The Hindu Business Line : IMF: A mandate misplaced?

The IMF's recently-released Strategic Review of its activities hardly created a flutter, perhaps because of the limited relevance of the Fund, its lending and its prescriptions. The Review, says K. Subramanian, is based on exaggerated notions of the IMF's ability to foresee and manage financial market risks. But the Fund has not quite been able to work its mandate of `surveillance', and its credibility to predict and prevent financial crises has been in doubt for some years now.

ON SEPTEMBER 19, the International Monetary Fund Managing Director, Mr Rodrigo de Rato, unveiled the much-awaited Strategic Review of the Fund's activities and new focus. It was an agenda item of the recent Annual IMF/World Bank Meetings held in Washington (September 23-25). Though much was expected, the Review did not create any flutter.

The Review comes at a time when the Fund's lending activities are at their historic low and, as Bloomberg (September 19) reported, when (the) "IMF's clout and relevance wane" and "nations turn to other lenders." Mark Weisbrot reported in International Herald Tribune (September 22) how "its power to shape economic policy in developing countries has been enormously reduced." The Review is based on exaggerated notions of the Fund's ability to foresee and manage risks in financial markets. It does not elaborate some of its suggestions, especially its relationship the World Bank and involvement in poverty-reduction programmes.

Mediator of globalisation

The Review seeks to shift the role of the Fund from that visualised in the 1944 Bretton Woods Agreement — that is, to maintain exchange rate stability and to provide balance of payments support to those in distress — to become a mediator of globalisation. Indeed, this is desirable. However, if the Fund were to assume such a role, it could do so only after a new agreement is negotiated in a Bretton Woods-type conference. Currently, the discontent of critics is that the Fund has intruded into non-economic areas through `mission creep' and `mission push' and serves the interests of developed countries and their banks more than the interests of developing countries.

In Prof Joseph Stiglitz's view, "Keynes would be rolling in his grave were he to see what has happened to his child." The authors of the Strategic Review seem to be dismissive of these critics and proceed to make globalisation their `mission' without spelling out the contents or whom it will serve. The Communiqué issued by the IMF on September 24 does not approve of globalisation as such and requests the Fund "to work within its mandate." The mandate for the Fund is "surveillance".

Questionable crisis management

Sadly, the Fund's credibility to predict and prevent financial crises has been in doubt for some years.

The Fund has evolved a number of elaborate reporting systems by member-countries. These are voluntary for members and mandatory for the indebted. After the Asian crisis of 1997, the Fund introduced the Financial Sector Assessment Programme (FSAP) to report on the member-countries' financial sectors and the Reports on the Observance of Standards and Codes (ROSC) to assess their adherence to 12 standards (developing countries had no role in setting these standards).

Surveillance is based on these reports. Substantial amount is spent on this work. A recent Fund document suggests that in FY 2006 it runs to $240 million, which is more than a quarter of its administrative budget. In recent years, the Fund has taken more steps to strengthen the surveillance system. It leans heavily on two other pillars: Bi-annual World Economic Outlook (WEO) and the Early Warning System (EWS).

While the surveillance work done by the Fund staff has been a `black box' to outsiders, many critics feel that the Funds' efforts have not saved `the earth' from financial crises. The Fund swings into action only after a crisis erupts and never before. Then it prescribes remedies, which are anti-growth and anti-poor. As a result, in recent years, developing countries have moved away from the Fund and lean more on private banks. Further, many countries, especially in Asia, have built substantial foreign exchange reserves as an insurance against financial crises. Surprisingly, these reserves are substantially larger than the Fund's and countries like China can bail out the IMF if it is in trouble. As a result, Fund's lending has reached an all time low this year and its liquidity risen to $138.2 billion from $85.20 billion last year.

More money goes into the Fund by way of repayments, etc, than out of it as new loans. Brazil decided to repay $5.1 billion of its loans ahead of schedule. This is another story. Now to get back to the surveillance story.

A grim performance review

In its report to the Committee on Financial Services, the General Accounting Office (GAO) of the US Government examined the IMF's ability to anticipate, prevent and resolve financial crises. It took a dim view of the Fund's overall performance. The report said: "... some private sector market participants have found the reports untimely, outdated and dense." The GAO was harsh on the usefulness of the WEO and the EWS. In its view, "The WEO has not successfully anticipated the severe financial crises of the past decade. The Fund's EWS models have had a high false alarm rate having predicted many crises that did not occur... During the 1991-2001 forecast period, 134 recessions occurred in all 87 emerging market countries. We found that the WEO correctly forecast only 15, or 11 per cent, of these recessions."

It also found that the WEO forecasts for current account were inaccurate most of the time. The GAO was shocked that even in analysing stable economies with excellent data, the WEO had done a poor job of forecasting the key crisis anticipation value.

A weak surveillance system

The Independent Evaluation Organisation (IEO) also drew attention to the weaknesses in the surveillance system. It showed that often the surveillance and Debt Sustainability Analysis were on over-optimistic assumptions made by the Fund staff. There is also a conflict of interest if those in charge of country programmes are also responsible for surveillance. IEO studies found that IMF surveillance was often lacking in candour due to persisting conflict of interests between country work and surveillance.

Moreover, as Dr Montek Singh Ahluwalia cautioned, "If surveillance is expected to improve the functioning of financial markets it must also pay greater attention to market perceptions than is done at present." It is rather difficult for the Fund to incorporate market perceptions in formal documents since governments would downplay such assessments as subjective.

It is difficult to sift market gossip from serious financial data. It is obvious that players in the financial market have their own agenda and contribute to instability. Thus, any attempt to seek a unique formula for predicting crisis is a search for the Holy Grail.

There is yet another dimension to the surveillance conundrum created by Fund's own policies and working. This has been brought out in a recent report of the IEO (imf.org/external/np/ieo/2005, April 20) on IMF's approach to capital account liberalisation. As the report says, "In multilateral surveillance, the IMF's analysis emphasised the benefits to developing countries of greater access to international capital flows, while paying comparatively less attention to the risks inherent in their volatility."

Wither the financial market gatekeeper?

As the IEO further elaborated, the entire focus of the Fund staff was on developing countries and "little advice was offered, in the context of multilateral surveillance, on how source countries might help to reduce the volatility of capital flows on the supply side."

In short, the Fund, which should act as the gatekeeper of global finance, helps poachers to invade developing countries through portfolio windows and destabilise their economies. This is the consequence of `mission creep' and `mission push' losing sight of its global responsibility. And yet, the Strategic Review dares the Fund "to engage in global, regional and country surveillance and `more active Fund engagement in the policy debates that shape public opinion and policy choices."

In its concluding part, it recommends a re-look at the IMF's quotas that "gives more vote to countries that now account for a much larger share of the world economy and more voice to smaller members." This guarded suggestion received much publicity in newspapers screaming that Mr Rato pleads for bigger say for Asia in the IMF.

The Review itself makes it clear that the decision is political and, therefore, outside its purview. For many years the US has blocked efforts for a re-look at the Fund quotas. It is unlikely to relent now and cede power to countries such as China or India, as that would erode its economic power.

The US Treasury has dismissed the Review out of court. Responding to the IMF reforms, Mr Tim Adams, Under Secretary, US Treasury, said the Fund should be "far more ambitious in its surveillance of exchange rates" and should not be seen "asleep at the wheels on its most fundamental responsibility — the exchange rate surveillance."

In short, the US wants the Fund to become a willing partner in its war against China over the yuan overvaluation. It sees no value for any other surveillance work. Poor Fund, it will have no new clothes to wear.

(The author, a former Finance Ministry official, has extensive experience in international, financial and trade issues.)

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