The grin and the cat

EVER SINCE the economic crises erupted in East Asia and spread later to Russia and Brazil, the International Monetary Fund (IMF) has been busy designing a New Architecture of the International Financial System. In fact, the IMF has assumed the lead role and treats it as a part of reforming and strengthening its operations. There are several committees and groups working on various pillars and bricks that will finally shape the new edifice.

While work is going on, it has become the habit to impose individual components of the proposed design as conditionalities and relate them to financial deregulation. For instance, application of capital adequacy guidelines of the Bank for International Settlements (BIS) is taken as a sine qua non of bank restructuring schemes. It is not appreciated these guidelines themselves paved the way for reckless lending by major banks in the early Nineties and created the crises in Asia and elsewhere. The Basle Committee has taken note of the deficiencies and circulated revised proposals. And yet, the older guidelines are enforced on countries like India. There is thus a risk that some parts of the new architecture could be enforced on developing countries even in advance of the completion of the main work.

One segment of the new architecture seeks to involve the private sector in forestalling and resolving crises or PSI for short. Work on this area should cause concern to developing countries which look to the IMF to provide adequate and timely resources when a crisis occurs.

The issue is whether the IMF could become an institution playing a developmental role in its dealings with the developing countries. It is a half a century old issue raised during the Bretton Woods negotiations when developing countries were keen to include "development" within the ambit of IMF. However, this was not accepted by developed countries and finally its role was confined narrowly to "monetary management of world economy."

By the end of 1970s, as the turn of events would have it, the developed countries did not need any finance from the IMF and the institution, established to address the problems of all member countries, came to deal only with developing countries. This, in turn, began to have its impact on the debates and negotiations over its role and access to its resources. The harder the developing countries tried, the less they seemed to get. Debate over PSI is crucial in this game.

Private sector involvement

One of the early references to PSI is contained in an IMF document of January 1999 (The IMF's Response to the Asian Crisis)." Based on the lessons from the Asian crisis, six areas of further work for strengthening the financial system were identified. One of them was to evolve "more effective structures for orderly debt workouts, including better bankruptcy laws at the national level and better ways at the international level of associating private sector creditors and investors with official efforts to help resolve sovereign and private debt problems."

In a report given in April 2000 by the Acting M.D. of IMF to the International Monetary and Financial Committee on the progress in reforming the IMF and strengthening the architecture of the international financial system, there is one part dealing with PSI. It claimed that concrete progress had been made on the issue and referred to two successful efforts made in involving the private sector. Though it said, "further work is needed to construct an operational framework for securing involvement", it did add that the principle underlying PSI was accepted.

It relied on the principles and framework articulated by G-7 Finance Ministers in their report to the Koln Economic Summit. Under this framework, "private sector involvement could be ensured primarily through reliance on the IMF's traditional catalytic role if the member's financing requirements are moderate, or if the member has good prospects of rapidly regaining market access on appropriate terms even when financing requirements are more substantial." A threshold level for IMF funding was also mentioned.

U.S. stand on IMF's role

Policy pressures from the G7 are thus clear. There have been other pressures as well. The U.S. Congress as also the U.S. Treasury began to feel that the international financial institutions were doing a poor job and were no substitutes for private financial institutions. Some American academic groups (think tanks) supplemented this view.

The Congress had serious reservations when, in October 1998, it considered the proposal for additional funding to the IMF. Both the Republicans and the Democrats were deeply divided among themselves and some demanded abolition of the Fund. Debate was inconclusive. Ultimately, it was the fear that lack of funding might send wrong signals and aggravate the Asian crisis that led to the passage of the omnibus bill. It was done with several caveats. But Congress will continue to review the work and policies of the IMF.

The package approved by the Congress led to the creation of an International Financial Institution Advisory Commission (IFIAC) to consider the future roles of these institutions. It was headed by Dr. Alan Metzler and submitted its report in March 2000.

On the role of the IMF, the IFIAC felt, "the IMF has given too little attention to improving financial structures in developing countries and too much to rescue operations. Its system of short- term crisis management is too costly, its responses too slow, its advice often incorrect, and its efforts to influence policy and practice too intrusive."

The IFIAC is firm in its view that an acceptable exchange rate policy is one that is either "fixed" (dollarised) or "free- floating" and not the one that is "flexible" or "managed." In its view, exchange stability is better served by fiscal and credit policies than by rate management per se. If these premises are granted, it leads to the logical conclusion that the IMF's role should be considerably circumscribed.

It thinks that the IMF should serve as a quasi lender of last resort to emerging economies and lending should be confined to extending short-term funds (liquidity) when financial markets close. This lending should be at a penal rate and secured by a clear priority claim on borrower's assets - collaterals.

IFIAC is wholly informed by the private corporatist philosophy. It has suggested that IMF should not lend routinely to any or all countries unless the crisis in the country poses a threat to the global economy. Lending, again, should be subject to pre- conditions which are so set that, it is argued, there would be no need to set front- end conditionalities as are being set by the IMF now. The basic thrust is to rely more on the market and reduce access to IMF resources except when it is unavoidable or necessary to ensure global finan cial safety. It is against this back ground that one might read the Public Information Notice (PIN) dated September 19, 2000 summarising the discussions held in the Executive Board on September 5, 2000 on PSI. The Staff Paper on which discussions are based is not yet public, but the PIN contains adequate material to form our own inferences.

It is unclear at this stage what framework will be in place on PSI. Though the Executive Board is still groping in the dark, it is odd that it should say, "good progress has been made in developing a framework for involving the private sector in forestalling and resolving financial crises" and "welcomed the convergence of views on many topics." All this wisdom, it appears, was gained while putting through programmes for Mexico, Thailand, Korea, Brazil, Russia, Indonesia and Ukraine.

Those who have followed the developments in these countries are aware of the complex power play and the negotiations that took place in several centres and levels. A great deal depended on the nature of loan liabilities, relative claims of American, E.U. or Japanese banks on the banks (and non-banks) of crisis countries. Unlike the U.S. response in 1995 to the Mexican crisis when American banks were involved, in Asia there was an attempt to shift the burden on to Japan which itself was under severe financial strain. It took a long time to arrange the bankers' meeting to deal with Korean liabilities since Japanese and E.U. banks had a larger share.

Geopolitical factors were at play, as in the case of Indonesia. In the globalised banking system there are claims and counter- claims and off-balance sheet activities like derivatives, and linkages between banking crises and currency crises. There are still unresolved transmission mechanisms which economists are yet to unravel. Thus, any attempt to deal with individual countries in isolation may seem to lose touch with realities. So, what is the "convergence" they talk about? How do you involve pirates while devising schemes for high sea safety?

The main thrust in the Staff Paper is to limit access to IMF's resources in rescue operations and to bring its operations in line with the IFIAC philosophy. Members are expected to take preventive measures at the earliest. They are advised, when there is a crisis, to "work with all its creditors to ensure continued funding." And, if this is not successful, to take "concerted private sector involvement... to achieve an orderly resolution of the crisis."

While the Executive Board has made several observations of a general nature and expressed the need for further work, one fact that emerges from all the verbiage is that Fund resources would not be available in the first instance as hithertofore and fund support may be available "to catalyse package being worked out with the private sector." It has also been recorded that "while differences remain among Directors, ....there has been welcome progress toward a convergence of views concerning the circumstances in which the use of Fund resources would be conditioned on action to secure private sector involvement." It may seem that the decisions of the IMF Board are tentative and more time may be needed to arrive at a framework. It is not clear how the Director's of developing countries react to these proposals.

The U.S. Treasury has its own ways of working on the IMF and achieving its objectives. Dr. Stiglitz has been outspoken on this as also Prof. Jagdish Bhagwati. With a new President in office (already weakened by the electoral process), when the Congressional pressure gains momentum, a formal scheme could be rushed through the IMF Board.

We are witnessing the transformation of the IMF. It was in 1982 when Mexico declared default that it got involved with the private banking system. The "debt hang" in Latin America made for its greater involvement in the Eighties in rescheduling programmes with banks. In 1995, it was used by the U.S. Treasury and FED to bail out Mexico and American banks. In the late 1990s, its role got enlarged due to the Asian crises. Debates continue on the efficacy of IMF packages. There was, however, renewed hope that the IMF could play a role in "development." Newer ideas like the IMF becoming a 'lender of last resort' also came up. It seems that developed countries have no use for any of these ideas and would latch the IMF onto PSI. It amounts to using the IMF in a pivotal role without using its resources - it is a grin without the cat.

K. Subramanian

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