Global financial crisis and the International Monetary Fund - Part II:

Can IMF bail out developing countries?

Jayatilleke DE SILVA

Eonomic neo-liberalism demands the deregulation of the economy, privatization of State enterprises, free play of market forces and free mobility of capital, products and services, relaxing labour laws in favour of capital, cutting down of social welfare measures, emphasis on individual good instead of public good and increasing commodification of nature.

The market is supposed to decide everything and the role of the State is reduced to the minimum. Of course, its role as protector of private property is left intact so as to guarantee maximum profits for multinationals and other entrepreneurs. This includes bailing out bankrupt private business enterprises through State funds. These principles are embodied in the Washington Consensus. Due to this heavy reliance on markets neo-liberalism is also known as ‘market fundamentalism.’

In fact, the flaw in this ideology was evident several years ago during the time of the East Asian crisis. The IMF insisted that East Asian nations liberalise the capital account which paved the way for an influx of foreign capital but there were no regulatory mechanisms in place to administer capital flows.

With doors wide-open foreign capital flowed out with even greater speed at the first signs of financial instability. East Asia showed that free market deregulation was no panacea for all ills in all countries. Former World Bank Chief Economist Joseph Stiglitz criticising the approach of the IMF which was based on a ‘one size fits all’ prescription said that it failed to take into account the specific conditions in each country. Similarly in the case of Argentina IMF prescriptions proved to be detrimental.

IMF in decline

The aftermath of the East-Asian crisis was a deep mistrust of the International Monetary Fund (IMF) in the region. Almost all of them stopped going to the IMF for loans. A similar situation arose in Latin America and elsewhere following the crisis in Argentina with its widespread social repercussions. By 2007 Venezuela, Brazil and India had paid up their loans and were independent of the IMF. The IMF itself faced a financial crisis and was almost downsized.

The IMF credit outstanding which stood (on an end -of-year at almost basis) at almost US $ 100 billion at the end of 2005, declined to US $ 10 billion (a 90 percent drop) by September 2008. (Remarks delivered to the Tula Committee on Foreign Relations, United States, on January 22, 2009 and to the Dallas Committee on Foreign Relations on January 23, 2009 by Edwin M. Truman, Peterson Institute for International Economics). Since the IMF’s main source of income is the interest on loans, the demand for which declined progressively IMF’s administrative budget had to be curtailed. This resulted in a reduction of the IMF staff by 20 percent in 2007-2008.

The third world countries were searching for complementary or alternative sources of funding to meet emergencies. For example, after the East-Asian crisis a proposal for an Asian monetary fund was considered. Though the proposal has still not reached the implementation stage, a lesser initiative called the Chiang Mai initiative was created in 2000 by the Association of South East-Asian Nations (ASEAN), China, Japan and the Republic of Korea.

Since a country could draw only up to 20 percent without being placed on IMF surveillance this is only a complementary mechanism. On the other hand, initiatives like the Banco de Sur (South Bank) in Latin America is an attempt to develop an alternative to the IMF.

Crisis gives new legitimacy to IMF

The global financial crisis has lent a new legitimacy to the IMF and saved it from redundancy. Even countries which were reluctant to seek IMF assistance are looking forward to IMF assistance to get over their balance of payments difficulties and to augment their international reserves.

The crisis has not only given an opportunity to stage a come back but is also a challenge, since its financial resources have not kept pace with the global economy in the recent past. In fact, they declined. The IMF estimates that its reserves should grow by nearly 55 percent if it is to reach the levels relative to the global output at the time of the Asian financial crisis.

At the G - 20 Summit in London in 2009 it was decided to treble the resources available to the IMF. They decided to give US $ 500 billion for that purpose. This could be further raised as the European Union (EU) announced in September 2009 that it has decided to increase its funding to the IMF from Euro 75 million to 125 million (US $ 178 billion).

China signed an agreement with the IMF at the beginning of September 2009 to purchase US $ 50 billion SDRs (Special Drawing Rights) in IMF notes. Japan gave US $ 100 billion in February 2009. Brazil and India have promised to loan US $ 20 and 10 billion respectively to the IMF. Canada, Switzerland, Russia and Korea have also pledged US $ 10 billion each.

The IMF says, it is changing in responding to the crisis. It has stepped up crisis lending. By September 2009 lending commitments had reached US $ 160 billion. It also says that it has become more flexible by streamlining loan conditions. It has now doubled the member countries’ access to fund resources and structural performance conditions have been discontinued for all loans from May 1, 2009.

Structural reforms will be retained only in cases where they are critical to a country’s recovery. Allocation of SDRs has been increased to an equivalent of US $ 250 billion which is nearly a 10-fold increase in SDRs.

Would the IMF succeed?

Would the IMF be able to bail out the developing countries, with these changes and enhanced funding? In this respect a study undertaken by Yonka Ozdemir of the Political Science and International relations program of the Middle East Technical University provides some interesting insights into IMF crisis prevention strategy and evaluates its short-term and long-term effects on the client state.

In a comparative study of the IMF handling of the financial crisis in Argentina and Turkey in 2001, she shows that IMF reaction to the crisis was different in the two cases.

The study revealed that “While Turkey received a huge amount of IMF help right after the crisis, the Argentine crisis was left to degenerate before IMF help eventually came. The Turkish Government strictly followed an IMF sponsored program for its economic recovery while Argentina declared a moratorium and persistently challenged IMF and private financial institutions.

Although in the short-term it seems that Turkey’s recovery was faster, when we evaluate the economic results of these two different strategies seven years after the crises, it appears that IMF has proven to be more a curse than a cure for Turkey. Despite its impressive growth rates, with its unsustainable levels of trade and current account deficits, Turkey is again among the riskiest emerging markets.” (Ozdemir, 2009).

To be continued Courtesy: The Economic Review