Business, IFR - Mon September 9, 2013

Limping to the rescue

The IMF presents itself as the world’s police officer, or at least its willing auditor. But many see it as an alarmingly out of touch body staffed by Ancien Regime Europeans, lacking the ability to police itself, let alone an increasingly chaotic world.

If misery does indeed love company, then the International Monetary Fund is a firm that revels in misery. In the years leading up to the financial crisis the veteran institution, set up in the dog days of World War Two, had become an irrelevancy. At the height of the Asian financial crisis in the late 1990s, the Fund was issuing four new extended facilities a year to troubled economies. Between 2002 and 2008, it issued just four more.

By the time Dominique Strauss-Kahn joined in September 2007, the role of managing director had been reduced from global factotum to a de facto cost-reduction officer. Just 18 days before Lehman Brothers filed for bankruptcy in September 2008, DSK told shareholders that the Fund had secured US$100m in savings by sacking 380 mostly veteran staff.

The IMF’s dominant shareholders, overwhelmingly still the leading economies of North America and Western Europe, applauded. And then the crisis hit, one that, by any measure, the world’s self-styled policeman-cum-auditor utterly failed to predict.

To be fair, a smattering of internal voices had whispered of trouble ahead. “We knew the Fund needed to remain relevant, but beyond the likes of the UK and Canada no one was looking at balance-of-payment and balance-sheet issues,” said Jens Larsen, the UK’s alternate executive director at the IMF between 2006–08, now chief Europe economist at RBC Capital Markets. “And as it turns out, those few voices were spot on.”

Yet too few were willing to listen. DSK’s cost-cutting created a “pretty morose” atmosphere across the Fund, said a former senior IMF official who worked on the later bailouts of Latvia and Greece. Prior to the financial crisis, “the IMF had stopped creating the sort of important macroeconomic and financial analysis it once did. So when the crisis struck, it had neither the ability nor the inclination to provide advice to anyone”, he said. Gabriel Sterne, a former IMF senior economist and regular critic of the Fund said: “[The Fund’s] surveillance did not anticipate the crisis and its programmes did not contain it.”

Others question how much the Fund could have done. Governments of all stripes were under pressure in the mid-2000s to cut funding to multilaterals. Some were threatened with extinction.

Waiting for the call

Moreover, the Fund’s remit is pretty clear: to promote international monetary co-operation, foster global trade and exchange rate stability and, finally and most pertinently, and quoting the IMF’s latest annual report, to make “resources available … to members experiencing balance-of-payments difficulties”.

Here is the IMF in a nutshell: it exists as a reactive rather than proactive force, designed to address the world’s ills, not to offer a preventive solution. “You only hire the IMF when you are already in a crisis,” said Carlos Braga, a former head of economic policy and debt at the World Bank, now a professor of international political economy at IMD business school in Lausanne.

Post-Lehman, the Fund acted rather like a revived coma victim. It relearnt the basics while grappling with the complex financial products that led to wide-scale banking insolvency. Workers were rehired, often at significant cost, to do jobs so recently discarded, boosting headcount from 2,000 in 2008 to more than 2,500 by April 2013.

“You only hire the IMF when you are already in a crisis”

For a while, the Fund’s financial overseers struggled to keep pace with demand. Requests for bailout funds were received in late 2008 from the governments of Pakistan and Latvia, followed by Iceland, Hungary and the Ukraine. Greece received a mammoth US$145bn emergency package in 2010 as the eurozone debt crisis started unspooling, followed by bailouts in Portugal, Ireland, and Spain’s banking sector. Cyprus then accepted a bail-in that scalped local depositors and wealthy Russians.

Each was controversial in its own way. In Riga, faced with an indebted economy teetering on the edge of ruin, the Fund opted to balance the books first by expanding the fiscal deficit, then by slashing public-sector wages and prices, rather than merely fiddling with the nominal exchange rate of Latvia’s euro-pegged currency, the lat. This helped shore up the finances of exposed Nordic region banks but led to a slump that erased a fifth of Latvia’s economy.

Riga’s bailout programme was then loosely transplanted to Athens, where IMF staffers and the other members of the Troika, the European Central Bank and the European Commission, got to work slashing public spending and privatising state assets. What surprised many working on both programmes was how much, in the words of the former IMF bailout official, “was made up on the fly. You’d be amazed by how simplistic the austerity arguments were”.

The flaws

Critics say three key mistakes were made around this time, each focusing on the Greek bailout. The first was an almost wilful inability to foresee how much damage austerity would do to Greece’s economy, now mired in recession for more than six years. The Fund only admitted in recent months that it twisted its own rules to make the country’s debt burden seem manageable – and then only through an internal memo leaked to media.

Anyone with even a passing interest in the case can view the Fund’s internal struggle to admit culpability. While Poul Thomsen, lead negotiator in the Greek bailout, blusters that the Fund would, given a second chance, merely do “the same thing again”, the internal memo admits that the country failed on three of its four bids to qualify for aid.

“The Fund has never explained why it broke one of its most essential rules by supporting a lending programme that was inadequate to secure sustainability,” said Sterne, now an economist at Exotix in London. “That doesn’t just break the Fund’s own rules, it throws good money after bad. It not only delays the inevitable, but makes it worse.” To underline this point, it’s worth noting that between November 2010 and April 2013, the Fund revised down the projected level of Greek GDP in 2014 by 27%.

Second, many within the IMF believe it was too willing, in the early days of the financial and European debt crises, to open the lending spigot. “There was a view that the crisis offered us a way of recouping some of the respect we’d lost,” said a senior European IMF official, who declined to be named. “Many saw it as a chance to get our good name back – hence the push internally to lend big and quickly to Latvia and Greece.” The IMF decided it was “in the business of saying yes”, the official added. “Our attitude was to lend first and think later.”

The final mistake was the Fund’s willingness to treat Greece and, by logical extension, Europe, with kid gloves. Critics have alleged that the Fund’s recent European bailouts focused more on propping up the euro, bailing out French and Italian lenders exposed to Greece’s flailing economy, and smoothing the ruffled feathers of humiliated politicians in Paris and Berlin, than on enforcing much needed institutional capacity in a politically divided continent.

Past bailouts in Asia and Latin America saw the Fund unilaterally impose swingeing budget and tax programmes and exchange rate policies on helpless governments. In Europe, the IMF worked as part of the Troika, sometimes playing a quieter, more conciliatory role.

This has, rightly some say, engendered accusations of European favouritism, notably in Latin America, resentful of its past treatment by haughty Fund officials. Officials from Brasilia to Buenos Aires noted that more than 40% of the Fund’s voting rights are held by European governments, with a further 21% held by the US and Canada.

Past bailouts in Asia and Latin America saw the Fund unilaterally impose swingeing budget and tax programmes and exchange rate policies on helpless governments. In Europe, the IMF worked as part of the Troika, sometimes playing a quieter, more conciliatory role

It’s this perceived sense of partiality that led Paulo Nogueira Batista, who represents Brazil and 10 other developing countries on the IMF’s executive board, to reproach in July this year the Fund over its Greek bailout, and to abstain on a key vote to authorise the latest payment to Athens. Jose Antonio Ocampo, a former candidate to head the World Bank, now a professor at Columbia University in New York, spoke for many in the developing world when noting the “broad dissatisfaction with the Greek programme everywhere except in Europe”.

Herein lies perhaps the IMF’s biggest future challenge. On the one hand, said James Boughton, a former official IMF historian now working as a fellow at the Canadian think-tank Centre for International Governance Innovation, it was clear as early as 2008 that “Europe wasn’t able to deal with its debt crisis by itself. The IMF gave the process credibility and cover, otherwise this would have just been Northern Europe bailing out Southern Europe and enforcing painful financial and economic change”.

On the other hand, and however you cut it, the botched Greek bailout left the IMF looking like a pawn in a game played by Berlin and Paris, the Fund’s traditional twin power base. “It’s a very important principle within the IMF that all countries get treated equally, and clearly this wasn’t the case with Greece,” said RBC’s Larsen.

Exotix’s Sterne asks why the eurozone was treated by the Fund as “a partner to be accommodated wherever possible, not as a patient to be cured”. He said the IMF should have withheld funding until Europe had made “energetic progress” in areas like the creation of a full banking union, an issue long seen as the endgame in European cohesion, yet which still divides French and German legislators.

Future challenges

Any discussion about the IMF’s future role in a chaotic world – one where crises will occur, often in unexpected places – quickly dissolves into power politics. Emerging markets, growing in size and power, rightly want a greater say in how the world is policed and audited. But change will not come easy. The IMD’s Braga, who participated in “endless” meetings about voting rights at the World Bank, that other veteran Bretton Woods institution, said “getting consensus between 187 countries isn’t easy”.

Transforming the Fund will take decades, and will likely never end. That China boasts just 4% of the IMF’s voting rights is largely because its astonishing economic rise began so recently. Other emerging markets, some now struggling for economic and financial traction, are desperate for a greater say at the Fund largely because, as one official said, “it’s a highly political institution. By no means is it ‘fair and impartial’. You need a representative there because you need a voice in the process. And the more voices you have, and the louder they are, the stronger your position will be”.

And Europe, humbled and weakened by its debt crisis, is unlikely lightly to cede control of such a vital global institution. “I sense a great reluctance on the part of [European] powers to relinquish any control,” said Benoit Anne, head of emerging market strategy at Societe Generale and a former Africa economist at the Fund. “There is an ingrained fear that if power is lost it won’t come back.” Nor is it hard to fault this thinking among European officials. It’s difficult to imagine Beijing or Moscow relinquishing supremacy over the Fund without a fight.

Few doubt that we need an institution like the IMF, which to an extent is there merely as a buffer, a handy institution to blame for our own short-sighted economic and financial transgressions. The IMD’s Braga said if it didn’t exist, “we would have to create something like it”.

CIGI’s Boughton believes the financial crisis has “reaffirmed the necessity of having the IMF, or at least an institution like it, with history and credibility at the centre of the process”.

Yet much of the Fund’s future credibility will depend on its willingness to accept and learn from past mistakes, whether it’s able to design new instruments that tackle future shocks, and how it acts outside the Western world in times of crisis.

The Fund’s inadvertent mea culpa over Greece (see page 19) was both grudging and unsatisfying. A more revealing moment occurred at an April 2013 roundtable hosted by the Peterson Institute for International Economics, shortly after the controversial Cyprus bail-in. Asked by the audience why the Cypriot bail-in discriminated against even small depositors, the senior Troika members present, including Reza Moghadam, the IMF’s most senior European official, sat impassive and stony-faced, forcing PIIE president Adam Posen to come to the rescue.

Moreover, how will a still Western-led IMF act in the months and years to come in the event of a systemic crisis in, say, Australia, India or Japan, or the return of hyperinflation in Latin America? Will it ride in on a white horse promising to save the day, or arrive dressed as death, the eternally conjoined European judge and jury. Only time will tell.

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