The IMF and the Global Financial Architecture
1. Better regulation of international capital markets is essential
The Lessons from the crisis in East Asia have not been heeded. Reform of the global financial architecture has been half-hearted, focused almost exclusively on reforms in developing, rather than capital exporting, countries. Better monitoring and regulation of international capital markets is essential if future crises are to be prevented.
2. Developing countries must be properly involved in the architecture debate
Developing countries have been left out of the financial architecture debate. The IMF and the Bank for International Settlements are dominated by G7 governments. Even the Financial Stability Forum, set up a year ago, has no developing country membership. This must be remedied for both democratic and efficiency reasons.
3. IMF lending should be depoliticised
The Meltzer Report, echoing the views of the US Treasury, stated the IMF should have a sharper focus on crisis prevention. For the Fund to help prevent future crises, it must abandon its zeal for capital account liberalisation in developing countries, and IMF lending must be depoliticised.
4. Multilateral rules on involving the private sector during crises are needed
A consensus is emerging in favour of involving the private sector during financial crises. Now the international community needs to set up a framework to govern private sector involvement. This should require private creditors to agree to debt rescheduling when unsustainable repayment levels threaten to undermine human development.
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This week thousands of demonstrators in Washington are protesting against an unaccountable and undemocratic IMF that has repeatedly failed to help poor people. Public awareness of the consequences of Fund policies was heightened by the financial and economic crisis that swept through Asia and other emerging markets following the devaluation of the Thai baht in the summer of 1997. As economies collapsed in East Asia, Russia and Latin America, livelihoods were destroyed and millions of people were thrown into poverty.
Any serious analysis of the crisis identified problems in the international financial system, as well as the shortcomings of national policies, in seeking to explain how “miracle economies” disintegrated almost overnight. Many, including former World Bank Chief Economist Joseph Stiglitz, concluded that the system was in need of a thorough overhaul if disasters on this scale were to be prevented. The IMF has been the lead institution on reforms to the so-called Global Financial Architecture - to date they have fallen far short of a grand re-design. And with recovery in many crisis-hit countries, the impetus for change has diminished.
IMF work on global financial architecture has focused on transparency and improved standards in emerging market countries. Much of this work is laudable. Better liquidity and debt management in developing countries, for example, can only be a good thing. There are, however, two major problems. First, the Fund’s focus on reform in developing countries has meant that the need for better monitoring and regulation of international capital markets has largely been overlooked. The work of the Financial Stability Forum (FSF), set up following the Asia crash, should go some way to redress the balance. However, the three reports that the Forum will present to the IMF at the Spring Meetings – on capital flows, highly leveraged institutions, and offshore centres – contain timid recommendations.
The second problem is that developing countries have been marginalised in the debate on standards. Decisions are made in the IMF, the Financial Stability Forum (FSF) and the Bank for International Settlements (BIS), all dominated by G7 countries. Increasing interdependence between countries means that failing to involve developing countries in the debate is not only undemocratic, but also foolish. At the Spring meetings, the International Monetary and Financial Committee (IMFC) will discuss whether compliance with standards should be voluntary or compulsory - their time might be better spent coming up with ways to involve more countries in the decision-making process.
The Meltzer Report, echoing the views of the US Treasury, stated the IMF should have a stronger focus on crisis prevention. This should be welcomed. However, preventing future crises will depend not only on better regulation in international capital markets, but also on a major shift in Fund policies. First, the IMF should not be pushing developing countries to liberalise their capital accounts prematurely. There is compelling evidence that the Fund’s insistence on capital account liberalisation contributed to financial crises in a number of countries. Oxfam calls on the US Treasury to state unequivocally that the IMF should not
continue in that direction. Second, as the IMFC prepares to review IMF lending facilities at the Spring meetings, it is imperative that Fund lending is depoliticised. Too often IMF loan conditions are used to advance the trade interests of major shareholders – notably the US.
Since the Mexican peso crisis, the IMF has led the international response to financial crises. The large-scale rescue packages in east Asia imposed public spending cuts, high interest rates, increased taxes and widespread structural reforms. These measures were intended to restore confidence – they failed, and the crisis-hit economies were dragged further down with devastating consequences for poor people. As Joseph Stiglitz has famously argued, the East Asian economies, which didn’t have large budget deficits and already had tight monetary policies, didn’t need a dose of economic austerity, but rather expansionary policies that could have prevented the financial crisis from becoming a deeper social and economic crisis. Neither was the midst of a financial crisis the time for the Fund to advance the interests of its shareholders, by pushing countries towards further liberalisation under the guise of structural reform. It seems ludicrous, looking back, that opening up the Korean market to foreign car part manufacturers was part of their policy package.
A third area for reform, also up for discussion at the Spring meetings, is the role of the Fund in developing more orderly debt work-out procedures for countries experiencing crises. The financial crises of the 1990s have shown that reforms are needed which will make it easier to reschedule loans, in order to limit financial crises, and write-off bad debts, in cases of excessive indebtedness. The devastation of the Indonesian economy might have been avoided had such procedures been in place when the crisis erupted. Under current arrangements, official sector loans go to refinance private creditors while the pain from adjustment falls almost entirely on the debtor country. This is clearly unfair – for every bad borrower, there is a bad lender. Banks and other financial institutions lending and investing in emerging markets must appreciate that returns are high, because risks are high. A more even burden-sharing between the official and private sectors during financial crises would reduce the burden on debtor countries and also serve to temper “irrational exuberance”.
Over the last eighteen months, G7 governments and the IMF have made it clear that burden-sharing between the private and official sector during financial crises will have to increase. Progress on establishing ground rules has been slow, not least because of resistance from the private sector. However, the recent experiences of Pakistan and Ukraine have fuelled the growing consensus that private sector involvement during crises is both legitimate and possible. Now the international community has to decide whether these arrangements should continue on an ad hoc basis or whether a firm framework is needed. Oxfam believes there should be clear multilateral rules governing private sector involvement in financial crises. Such rules should require private creditors to agree to debt restructuring in cases where unsustainable repayment levels threaten to undermine human development.