IMF gets emerging markets wrong, again

4 October 2013

Amidst heightened risks of financial instability in major developing country economies, the Fund was forced to re-assess its global economic prognosis and risk assessment in an analysis provided to the G20 summit in September. Managing director Christine Lagarde conceded in August that, despite the Fund’s April forecasts highlighting the positive contribution of emerging markets’ growth, there is “the risks of a slowdown in emerging markets pulling back growth everywhere” in a move reported by the Financial Times as a “humbling series of U-turns”. Lagarde added that “tracing the interconnections” between countries is core to the Fund’s “revamped surveillance framework”, the centerpiece of which is the series of Spillover reports which identify risks through the economic and financial ‘interconnections’ between countries.  The Financial Times article also reported that “[the Fund’s] clout with presidents and prime ministers is likely to be diminished by the IMF’s failure to provide an accurate assessment of the world economy as recently as its spring meetings in April”.

Pressure on developing countries

While the 2013 Spillover Report was being readied for publication, large developing countries’ economies came under sustained pressure in recent months, with currency values falling sharply in Brazil, Indonesia, South Africa, Turkey and India, amongst others. As a result a number of developing countries have instituted policies to support their currencies’ value, including a late-August announcement from Brazil of $60 billion resources being earmarked to support their currency. In July, Indian officials denied any need for IMF support amidst growing rumours of economic fragility. India’s then central bank governor Duvvuri Subbarao responded to questions about the need for India to turn to the Fund by saying “the answer is no!” By late August, India’s rupee had fallen to its lowest-ever level against the US dollar after weeks of speculation.

The IMF’s September G20 briefing note argued that India’s “rising deficits” required “tough choices” in particular calling for reform of the tax and subsidy regime so that spending would be reduced, and a singles sales tax introduced. A September briefing from Kavaljit Singh of Indian policy research institute Madhyam, advised against turning to the IMF for a loan “which comes with stiff conditions”. It reiterated that Indian authorities “should not hesitate to impose capital controls … to protect … from a sudden capital flight” and instead suggested that India should expand on its bilateral arrangements with key trading partners.

Singh said that “the IMF’s policy advice to India to undertake tax and subsidy reforms to avert an impending crisis is completely off the mark. The main source of India’s vulnerability is the external sector imbalances (i.e. the current account deficit and its dependence on  short-term “hot money” flows to finance it). The IMF had given similar policy advice to Thailand, Indonesia and South Korea when these countries experienced rapid capital flight and currency crashes in 1997. It proves that the IMF has not learnt lessons from the past (and current) financial crises as it continues to pursue an orthodox economic policy agenda to the detriment of developing countries. Due to its policy mistakes, even a mention of a future loan from the IMF raises suspicion in India.”

IMF surveillance calls for more reforms

The IMF published the centerpiece of its crisis-prevention work, the 2013 Spillover Report, in August. The report examined the external effects of domestic policies in five systemic economies or regions: China, the euro area, Japan, United Kingdom and the United States, analysing how their policies impact each other and the rest of the world. The Spillover series was initiated in 2011 in response to criticism of the Fund’s failure to sound alarms in the run-up to the 2007/8 global financial crisis.

Lagarde’s August speech acknowledged criticisms of the Fund’s crisis-prevention efforts for failing to criticise the destabilising policies of richer nations while highlighting the reforms developing countries required, saying there are “some who feel the IMF has been reluctant to advise … [or] has been soft on [certain] countries” but she declared that “I disagree.” Lagarde instead called for more “lines of defence” and even accepted that capital controls have “in some circumstances … been useful”.

The goal of the report is not simply to examine global economic conditions but to assess the potential risk of instability or financial crisis owing to the inter-connections amongst key economies and regions. The 2013 report found that significant risks remain in the systemic countries, and advocates more structural and financial reforms, in particular in Europe. It advises China to embark on policies “to re-balance” toward “domestic consumption and liberalise the financial sector”. Its advice to non-systemic and developing countries was to ensure resilience through “macroeconomic and macroprudential levers”, including capital controls though “not as a substitute for other needed policy adjustments”: meanwhile they must “continue to undertake reforms”.