IMF PROFILE: From Maytag to Mayday to… what?

Although it is hard to imagine, a decade ago the International Monetary Fund was struggling to find a role and relevance within the global financial system.

Several years of global economic growth well above trend had meant that the IMF had been called in to help countries less and less frequently. As the then governor of the Bank of England Mervyn King told a House of Commons committee in the UK in 2005: “One of the good news stories of the past five years is that the Fund is no longer a major lender.”

This declining lending function was causing concern within the IMF. Officials at the time were comparing the Fund to the Maytag Repairman, an advertising company’s embodiment of the idea that the appliances made by the US company were so reliable they would never need mending.

They were foolish to do so. By 2012 it had pledged $103bn to Greece, Ireland and Portugal. That was much more — even allowing for inflation — than during the Asian crisis of the late 1990s when IMF lending reached $35bn. The IMF landed a $1tr funding package at the London 2009 summit of the leaders of the G20. It was back in business.

WAR ZONE

“The IMF is still a crisis firefighter but that’s the one thing I think is going to be most difficult for them to navigate in the coming years,” says Benn Steil, director of international economics at the Council on Foreign Relations in Washington.

The volume and destination of its lending was a surprise — particularly to developing countries who were used to the IMF’s parsimony and tight conditions when it came to helping bail them out of their crises.

As Susan Schadler, a senior fellow at the Centre for International Governance Innovation and a former deputy director of the IMF’s European Department, has pointed out, the key condition that the IMF only intervened when its lending would put the country’s debt on a sustainable path had been “effectively eliminated”. She says this raises key questions about the role of the IMF.

Steil says the IMF’s intervention in Greece but also in Ukraine will “come home to roost”. In May, it agreed to provide an $18bn standby arrangement to Russia’s neighbour, supplying $3.2bn immediately, of which over a third was to pay outstanding bills to Russian gas exporter Gazprom. However, the IMF says the country could require as much as $19bn of additional international financing.

“There are significant risks if the IMF is not going to get paid,” he says. “The Fund is clearly lending into a war zone so the sort of structural reforms they have been insisting on for many years have been made into a nonsense by the negotiations with Kiev because the government is simply in no position to implement reforms.”

CORE MISSION

Meanwhile the Fund is very much engaged in its core mission of providing financial support to emerging markets that have been hit by crises. In August Ghana’s authorities bowed to the inevitable and formally requested IMF help in dealing with the country’s enormous twin budget and current account deficits. This followed soon after Zambia which, faced with similar vulnerabilities, turned to the Fund in June.

“The IMF is the frontline,” says Homi Kharas, deputy director of the non-partisan Brookings Institution in Washington. “In the grand scheme of things, I think that developing countries care far more about the role and function of the IMF than the role and function of, say, the World Bank because there are alternatives to the World Bank and there are no alternatives to the IMF — at least alternatives of that kind.”

One of the consequences of the financial liberalisation over the last three decades is that more and more countries are able to

access the international capital markets. This year alone 14 sub-Saharan African countries have issued Eurobonds, including Kenya’s $2bn issue in June.

“You now have a much larger range of countries that have become integrated into global capital markets,” Kharas says. “If you have all these countries that are participating in these markets inevitably there will be some that will need assistance from the IMF when bad things happen.”

Steil agrees that there is a consensus that the Fund has a crucial role to play, although he dismisses the idea that the proposed $100bn contingent reserve arrangement (CRA) unveiled by the Brics grouping — Brazil, Russia, India, China and South Africa — at their July summit could ever be a rival.

“It is just too small,” he says, pointing to the fact that the IMF lent almost $70bn to Brazil and Russia alone at the turn of the century when net private financial flows to emerging markets today were roughly 10 times smaller. “The Brics countries know this, which is why they maintain such vast pools of foreign exchange reserves.”

BACK TO THE 1940S

The Fund has also returned closer to the traditional role envisaged for it when it was founded 70 years ago at the Bretton Woods summit in July 1944 with a mission to “promote international monetary co-operation” and be a forum for “consultation and collaboration on international monetary problems”.

Steil says: “Surveillance research was always part of its remit and neither the US nor the UK, who basically created the institution, ever intended the IMF to be fighting crises.

“It was just meant to grease the wheels of a dollar-based exchange rate system when countries had temporarily unmanageable balance of payments problems.”

The IMF has built up its surveillance efforts in the wake of the economic crisis — which it was not alone in failing to forecast. Since 2011, it has prepared spillover reports analysing the impact of economic policies in the world’s five largest economies — China, the eurozone, Japan, the US and the UK — on each other.

Since 2012, it has put together a snapshot of the external positions of the largest economies simultaneously, covering 28 large economies and the eurozone, and points to potential policy responses.

This role has become increasingly important in the wake of the rollercoaster fortunes of the world economy and financial systems but has become combined with its firefighter role. “The IMF is the agency that both does the surveillance of those countries and also stands ready to help them adapt to shocks when they happen,” says Kharas at Brookings.

He points to the immense amount of analysis work that it does on financial regulations and standards with bodies such as the Financial Stability Board. “This also extends to areas such as the role of monetary policy versus macroprudential policy in combatting asset bubbles and a whole range of what I would call norms and standards and analysis of global financial markets and the policy responses to it.”

INEQUALITY THEME

But the theme that the IMF has chosen to highlight recently is the growing evidence of inequality and its impact, not just in moral terms but also on economic growth. As IMF managing director Christine Lagarde said earlier this year: “Excessive inequality makes capitalism less inclusive. It hinders people from participating fully and developing their potential.”

The Fund broke new ground when it published a working paper this year written by Jonathan Ostry, deputy head of its research department, which looked at 173 countries over the last 50 years. It found that more unequal countries tended to have lower and less durable economic growth. It warned inequality could make growth more volatile and create the unstable conditions for a sudden slowdown in GDP growth.

Joseph Stiglitz, the Nobel laureate economist who has been a long term critic of the Fund’s thinking, applauds the sign that the IMF is taking on these concerns. “I think the very fact that the IMF has recognised inequality is a very important thing,” he told Emerging Markets on the sidelines of the 5th Lindau Meeting on Economic Sciences at Lake Constance in August.

“The fact that they have been repeating this over and over again is important,” he says. “People have been moaning about the weakness of the economy and not thinking about the underlying factors that have caused the weaknesses in the economy like growing inequality. When you move from the bottom to the top of the income distribution people don’t spend as much, aggregate demand goes down.”

Central banks, and in particular former Federal Reserve chairs Alan Greenspan and Ben Bernanke, had offset the effects by cutting interest rates to historic lows, according to Stiglitz, which created asset bubbles. “That’s not a long term solution,” he says. “The long term solution is to try and understand both the causes of the inequality and what you can do about the inequality.”

This raises the question of what the IMF and its 188 member countries meeting in Washington DC this week can do to address the issue. Stiglitz says some of the measures involve long term investment in areas such as public transport to make it easier for people to find work, and in education to reduce skills gaps.

“They are important to make a start but you are not going to get answers in two years,” says Stiglitz. “But you can do things short term like progressive taxation. These are simple things like saying rich people have to pay as much tax as poor people. Get rid of some of the loopholes that enable people at the top to escape taxation. That will create more equality and a bigger economy.”

GOVERNANCE REFORM

While inequality will be a big talking point at this week’s annual meetings, Steil says it is the firefighting interventions in countries like Greece and Ukraine that could cause problems for Lagarde, who is already under pressure over allegations relating to her time as French finance minister [see box].

Steil says that while the US and the EU can justify intervention in Ukraine on geopolitical or humanitarian grounds, it is “hard” for the Fund to justify it on the basis of the role it normally plays. “This may be used as further ammunition, particularly from non-European emerging markets arguing that the governance of the organisations needs to be changed significantly.”

While few outside the world of NGOs and protest groups would argue for the abolition or wholesale replacement of the IMF, the Fund faces persistent calls to reform the way that it operates and how it is run.

So will Lagarde face a challenge at the meetings? “I don’t think they have a lot of motivation right now to yell about it in public,” says Steil. “Behind closed doors I think that there is little doubt that they will use this as evidence that the old powers that dominate the organisation are pushing the Fund in directions that are going to undermine its effectiveness and credibility in the future.”

Four years ago, the 188 member countries agreed to a package of governance reforms that would give fast growing emerging economies more seats on the board and a greater share of the vote — or quota — at the expense of mainly European countries. However, as the US holds more than 16% of the votes and the move requires 85% approval, the reforms are in limbo because the US Congress has refused to ratify the deal.

“Among their motivations for doing this are obviously the need to push forward with governance and quota reforms but also to lay the groundwork for a non-European to be the next managing director of the Fund,” Steil says. Lagarde became the 11th successive European MD of the Fund in 2011 after seeing off a challenge from Mexican finance minister Agustin Carstens.

“It is highly unlikely that Europe will be able to maintain its hold on this particular position,” says Steil. “It puts the Americans in a difficult position because in the event that the Europeans relinquish their claim on the IMF the pressure on the US to relinquish its claim on the World Bank job will be enormous.”

But will politicians in the US, which will gain from the quota reforms, agree to the new structure and thus take the heat out of the debate, at least for the next few years? “[Winston] Churchill said that the Americans would always do the right thing after all other options had been exhausted,” says Steil.

“My view is that he will be proved right yet again when it comes to the IMF just because it is in the US’s interests to allow this governance reform process to go forward,” he says. “The IMF will still be necessary to everybody in the future.

“When I talk to people around the organisation, no matter how frustrated they may be and whatever the reasons for their frustration, they all believe it is necessary to stay in the game and hammer this out because the Fund is just too important to the functioning of the international financial system. None of the major players sees a viable alternative.”

After the rollercoaster ride of the last 10 years that has seen the IMF shift from being irrelevant to seemingly indispensible, the Fund is braced for a fresh round of controversy and criticism that could leave a post-Lagarde IMF looking like a very different vessel.