This paper briefly reviews the IMF’s current practices and policy-making in the context of a proposed quadrupling of IMF resources to $1 trillion dollars, and a consequent increase in the Fund’s influence over economic policy-making in developing countries.
In the last major set of economic crises of the 1990s, the Fund made serious mistakes that adversely affected the economies of Argentina, Indonesia, South Korea, Thailand, Russia, Brazil, and other countries. At the time, these mistakes drew widespread criticism, including from prominent economists such as Nobel Laureate Joseph Stiglitz and Columbia University’s Jeffrey Sachs.
In those crises the Fund failed to act as a lender of last resort, when it was most urgently needed in Asia, as countries such as South Korea, Indonesia, Thailand, the Philippines, and Malaysia fell victim to a severe shortage of foreign exchange. It then imposed procyclical policies and in some cases, such as South Korea, set unrealistic inflation targets that would be impossible to achieve, given the currency depreciation, without a severe economic contraction. The IMF’s own Independent Evaluation Office later conceded that “[I]n Indonesia… the depth of the collapse makes it difficult to argue that things would have been worse without the IMF…”
In Argentina, the Fund lent tens of billions of dollars to support an overvalued exchange rate that inevitably collapsed, while attempting to adjust the economy to this unsustainable exchange rate through contractionary macroeconomic policies. When the inevitable sovereign debt default and exchange rate collapse occurred at the end of 2001, the Fund again failed to act as a lender of last resort. Instead, it (together with the World Bank) drained a net 4 percent of GDP out of the country in 2002, while pressuring Argentina to pay more to its foreign creditors, and opposing some of the most important economic policies that facilitated Argentina’s recovery and ensuing six-years of rapid economic growth.
This paper finds that the IMF is still prescribing inappropriate policies that could unnecessarily exacerbate economic downturns in a number of countries. In El Salvador, for example, the country has signed an agreement that precludes the use of expansionary fiscal policy. This is especially problematic because the country cannot use exchange rate policy and is very limited in monetary policy since it has adopted the dollar as its currency. The IMF agreement thus cuts off practically the only policy tool for a country that is heavily dependent on a contracting U.S. economy – El Salvador gets remittances amounting to 18 percent of GDP from the United States and exports about 9.6 percent of GDP there.
In Pakistan, the IMF agreement signed last December provides for tightening both fiscal and monetary policy, including a sharp reduction in the fiscal deficit from 7.4 percent of GDP last year to 4.2 percent of GDP for the current fiscal year. It is questionable whether such policies are necessary, especially given that the country’s current account deficit has largely disappeared, and inflation has fallen considerably since last October. Furthermore, thecountry is facing a number of external shocks, including declining exports and capital inflows.
The Fund has also prescribed fiscal tightening for Ukraine, where GDP is now projected to decline by 9 percent in 2009. The IMF Standby Arrangement approved in October 2008 provided for a zero fiscal balance. At the time, the country was undergoing a number of severe negative external shocks: the price of Ukraine’s steel exports, which amount to 15 percent of GDP, had fallen by 65 percent; Russia had decided to phase out natural gas subsidies, implying a price increase of up to 80 percent in gas imports, which amounts to 6 percent of GDP; and a slowdown in capital inflows due to the international financial crisis. It was also suffering from liquidity strains and falling confidence in the banking system. Given these conditions, and the fact that Ukraine’s gross public debt is a very low 10.6 percent of GDP, the agreed upon fiscal tightening would appear to be inappropriate.
Hungary, Georgia, Latvia, Serbia, and Belarus all have signed IMF agreements that provide for fiscal tightening that could unnecessarily exacerbate these countries’ economic downturns.
The Fund may also have contributed to the vulnerability of countries in the current crisis, as it did in the run-up to the Asian crisis a decade ago. For example, the Fund has supported the liberalization of capital flows, as well as inflation targeting. Central banks that have targeted a specific inflation rate tend to let the currency appreciate, which encourages the private sector to borrow in foreign currency. This foreign borrowing has made many countries more vulnerable to the current crisis, because households and firms are hit especially hard when the currency depreciates. This also limits the ability of countries to ameliorate the crisis by allowing the currency to depreciate. The IMF has also generally opposed capital controls, which can help governments stem the loss of reserves, currency crashes, and other problems associated with large capital outflows. This cuts off an important policy tool and makes governments more dependent on tightening fiscal and monetary policy to resolve balance of payments difficulties.
The main purpose of having international institutions to provide hard currency lending, especially in a time of world recession, is to allow countries that would otherwise be prevented by balance of payments problems from pursuing expansionary (counter-cyclical) policies to do so. China, for example, is able to implement one of the largest stimulus packages in the world because it has $1.95 trillion in reserves. The resources of the IMF should be used to allow and encourage counter-cyclical policies wherever possible, not procyclical policies.
The IMF’s current lending practices have implications for the immediate future of the affected countries, because procyclical policies can exacerbate the world economic downturn. But more importantly, the proposed quadrupling of IMF resources will have implications for many years to come, even after the world economy recovers. Although the new resources are unlikely to reverse the trend of governments avoiding, whenever possible, the Fund’s lending and influence, they will help to re-establish an unreformed IMF as a major power in economic and decision-making in low-and-middle income countries, with little or no voice for these countries in the IMF’s decision-making. This could have long-term implications for growth, development, and social indicators in many countries.
Governments that are contributing to this increase in funding should think carefully about these implications and the possibilities of making such increases contingent on serious reforms of the IMF – especially in the areas of governance and accountability.
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