Charm offensive

The IMF is courting Asia in its bid to manage a chunk of the region’s foreign exchange reserves

  • By Anthony Rowley
  • 07 Oct 2010
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For years, talk was of the IMF’s declining clout in the global economy as demands for emergency lending had dropped off amid a relatively benign global economic climate for the greater part of the past decade. Newly-empowered Asian economies routinely snubbed the global policy lender as memories of IMF rescue packages to east Asian nations in the 1997 crisis –seen as both humiliating and damaging in equal measure – were still raw. Latin economies scrambled to repay their debts, as if to thumb their noses at the so-called Washington Consensus. And a governance regime tilted heavily in favour of western powers only served to reinforce the Fund’s estrangement from emerging economies.

But as the global financial crisis erupted in 2008, it didn’t take long for the Washington-based multilateral to regain the spring in its step. Its shareholders have bulked up its resources, while the institution has proved its fire-fighting prowess, following seemingly successful bailouts of the Seychelles to Latvia to – perhaps – Greece.

The IMF is now at the forefront of efforts to craft a more stable financial system, vying to show its leadership on global policy co-ordination challenges from banking, capital flows to fiscal stabilization measures. Moves to increase the representation of emerging markets at the institution are gathering pace – with European nations poised to rationalize their representation on the executive board.


But the vexed question of currency regimes in today’s global economy could prove one of the IMF’s biggest challenges yet.

Brazilian finance minister Guido Mantega rocked global finance in late September with his claim that the world is in the grip of an “international currency war” that he said was squeezing the competitiveness of his country’s export sector. At the heart of the challenge is the fact that developed economies and many emerging nations face feeble domestic demand prospects in the near-term, increasing their dependency on exports. As a result, exchange rates are useful for boosting a country’s output.

In the past month, Japan has intervened to drive down the value of the yen and Latin American and Asian nations have stepped up their forays into foreign exchange markets to stem currency appreciation. Meanwhile ultra loose monetary policy in the US and eurozone has helped drive down the dollar and euro, while adding to the upward pressure on emerging market currencies. And fears are growing that a full-scale global currency war will break out, as countries competitively devalue their currencies to boost export competitiveness.

Against this backdrop, the IMF – originally founded in 1944 with a remit to co-ordinate exchange rate policies – is now faced with the task of fixing the imbalances in the global exchange rate system. Asian economies, principally China, have accumulated vast holdings of US Treasuries to prevent exchange rate accumulation. This policy has reduced interest rates in the US, making it easier for Americans to rack up debt. As a result, the key challenge is to rebalance global demand: in short, the US and Europe need to export more goods and rely less on consumption while Asia takes up the slack by rewiring its growth model to increase domestic consumption. The latter part of the equation entails stronger currencies to reduce the cost of imports and incentivize investment to domestic-orientated goods and services.

In a bid to pursue the global rebalancing agenda – while increasing its own firepower – the IMF in recent months has launched a charm offensive in the region to encourage Asian nations to park some of their excess reserves at the Fund. With nearly $5 trillion of foreign exchange reserves, Asia has far more potential financial fire power than the IMF itself. Accumulation of large-scale dollars also provides countries with “self insurance” against abrupt reversals of private capital from emerging markets during a crisis.


The IMF’s courtship of Asia kicked off in earnest a year ago when John Lipsky, the Fund’s first deputy managing director, came to Tokyo declaring that Asia’s surplus nations need no longer feel they should hold such huge reserves as buffer against possible future crises. It made little sense for Asian nations to rely on “self-insurance” when they could make use of an expanded range of IMF financial facilities (credit lines) that offered outside insurance, Lipsky argued. In short, Asian nations could “borrow” reserves rather than hoarding them.

The Fund’s hope is that a well-capitalized IMF could be a suitable alternative as it vies to become the de facto global liquidity lender of last resort. In addition, weaning Asian nations off foreign exchange accumulation would also encourage these countries to have a more market-based currency system – a move that would curb the threat of a global currency war.

To this end, the IMF is putting on a humbler face in Asia as it vows to atone for its mistakes and heal wounds still festering since the Asia crisis when the Fund was lambasted for imposing fiscal austerity with devastating social costs.

This message was driven home this summer when the IMF, along with the government of South Korea, staged a two-day meeting for the benefit of several hundred Asian finance ministers, central bank governors and other officials.

The event received relatively little international publicity given its importance - largely because it was held in the out-of-the-way Korean city of Daejeon, three hours by bus from the nearest airport. This helped the IMF to cover its blushes in apologising for past mistakes.

“There were things that we could have done better,” IMF managing director Strauss-Kahn admitted in Daejeon. “We have to admit that there are bad memories [and] learn lessons from the Asian crisis.” Other top IMF officials spoke in similarly humble terms, stressing the Fund’s desire to mend fences and “work with” Asia.

They acknowledged that the conditions the IMF imposed on a number of east Asian countries during the 1997 crisis, as a precondition for IMF loans, were often far too sweeping in scope and severity. And they insisted that IMF loan conditionality since become far more focussed and less economically and politically damaging.

Strauss Kahn and other IMF officials refrained from criticising the huge treasure chest of foreign exchange reserves in East Asia, while acknowledging it to be a ‘cushion’ against future shocks. But at the same time they tried hard to sell the idea that the IMF stands ready to provide funds with few strings attached if Asia cares to run down its forex reserves now and then finds itself in need of emergency reserves later.

The IMF subsequently made a preliminary announcement that it is “expanding and enhancing its lending tools to help contain the occurrence of financial crises”. It has decided to increase the duration and credit available under the existing Flexible Credit Line and to establish a new Precautionary Credit Line. Other instruments remain under wraps for now.


This “no strings attached” sales pitch meets with a very cautious response from some in Asia. “We don’t believe it,” is the blunt reaction of Eisuke Sakakibara, Japan’s former vice finance minister who in his own words led a “rebellion” against the IMF in 1997 at the time of the Asian crisis by proposing the formation of an Asian Monetary Fund. The IMF “would probably lend to us [in time of crisis] but with lots of conditions attached. So, we had better have our own reserves,” Sakakibara tells Emerging Markets.

Tellingly, the nature and speed at which the IMF has bailed out European countries in the crisis has served to reinforce the impression of the Fund’s double-standards. Angib Abimanyo, a senior Indonesian finance ministry official, said at the Asian Development Bank meetings this spring that the IMF needs to be “modernised” and to become more “even handed” in its dealings with different countries.

Crucially, the IMF’s plan to deter key emerging economies from building up excess foreign exchange reserves is falling on deaf years, says Tim Adams, former assistant US Treasury secretary. “I think this recent crisis has reaffirmed in the minds of economic officials, not only in Asia but generally in the emerging world that self insurance is an important objective.”

“Reserves disappear at a fairly alarming rate in time of crisis and one of the lessons to be taken away from this crisis is that whatever is available from the IMF and elsewhere, still there is a need for a substantial amount of self insurance. I don’t think this is going to change anytime soon. I think reserve accumulation is going to continue for the foreseeable future, although not at the pace of recent years.”

Adams is, nevertheless, impressed by the IMF’s attempts to win back Asia, as are others such as Sakakibara. The Fund is making a “very serious effort to win back Asian support,” Sakakibara acknowledges. “But the problem is that Asia does not need the IMF,” he says. “The countries that need it are European countries. They might as well change their name to the European Monetary Fund.”

“Asian countries have the perception that the IMF is not really for Asians but for Europeans and Americans,” says Masahiro Kaway, dean of the Asian Development Bank Institute, while former Japanese executive director at the IMF Shigeo Kashiwagi is sceptical of the Fund’s charm offensive in Asia. “The IMF needs Asia in peace time but what about war time?” he asks - meaning that the Fund might not be so accommodative toward to Asia in the event of another crisis.

Asia’s perennial fear of abrupt capital outflows and lack of faith in the IMF lies at the heart of the matter: Asia needs to accumulate forex reserves and trade surpluses as the IMF fails to provide a credible liquidity backstop in the event of a crisis, the argument goes.

Lipsky had argued in Tokyo that Asia could afford to use some of its huge foreign exchange resources (held mainly by China and Japan but which also run into billions of dollars in other parts of East Asia and in India) to develop their own economies now that the IMF’s own resources have been beefed up.

Some believe that the IMF is sincere in its desire to build better relations with Asia and that it has learned its lesson from past mistakes. “The IMF has really changed under Strauss-Kahn,” declared president of the Asian Development Bank Haruhiko Kuroda during the Daejeon meeting. “It is now up to Asia to respond,” Kuroda suggested.

But others have still to be to be convinced. Sakakibara, in particular, says “it makes no sense that any one nation (the US) should exercise ‘veto power’ over the IMF, or that Europe should hold 40% of the votes,” he says. Similar sentiments are voiced by Li Daokui, an economics professor at China’s Tsinghua University. The IMF must become “more independent of major powers” before Asia can fully trust it, he says.

The stakes are high: the IMF needs to win Asia’s trust back as it seeks a role in re-designing the global exchange rate system – a move that would help to better balance global growth. Winning a mandate to grab a portion of Asia’s huge foreign exchange reserves would show the region has faith in the IMF as a liquidity provider of last resort – a powerful first step in resolving global financial imbalances.


Competing initiatives to manage Asian forex reserves could have a profound impact on the global monetary architecture

A global financial safety net, the IMF’s special drawing rights and plain old Asian central bank accounts. Asia’s $5 trillion in foreign exchange reserves could soon have three homes.

Japan has loaned $100 billion (roughly one tenth) of its forex reserves to the IMF, receiving in exchange IMF obligations denominated in the Fund’s fiat currency, Special Drawing Rights or SDRs. This helps to reduce Japan’s exposure to a declining US dollar. China has bought $50 billion of special IMF “notes” for similar purposes and others are expected to follow suit.

Rei Masunaga, a former senior Bank of Japan official and deputy president of the Japan Centre for International Finance Rei Masunaga believes that this type of arrangement needs to be expanded, rather than the IMF offering no or few strings- attached credit lines to Asia.

The IMF needs to become a “bank as well as a fund,” he tells Emerging Markets.

If the IMF revived the “Substitution Account” plan proposed in the late 1970s and accepted dollar deposits from Asian and other surplus nations, issuing them with SDR-denominated obligations in return, lenders could make us of their “own money” whenever they wished without having to appeal for IMF credit lines, says Masunaga.

Meanwhile, South Korea, one of the countries (along with Indonesia, Thailand and others) that suffered most from the stern policy conditionality that the IMF imposed on it in return for emergency financing in 1997 is leading efforts to get the IMF to offer a “realistic” alternative for Asian and other surplus nations other than holding huge reserves.

“The IMF has not really assumed its role of ensuring macroeconomic stability and supporting economic development in Asian developing countries,” charged South Korea’s minister of strategy and finance Jeung-Hyun Yoon in Daejeon. What’s needed are “concrete measures to strengthen financial safety nets around the world,” he added.

As host of both the recent IMF meeting in Daejeon (the first such to be held in Asia) and of the G20 summit to be held in Seoul (another first for Asia) in November, Korea is giving “intellectual leadership” to the idea of a Global Financial Safety Net, observed Strauss Kahn. “They are really pushing us” on this, he added.

The idea of a Global Financial Safety Net or GFSN was proposed by South Korea at a G20 summit in Toronto earlier this year, Heenam Choi, director general of the Policy Strategy Bureau of the Korean Presidential Committee for the G20 [Seoul] Summit tells Emerging Markets.

Details of the scheme are still being worked out but basically there will be four parts to the safety net, he says. One element will be to enlarge the IMF’s conditionality-free Flexible Credit Line (FCL) and lengthen its maturity in order to make it appeal to a wider range of countries and lengthen its maturity; and another will be a Precautionary Credit Line or PCL for what Choi called “non-platinum” countries that do not qualify for the FCL.

A third element will be a facility for the IMF to provide liquidity to “systemically important countries” that could pose a wider threat if they are subject to market attacks. Yet another will be a “global stabilisation mechanism” under which the IMF will cooperate with regional financial arrangements such as the Chiang Mai Initiative Multilateralised, Choi added.

IMF officials are anxious to assure Asia that the CMIM which has been painstakingly constructed by the ASEAN+3 group of countries (Japan, China, Korea plus the ten ASEAN states) over the past ten years will be no obstacle to a rapprochement with the IMF. Strauss Kahn says he “welcomes” the CMIM.

“We have no reason to oppose it,” he said in Daejeon while pointing to the fact that Europe too now has its own regional monetary arrangement in the shape of the European Financial Stability Fund or EFSF. “We should build complementarily between multilateral and regional institutions,” adds Anoop Singh, director of the IMF Asia Pacific Department.

But beneath this seemingly benign rhetoric about how best to deploy Asia’s reserves in the interests of financial stability belies a more stark reality. China’s central bank governor Zhou Xiaochuan sparked a debate in late March about the dollar’s status as the world’s main unit of exchange by suggesting the SDR be more widely used as part of a sweeping overhaul of the global monetary system. How Asian nations use their reserves in the coming years will be a telling signal on how the region intends to shift away from the dollar.

  • By Anthony Rowley
  • 07 Oct 2010

All International Bonds

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