The International Monetary Fund (IMF) should give up its lending and policy activities relating to development and trade, and instead return to its original mandate of safeguarding international financial stability, according to an expert on development and finance issues in a paper presented to a Group of 24 meeting recently.

This suggestion was part of a set of proposals by Dr. Yilmaz Akyuz, former Chief Economist of UNCTAD, in a paper "Reforming the IMF: Back to the Drawing Board", which was discussed at the 21st technical group meeting of the G24 held at the IMF headquarters in Washington on 15-16 September.

The G24 is the main grouping of developing countries operating in the IMF and World Bank

The paper comprehensively reviews the IMF's various activities and performance, and provides reform proposals that include removing several issues from its activities, changing the content of the remaining functions, and overhauling the governance system.

Akyuz, who was formerly Director of UNCTAD's Division on Globalisation and Development Strategies and the coordinator of its annual Trade and Development Reports, said the original rationale of the Fund, namely to safeguard international monetary and financial stability, is now even stronger than in the immediate postwar era given the size and speed of international capital flows and their capacity to inflict damage on the real economy.

"Thus, the Fund needs to go back to its core objectives and focus on preventing market and policy failures in order to attain greater international economic stability and facilitate expansion of employment, trade and income."

To realise this objective, there should be reforms of the IMF on many fronts, including for the IMF to have a greater focus and stay out of development finance and policy. There should be strict limits to its crisis lending and instead the Fund should develop orderly debt workout mechanisms.

The Fund should also focus on lending to finance temporary current account imbalances, with greater automaticity in meeting imbalances and less emphasis on policy adjustment. Conditionality should not be extended to structural issues but confined to macroeconomic and exchange rate policies.

Akyuz added that the IMF's surveillance activity has increased the vulnerability and fragility of emerging markets by promoting premature capital account liberalization and failing to alert countries to looming dangers. There should thus be fundamental change in the IMF's approach to capital market issues. The reforms must also address shortcomings in the Fund's governance.

The paper says that the Fund is no longer performing its original functions - securing multilateral discipline in exchange rate policies and providing liquidity for current account financing. Rather, it has been focussing on development finance and policy and poverty alleviation in poor countries, and the management and resolution of capital account crises in emerging markets.

The paper argues that there is no sound rationale for the Fund to be involved in development matters, including long-term lending. This is also true for trade policy which is a matter for multilateral negotiations elsewhere in the global system. There is also little rationale for financial bail-out operations that have so far been the main instrument of the Fund's interventions in crises.

By contrast the Fund should pay much greater attention to two areas in which its existence carries a stronger rationale: namely, short- term, counter-cyclical current account financing, and effective surveillance over national macroeconomic and financial policies, particularly of countries which have disproportionately large impact on international monetary and financial stability.

The IMF was originally designed to ensure an orderly system of international payments at stable but adjustable exchange rates under conditions of strictly limited international capital flows. A key task was to provide international liquidity to avoid deflationary and destabilizing adjustments and trade and exchange restrictions in countries facing temporary balance of payments deficits.

A major divergence from the Bretton Woods objectives has been in conditionality.Through conditionality the Fund has imposed exactly the kind of policies that the postwar planners tried to avoid in countries facing payments difficulties - austerity and destabilizing currency adjustments.

Austerity has been promoted not only when balance of payments difficulties were due to excessive domestic spending or distortions in the price structure, but also when they resulted from external disturbances such as adverse terms of trade movements, hikes in international interest rates or trade measures introduced by another country.

Furthermore, the distinction between temporary and structural dis-equilibria has become blurred, often implying that a developing country should interpret every positive shock as temporary and thus refrain from using it as an opportunity for expansion, and every negative shock as permanent, thus adjusting to it by cutting growth and/or altering the domestic price structure.

A major transformation of the Fund took place with the breakdown of the Bretton Woods exchange rate system. Currency stability ceased to be a key objective of international economic cooperation. The paper traces the changes in mandates and focus as the IMF increasingly took on development issues through the structural adjustment programmes and Poverty Reduction and Growth Facility, and became a crisis lender and manager for emerging markets.

Thus, sixty years after its inception, the IMF is now quite a different institution from the one created by the architects. It is now deeply involved in development issues. It started out as an institution designed to promote global growth and stability through multilateral discipline over exchange rate policies, control over capital flows and provision of liquidity for current account financing.

It has ended up focussing on the management and resolution of capital-account crises in emerging markets associated with excessive instability of capital flows and exchange rates, allocating a large proportion of its lending for financing capital outflows.

Also, while originally all IMF members had equal obligations for maintaining stable exchange rates and orderly macroeconomic conditions, the Fund's policy oversight is now confined primarily to its poorest members who need its resources because of lack of access to private finance.

The paper analyses the IMF's "mission creep" into development finance and policy. The Fund has been criticised for three things: its promotion of rapid deregulation and liberalization, with adverse effects on growth and poverty; the interference with sovereignty caused by Fund conditions; and the inadequacy of financing for such programs.

Akyuz, however, pointed to the issue of whether the Fund should really be involved in development finance and policy, and poverty alleviation. He said there are indeed no compelling reasons why the IMF should deal with structural problems in developing countries.
As noted, the Fund moved towards developing countries in large part because it was no longer needed by industrial countries as a source of liquidity and it lost leverage over exchange rate and macroeconomic polices of these countries.

The Fund introduced long-term facilities and concessional lending. In doing so, however, it has gone into the domain of development, with its programs and structural conditionality having addressed almost all areas of development policy, which are issues dealt with by multilateral development banks.

This is problematic for several reasons. First, it is not clear that the Fund has the necessary competence and experience in such complex issues. Furthermore, there are serious risks in entrusting development matters to an organization preoccupied with short-term financial outcomes and susceptible to strong influences from sudden shifts in market sentiments about the economies of its borrowers.

Difference of perspective is a latent source of conflict and competition between the Bank and the Fund, creating confusion in countries relying on policy advice from these institutions.

In reality much of what is being done in development by the Fund could easily be transferred to the Bank, said Akyuz. It is important that they have distinct mandates and objectives. He suggested that the Fund should cease development-related activities and transfer them to the Bank.

The paper criticises the Fund's intrusion into trade policy matters. It says that the Fund, as a monetary institution, was not to be involved in trade issues. In the event, however, it has gone in the opposite direction, putting pressure on deficit developing countries to undertake payments adjustment despite mounting protectionism in industrial countries against their exports, forcing them to resort to import compression and sacrifice growth.

More importantly, it has increasingly seen trade liberalization as an important component of
structural adjustment to trade imbalances. As noted by some experts, IMF surveillance has expanded into trade liberalization, partly as a result of pressure from the US.

Low-income countries and LDCs working under Fund programs have been encouraged and even compelled to undertake unilateral trade liberalization, putting them at a disadvantage in multilateral trade negotiations. Trade liberalization has also been promoted in certain emerging market economies in response to surges in capital inflows as a way of absorbing excess reserves and preventing currency appreciation.

An implication of unilateral liberalization is that the industrial countries would not need to lower their tariffs in areas of export interest to developing countries in order to secure better access to the markets of these countries in the WTO where trade concessions are based on some form of reciprocity.

Liberalization without improved market access in the North creates the risk of deterioration in their trade balances, hence leading either to a tighter external constraint and income losses, or to increased external debt.

Indeed there is a disparaging asymmetry in the multilateral consequences of trade policy actions taken by developing countries in the context of Fund-supported programs. A country liberalizing unilaterally acquires no automatic rights in the WTO vis-a-vis other countries, but it could become liable if it needs to take measures in breach of its obligations in the WTO.

The paper added that no mechanism has so far been introduced in the WTO for crediting developing countries for their unilateral liberalization in the context of Fund-supported programs.

Developing countries find it difficult to raise their tariffs once they are lowered. Also, applied tariffs are now a benchmark in binding and reducing tariffs in the current negotiations on industrial tariffs in the WTO, as seen in the WTO's "July package" which takes the applied rates as the basis for commencing reductions for unbound tariffs in developing countries.

The paper notes that Fund staff have been advancing arguments in favour of unilateral liberalization in developing countries that go even beyond the positions advocated by major developed countries in the current negotiations on industrial tariffs.

For instance, a recent Fund paper argues that Africa's interest in the Doha Round would best be served by its own liberalization, and that African countries, including the LDCs, should bind and reduce all tariffs, even though the July package exempts LDCs from tariff reductions and recognizes the need for less-than-full reciprocity.

The First Deputy Managing Director of the IMF has encouraged developing countries to undertake unilateral liberalization on several occasions, arguing that "countries that press ahead with unilateral liberalization will enjoy enormous benefits and they will not be penalized by further multilateral liberalization."

The Fund recently introduced a Trade Integration Mechanism to mitigate concerns among some developing countries that their balance-of- payments position could suffer as a result of multilateral liberalization in the current round of negotiations, insisting that such shortfalls would be small and temporary. This is despite mounting evidence that rapid liberalization in poor countries can raise imports much faster than exports and that the external financing needed can add significantly to the debt burden.

The Fund staff have been advocating binding tariffs closer to their applied levels on grounds that this would increase trade by reducing uncertainty of trade policy. This may well be the case, said the paper, but it is not a matter that should be of primary concern to the Fund.

"The international trading system no doubt needs greater predictability and stability, but discretion over tariffs by developing country governments is not the most serious source of disruption," said Akyuz. "As the recent experience regarding the movement of the dollar shows, exchange rate instability and misalignments are an even more important source of uncertainty and friction in the international trading system.

"It is thus advisable for the Fund to focus on its core responsibility of ensuring greater stability and better alignment of exchange rates, rather than narrowing the policy space for developing countries in matters related to trade and pushing trade liberalization as if a consistent international monetary order had existed.

"As the Fund transfers its work on development to the Bank, it should also stop being involved in trade policy issues or undertake activities that interfere with multilateral trade negotiations."

Its relation to the WTO should be confined to areas explicitly stated in the GATT, notably in Article XV on exchange arrangements.

On the IMF's handling of recent financial crises, the paper criticises the Fund's ad hoc management of crises and instead proposes that it assists in orderly debt workouts. It says the IMF rescue packages tend to aggravate market failures and financial instability by creating moral hazard. The bailouts encourage imprudent lending since private creditors are not made to bear the consequences of the risks they take.

The paper adds that there has been growing agreement that orderly debt workout procedures drawing on certain principles of national bankruptcy laws provide a viable alternative to official bailout operations.

These should meet two goals: prevent financial meltdown in developing countries facing debt servicing difficulties and facilitate an equitable restructuring of debt. This requires a few key principles: a temporary debt standstill;provision of debtor-in-possession financing; and debt restructuring including rollovers and write-offs, based on negotiations between the debtor and creditors.

These principles could serve as the basis for a coherent approach to crisis intervention. The Fund appeared to be moving in this direction at the end of the previous decade, with the Board at first recognizing that a unilateral standstill may be necessary in extreme circumstances, and the Fund secretariat moving towards a sovereign debt restructuring mechanism (SDRM).

The paper says the secretariat's SDRM proposal had many shortcomings. But even a watered down version could not elicit adequate political support, and has been put on the backburner. Indeed, the impetus for reform has generally been lost.

Other conclusions of the paper are as follows:

* The Fund should focus on lending to finance temporary current account imbalances. There should be greater automaticity in meeting payments imbalances resulting from external shocks and less emphasis on policy adjustment. Conditionality should not be extended to structural issues but confined to macroeconomic and exchange rate policies.

* The Fund's resources need to rise to keep up with growth in trade. Access of countries to Fund resources should be based on the principle of need and not on countries' contribution to the Fund or their relative importance in the world economy.

* Fund surveillance has been ineffective in preventing emerging market crises. The Fund has contributed to increased vulnerability and fragility of emerging markets by promoting premature capital account liberalization and failing to alert countries against unsustainable surges in capital inflows, currency appreciations and current account imbalances. Progress on this front depends on a fundamental change in the approach of the Fund to capital market issues. The Fund should improve its ability to identify risks and fragilities, and develop policy tools to prevent unsustainable capital flows to emerging markets, including direct and indirect control mechanisms, and provide policy advice.

* The Fund surveillance has also been unable to prevent destabilizing impulses originating from persistent trade imbalances and exchange rate misalignments in major industrial countries. This too is partly due to the poor quality of policy analysis and assessment of market conditions. Separating surveillance from lending decisions and assigning it to an authority independent of the Board could improve its quality, legitimacy and impact. However, such a reform alone is unlikely to increase significantly the leverage of the Fund over non-program countries and eliminate the imbalance between the Fund's debtors and creditors.

* Any reform designed to bring greater authority and legitimacy would need to address shortcomings in the Fund's governance, including selection of its head, the distribution of voting rights, transparency and accountability. However, the Fund is unlikely to become a genuinely multilateral institution with equal rights and obligations for all its members as long as it depends for resources on a handful of industrial countries and its financial activities are intimately linked to bilateral debtor-creditor relations between donor and recipients. These problems could be overcome if the IMF ceases to be an institution funded by its members, and relies on SDRs for the resources needed.

Full text:
Reforming the IMF: back to the drawing board, by Dr.Yilmaz Akyüz

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