SOURCE: AP/J. Scott Applewhite
Over the past decade or so the International Monetary Fund has seen its role as the world’s chief economic rescue institution diminish—to a point where about a year ago it was beginning to restructure and shift its own tasks to reflect a fundamentally-changed environment. Today’s global credit crisis, however, may well offer the IMF a new lease on life as government financial policymakers and financial regulators worldwide grapple with new sets of issues sparked by the first worldwide financial crisis of the 21st century.
During the Asian financial crisis in the 1990s or the Latin America debt crisis of the 1980s, countries struggled to fund massive current account deficits. A loan from the IMF, with stringent conditions attached, bridged the financing gap and helped reassure domestic and international investors that tough macroeconomic policy adjustments to revive the economy would take place. IMF conditionality, however, was highly controversial, leading many to question the efficacy of the “tough love” policies of the Fund.
Between 2000 and early 2007, however, this controversy seemed to lose much of its relevancy as global markets were awash in private capital. Ambitious countries were able to turn to private capital markets to fuel rapid growth. IMF lending slipped, as did its earnings. To cope, the Fund this year said it planned to sell some 400 tons of gold to boost its coffers; it reported a $140 million budget shortfall in the year to April 30, 2008. Capitol Hill will have an opportunity to weigh in on the gold sales plan—and IMF policy more broadly—as congressional approval is eventually required for such action. The Fund also said it planned to cut its staff by 15 percent.
Then suddenly, global financial liquidity dried up as the ramifications of the U.S. subprime mortgage crisis cascaded into other credit markets until the global financial system faced a full-blown credit crisis. Commercial banks and investment banks, insurance companies and public- and private-sector institutional investors, private-equity firms and hedge funds all registered big hits to their investment portfolios as the subprime mortgage crisis spread. This entire collection of financial players became increasingly risk-averse. Massive de-leveraging of debt led to a generalized constriction of credit that today continues to affect borrowers worldwide.
So can the IMF revert to its past role as lender, rehabilitation clinic, and credit organizer of last resort when private capital flows suddenly constrict? Or more to the point, can the United States and other members of the IMF board re-tool the Fund to tackle a new set of problems in global credit markets while also re-emphasizing the multilateral institution’s more basic role as global financial police officer? To do so, some key questions are:
- Would the Fund be able to structure a role to deliver more transparency in global financial markets?
- Would the IMF then be able to act upon the information it gleaned, reacting fast enough with loans to prevent a credit crisis in one country or region from rocking world markets?
- Would the Fund move to help individual governments support private financial institutions or domestic financial markets coping with stress? Or perhaps instead come to some generalized agreement to help private lenders and other financial institutions in borrowing countries as needed?
These are difficult questions to answer definitively amid a still raging global credit crisis, but certainly the IMF can play some sort of role when so many countries that would likely benefit from efforts to stabilize global capital markets are those that may be called upon to steer the IMF in such a direction. The Center for American Progress examined one possible avenue the IMF could take in our December 2007 report “Virtuous Circle: Strengthening Broad-based Global Progress in Living Standards.”
The report offers a back-to-basics reform agenda for the IMF that includes improving the Fund’s currency surveillance and macroeconomic coordination functions in order to reduce the incentive for countries to undervalue their exchange rates and accumulate large foreign exchange reserves. The report also calls for increasing resources available to the Fund to carry out its original mandate of currency crisis prevention—as well as broader debt cancellation—while placing greater emphasis on policymaking latitude and domestic consumption (rather than export growth) in policy advice to development countries.
The current global credit crisis clearly underscores the systemic dangers of sudden credit contractions in global financial markets and the concomitant need for a global institution that can help alleviate those illiquidity pressures as well as issue alarm signals about looming problems. There is also a need for better mechanisms to encourage all governments to think harder about the international implications of their domestic fiscal and monetary policy choices.
These objectives can best be achieved by sharpening the mandate and strengthening the cor responding resources of the International Monetary Fund, which in recent decades has strayed sometimes unsuccessfully away from its core responsibilities regarding balance of payments adjustment into such areas as structural economic reform and long-term development finance. The limited use of the Fund’s surveillance powers today limits the IMF’s influence on financial market expectations and public perceptions, leaving the international monetary system without the impartial moral arbiter it needs to look after the health of the global economic system as a whole.
That’s why the United States should work with other members of the Fund’s board to strengthen the institution’s independent execution of its surveillance and macroeconomic coordination functions along these lines. Certainly there are national economies that could profit from such attention. Examples include Iceland, Hungary, South Korea, and Vietnam, all of which boast economies that were enjoying fast debt-driven growth but are now facing varying degrees of trouble. Investors worry about these nations’ economies—and particularly their financial institutions—in which easy credit and asset-price bubbles fuelled rapid growth.
Iceland, for example, transformed itself from an also-ran among developed economies to a high performer in recent years, but now may be the first casualty of this turnaround. Iceland’s current-account deficit has ballooned to 16 percent of its Gross Domestic Product, and is now more difficult to fund. The Icelandic krona has also dropped some 20 percent against the euro since the start of the year. Its banks are looking weak. On March 25, the Central Bank of Iceland raised interest rates by more than 1 percent to 15 percent as fears of capital flight spread.
Other countries may follow suit. South Korea has reported a huge current-account deficit in January and February 2008—the biggest in 11 years—and South Korean authorities have already expressed worry about the declining value of the South Korean won. The Baltic states Latvia, Lithuania, and Estonia have current-account deficits of 25 percent, 16 percent, and 14 percent, respectively. These numbers do not bode well according to Fitch, a ratings agency, which says that countries that run current-account deficits in the double-digits usually run into economic difficulties. Bulgaria and Romania, which also have large current-account deficits (23 percent and 14 percent), are also shoes that may drop.
Other countries, such as Turkey and South Africa, have big current-account deficits, looming external debt, and currencies in danger of attack. They also have what appear to be asset bubbles, particularly in housing, that could shake their banking systems should they burst. Turkey’s current account deficit, for example, widened to $3.3 billion in February, some 10 percent more than economists expected and the Turkish lira has dropped sharply since the start of the year. And South Africa’s current-account deficit grew to 8.1 percent of GDP in the third quarter of 2007, its highest levels since 1971. The South African rand has fallen 21 percent against the euro and 15 percent again the dollar since the start of the year.
Any IMF mission-realignment contemplated by Fund board members should take into account both the global credit crisis and overall world macroeconomic conditions related to the globalization of trade and investment. Recent developments have sharply shaken the global financial system over the past year. Re-tooling the Fund so it can get back to basics could well help the international economic system better cope with the current crisis and future crises as they arise.
Naoko Nakamae is a Visiting Fellow at the Center for American Progress. Jonathan Jacoby is Associate Director for International Economic Policy at the Center.