IMF emergency loans: Greater flexibility to overcome the crisis?

17 April 2009

By Nuria Molina, Eurodad

Despite promising IMF rhetoric about greater flexibility in fiscal and monetary policies because of the current crisis, IMF loans in Romania, Latvia and Armenia show that practice is not in line. The Fund is still pushing tight fiscal policy and single-digit inflation.

In late March the IMF executive board agreed to phase out the use of one type of IMF structural conditionality (see Update 65). Sources from within the IMF recently stated in private conversations that the instructions received from senior management are clear: advice to member states should clearly point at swiftly increasing fiscal stimulus, higher public spending, and flexible monetary policy.

At an International Labour Organisation meeting in Geneva at the end of March, IMF head, Dominique Strauss-Kahn said, “I’m especially concerned by the fact that our forecast, already very dark … will be even darker if not enough fiscal stimulus is implemented.”

Olivier Blanchard, IMF chief economist, has been even bolder: “I would put it more starkly. What is needed is not only a fiscal stimulus now, but a commitment by governments that they will follow whatever policies it takes to avoid a repeat of a Great Depression scenario.” He added: “monetary and fiscal policies need to become even more supportive of aggregate demand.”

Rhetoric versus reality

Preliminary research by the Third World Network (TWN) on the Fund’s advice to countries that seek assistance to cope with the effects of the crisis is not promising. According to TWN “the documentation on the IMF’s current loan conditionalities and policy advice demonstrate that the traditionally contractionary nature of the IMF’s fiscal and monetary policy framework has not changed.” The old recipes of tight fiscal policies, cuts in government spending, and single-digit inflation seem to be at the top of the Fund’s conditions and advice to countries that it has bailed out.

In March it was announced that Mexico will become the first country seeking IMF support from the newly created Flexible Credit Line (FCL), which provides precautionary support to what the IMF considers strong performing countries (see Update 65).

This follows a series of arrangements with low-income countries and Romania, the third EU country to seek IMF support in the past few months. Although most of the loan documents have not yet been published, the information so far disclosed by the IMF suggests that all these programmes push pro-cyclical policies.

According to the declarations made by the IMF mission chief for Romania to the Financial Times, the country will receive about $17.5 billion from the IMF in exchange for bringing “its budget deficit below 3 per cent of gross domestic product by 2011”. Moreover, he said, “there will be specific reforms in the fiscal area to make sure the deficit stays low over time – restructuring wage policies, recalibrating the pension system to make it sustainable, improving the control and monitoring of public enterprises.” The Fund will also seek to ensure that bringing down inflation is a core goal of the country’s monetary policy.

Guatemala will also have to follow stringent monetary policies in exchange for their $950 million IMF loan, with requirements that “monetary policy [be] focused on anchoring inflation at low levels combined with a flexible exchange rate system.” In Mongolia, the programme envisages tightening fiscal policy to “restore the deficit to a sustainable range”.

Although Armenia will also need to cut expenditures to meet the target of 1 per cent deficit in 2009, the newly approved Poverty Reduction Growth Facility (PRGF) grants small concessions as “the zero limit on contracting/guaranteeing new nonconcessional external debt was replaced by a small positive amount [$50 million], making room for the authorities’ debt issuance plans and projects financed by the World Bank and Asian Development Bank.” However, monetary policy is as stringent as in the other loans, including a transition to inflation targeting and a tightening of the target to below five per cent.

The Exogenous Shocks Facility (ESF) loan for Malawi shows a slightly higher degree of flexibility, and does not include structural conditions. However, the programme still aims at a rather low inflation rate, “converging gradually toward the medium-term goal of 5 per cent.”

The ESF for Ethiopia, although slightly more flexible in its conditionality framework, still pushes for the “elimination of domestic fuel subsidies and for “significantly tightening fiscal policy”. It also includes removal of some taxes, including on basic food items, as well as increased cash transfers in the safety net programmes.

In March, the IMF approved yet another ESF agreement with the Democratic Republic of Congo, where the Fund will require “keeping monetary policy tight”. This will somehow need to be reconciled with one of the key objectives of the programme; “redirecting spending to activities that would prop up domestic demand.”

A substantial change from previous loan agreements is that the IMF consistently suggests sustaining expenditure in the social sector, including on safety nets to protect the most vulnerable. Unfortunately, possible changes towards greater flexibility in some of the programmes are so minimal that it is hard to tell whether this is change in policy by the IMF.

In the meantime, the IMF reported that the first review of the Latvian loan, originally approved in December, has not been completed. According to the Financial Times, the Fund “has suspended lending to Latvia until it sees more progress in cutting public spending” and “Latvia is racing to prepare more cuts to keep its $9.9 billion stabilisation plan on track … [as] the budget deficit threatens to overshoot the target of 5 per cent of gross domestic product agreed with the IMF.”

Ongoing negotiations over an IMF loan are heating up in Sri Lanka. In early March, the president Mahinda Rajapaksa said that “We will not pawn or sell our motherland to obtain any monetary aid.” However, according to the Sri Lankan newspaper the Sunday Times, opposition politicians and some economists fear that the IMF loan that the government now hopes to get will include stiff conditions.

Practice what you preach

In words of the Thai prime minister, “When the G20 talks about reform of international financial institutions, it is not just a question of increasing capital, but also of how that capital is used … that means making sure there are new facilities for fiscal stimulus, continued development and social safety nets for developing economies … one of the lessons of the 1997 financial crisis in Asia was that the conditions enforced by the IMF had caused unnecessary pain.”

G20 leaders decided to increase IMF resources up to $750 billion (see see Update 65). The main downside of the agreement is that there is little mention of the need to reform IMF terms of lending and advice. Southern civil society groups, such as TWN, fear that “additional resources to the IMF would give it the means by which to discipline crisis-hit countries the wrong way, worsening the crisis for them.”

At the spring meetings, the executive board is expected to discuss and agree higher access for low-income countries. Over the summer, the board will discuss the terms of lending of IMF facilities, including the issue of conditionality. Southern governments, civil society and other actors are likely to put pressure on the board to ensure that recipient countries get the necessary fiscal and policy space to decide the best measures to overcome the crisis, and that they will not be constrained by stringent IMF policy advice and conditions.

Now that the IMF has recognized the merits of Keynesian policies in times of crisis, the need for counter-cyclical measures, and the need for greater monetary and fiscal flexibility, it is just a matter of practicing what it preaches.