A New Life for the IMF: Capitalizing on Crisis

by Robert Weissman

April's G-20 meeting - involving the heads of state of 20 of the world's most economically powerful countries - failed to yield an agreement on increased European stimulus spending or on new global financial regulatory rules. But it did feature one overriding tangible agreement: A commitment to expand massively the International Monetary Fund (IMF), in order to channel funds to developing countries rocked by the financial crisis.

The G-20 countries agreed to give the IMF up to $750 billion in new resources, three times more than it currently controls. The G-20 also pledged to provide $250 billion in trade financing to developing countries, and to channel $100 billion to low-income countries through multilateral developing banks.

Fleeing foreign investors, plummeting remittance earnings, falling commodity prices and shrinking export markets are devastating developing countries, leaving them in dire need of infusions of hard currency. The IMF money is intended to fill the developing countries' financing gap, and also contribute to the global stimulus effort.

But IMF critics warn that the Fund is requiring countries to implement contractionary policies, such as higher interest rates and lower government spending, that are the opposite of the expansionary policies pursued by rich countries, and that will undermine the stimulative intent of the promised new money.

The Hardest Hit

Developing countries are in desperate need of additional finance. Although they had nothing to do with mortgage-backed securities or credit default swaps, developing countries are getting worst hit by the global economic meltdown.

Eastern European countries benefited for a time from the financial bubble, as an infusion of loans from Western European banks helped pump up investment and consumer spending. With the financial crisis, the banks are unwilling to roll over loans. With the countries already running major trade deficits, the pull back in foreign bank lending has sent countries' currencies plummeting. As a result, Eastern European countries have been the worst hit by the crisis.

But no part of the world is escaping from the crisis. The World Bank predicts growth rates in Latin America will fall 5 percent in 2009, in East Asia by almost 3 percent, in South Asia by 2 percent and in sub-Saharan Africa by 2.5 percent.

The World Bank conservatively estimates that, due to the crisis, 53 million more people will be trapped in deep poverty - meaning they must subsist on less than $1.25 a day - than would have been the case.

"Conditions of recession are affecting the world's poorest people, making them more vulnerable than ever to sudden shocks - but also reducing the opportunities available to them, and frustrating their hopes," says Justin Yifu Lin, World Bank chief economist and senior vice president, development economics. "This could reverse years of progress, and is nothing less than an emergency for development."

Questionable Commitments

The extent to which new resources will be made available to developing countries remains uncertain, the G-20 headlines notwithstanding.

The commitment of $750 billion to the IMF consisted of two separate pieces. The first was a promise of $250 billion to an IMF lending facility known as the New Arrangements to Borrow, with a statement that an additional $250 billion would be made available if necessary. Much of the first $250 billion will come from pledges already made to the IMF, including $100 billion provided by Japan to the Fund in February. Whether the other half of the $500 billion will ever materialize remains unclear.

The other $250 billion promised to the IMF involves issuance of Special Drawing Rights (SDRs), a kind of IMF currency. SDRs will be allocated to countries according to the resources they have provided to the Fund - which means the rich countries will accumulate the vast majority of the new SDRs. Because of the special conditions attached to them, there is a good chance the rich countries will not make use of the SDRs. Some anti-poverty advocates have urged that rich countries transfer their SDRs to poor nations, but it remains very unclear if that will occur. There is also some uncertainty about the potential benefits of such a move, because countries using SDRs must pay interest to the IMF.

Whether the other money pledged at the G-20 - the $250 billion in trade financing (money lent to developing countries to buy rich country goods), and $100 billion in support through the World Bank and other multilateral development banks - ever materializes is also something that will only be revealed over time. Donor countries have a striking record of failing to fulfill aid pledges at global conferences, however.

A Lifeline for the IMF

Still, there is no question that the IMF will see a massive expansion of its resource base as a result of the financial crisis.

Just a year ago, the Fund was searching for a way to stay in business. Virtually all middle-income countries had taken advantage of booming commodity prices to pay back their loans to the IMF, and most began storing foreign currency to avoid going back to the Fund. Although the Fund maintained its dominant position in Africa and in low-income countries - which continued to need an IMF stamp of approval in order to receive aid from most foreign donors - the Fund had relied on money it earned from interest on loans to middle-income countries to pay its administrative costs. With those interest payments no longer coming in, the Fund was forced to cut staff and seek other revenue sources.

The new middle-income country demand for Fund loans, and the new resources available to the Fund, will solve the IMF's own financing troubles.

The IMF still faces the problem of countries maneuvering to avoid taking its loans, however, because of the onerous conditions traditionally attached to them.

For the past three decades, IMF loans have been accompanied by demands that countries adopt a series of market fundamentalist policies. These include deregulation (including of financial services), privatization, opening to foreign investment, orienting economies to export markets, removing protections for local producers growing food or manufacturing for the local market, removing labor rights protections, cutting government budgets, raising interest rates, and more.

But now, says the new IMF Managing Director, Dominique Strauss-Kahn, those days are gone. In March, the IMF announced an overhaul of its lending framework, with the self-proclaimed purpose of reducing conditionality. It touted a new lending facility, the Flexible Credit Line, available to "strong-performing countries," which makes loans with no conditions, and can make loans for precautionary purposes. For lending programs with conditions, it indicated a softening in approach.

"These reforms represent a significant change in the way the Fund can help its member countries - which is especially needed at this time of global crisis," says Strauss-Kahn. "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."

Critics remain unimpressed. The Flexible Credit Line is available to countries that least need loans - one example is Brazil, which is actually lending to the IMF - and that effectively have already adopted IMF policy prescriptions. The Fund announced only general standards for which countries would be eligible for Flexible Credit Line loans, but critics point out that, if the standards were applied honestly, even the United States would be ineligible. Among the standards are a sustainable external position and the absence of a systemic banking crisis.

The Fund also says that it is moving to apply structural conditions ex-ante (meaning before a loan is made) rather than ex-post (after the loan). But as Nancy Alexander, a Washington, D.C.-consultant and longtime IMF critic points out, this arrangement can be even more coercive than the Fund's old policies, as countries rush to impose IMF-favored policies before they can get any access to desperately needed monies from the Fund.

Strauss-Kahn further claims that conditionality will be looser. "From now on," he says, "policy conditions will be more tightly focused on core reform objectives and will allow for greater flexibility, tailored to country circumstances." Development groups express great skepticism that Fund practices will match this rhetorical claim, pointing to the IMF's most recent loans to explain their doubt.

Pro-Recession Policies

The logic of providing assistance to developing countries is to help them adopt expansionary policies in time of economic downturn. Yet the IMF is forcing countries in financial distress to pursue contractionary policies - the mirror image of the stimulative policies carried out by the rich countries (and supported by the IMF, for the rich countries).

The Fund's loans since September 2008 to countries rocked by the financial crisis almost uniformly require budget cuts, wage freezes and interest rates hikes. The first nine "IMF loans to countries affected by the crisis clearly demonstrate that the IMF is still prescribing pro-cyclical policies of fiscal and monetary policy tightening," says Bhumika Muchhala of the Penang, Malaysia-based Third World Network. "The Fund's crisis loans still contain the old policy conditions of cutting public sector expenditures, reducing fiscal deficits and increasing interest rates - which is the stark opposite of the expansionary, stimulus policies being supported in the G-20 countries."

In Ukraine, Georgia, Hungary, Iceland, Latvia, Pakistan, Serbia, Belarus and El Salvador, the IMF has told countries to cut government spending, an analysis by the Third World Network shows. This means less money for health, education and other vital priorities. In April, the IMF told Latvia - where the economy is expected to contract 12 percent this year - that its loans would be suspended until it further cuts spending.

"Our economy is imploding," says Inga Paparde of the Latvian AIDS activist group Association HIV.LV. "They say it will shrink 12 percent this year and our government has cut the budget by 40 percent, but the IMF is demanding a 'deficit target' of 5 percent of GDP. To reach this, we will have to shut down our hospitals and cut pensions. People are scared, and they are taking to the streets to protest these draconian measures."

The IMF also instructed almost all of the borrowing countries to raise interest rates, the Third World Network analysis shows.

An April paper from the Washington, D.C-based Center for Economic and Policy Research (CEPR) - "Empowering the IMF: Should Reform be a Requirement for Increasing the Fund's Resources?" - argues that these kind of contractionary policies are generally inappropriate in time of economic crisis.

"The main purpose of providing balance of payments support to a developing country in a time of recession or approaching recession is to enable the government to pursue the expansionary fiscal and monetary policies necessary to stabilize the economy," the CEPR paper contends.

"The main reason that many low- and middle-income countries cannot pursue" expansionary policies like those adopted in rich countries "is that they can run into balance of payments difficulties and foreign exchange constraints," the CEPR paper explains.

For these countries, says the CEPR paper, "any increase in growth relative to the baseline will tend to worsen a country's balance of trade and therefore [its] current account balance. This is because imports will tend to grow faster than exports. Also, if investors see fiscal or monetary policies that they think will lower the value of the domestic currency, this may promote further capital flight, which worsens the balance of payments problem. Also, if the domestic currency drops precipitously, this can cause balance sheet problems in countries where the private or public sector has borrowed heavily in foreign currency."

"Thus, the purpose of providing balance of payments support, as is done through an institution such as the IMF, is preferably to allow the country to continue growing while gradually reducing its current account deficit to a sustainable level."

But this is not the perspective of the IMF. The Fund said in a March policy paper that a few poor countries might have some capacity to undertake small stimulative programs. "A few countries may have scope for discretionary fiscal easing to sustain aggregate demand depending on the availability of domestic and external financing." But even then: "All this must be done carefully so as not to crowd out the private sector through excessive domestic borrowing in the often thin financial markets."

But for countries in weak positions - the vast majority - the Fund says that, "the scope for countercyclical fiscal policies is limited."

The Fund also continues to counsel against capital controls, which could limit the ability of foreign funds to enter and flee a country easily. As a measure to address capital flight, capital controls are a potential alternative to the Fund's emphasis on tight monetary policy and reducing aggregate demand. Concludes the CEPR paper in this regard: "the Fund's preferences may cause it to reject viable options that would allow for higher growth, more employment, and lower poverty rates."

Conditionality for the IMF?

Although the G-20 countries committed to providing new resources to the IMF, they have not yet delivered most of the money. The Obama administration is seeking to provide $100 billion to the IMF as part of the $500 billion total, but these funds require Congressional approval. Congress can attach conditions to the money (as could other governments considering providing new resources to the IMF).

Development and anti-poverty groups (including Essential Action, a project of Essential Information, the publisher of Multinational Monitor) are urging that Congress demand meaningful, verifiable change at the Fund before agreeing to provide it with new monies.

"New funding should not be provided to the IMF unless the institution is subject to important reforms that will prevent the Fund from continuing and repeating the serious errors that they made in the last major crises of the 1990s," says Mark Weisbrot, co-director of CEPR and lead author of the April paper from the group.

"For years the IMF has imposed disastrous conditions on poor countries that have contributed to massive underinvestment in health, HIV/AIDS and education, particularly in sub-Saharan Africa," says Asia Russell, director of international policy for Health GAP (Global Access Project), a global AIDS advocacy group. "The G-20 must make sure the IMF abandons these policies before infusing the Fund with hundreds of billions of dollars in new resources."

Development advocates say the Fund should have to demonstrate that contractionary policies are necessary before imposing any such conditions during recessionary times. They are calling for increased health and education spending to be exempt from any budget limitations in IMF loans. And they are urging that no IMF loan agreement go into effect unless it has received parliamentary approval - most IMF loans are negotiated with finance ministries, typically in secret, and not subject to meaningful public or even parliamentary input. The refusal of the Ukrainian parliament in April to agree to IMF demands led to a renegotiated agreement that permitted the country to maintain more expansionary policies.

In a Congress that it is very reticent about taking steps that may be perceived as providing more no-strings bailout money, there is considerable interest in such proposals. At the same time, some key Members of Congress are reluctant to prescribe policy for an international institution like the IMF, and Democrats are generally eager to cooperate with the Obama administration. With these and other confounding factors, whether Congress will demand meaningful reforms in IMF policy as a condition of providing it with $100 billion thus remains very uncertain.