Will IMF set its sights on managing global reserves?

Latest on IMF strategic review

8 April 2006

The managing director’s report on implementing the Fund’s medium-term strategy was discussed by the board 3 April and is anticipated to be released at the spring meetings. The report will capture those recommendations that Fund head Rodrigo de Rato has selected from the findings of several internal working groups (see Update 48). Civil society groups have been critical of the opacity of the process and the failure to broaden participation. Some indication of the report’s likely content can be gleaned from a series of speeches given over the past two months by de Rato, and deputy managing directors Takatoshi Kato and Anne Krueger.

New fund for crisis prevention: If at first you don’t succeed

Discussion has centred on the possible introduction of a “high-access contingent arrangement” – large, quick-disbursing funds geared towards emerging market economies with capital account difficulties. While supported by many emerging market countries, donor countries which are represented by their central bank at the Fund board, such as Germany, are expected to be in opposition to the idea. The Contingent Credit Line, designed to serve the same purpose, lapsed in November 2003 because no country had applied for it due to concerns over conditions attached and the signal sent to financial markets. The likely result of this debate will be a newly-tweaked precautionary programme which allows access to larger funds more quickly, but still involves some conditions.

Fund surveillance efforts will give greater prominence to financial sector and exchange rate issues, particularly in emerging markets. There is also hope to better integrate bilateral and multilateral surveillance. This comes in response to the findings of the McDonough report (led by former president of the New York Federal Reserve Bank, William McDonough), commissioned in June 2005 to review the Fund’s financial sector analysis and surveillance activities. The Fund has already merged the International Capital Markets department and the Financial Systems department in February, and a taskforce is to review the Article IV surveillance reports to give a central role to financial sector issues. No indication whether the Fund will make any moves to respond to calls to make the governance of its surveillance efforts more independent.

the gains expected from capital account liberalisation were unrealistically high and the risks underestimated

Coming in response to US pressure over what they see as Chinese manipulation of its exchange rate, there are indications that the review will suggest a new role for the Fund in convening multilateral discussions over exchange rate imbalances. These ‘special consultations’ would involve the Fund calling in countries which are not behaving according to the rules of the global economy and encouraging them to reform. Beyond naming and shaming, it is difficult to see what leverage the Fund would exert over powerful middle-income countries in such discussions.

More controversially, de Rato weighed in on the debate over what to do with what many view as excessive reserves being held by a number of developing countries, particularly in Asia. He indicated that the Fund “should be open to supporting arrangements for pooling reserves, at least by signalling sound policies” and that there may be “scope for links between such arrangements and the new contingent facility”.

Recent debate may shed some light on what de Rato meant. In a March speech in Mumbai, former US treasury secretary Larry Summers proposed that developing nations could turn over part of their excess reserves – he cited a figure of $500 billion – to a facility managed by the IMF. These funds would be invested, with the profits distributed to the contributing countries, and the IMF taking home a one per cent management fee of $5 billion. The Financial Times, in a 27 March editorial, called the idea a “non-starter”, arguing the Fund’s role should be restricted to advising governments on what level of reserves they need to maintain and how best to manage any surplus.

Still missing from discussions on crisis prevention is the need for more systematic guidance on the use of capital controls. In a recent article in the Fund’s in-house magazine entitled Re-thinking Growth, authors conceded that “the gains expected from capital account liberalisation were unrealistically high and the risks underestimated”. They note that the only major recipients of private capital flows during the 1990s which did not experience a financial crisis were those that had imposed capital controls and had not completely opened their capital account. Successful countries, conclude the authors, minimised volatility through “macroeconomic policies that reduced vulnerabilities” (see At Issue on speed bumps and trip wires).

IMF role in low-income countries

De Rato has made repeated mention of the need for a more systematic division of responsibilities with the Bank. In his view, the Fund should focus on fiscal, monetary and exchange rate policies; trade policy; financial sector soundness; debt management; and advice on how to adapt macroeconomic policy to handle anticipated higher aid inflows. A review committee, including investment bankers, finance ministry officials and senior WB and IMF staff (with civil society conspicuous by its absence), was announced end March to look into areas of cooperation and overlap in their work. The committee is to present its findings before the end of the year.

The Fund is also looking at increasing its provision of technical assistance and capacity building in low-income countries. It will be “considering attempts to mobilise additional donor support or levying charges for these services”. The Fund is due to open a new regional technical assistance centre for central Africa, in Libreville, Gabon, January 2007. The need to charge for what the IMF used to give away for free is driven by a projected shortfall in income of $116 million for 2006. This is due to the early repayments of countries such as Brazil and Argentina, most recently Uruguay. The IMF’s outgoing director of external relations Thomas Dawson said that the Fund’s current financial position was “adequate”, but that in the medium-term they would investigate the “possibility of investing the Fund’s reserves”. Some analysts have suggested that the IMF could invest its reserves in higher yield government securities.

Civil society groups will be looking for signs in the review that the Fund is re-examining the impact of its macroeconomic conditions. Two new reports by AFRODAD on the impact of the IMF Poverty Reduction and Growth Facility (PRGF) in Malawi and Zambia find that the signalling role of the PRGF continues to negatively affect aid flows. As countries go ‘off-track’ on macroeconomic policies and targets, such as inflation and public sector spending, other donors withhold much needed finance. In discussion of a recent IMF paper on the macroeconomics of managing increased aid flows, Andy Berg of the Fund’s Policy Development and Review department, sounded a new tone, conceding that there are country circumstances where “inflation may be part of a needed relative price adjustment”. The paper concludes that in poor countries, the danger point for inflation is between 5 and 10 per cent.

Improve ‘voice’ or “slip into obscurity”

Criticism of the Fund’s failure to make progress on this issue continues to pour in. South African central bank governor Tito Mboweni recently called developing countries’ voice in the IMF an “embarrassment”, while UK secretary of state for international development, Hilary Benn, questioned the legitimacy of the IMF presidency restricted to European nationals “because of a cosy deal made sixty years ago”.

6 April, de Rato circulated some details of a two-stage plan to address the voice issue. The first would “involve slight quota increases for several fast-growing Asian nations like South Korea, and countries like Turkey and Mexico.” The second stage is less clear but could possibly see adjustments of basic votes for African nations and the more politically delicate change in the distribution of chairs on the IMF’s 24-member board.

At least two new proposals for structural reform of the Fund were put on the table in the past two months. Speaking in India in February, Bank of England governor Mervyn King suggested that “to foster greater independence, serious consideration should be given to a non-resident board, with directors comprising senior finance ministry or central bank officials”. He warned that without fundamental reform, the Fund “could slip into obscurity”.

In mid-March, the European Parliament adopted a resolution on the strategic review of the IMF. On governance, the resolution calls on member states “to work towards a single voting constituency”. Lorenzo Bini-Smaghi, responsible for international affairs at the European Central Bank (ECB), said the IMF should “start by recognising a stronger position for the eurozone”. Currently the ECB president only has observer status on the Fund’s board. Lorenzo Bini-Smaghi, responsible for international affairs at the European Central Bank, echoed this call: “If the IMF is to become a credible forum for surveillance, it should start by recognising a stronger position for the eurozone.” Currently the ECB president only has observer status on the Fund’s board.