International Political Economy: The Role of the IMF and the Debt Crisis 10/03/03.

Eliza Gaffney

 

The IMF was conceived of in July 1994 at the UN conference in Bretton Woods in New Hampshire, USA; the impetus for it was the disastrous economic policies that had caused the Great Depression of the 1930s. In Dec 1945, the IMF was officially opened with 29 member countries. This number has since grown to 184.

Although it’s active role in the international monetary system has been adapted and modified in reaction to global circumstances, (this is sth I intend to address later in the presentation) the IMF statutory purposes have remained the same. These can be identified as:

Ø      To promote international monetary cooperation (through the existence of a permanent institution for consultation and collaboration)

Ø      To facilitate the expansion and balanced growth of international trade

Ø      To promote exchange rate stability among members

Ø      To establish a multilateral system of payments between members and to eliminate foreign exchange rate restrictions (which hamper the growth of world trade)

Ø      To make resources of Fund temporarily available to give members the opportunity to rectify balance-of-payments difficulties.

Ø      To shorten the duration and lessen the disequilibrium in international balance-of-payments of members.

In order to fulfil these purposes, the IMF carries out a number of activities:

Ø      Monitors economic and policy developments and gives policy advice to members

Ø      Lending for balance-of-payments difficulties (this evolved over time to cover not just temporary financing, but to support adjustment and reform policies). [1]

Ø      Provide governments and central banks of member countries with technical assistance and training in its areas of expertise.

Effectively what the IMF will look at in a country is:

Ø      The performance of an economy as a whole: total spending, output, employment, inflation, balance-of-payments.

Ø      Macroeconomic policies: government budget, management of money and credit, exchange rates.

Ø      Financial Sector policies: regulation and supervision of banks

Ø      Structural Policies: (which affect macroeconomic performance) labour market policies-employment, wage behaviour.

In performing its functions to serve the purposes I have outlined, IMF lending has evolved over time. Different features of IMF lending have designed in reaction to global circumstances as they have emerged; it is quite indicative of the flexible and adaptive nature of the Fund that as new facilities have been introduced to deal with new challenges, redundant facilities have over time been terminated. It could also be argued that the Fund has had to alter the nature of its lending in order to compensate for the mistakes it has made in the past.

 

Evolution of IMF lending:

Ø      1952 Standby Arrangements: designed to provide funds for short-term balance-of-payments problems.

Ø      1963 Compensatory Financing Facility: Fund to help countries cope with temporary shortfalls in export earnings; particularly for countries that are dependent on primary commodities.

Ø      1974-1976 Oil Facility: energy crisis of ‘70s, IMF helped recycle foreign currency surpluses of oil-exporting countries-it borrowed from oil-exporting nations and lent to oil importers to help finance oil related deficits.

Ø      1974 Extended Fund Facility: medium term assistance for balance-of-payments difficulties related to structural weaknesses.

Ø      1980s Debt Crisis Management: (see below)

Ø      1989 Assisting the transition from centrally planned economies to the market oriented systems in the former SU countries of central and Eastern Europe.

Ø      1996 HIPC initiative

Ø      1997-98 Asian financial crisis- provision of large loans to Indonesia, Korea and Thailand; creation of the Supplementary Reserve Facility to help countries deal with large short-term financing needs stemming from sudden loss of market confidence reflected in capital outflows.

Ø      1999 Contingent Credit Lines (CCL) member pursuing strong economic policies can obtain IMF financing on a short-term basis when faced with sudden loss of market confidence.

Ø      2000 Major review of financial facilities.

 

Debt Crisis Management:

1982-1984 Austerity Programmes

The IMF initially approached the debt crisis as a problem of liquidity and made more money available to countries and rescheduled debts on the basis of them committing to the following arrangements:

·        Reduce budget deficits: restrain spending, reduced subsidies, higher taxes

·        Improve external imbalances: slowing domestic demand, raising export volume, cutting prices of tradable products, currency devaluation.

·        Control inflation: tight monetary policy, competitive exchange rates, positive real interest rates, limits on wage increases and fiscal austerity.

·        Arranging financial flows from governments, central banks, private commercial banks, BIS and WB. This was considered so essential by the Fund to the success of adjustment programmes that it continued to ask other creditors to make their commitments before approving programmes and providing their own financial assistance. The IMF’s role here was to certify and act as a catalyst. (This emergent role has later been criticised as partly responsible for inappropriate lending and programmes been made available to countries, i.e. if the availability of other sources of funding is contingent on the IMF’s “seal-of-approval”, there was always a danger that pressure to provide this money would supersede the consideration of how suitable the programme was).

·  Surveillance over external debt policies of members strengthened.

·  New technical assistance programmes to help members monitor their external borrowing.

However, the impact of austerity programmes, while temporarily adequate in that they provided debtor countries with cash flow relief and financing for reform, in the long-term they were quite ineffectual. A number of reasons can be identified for this:

·        They reduced domestic demand, which was a short-term goal, but also helped to reduce growth to a halt.

·        Investment and import cutbacks removed other catalysts for growth.

·        Devaluation of currency made it more costly in local currency to service external debt.

So while a few countries, e.g. Korea and Turkey, made quick structural reforms and resumed growth, in the main, countries were falling into recession: Real GDP for the highly indebted group fell by .4% in 1982, 2.9% in 1983 and rose by just 1.9% in 1984. Overall external debt outstanding increased from $391bn in 1982 to $454bn in 1985.[2]

By the mid 80s, it was realised that some degree of concessionality was required in order to enable countries to have a realistic chance to get out of the debt crisis. This came in the form of the Structural Adjustment Facility (SAF); 1994 Enhanced Structural Adjustment Facility (ESAF); 1999 Poverty Reduction and Growth Facility (PRGF) part of HIPC initiative.   These facilities were designed for the Fund’s poorest member countries and lent to them on the bases that poverty reduction and economic growth are the central objectives of policy programmes in the countries concerned. These facilities came about as a reaction to criticism that the Fund had not concerned itself with the structural impediments to growth and in so doing had not adequately addressed the needs of the countries concerned. The was the first introduction of concessionality of lending; however the concessions were contingent upon the country concerned meeting and implementing a wide variety of conditions which proved to be highly problematic

The development of these facilities seemed to indicate a softening of attitude of the Fund towards debt relief. This included a change in the treatment of arrears whereby the Fund became more willing to make loans while countries were in arrears with banks; there also emerged an “increasing concern for the effects of Fund-supported programmes on income distribution, with the related recognition that income distributive effects might be important in determining the political and therefore the practical feasibility of programmes”.[3] This change in attitude indicated a step in the right direction for the Fund and, as Graham Bird states “If the Fund was still not coming up with the right answers, at least, according to some critics, it seemed to be asking more relevant questions”.[4]

However, in no way can it be denied that, despite introducing degrees of concessionality on debt and structural reforms targeted at alleviating poverty, hardship and disadvantage are still prevalent in the majority that undertook SAPs (an overwhelming amount: 1986-1999 56 countries with a total population of 3.2bn). [5] This failure to succeed entirely can be attributed to a number of factors, some of which are outside of the sphere of activity of the IMF and others, which are the result of a lack of foresight and planning on the part of the IMF. Indeed if one remembers that the original mandate of the IMF specified the provision of temporary loan facilities this prolonged use of IMF loans represents either a failure on the part of the IMF to achieve its aims or an indication of its ability to adapt.

 

There are a number of factors identifiable that have contributed to the failure of SAPs; due to the constraints of time, I will only outline a few:

• Conditionality:

This has been widely criticised. While obvious faults exist with this aspect of lending, it is insufficient to advocate the abolition of conditionality entirely-indeed it can be very important for two reasons: 1: on the one hand conditionality assures the country concerned that once it implements IMF reforms, it is guaranteed financing and 2. it acts as a safeguard to the IMF that the money is being used for its intended purposes. However it poses a number of problems:

Ø      Structural conditionality has largely concerned itself with structural reforms that promote economic growth; growth alone does not directly alleviate poverty-a rising tide does not necessarily lift all boats.

Ø      It can act to undermine domestic “ownership” of policies, which presents problems of political commitment and may galvanise opposition to IMF programmes already present in the country.

Ø      Conditionality has often been imposed in a “one-size-fits-all” manner, with little regards being paid to the differences between countries.

• IMF Role as a “seal of approval”:

Because an IMF negotiated package came to be a prerequisite for the receipt of loans from other international financial institutions, programmes have been undertaken under significant pressure, with countries agreeing on paper to implement reforms which are either unsuitable and ill-considered or which they have no intention of implementing.

·        A distinction can’t be drawn between balance-of-payments and development:

Payments deficits are a result of countries having undiversified product mixes with a high concentration on products that have lower prices and income elasticity’s. Reliance on a few key exports makes these countries more susceptible to external shocks and movements in the terms of trade. The resolution of these problems requires a long-term process focussing on the supply side of the economy-short-term management of demand is “important but fails to capture the essence of the problem”.[6] This relates to a wider issue about IMF lending and its attitude to development: a separation of the economic and the social issues is not an adequate way to deal with development.

In recognition of the many failures if IMF activity in the past 20 yrs, the IMF has undertaken various reviews in order develop new strategies and bring about reform of its policies and its institutions. Some of these include:

·        Highly Indebted Poor Countries Initiative: started in 1996, enhanced in 1999.

Ø      Aims to provide broader, deeper and faster debt relief

Ø      Debt relief to 7 countries by Sep 1999, totalling $6bn

Ø      No of countries eligible is now 36, having previously been 29.

Ø      Financing provided at an early stage for use in poverty reduction spending.

Ø      By April 2002, 27 low-income countries had begun to receive debt relief as a result of the HIPC initiative.

·        Focus on Serving the Poor:

Ø      Needs of the poor take priority-countries themselves “in the driving seat” of policy development.

Ø      Country concerned draws up a Poverty Reduction Strategy Paper (PRSP), which is endorsed by the WB/IMF Executive Boards; however strategies need not be fully in accordance with staff assessments to receive endorsement.

Ø      The IMF identify the following as the main principles of the new approach:

q       Comprehensive approach to development

q       Faster economic growth with participation of the poor in this growth seen as an essential facet.

q       Country “ownership” of goals, strategies and direction of development.

q       Development community (i.e. civil society) must participate.

q       Focus is on results.

·        Streamlining Conditionality: review of conditionality undertaken in Sep 2000

Ø      Distinction to be made between conditions that are absolutely essential and those that are relevant but not critical.

Ø      Avoid establishing conditionalities that are outside the IMFs area of expertise and delineate functions of IMF and the WB.

Ø      Apply conditionality on a case-by-case basis.

Ø      Refocusing conditionality has meant a reduction of 1/3 on average in the number of conditionalities required in low-income countries.[7]

·        IMF/WB Collaboration and Co-operation:

Ø      There needs to be a change in the organisational culture and attitude of both institutions.

Ø      The new stated goal is that the IMF and the WB should work together in a country led framework.

Ø      Each institution must focus on its area of expertise, introducing a concept of a “lead agency” in each policy area whose recommendations will be deferred to by either agency.

 

 

Conclusion:

In attempting to assess the evolutionary nature of the role of the IMF in its different efforts to deal with debt, all of which have had varying degrees of success, it is impossible to conclude whether or not its role has proven to be an outright success or failure. By managing to avoid an all-out collapse of the international monetary system after the debt crisis in the 1980s, it could be said that the IMF succeeded in its role as temporary provider of finance.

However, as has been stated and as evidence from the past has shown us, the avoidance of widespread international crises is not alone an accurate measure of IMF performance and it is not realistic to attempt to judge it by asking the counterfactual question of what would have happened should the IMF not have been in existence to intervene in the 1980s. The role of the IMF cannot be critically evaluated without reference to development issues; this is problematic because the Fund repeatedly states that it is not a development institution but a monetary institution. Underlying this claim is a root cause of the many failures of the IMF: the belief that it is possible to separate entirely economic issues from social issues. Widening gaps in income distribution both between and within countries is indicative of the fact that the pursuit of economic growth without reference to social impact and consequences is an inadequate means of achieving satisfactory socio-economic development.

It seems there are now changes afoot to address this imbalance; it is a good sign that it is finally acknowledged by the IMF that it’s activities play some part in poverty reduction.