IMF macroeconomic advice: ‘thanks, but no thanks’

23 November 2006

versión en español

The IMF’s ability to dictate economic policy to member states is fraying because of lost credibility in the wake of its failures in East Asia, Argentina and Russia (see Updates 8, 10, 28). Smaller developing countries are now joining the larger ones such as Brazil and Indonesia in rejecting the Fund’s interference in their economies.

In the midst of Ecuador’s presidential election in October, the IMF reportedly recommended in private that the government accumulate reserves to guard against a drop in the oil price and a possible adverse ruling in an investment arbitration case with a multinational oil company. The September 2006 World Economic Outlook (WEO), a semi-annual IMF report, criticised Ecuador’s energy investment policies.

Ecuadorean economy minister Armando Rodas called the WEO “a poor report filled with fallacies”. The advice on reserves prompted the minister of foreign affairs Francisco Carrion to state “Ecuador will act according to its own interests rather than upon the recommendations of international institutions.” Rodas demanded that the IMF stop “meddling in the legal and internal affairs of Ecuador and respect its sovereignty.” One candidate in November’s presidential run-off, Rafael Correa, has flirted with declaring a unilateral moratorium on repayment of Ecuador’s debt to the IMF to free up resources for social programmes.

South Africa has also publicly refused the IMF’s advice. The central bank in South Africa has a relatively broad band for its inflation target of three to six per cent. In the Fund’s 2006 Article IV consultation, an annual economic report produced for each Fund member, staff suggested that the bank explicitly target the midpoint of the band. Central bank governor Tito Mboweni rebuffed the IMF and declared that both he and the finance minister Trevor Manuel agreed that the IMF should “avoid anything that would appear to be policy prescriptive for countries which are not borrowing from [it]”.

Rates, reserves policies in flux

The industrial world, increasingly concerned over China’s trade surplus growth, is pushing for the IMF to increase its surveillance of exchange rate regimes. This has been bolstered by an Independent Evaluation Office report that criticised the Fund’s surveillance efforts (see Update 51). One idea floated by US researcher John Williamson, among others, is for the IMF to publish equilibrium exchange rates for each member country regardless of the currency regime in use. It is widely viewed that this suggestion is targeted at China, whose currency is considered undervalued by the United States and Europe.

However, an October Fund working paper by Dunaway, Leigh and Li casts doubt on this exercise, concluding that “small changes in model specifications, explanatory variable definitions, and time periods used in estimation can lead to very substantial differences in equilibrium real exchange rate estimates. Thus, such estimates should be treated with great caution.”

The executive board is still reviewing the IMF’s policy on exchange rate surveillance, which was last revised in 1977, but it is unlikely to reach consensus on this topic. In his statement to the IMFC, Nor Mohammed Yakcop, Malaysia’s finance minister, argued against the review of the policy, saying “we do not support the proposal for the Fund to determine and make public whether a member’s exchange rate is misaligned. It is widely known that the estimation of equilibrium exchange rate levels is highly sensitive to the underlying assumption.” Similar resistance was expressed by ministers from Argentina and Nigeria.

A recent Fund working paper on the optimal level of foreign exchange reserves by Jeanne and Rancière was unable to account for the enormous build up of dollars in East Asia’s coffers over the last few years. The weakness of the model was its assumption that the sole rationale for holding reserves was to buffer against shocks to growth from sudden stops of capital inflows. It ignored the political and economic risks countries and politicians face in going to the IMF during a crisis.

A recent G24 technical paper by Injoo Sohn of Princeton University explained Asian countries’ rationale in developing alternatives to the IMF as a counterweight strategy. “An increasing number of developing countries have questioned the legitimacy and effectiveness of the relatively exclusive decision-making structure of global financial governance, particularly after the 1997-98 Asian financial crisis. East Asia is thus calling for substantial IMF reform at the global level while pursuing new financial multilateralism at the regional level.”

Imbalances remain

Meanwhile global economic imbalances continue to increase with the WEO predicting that “the US current account deficit would rise further – to 6.9 per cent of GDP in 2007 – with large surpluses continuing in Japan, parts of emerging Asia, and oil-exporting countries in the Middle East and elsewhere.” The multilateral consultations initiated by the IMF in June (see Update 51) were to help unwind these imbalances, but as of yet have produced no results.

The IMF has recommended strengthened policies to ease orderly adjustment, including increasing exchange rate flexibility in China, reducing US fiscal deficits, implementing structural reforms in Europe and Japan, and additional spending by oil exporters. Larry Elliot, business editor at UK newspaper the Guardian, was doubtful of the IMF’s ability to convince the major players to take the necessary moves. “Believe it when you see it. In the meantime, the clock is ticking.”