IMF policies at crossroads

Hema Senanayake

Finally IMF has approved a loan to Sri Lanka. Along with it IMF is sure to exert some pressure on our domestic policies. Denial of such pressures might be politically appropriate. But what is more important is to take IMF face to face on theoretical level and prove them that they are wrong in choosing their policies and get them relieve their pressure on us on that basis.

Usually IMF advocates a policy of “tight money”. They do ask loan recipient governments to cut expenditure, welfare etc. They would suggest to limit budget deficit to around 4% of GDP. IMF often asks to freeze wages and shed government initiated income generating projects. Most of these policies are based on the views of “the monetarist school of economic thought.”

Those economists say “stick to these principles and market will take care of everything.” However with the current global crisis IMF is not so confident to pronounce this ideology but does not deviate from the policies associated with this particular economic ideology specially when they deal with developing nations like ours.

The current U.S. budget deficit is around $1.4 trillion or 11% of its GDP. Does the IMF has any advice to the U.S. to limit budget deficit to 4%. Nobody knows. European Union set that each member country should not exceed a budget deficit of 3% of GDP. Already Germany, France and many other states are running over 5% of deficit.

Apart from that the U.S and Europe are running more welfare than Sri Lanka. The U.S provides $8,000/= of government grant for those who purchase a house. It is a direct fiscal incentive. Why? - To boost the housing market. The U.S. ran program call “cash for clunkers” till recently.

Under this program old cars can be traded in and buy a new fuel efficient car to be entitled to a government rebate of $3,500 to 4,000/=. Also in early 2008 the U.S. government sent a cheque to almost each household. The money so distributed free amounted to nearly 170 billion dollars. The list of such “welfare” is long. Similar kind of programs are run in Europe. We have no grudge with those countries or belittle IMF not advocating those countries what they do with us. But history has proved that IMF has done many blunders in choosing their policies. In a more recent debacle Argentina refused to repay IMF loans in 2001 due staggering amount of debt. Simply Argentina could not service IMF loans.

Though it was settle later by granting another loan to repay the previous dues the reason that Argentina had to endure such an amount of debt is due to a bad experimentation of a peculiar policy. IMF tolerated and/or partnered in this disastrous policy.

In early 1990s Argentina enacted a law call “currency convertibility law.” Though it is difficult to find out who got the Argentina to enact this law, one notable advocate of this policy was Prof Robert Mundell in Columbia University in New York. After winning the Noble Prize for economics in 1999 Prof. Mundell presented a major paper in April 2000 in Buenos Aires University in Argentina.

In that speech he hailed this law and expressed optimism that rest of the Latin American countries follow Argentinean example. IMF either supported it or tolerated it. Within 19 months from Mundell speech Argentinean economy collapsed. In December 2001, Argentina recorded the largest sovereign-debt default in history.

Under this law each Argentinean Peso should be backed by one U.S. dollar. The proclaimed objective was to have the same rate of inflation as of USA. So, if Argentina had to expand domestic money supply due to economic growth it has to earn more dollars by expanding export activities. If exports are not expanded enough then it has to borrow dollars in order to avoid breaching the law.

In 1990s Argentinean economy was expanding. Imports did its part rather than exports becuase due to the pegging of Peso to dollar imports were cheaper and exports were relatively uncompetitive. However inflation rate was low and in par with the U.S. This attracted a good amount of foreign investments too. But expansion of economy needed to expand money supply. To expand money supply Argentina need to keep a similar amount of dollar reserve according to the law. So Argentina kept on borrowing dollars and IMF was providing loans.

The result was by 2001 Argentina inundated with unserviceable amount of debt to IMF just to keep an idiotic law intact. By the end of 2001 Argentina had no option other than defaulting loan repayments and it declared so, plunging the country into a chaos. Peso lost all credibility and worth to nothing. It was a pathetic experimentation done in collaboration with IMF. Today this piece of legislation does not exist.

The myth about the IMF is that it is an international body. Indeed, it has lots of members, but a few countries make all the decisions. The Netherlands, for instance, has more voting power than China and India. However the current global crisis made an opening for other countries to bring their views to the table. “Chinese Vice Premier Wang Qishan explicitly called for developing countries to have a stronger say in how the international financial system is run. He published those statements in an article entitled, “G20 must look beyond the needs of the top 20,” which ran in the British newspaper, The Times, on March 29.” (quoted as reported in China Daily)

Humanitarian and political pleas would not mend IMF. This is the very reason that we need to bargain with IMF on theoretical level. Without it developing countries will not have a stronger say though China wants it. Therefore we need to do our homework best before we go to IMF next time.