draw upon if needed.

So, despite all its known rigidities, incompetence and open adherence to the interests of global capital, the IMF is once again in a position to become a major (in some cases the sole) source of much-needed liquidity to developing countries in financial distress, this time caused by a global crisis that is not of their own making.

Back from the dead

As a result, IMF lending programmes to the developing world have revived after being in the doldrums. In 2007, total new lending by the IMF amounted to only $7 billion, but this year it is projected to rise by several times that amount.

The chart shows how in 2006 repayments exceeded disbursements under two major programmes of the IMF, the Poverty Reduction and Growth Facility (PRGF) which replaced the earlier structural adjustment facility, and the Exogenous Shocks Facility (ESF). The pattern started changing in 2008 and by the second quarter of 2009 it was quite marked.

Meanwhile many new lending arrangements have opened up in the wake of the crisis.

In addition to the Stand-by Arrangements (SBAs), which are designed to help countries address short-term balance of payments problems, there is the new Flexible Credit Line (FCL), which is supposed to provide unconditional support to countries with “strong fundamentals”.

The table shows the new loan agreements signed since the crisis fully broke in September 2008.

A number of interesting features of recent IMF lending emerge from this table. The first is the very significant weight of transition economies in East and Central Europe — seven such countries account for 52 per cent of all the funds committed to these 22 countries, and on average they have received significantly larger loans.

It is not only that these economies have large deficits and external debt positions: it is also that mostly they are heavily indebted to European banks, whose portfolios would be severely affected by default.

This has not gone unnoticed, which is why several observers have commented that the IMF loans to Eastern Europe amount to settling the counterparty risks of several European banks.

The other noteworthy feature is the fact that several countries have received pitifully small amounts as loans, often less than $1 billion, which are not more than nominal token amounts. Yet it turns out that despite these small amounts, the loans still carry conditions, often quite stringent ones.

In seizing this opportunity to reinvent itself and become significant once again, the IMF claims that it has changed. It has suddenly become a votary of Keynesian countercyclical policies — for the developed countries! After the G-20 summit, the head of the IMF, Mr Dominique Strauss-Kahn, said in a press conference, “The IMF has been outspoken during the crisis in pressing for a coordinated response to the crisis through cuts in interest rates, big increases in government spending, cleaning up the financial sector, and bolstering regulation.”

This will no doubt surprise governments in developing countries who are used to the IMF demanding precisely the opposite from them when they have had to approach the institution in a crisis. And it is also likely to inspire hope that the IMF has indeed changed its attitude to what is the correct policy response in crisis.

Such a hope would be reinforced by the IMF’s own claims. The organisation has announced that it is “modernising” and streamlining its loan conditionalities and will rely more on preset qualification criteria (ex-ante conditionality) rather than on traditional (ex-post) conditionality.

It has supposedly increased access to non-conditional loans, to provide more lending without strings. And it has explicitly declared its support to Keynesian-style countercyclical policies.

So does that mean that the bad old IMF is a thing of the past and developing countries no longer need to be concerned about the impact of dealing with the IMF? Sadly, that is not the case. All these countercyclical measures are only to be applied in developed economies.

For the developing world, it turns out that despite all protestations to the contrary, the typical (and terrible) measures that have been imposed upon countries in the past continue to dominate in the new lending: tightening fiscal policy and cutting expenditure, including spending on very vulnerable sections of the population; raising user charges on utilities and public services, thereby hurting the poor; tightening monetary policy and raising interest rates.

Fiscal policy approach

Consider the following examples of the IMF’s approach to fiscal policy in the financial crisis programmes instituted in the past nine months:

In Latvia, the agreement with the IMF signed in December 2008 required a cut in government spending equivalent to 4.5 per cent of GDP, to be achieved through an immediate 15 per cent reduction in local government employees’ wages, a wage bill ceiling that mandates a 30 per cent cut in nominal spending on wages from 2008 to 2009, a pension freeze and a value-added tax increase.

In Pakistan the IMF required a reduction in the fiscal deficit from 7.4 per cent of GDP to 4.2 per cent through lowering public expenditure, gradually eliminating energy subsidies, raising electricity tariffs by 18 per cent and eliminating tax exemptions.

For Romania, the requirement is to bring the budget deficit down to below 3 per cent of gross domestic product by 2011. Even this is not good enough; in addition there have to be specific reforms in the fiscal area to make sure the deficit stays low over time - restructuring wage policies, recalibrating the pension system to make it sustainable, improving the control and monitoring of public enterprises.

In Hungary, the IMF has targeted fiscal deficit reductions from 3.4 per cent of GDP to 2.5 per cent through a fiscal consolidation plan which involves freezing public sector wages, placing a cap on pension payments and postponing social benefits.

For Ukraine, where GDP is slated to decline by 9 per cent this year, the IMF has targeted zero fiscal deficit as a binding conditionality in its loan agreement. Public savings are to be generated through freezing public wages, pensions and other social transfers, postponing for a minimum of two years any increase in the minimum wage and cancelling promised tax cuts.

Much has been made of how the IMF is more willing than it was earlier, to tolerate and even encourage social sector spending. For example, in Pakistan social spending has been allowed to increase by 0.3 per cent of GDP. But since this is combined with the aggregate budget cuts of more than ten times that amount, the likely positive impact will be minimal.

In general, IMF tolerance of higher social spending involves such small increases that they may well go unnoticed. Further, they are combined with other fiscal conditions that precisely work to undermine public provision in the social sectors.

The Exogenous Shocks Facility was intended to provide unconditional or low conditionality loans with a lot of flexibility. Yet the recent experience suggests that even such loans have come with fairly detailed conditions in certain cases. For example, the ESF for Ethiopia requires “significantly tightening fiscal policy” and the elimination of domestic fuel subsidies.

Contrary to Mr Strauss-Kahn’s approving mention of interest rate cuts in the face of crisis, the IMF has been recommending tight money policies and interest rates designed to meet inflation targets to developing countries that have come to it for funds even after the crisis.

For example, in Guatemala, the IMF’s requirement is to make “monetary policy focused on anchoring inflation at low levels combined with a flexible exchange rate system.” The IMF Standby Arrangement for Ukraine not only prescribes monetary tightening, but also insists that foreign exchange controls be eliminated as soon as possible.

Both of these are really the opposite of what should be done in Ukraine now. More to the point, they are also the opposite of what the IMF approves of for the developed economies facing crisis-induced recession.

Unexpected powers

So the unfortunate configuration of events that has given unexpected powers once again to the IMF is likely to be doubly unfortunate for developing countries. On the one hand, they have been denied direct access to resources or compensatory financing to cope with a global crisis that was not of their making. On the other hand, they are once again exposed to the dreadful and damaging conditionalities imposed by the IMF in return for small amounts of finance, provided at market interest rates.

None of this needed to have happened. If the proposals made at the conference on financial reform organised over June 24-26 by the UN General Assembly had been accepted, a fresh and unconditional issue of SDRs, with double the allocation for Least Developed Countries could have dramatically eased the current liquidity constraints of many developing countries. And it would have allowed for more democratic and country-specific responses to have emerged to deal with the crisis.

This is still possible, just as alternative regional financial arrangements that reduce the power of the IFIs are still possible.

But for these to come about, much more pressure is required from the citizenry of developing countries, especially those in the G-20, to force their governments to push for these more progressive alternatives.

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