To much fanfare, the International Monetary Fund Tuesday announced its latest attempt to revamp its lending instruments to better serve the post-financial crisis world. The new “flexible credit lines” are intended to speed bailouts, cut down on conditionality, and improve countries’ payback terms -- in theory, pleasing both donor countries and recipients.
IMF Managing Director Dominique Strauss-Kahn claimed:
“More flexibility in our lending along with streamlined conditionality will help us respond effectively to the various needs of members. This, in turn, will help them to weather the crisis and return to sustainable growth."
Despite its latest attempts, however, there is still a dramatic disconnect between the two masters -- donors and recipients -- that the IMF serves. If ever the fund is to serve either well, it must stop shape-shifting and decide what exactly it wants to be: bank or oversight body.
Since the crisis began, recipient countries have turned a cold shoulder toward the IMF. The fund’s $100 billion lending program announced in October 2008 hasn’t attracted a single borrower among the countries targeted: Mexico, Peru, Chile, Brazil, Singapore, South Korea, Taiwan, and perhaps Poland. Even when the IMF approached Mexico, a country whose finance minister, Agustín Carstens, is a former IMF deputy managing director, to break the logjam in its lending program, the offer was rejected. Asian economies targeted for a sweetened credit backstop from the IMF said "thanks but no thanks," according to the Wall Street Journal. Undaunted, the IMF has begun a full-court press to expand its lending and role in global surveillance with its new flexible credit lines.
Of course, the “new” IMF is contrite and issued a mea culpa, undertaking a major study on the lessons learned from the financial crisis and accepting blame for missing the dangers arising from weakly regulated financial institutions. In short, the fund admitted it had failed to provide global leadership.
Now after the “window dressing,” and recalling that the definition of success is marching from failure to failure with the same amount of enthusiasm, the managing director of the IMF is asking the international financial community for more resources. It promises to do a better job in international surveillance. Alarmingly, the G-7 countries are responding favorably. Europe wants to double the resources of the IMF to $500 billion; Washington has suggested lifting its lending capacity threefold to $750 billion; and Japan has committed an outright $100 billion.
Such disconnect between the G-7 lenders and the prospective G-20 borrowers targeted by the IMF is indicative of the personality crisis that renders the fund ineffective. There is an innate conflict between being a lender and exerting oversight on the global financial system. As Nicholas Stern has put it very well in the Financial Times, “Any forthright, disinterested assessment of the global economic system’s stability requires two sorts of independence.” He points out that the institution that is making the analysis and judgments about the stability of the system must not have anything other than its own reputation riding on its assessment. It must be independent of the G-7. On both these grounds, the IMF is conflicted. The drive to make loans for the sake of self-sustainability -- while meanwhile policing -- is an even more problematic.
Second, the extension of credit by the IMF is not benevolent for the counties that have run into troubles in the recent crisis. The IMF is planning to move private risks, incurred by corporations and banks in various emerging markets, onto sovereigns’ balance sheets. The fund’s loans are designed to bail out countries, permitting the international banking institutions to exit domestic financial systems unscathed, as in the case of Eastern Europe. It would be far more appropriate, as in the case of the previous Ukraine restructuring, for those countries to declare a standstill and restructure the debt, as opposed to indebting generations of middle-class citizens to IMF loan repayment.
Third, the foreign currency-denominated loans and other short-term capital inflows that the IMF hopes to inject into failing economies are the very same instruments at the core of the imbalances we have witnessed in recent years. Most developing countries today have fewer foreign assets than they do foreign currency liabilities -- meaning they are ill-equipped to cushion a sudden change in exchange rates against their favor. Accepting IMF loans in foreign exchange only exacerbates this mismatch and compounds an already innate financial vulnerability.
Fourth, there is inherent moral hazard in IMF loans, such as those proposed amid financial crisis. As Jeremy Bulow and Kenneth Rogoff articulate in "Sovereign Debt: Is to Forgive to Forget?," the fund has in recent years made it easier for countries to default. Rather than exerting the pressure that a private lending institution would to ensure repayment of the loan, the IMF allows for perpetual indebtedness -- that keeps the loan business booming.
To address these important shortcomings, the IMF needs more than aesthetic change. As Trevor A. Manuel, South Africa's finance minister, wrote in a letter to the Financial Times:
"… the training and recruitment of staff should adequately reflect changes in the role and mandate of the organization. Changing the Fund`s structure and function without diversifying its intellectual portfolio will undermine the effectiveness and relevance of the institution in the future."
The institution's very DNA must literally be renewed.
At this time of crisis in particular, the IMF must assess its own weaknesses before it can ever prevail upon the international financial system to monitor global stability. The fund's current shortcomings should warrant careful reflection before the IMF is granted the funds and the broad reaching powers it has requested. The IMF needs to find one identity and stick to it.