IMF lending programmes: old wolf in sheep’s clothing?

20 November 2009

The debate over IMF conditionality heats up as data comes in about IMF programmes; economic turmoil continues in countries such as Latvia and Ukraine, which face stern IMF demands.

While the IMF claims it has been cleaning up its austere reputation over the last year, an October study by US-based think tank Center for Economic and Policy Research (CEPR) found that 31 of 41 recent IMF agreements require ‘pro-cyclical’ macroeconomic policies – restictive, demand-reducing monetary and fiscal policies during a downturn, which would push countries further into recession.

The IMF defended its programmes, claiming that it has pursued ‘counter-cyclical’ policies. IMF staffer James Roaf argued that fiscal deficits were allowed to expand in 14 of the 15 countries reviewed in a September IMF study, and that the reason for initally overly restrictive macro-economic policies was that IMF growth forecasts for many borrowing countries were too optimistic.

the IMF requirement to cancel the minimum wage law is unacceptable

CEPR issued a rapid counter-response, arguing that the IMF’s definition of counter-cyclical fiscal policy, which is limited to expanded fiscal deficits, is too narrow as it ignores the effects of automatic stabilisers – government spending such as income support and unemployment benefits which automatically increase during a recession.

Additionally, the IMF study only looks at fiscal policies, and does not mention monetary policies, which CEPR argues have been pro-cyclical in many low-income countries, and can be equally as harmful as fiscal restrictions.

The IMF’s economic rationale for pursuing more stringent policies for low-income countries, while happily supporting expansionary policies for rich countries is that developing countries face a much more binding foreign exchange constraint. Excessive demand during a downturn, can risk increasing current account deficits by boosting imports, resulting in a short fall in foreign currency. However, as highlighted by a G24 policy brief earlier this year (see 66 ) 30 low-income countries may have sufficient reserves to finance a fiscal stimulus, where as only 3 had been advised to spend more to counteract the crisis.

CEPR argues that the purpose of IMF lending during a world recession should be to provide sufficient reserves so that borrowing countries can pursue the expansionary macroeconomic policies that high-income countries are capable of, in order to minimize the loss of jobs and output, as well as longer lasting damage that can result from cuts in health and education spending.

Even in countries with unsustainable fiscal or current account deficits, “there should be a strong bias towards waiting until the world recession has passed before attempting to adjust these deficits.” In countries where the debt burden is unsustainable, there is an argument for “more and speedier debt cancellation in the near future, rather than trying to improve the fiscal balance while the economy is crashing.”

Worryingly, in a separate IMF study on conditionality in low-income countries, its programme projections for 2010 envisage cuts in fiscal spending to levels near or below pre-crisis times. This is in sharp contrast to the ‘exit strategies’ that rich countries will be following, where deficits are not projected to tighten as early as next year, so as not to jeopardise a recovery.

Eastern European quagmires

In Ukraine, the IMF has stepped into a domestic political dispute between prime minister Yulia Tymoshenko and president Victor Yushchenko over raising the minimum wage (see Update 67). Yushchenko signed a law passed by parliament but opposed by Tymoshenko, even though the IMF had demanded that he veto the bill. The IMF immediately suspended the fourth tranche of its $16.4 billion standy-by program and the prime minister is asking the Constitutional Court to overturn the law.

Roman Kravchyk, of the Federation of Trade Unions of Ukraine states “with the October monthly pre-tax minimum wage at €52, the IMF requirement to cancel the minimum wage law is unacceptable. High inflation and depreciation of the local currency have already pushed large numbers of workers and pensioners below the poverty line.” Kravchyk argues that, “there are enough resources within Ukraine to increase wages and take other countercyclical measures, but the main problem is unfair distribution of generated wealth, corruption and a weak taxation system, which allows avoiding taxes and transferring money to tax havens.”

In Latvia, where the economy has suffered an 18.4 per cent annual decline, parliament met IMF and EU demands and gave preliminary approval for a 2010 budget with $1 billion in spending cuts and revenue increases (see Update 67). It is expected that the cuts in spending will result in the closure of schools and hospitals and the government has also pledged to reduce maternity benefits, salaries and pensions and to raise taxes. Latvia’s government, the IMF and EU have held the Latvian exchange rate fixed, leaving economic shrinking as the only way to reduce the country’s current account imbalance. Commentators are comparing IMF policy in Latvia to that followed in Argentina before its financial crisis in 2002.

Romania is under IMF pressure to pass a series of laws, including spending-cuts and labour-unfriendly reforms likely to result in the loss of more than 100,000 state jobs, in a short space of time between the presidential election, scheduled for 6 December and the IMF’s 10 December deadline. The Fund has delayed access to its money after the Romanian coalition government collapsed in mid-October, following a vote of no confidence. The political crisis erupted days after 800,000 workers went on strike against the IMF-demanded austerity package.

Almost a year after disbursing the first $827 million instalment of the $2.2 billion loan for Iceland, the IMF agreed in late October to release a further $167.5 million to the country (see Update 67), after the parliament agreed to guarantee $3.5 billion of compensation to British and Dutch foreign depositors for the collapse of an Icelandic bank. Critics said the repayment plan would force Iceland to make payments it could not afford, and in September health minister Ogmundur Jonasson resigned over budget cuts.