Revamped IMF surveillance: lacks influence?

3 October 2012

The IMF has modified its mandate for scrutiny of its members’ economies, pushing for greater oversight of large important countries. Doubts remain over its ability to influence the policy process of its biggest members.

At end July the IMF announced a new decision “establishing a comprehensive framework for the Fund’s bilateral and multilateral surveillance” of member countries and the global economy (see Update 81, 78). The integrated surveillance decision (ISD) sets out how the IMF will interact with each member and what analyses it will make of their economies. For countries without a loan, bilateral surveillance is the chief implement the IMF uses to advise or criticise. Multilateral surveillance refers to periodic reports that the IMF publishes about the global economy and its prospects, such as the biannual World Economic Outlook and Global Financial Stability Report. The policy will come into effect in January 2013, modifying the 2007 decision on bilateral surveillance that led to much controversy over the issue of exchange rate assessments (see Update 57, 56).

The first change the ISD introduced was to clarify the wording about conditions that would give rise to enhanced examination of a member’s economy by the IMF. The 2007 decision had called for extra scrutiny if a country had exchange rate policies that led to “external instability”. Without changing the definition or concept, the IMF will now assess “balance of payments instability” instead.

the IMF has precisely zero influence on the two most important countries in the world

Secondly, the ISD introduced a new principle for the guidance of policies: “a member should seek to avoid domestic economic and financial policies that give rise to domestic instability”. This complements the existing four principles: to avoid manipulating exchange rates for competitive advantage; to intervene in exchange markets to counter disorderly conditions; to take the interest of other members into account when intervening in the market; and to avoid exchange rate policies that result in balance of payments instability. According to the summary of the IMF board discussion, this “will provide a basis for the Fund to engage more effectively with members on domestic economic and financial policies.”

The decision includes a clause saying that the Fund should “respect the domestic social and political policies of members”. Developing countries had demanded in the negotiation that safeguards against the IMF intruding into their political process be retained, leading to the reconfirmation that “the decision does not, and cannot be construed or used to, expand or change the nature of members’ obligations.” Nevertheless, this potentially gives the Fund more scope to publicly intervene on domestic policy, which could be problematic without a clear definition of “domestic instability” according to Butch Montes of intergovernmental think tank the South Centre. “It would be nice if the IMF had the capacity to tell countries whose domestic policies/instabilities cause systemic problems to cease these policies. And perhaps the IMF could stick with this and not lecture developing countries on every aspect of economic policy.”

Though the ISD “encourages members to consider the effects of their policies on the effective operation of the international monetary system”, it does not allow the Fund to require a change of policies for advanced economies. Former chief economist at the UN Conference on Trade and Development Yilmaz Akyüz argued: “I see nothing there that would prevent systemically important countries from pursuing beggar-my-neighbour macroeconomic, financial and exchange rate policies. We clearly see it now with the US and Europe flooding the world with liquidity. Even if this is believed to be useful in bringing their own domestic stability (which I doubt very much), it has been major source of instability in global commodity markets and forex and securities markets of developing countries.”

Referring to China and the US, Financial Times commentator Martin Wolf was emphatic in his assessment of the new ISD: “the IMF has precisely zero influence on the two most important countries in the world. And it looks set to stay that way.”

Financial sector surveillance strategy released

In late September, the executive board adopted the Fund’s strategy for financial surveillance – a key recommendation of the Triennial Surveillance Review (see Update 78). The strategy aims to “fulfil its mandate to ensure the effective operation of the international monetary system and support global economic and financial stability”. It aims to incorporate “innovations” from the last decade and consider “gaps” in financial surveillance revealed by the global financial crisis. The strategy comprises three components: first, it will “better identify macrofinancial risks” through strengthening the “analytical underpinnings of macrofinancial risk assessments”. Second, it will “better integrate” existing risk assessments in order to “foster an integrated policy response to risks”. Third, it aims to achieve better “early diagnosis” of risks by engaging “more actively with stakeholders”. The board’s adoption of the strategy noted that, in regard to capital flow management, “directors underscored the need to respect the members’ right to adopt measures they deem appropriate”.

Persistant global imbalances

In early July the Fund published two new reports under the rubric of multilateral surveillance, the 2012 Spillover report and a Pilot external sector report. The Spillover report “examines the external effects of domestic policies in five systemic economies, comprising China, the euro area, Japan, the United Kingdom, and the United States” and is in its second year (see Update 78). It focusses on the perceived risks by officials in other large economies from these five systemically important economies, including: euro area stresses, US fiscal policy, US monetary policy, Chinese growth and rebalancing, Japanese fiscal risks, and financial reform.

The External sector report uses a new analytical model called an external balance assessment, and focuses on ‘global imbalances’, to “provide a snapshot of multilaterally consistent analysis of the external positions of major world economies”, covering 27 individual countries as well as the eurozone. It defines any imbalance not “consistent with fundamentals and desirable policies” as a “distortion”, providing IMF staff scope to define what is desirable and what is a distortion, regardless of country preferences.

Annina Kaltenbrunner of the University of Leeds argued that the model used for the paper is based on a one-size-fits-all approach: “There are no ‘fundamentals’, because the factors which determine a sustainable external position will depend on the country (e.g. position in international financial markets; openness, export coefficient sensitiveness) and how equilibrium is estimated.” She added: “It is tautological and ultimately not objective, because the IMF is deciding which are sustainable policies and depending on that decision will determine if a country is externally sustainable or not. If you are the one who sets the rules and then judges them, it is really not a very fair game.”

Despite the supposed changes in the IMF’s approach to surveillance and increased traction over rich country policies, a late June paper by financial journalist Paul Blustein, published by the Canadian think-tank CIGI, exposes the failures the last time the IMF sought to address global imbalances and raises questions about the likely success of any new surveillance initiatives. It focusses on the implementation of the 2007 surveillance decision and the IMF’s first multilateral consultations in 2007 (See Updates 59 , 54 , 51), calling them “a flop and a debacle.”

Detailing the political machinations that led to the failures of effective surveillance under those two processes, Blustein finds “the governments of sovereign nations – especially big and powerful ones – can’t be compelled to act in the global interest. Indeed, ruling elites sometimes resist taking such action even when their own people would broadly stand to benefit, because they often have political motives for avoiding measures that might incur short-term adjustment costs. Second, international institutions such as the IMF have little leverage over major countries, or even minor ones, other than those to whom they are lending money. If anything, these institutions are often obliged to indulge the wishes of, and avoid offending, their biggest shareholders.”

Blustein argues that the IMF’s lack of even-handednesss during the 2007 episode means the Fund “can be ruled out as the kind of unimpeachably objective umpire capable of delivering a stinging rebuke at a G20 summit to a country whose economic or currency policies pose a threat to others.” To remedy this situation Blustein argues that the IMF needs “enforcement power; and sufficient credibility and neutrality to umpire effectively”, proposing a WTO-style dispute settlement body for exchange rate, monetary and financial policies.

This chimes with analysis by the University of Denver’s Ilene Grabel, published in July, which argued that the debates over exchange rates, capital controls, and the spillovers from rich country monetary policy are a reflection of “the underlying volatility and uncertainty in the global economy”. Given the volatility, Grabel asks “should someone play referee in currency markets?” She concludes that “this will require new financial architecture” but that “the bigger trick will be to discover and establish new norms that govern the authority and strategies of developing and developed countries in regards to currency values. The new norms must at once promote genuine development and economic security, while nonetheless preventing predatory currency manipulation.”