Pakistan yet again finds itself in a macro-economic mess with the International Monetary Fund (IMF) coming to its rescue with a $6-billion bailout package conditional on macro-economic adjustments by the government.

Pakistan is not the only country to approach IMF as time and again various countries have knocked on the IMF’s doors. But do IMF bailouts really work?

Effectiveness of IMF’s bailouts may be understood by analysing two major crises of the recent past. Historically, Latin American economies have been tumultuous — alternating from debt to currency crisis to hyperinflation and recession.

Specifically, let’s talk about the Tequila Crisis of Latin America of 1994 triggered by a sharp devaluation of Mexican peso. The Tequila effect (decline in the values of other currencies) thereafter spread to other Latin American countries.

The IMF has extended multiple bailouts to these countries to tackle hyperinflation, speculative capital outflows and plummeting growth in lieu of austerity measures. After a bout of temporary recovery, these economies continued to plunge in and out of crises.

The Latin American experience

Several factors explain this. First, for centuries, Latin American economies have experienced political instability at the hands of military leaders and weak governments elected on macro-economic populism with decades of lacklustre growth.

Second, higher economic growth post-1990s was primarily driven by external debt, foreign investments and speculation — making them highly susceptible to global pressures.

Third, most Latin American economies are resource-rich and suffer from intermittent phases of the ‘resource curse.’ Admittedly, the trouble lies with poor fiscal prudence and economic mismanagement. As a result, multiple IMF bailouts and radical austerity packages of opening up these economies without robust political and economic institutions have have led to further deepening of recession and speculative outflows. Unless, core economic management is strengthened, no number of bailouts can redeem these economies.

The other case is that of the Asian crisis which unfolded against the backdrop of decades of economic prosperity. Although the crisis originated in Thailand following a stark devaluation of Thai baht, signs of overheating in the economy, stock market bubbles, external deficits started appearing earlier.

A confluence of external and domestic shocks coupled with weak growth in Japan and Europe translated into an economic cyclone that soon spread to the ‘Asian Tigers.’ Also the slump in global export demand negatively impacted South-East Asian exports. Short-term credit and speculation boom had run their course, making way for mounting deficits. This led to a reversal of market sentiment, massive capital flight and bank-runs triggering a currency crisis.

At its peak, the IMF stepped in to bail out South-East Asian economies, in lieu of reforms. Within a few years, these economies restored growth to pre-crisis levels. Perhaps, not surprisingly, these governments have successfully prevented future economic crises since 1997.

What explains their effective recovery? First, Asian economies started experiencing a growth boom in 1970s driven by domestic savings and transition from agriculture to industry. Second, their governments, instead of radically opening up their economies followed a process of gradual integration with the global economy.

Consequently, 1990s saw a surge in foreign investment and credit expansion where the Asian Tigers became a magnet for foreign investment and speculation alike, which proved to be their undoing. Unlike Latin American economies, Asian crisis was more indicative of an irrational self-reinforcing speculation than major fundamental flaws in macro-economic management.

That is why they could leverage IMF support and re-embark onto the path of recovery and growth.

IMF bailouts are therefore not insurance against economic crisis and their effectiveness depends on certain factors.

First, the nature of the country’s macro-economic fundamentals: outward-looking policy driven by growth strategies or does it have inconsistent weak fundamentals fuelled by macro-economic populism?

Second is the nature of the economy’s growth model: growth driven by domestic savings or foreign capital, reliant on manufacturing sector or natural resources — which in turn determines its vulnerability to external shocks.

Third is the degree of political stability and quality of governance which are directly correlated to effectiveness of policy response. Fourth and an all-pervasive factor is the mismatch between the IMF loan and conditions of structural adjustment imposed on the crisis-ridden economy. While, the former is short-term in nature, structural adjustment is a long-term commitment. Accordingly, it stands to reason that such a time mismatch impacts the effectiveness of the IMF loans.

The writer is Young Professional, Economic Advisory Council to Prime Minister, NITI Aayog. Views expressed are personal

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