New signals from Washington

At the conclusion of the latest round of annual joint meetings in Washington, it is clear that the International Monetary Fund is seeking to stick to the same old goals, although the path it has taken has become a difficult one.

EVEN as conditions get difficult for the International Monetary Fund (IMF) to continue to function the old way, it is seeking to adapt itself and the environment to ensure the realisation of the same old goals.

The much shortened annual joint meetings of the IMF and the World Bank were held in September in Washington D.C. in circumstances that were not the most propitious. As the IMF's World Economic Outlook prepared for the meetings made clear, in the United States the recovery from the recession that set in well before the September 11 incidents was losing steam rather quickly, necessitating a downward revision of the Fund's April projections for growth in 2002 and 2003. Since this would only aggravate the problem of sluggish growth in much of Europe and the recession in Japan, as exports in both are significantly dependent on buoyancy in U.S. markets, the prognosis for the world economy is by no means upbeat.

Elsewhere, matters are even worse. The problem of crises in emerging markets persists, with some of the "best-behaved" among them by the IMF's standards, such as Argentina and Brazil, being faced with severe or potentially severe difficulties in both the financial and the real sectors. Clearly, poor or even dismal economic performance was not characteristic only of countries where governments had mismanaged their economies, precipitated a crisis and then turned to the IMF for help. Rather, countries whose economic management had been declared exemplary by the IMF were proving even more vulnerable. This implies that the Bretton Woods institutions are failing in their self-appointed role as monitors and managers of the world economic system. This, together with the fact that the image of "efficiency" and transparency of U.S. markets, long held up as the example for the rest of the world to follow, had taken a battering in the wake of an avalanche of revelations of market manipulation, corporate accounting fraud and managerial greed, lent credibility to and even validated much of the criticism of capitalism, the Bretton Woods institutions and the World Trade Organisation (WTO) by anti-globalisation protestors.

These circumstances have forced a response from the Bretton Woods institutions, which are now struggling to win developed-country moral, financial and institutional support for their role as guardians of the world economic system. This renewed effort to win legitimacy was visible in many forms at the latest annual meetings.

THE most pathetic expression of the desperate search for legitimacy is the effort to underplay or even deny the fact that world capitalism is in the midst of one of the worst crises of performance, confidence and legitimacy, in the post-War era. This tendency came through in the statement by IMF Managing Director Horst Kohler at the closing press conference to the September meetings, in which he declared: "We, of course, discussed a lot about the global economy, and I was encouraged because there was no doom and gloom discussion, but a differentiated analysis and some realistic confidence that the recovery will continue." He went on to elaborate this point saying: "There is a broad consensus coming from this discussion that globalisation has created unprecedented opportunities to improve the wealth of nations, and this expression came not least from the poor and emerging markets. But the members of the IMF and the World Bank are also aware of the challenges and risks that come along with it. They don't want less, but they want better globalisation. We all agree that we must make a conscious and determined effort to invest in better globalisation, to make it indeed work for the benefit of all."

Statements like these, however, do not ensure that the problems go away. Globalisation and the kind of policies recommended by the IMF and the World Bank to countries that want to benefit from it has indeed generated slow growth overall and severe crises in particular countries. There is acceptance now that a shift away from the IMF's conventional menu of policies may be needed. One aspect of the needed shift, which the IMF has tacitly supported in individual countries, is the adoption of a reflationary stance with deficit budgets. Not only is Japan, which has adopted close to a dozen reflationary initiatives, being berated for not going far enough, but the IMF has turned a blind eye to efforts by countries in crisis to hike the fiscal deficit to ensure some growth, as happened in Korea. What is more, the IMF Managing Director has gone on record supporting the European Commission's decision to delay the implementation of the stability conditions agreed upon as part of the Stability and Growth Pact.

The new need for a degree of ambivalence is also reflected in the formal changes made at this year's annual meeting, for the first time since 1979, in the conditionality guidelines that apply to IMF lending. According to the IMF, "Adoption of new guidelines for conditionality has been motivated by an increasing recognition of the importance of several interrelated principles for successful design and implementation of Fund-supported programmes. Chief among these are national ownership of reform programmes, parsimony in the application of programme-related conditions, tailoring of programmes to the member's circumstances, effective coordination with other multilateral institutions, and clarity in the specification of conditions." It should be clear that "ownership" of the kind sought to be achieved through the PRSP process and the Nepad initiative, is aimed at reducing the extent of Bank-Fund responsibility for policies that are increasingly tending to fail, while "parsimony" and the "tailoring of programmes to the member's circumstances" are aimed at giving the IMF and the Bank a degree of leeway to permit policies such as deficit-financed spending in situations where typical Fund-Bank policies have resulted in a crisis.

BUT even allowing for lax conditionality, the problem of crisis even in healthy economies persists, as the differing experiences in Argentina and Brazil illustrate. In a candid admission during a visit to Tokyo, Horst Kohler is reported to have declared: ""Recent experience should also make us even more humble. The fact that it was not possible to avoid the current difficulties in Latin America suggests that we still have a lot to learn."

There are many results that this "learning experience" is yielding. To start with, despite objections from some members to investing large sums in rescue packages for countries facing payments difficulties, the IMF, realising that whimsical investor sentiment in the context of elections rather than any major problems afflicting Brazil's economy explain the weakness of the real, has committed a record $30 billion to help stabilise the Brazilian currency. The message being sent out is clear. If countries meet their commitments as part of the global liberalisation agenda promoted by the Fund and the Bank, the IMF should be ready to help these countries meet international commitments as and when necessary, independent of whether such help resolves the basic problem or not. To that end, the IMF has clearly decided to win support for an effort to mobilise adequate resources to finance this role. It is now persuading members "to consider, at the appropriate time, an increase in IMF quotas to ensure that the IMF continues to have the resources to be a confidence-building anchor for the international financial system."

But clearly, the IMF alone cannot carry the burden of financing these rescue efforts. Unfortunately, in the view of the IMF, at present the only available mechanism to deal with countries that have accumulated unsustainable levels of debt is a bailout by organisations like the IMF. Why the restructuring of sovereign debt rather than IMF financing of commitments due on unsustainable debt is proving increasingly difficult has been summarised thus by Anne Krueger, First Deputy Managing Director of the IMF: "In the 1980s, restructuring sovereign debt was a protracted but generally orderly process. Typically the major creditors were commercial banks, and they negotiated through a steering committee of maybe 15 people holding perhaps 85 per cent of the debt... Today we live in an entirely different world. Since 1980 emerging market bond issues have grown four times as quickly as syndicated bank loans. With many banks and bondholders now involved, private creditors have become increasingly numerous, anonymous, and difficult to coordinate. The variety of debt instruments and derivatives in use has also added to the complexity with which we must deal. Bondholders are more diverse than banks, and so too are the goals with which they approach a restructuring... Individual bondholders also have more legal leverage than banks and are less vulnerable to arm-twisting by regulators. No wonder countries facing severe liquidity problems often go to extraordinary lengths to avoid restructuring their debts to foreign and domestic private creditors."

To deal with this problem, the IMF has been working to revise the contractual and statutory conditions governing international debt. Its proposal has two components. First, the insertion of collective action clauses that require creditors to come to the table when the restructuring of debt becomes inevitable. The second is to create a Chapter 11 bankruptcy law-type of formal mechanism "that would allow a country to request a temporary standstill on its debts, during which time the country would negotiate a restructuring with its creditors. The Fund would only approve such a request if the debt were judged truly unsustainable, a judgment that is clearly not an easy one to make. During this limited period, the country would have to provide creditors with assurances that money would not be allowed to flee the country, and that policies were being put in place to ensure that the country could repay its debts in the future."

Difficulties in implementing this proposal are many. Above all, it would require a uniform domestic bankruptcy law and enforcement mechanism in every country. This would be impossible to achieve. However, the IMF sees a way out. This is to establish a treaty obligation by amending the Fund's Articles of Agreement, which requires the support of three-fifths of members, holding 85 per cent of the Fund's total voting power. The majority decision would then be binding on all members. Realising that goal requires wide support from the international community. That support is yet to be mobilised, but work has clearly begun.

THE objective of this unlikely legal framework should be clear. It helps the IMF help the international financial system, which, because of its overexposure in some countries and its atomistic nature, is unlikely to be able to stall default by working out an appropriate restructuring process. In the event, stalling default has required the IMF to act like a "lender of last resort", providing the finance to help overexposed borrowers with unsustainable debt to meet their commitments. But with crises coming in rapid succession, the IMF is hard put to play its role. This far-reaching proposal is aimed at creating conditions where despite irrational practices, the business of finance can continue as usual, the evidence of overexposure, herd-like behaviour and moral hazard notwithstanding.

To summarise and reiterate, even as conditions get difficult for the IMF to continue to function the old way, it is seeking to adapt itself and the environment to ensure the realisation of the same goals. This is inevitable given the fact that the organisation was created and is sustained by the interests it extends itself to support.