IMF officials – like policymakers in Europe – were initially slow to recognize that excessive debts, yawning fiscal deficits and competitiveness gaps could pose risks to eurozone stability and global growth. Now the crisis that is seen by many in developed and emerging countries alike as the main threat to the global economy has become the main item on the IMF’s agenda. But doubts remain over the fund’s ability to deliver a happy ending, and many officials warn against the danger of overestimating its powers.
“I think it’s very difficult to focus on the IMF in the sense that it can solve Europe’s problems. It can’t,” South Africa central bank governor Gill Marcus tells Emerging Markets. “If you look at Europe and the role of the IMF, it is absolutely the responsibility of those individual and collective governments to take the tough decisions. The IMF can point the way and say ‘this is what needs to be done’, but it can’t take these decisions or enforce them.”
Peter Doyle, an economist in the fund’s European department, resigned in July complaining that the IMF had failed to issue a timely warning about festering eurozone imbalances. The fund, he said in his letter of resignation, was negligent in not calling attention to the fundamental flaws in European Monetary Union.
Hastily designed adjustment programmes with the EU and ECB for Greece and Ireland in 2010 and Portugal in 2011 underestimated the gravity of the problem, critics say. An expanded Greek programme had to be negotiated last year after the disruptive 70% write-down of Greek private-sector debt.
Bill Rhodes, the New York banker and pivotal player in debt negotiations going back to the Latin American crisis of the 1980s, advocates greater IMF involvement and leadership in overcoming the eurozone problem. He argues that a year ago the financial system was rudderless and the IMF appeared lost, its influence diluted by being part of the troika of lenders that includes the EU and the ECB.
Some senior figures in the emerging markets believe that this dilution of the fund’s power is a big challenge when it comes to its role in the eurozone crisis.
“If they are part of the troika, what exactly is their role? Is their role to monitor what is being done through the conditionality? Are the conditionalities that are looked at for advanced economies done with the same rigour and precision as they would be for emerging markets?” Marcus says.
“I think there are very serious challenges to the IMF in its interaction as part of the troika as well as [to] its role as it has traditionally played it in terms of having money, conditionality, lending itself.” IMF managing director Christine Lagarde has rejected the assertion that participation in the troika diminishes IMF clout. “We are not the yes-man of the eurozone partners, nor of the ECB,” she said in September.
But IMF officials concede that coordinating with two other entities is not easy as it adds further complexity to analyses and recommendations.
Rhodes is encouraged by Lagarde’s success in mobilizing resources, and views the upcoming period as an opportunity “for the IMF to show its stuff and to lead Europe out of crisis”.
That the fund failed to grasp the magnitude of the eurozone problem is reflected in economic forecasts that were overly optimistic. In October 2010 the IMF predicted that the Greek recession would bottom out in 2011 with growth resuming in 2012. In fact, Greece recorded negative growth of 6.9% in 2011, and a further 4.7% decline is expected this year.
Desmond Lachman, a former IMF official who is now a researcher at Washington’s American Enterprise Institute, calls the IMF and troika programme for Greece an unmitigated disaster. The initial diagnosis, he says, was wrong. “Greece should have been seen,” says Lachman, “as a solvency instead of a liquidity problem.” Fiscal tightening, he argues, was – and is – exactly the wrong policy, driving the economy into deeper recession.
He advocates a write-off of Greece’s debt and an exit from the eurozone as Athens’ only way out of the crisis. Lachman says even now, in pushing for more austerity in Greece, Ireland and Portugal, “the IMF is repeating the mistake of thinking that you can do a lot of fiscal adjustment in a fixed exchange rate without causing deep recessions.”
But others argue that many emerging countries have gone through exactly the same type of adjustment and, although very difficult at the time, it provided them with the discipline and the tools needed to bring their economies in order.
“As we have learned our lesson the hard way through IMF policies, I think it is time for the industrialized countries that are facing problems to use those recipes that were imposed upon us,” Peru’s finance minister Luis Miguel Castilla Rubio tells Emerging Markets. “We learned to behave with responsibility, so I think the fund should be more active toward redefining its role with countries that are facing problems, and give policy that is binding for these countries.”
FLEXIBILITY
Charles Dallara, the managing director of the Institute of International Finance (IIF), believes that the troika needs a more balanced approach in Europe. “There’s been too much belt tightening,” he says. “There needs to be more flexibility in programme design.”
Holger Schmieding, chief economist of Berenberg Bank, is also sceptical about the design of troika lending programmes. While giving Lagarde high marks for her performance since she took over, Schmieding says: “Her real test is ahead: will the IMF sink Greece, as many emerging markets seem to prefer, or will she toe the European line that, if Europe continues its support for Greece, so should the IMF?”
Edwin Truman, formerly a top Treasury and Federal Reserve official involved with US policy on the IMF, says it is premature to judge what he calls “the three-ring circus”. He suggests that there is evidence that on Greece the IMF has been too easy and the EU too hard.
Lagarde and her deputies have become emphatic cheerleaders for deeper European integration, including fiscal union. Lagarde has strongly endorsed ECB president Mario Draghi’s new bond buying programme – outright monetary transactions (OMT) – intended to drive down interest rates on peripheral nations’ debt. She also endorses longer-term measures including unified banking regulation, deposit insurance and banking union as necessary steps to safeguard the euro.
IMF officials believe Europe faces more tough times ahead. Zhu Min, the Chinese deputy managing director, told a forum in Tianjin on September 11 that, while the eurozone crisis is not over “and there is some way to go, it is moving in the right direction.” He expressed full confidence in sustainability of monetary union.
In his announcement of the ECB’s new bond buying programme, Draghi declared that before countries can participate, they must formally request assistance from the eurozone’s two rescue funds and agree to policy conditions, adding that IMF participation would be “the preferred scenario”.
Officials in emerging markets agree that the fund should continue to be deeply involved in the efforts to solve once and for all the eurozone debt crisis, as this would be beneficial for developing countries as well, since it would eliminate a lot of uncertainties that weigh on global growth.
But, many of them say, there is a need for a change in governance and in the way the advanced countries perceive the fund.
“Emerging markets are under-represented on the boards of these institutions, and I think this is part of the reform process, which is more voice and representation in both institutions for emerging markets,” says Castilla. “It is something that needs to be done so that there is more ownership on the part of member countries.”
In 2010 at their summit in Seoul, G20 leaders declared that “to be more reflective of new global economic realities”, the IMF would boost the voting shares of emerging market countries by 6%. Greater representation for emerging markets was promised in the executive board “through two fewer advanced European chairs”. The expectation was, says a fund insider, that the Europeans would give up two seats now and two later.
MUSICAL CHAIRS
Currently Europe has 31% of the votes and occupies one-third or eight of the 24 seats on the board, a misalignment called ludicrous by Bill Rhodes. The G20 leaders added: “We will work to complete [the reforms] by the time of the IMF annual meeting in 2012.”
But as the meeting kicked off, it looked like the deadline was not going to be met.
So what happened? After months of negotiations, the Europeans agreed to shift two seats from advanced to emerging Europe. The Belgians and the Swiss will go from permanent to rotating status, yielding initially to Poland and Turkey. Moeketsi Majoro, who represents 21 African countries on the IMF board, dismisses the move as “mere musical chairs”. Another board member calls it “something of a sleight of hand”.
But even these reforms – that among other things boost China’s vote from being on a par with Italy to 6% – are in limbo. That is because they have not been approved by the US, which ironically was their leading proponent. Facing opposition from the Republican-controlled lower house of Congress, the Obama administration has not presented the package for a vote. “It is,” says Dallara, “an example of a stunning lack of US leadership.”
Since IMF rules require an 85% majority for implementation, the Americans with their 17% voting share are holding things up. Treasury officials apologize saying they expect the delay to be temporary.
Truman says, given the imbroglio on Capitol Hill, a deadline for further governance reform will also go unmet. The G20’sSeoul summit promised a comprehensive review of quotas or membership subscriptions by January 2013. As of now there is no consensus on a formula for calculating the quotas of the fund’s 188 member countries. Truman predicts that the issue is so complex, “nothing is likely to happen until 2014.”
That’s bad news for the Brics (Brazil, Russia, India, China and South Africa) because they sought to link their contributions to Lagarde’s firewall to obtaining a larger say in fund affairs. A declaration by Brics leaders in Los Cabos was forthright: “These new contributions are being made in anticipation that all the reforms agreed upon in 2010 will be fully implemented in a timely manner, including a comprehensive reform of voting power and reform of quota shares.”
A Brazilian policymaker even regrets the Los Cabos contributions, complaining that “we put up $100 billion and got nothing for it.” South African central bank governor Gill Marcus is also unhappy. “The IMF and greater representation is a critical element,” she says. “They ask everybody here in emerging markets to commit to providing some contribution to this firewall, however adequate or inadequate that is, and therefore greater representation confirmation would be a part of that.”
Insiders expect the Americans to come around eventually and the 2010 reforms to come into force. But the upcoming quota reform will be tougher. Simon Johnson, the MIT professor who was formerly IMF chief economist, says the fund desperately requires governance change. “Very few emerging markets trust the IMF to treat them properly if there is a crisis,” he says. “Hence the push by so many countries to build up foreign exchange reserves. And the over-representation of the Europeans should be reduced as a pressing priority.”
Rhodes expects the G20 to be the vehicle that ultimately prods the IMF to get more reforms implemented. “It’s going to happen,” he says, as the fund becomes more reliant on China and other fast-growing surplus countries.
—Additional reporting by Lucien Chauvin and Antonia Oprita