IMF’s latest prescription: Cure the crisis with austerity

17 June 2010

The IMF has gone back to promoting fiscal austerity and pressuring governments to implement spending cuts and structural reforms. Austerity also remains at the heart of the Fund’s debt sustainability policies.

During a short period of the global financial crisis, the IMF seemed to be in favour of counter-cyclical fiscal stimulus packages. However, in February, despite little indication of a solid economic recovery, the Fund started to promote consolidation again. It called for comprehensive fiscal adjustment “when the recovery is securely underway” and for structural reforms in public finance to be launched immediately “even in countries where the recovery is not yet securely underway” (see Update 70).

Recommended consolidation policies are spelled out in more detail in an early June IMF working paper by Masato Miyazaki. Amongst the suggested instruments are the Fund’s usual recipes such as privatisation, broadening the tax base, “rationalising” public services, and structural deregulation.

In calling for austerity, the Fund is in opposition to the advice of other international institutions. A 2010 International Labour Organisation report Recovery with growth and decent work warns of the economic and social dangers of imposing fiscal consolidation in the midst of an ongoing recession, especially when spending cuts and tax increases primarily hit people on low and middle incomes.

UNICEF in April posted a desk review of the latest IMF country reports from 86 low- and middle-income members, which found that “in two thirds of the countries reviewed, the IMF has advised to contract total public expenditure in 2010 and further fiscal adjustment in 2011 for all but a few countries.” The UNICEF review argued against the withdrawal from fiscal stimulus when “social impacts of the economic slowdown are still felt in terms of rising poverty levels, unemployment, mortality rates and hunger.” Although the IMF has advised governments to prioritise poverty reduction and social policies when cutting public spending, the review questioned how “this much needed spending [can] be adequately addressed in parallel to fiscal adjustment.” After complaints by the IMF, the UNICEF paper has since been retracted.

Clients under pressure

The Fund’s return to fighting crises with fiscal austerity is also reflected in the conditions attached to its financing programmes to various countries. The latest disbursement of $1.8 billion from Pakistan’s November 2008 IMF loan is being withheld because of disagreement on the imposition of value added tax increases and fiscal tightening for 2010 and 2011.

Similarly, in Sri Lanka the IMF has refused to release $2.6 billion since February, because of the country’s failure to meet the Fund’s budget deficit target of 7 per cent of GDP for 2009. Under the terms of the IMF loan, the Sri Lankan government is required to cut the budget deficit to 5 per cent by 2011 by broadening the tax base whilst improving the investment climate, selling off public companies, and cutting public salaries and pensions, as well as subsidies for farmers. Policy impositions of this kind are in line with the IMF loan conditions in European countries (see Update 71).

Austerity for debt sustainability

According to the UNICEF briefing, the main rationale behind the Fund’s recent return to pre-crisis austerity policies is concern about fiscal and debt sustainability. At first sight, these concerns seem at odds with the IMF’s April paper on debt sustainability. According to the Fund’s optimistic conclusions, the global economic crisis will not result in long-term debt difficulties across low-income countries, with debt to GDP ratios returning to a downward trend by 2011 and 2012.

The Fund’s rosy view of debt sustainability presumes both a fast recovery of demand in industrialised countries and fiscal consolidation in low-income countries. A May analysis by NGO Eurodad notes that, “if the assumption of a fast recovery is wrong, or if the countries in question do not follow IMF advice to cut back on fiscal deficits, debt forecasts are likely to worsen for several of these countries.”

Moreover, the IMF’s projections about the effects of austerity are based on certain assumptions. Øygunn Brynildsen of Eurodad points out that “despite the Fund’s support for protecting spending on poverty alleviation, overall expenditure cuts including for investment and public sector employment could have detrimental consequences on long-term growth and development prospects.”

With two rich countries – Iceland and Greece – likely to face debt distress in the near future, proposals for orderly debt restructuring could soon regain political attention. An early June policy briefing by the European Trade Union Institute proposes “a fair and transparent debt work-out mechanism” that could help Iceland and Greece, and also ensure that developing countries in debt distress do not have to sacrifice their long-term social and economic sustainability.