The future of the IMF

Drawing on lessons from the financial crisis, the International Monetary Fund (IMF) - which holds its annual meetings with the World Bank in Washington, DC, in October - is busy reinventing itself and overhauling its lending and oversight work to better protect global financial stability.

At the same time, as part of a governance reform agreed in 2008 to reallocate IMF voting shares or quotas on its executive board with a view to correcting the over-representation of some rich countries, largely European, at the expense of some dynamic, mainly Asian emerging markets, Reza Moghadam, director of the IMF's strategy, policy and review department, says: "At the November G20 summit in Seoul there will most likely be an increase in the size of the quotas." These determine the amount countries contribute to the IMF, and the purpose would be to boost its resources from $750bn to $1000bn, says Mr Moghadam, giving it enough firepower to improve its global safety nets and stave off future financial disasters.

If agreed, this would be the second increase in financial commitments to the IMF since the G-20 decided, at a 2009 meeting in London, to treble the fund's resources from $250bn. Underlying that decision was the G-20's recognition that during the crisis, the IMF - the institution at the centre of the global financial system - was a backstop to prevent countries facing balance of payments crises from going into a tailspin that could be critical.

It was in 2008, when the credit crunch morphed into a global financial crisis, that the IMF sprang back into action, working with the European Bank for Reconstruction and Development to prevent a liquidity crisis and a systemic risk by making sure western European banks did not withdraw funds from their subsidiaries and affiliates in Romania, Hungary, Serbia, Latvia and Bosnia-Herzegovina.

When the economic downturn started to spread, the IMF stepped in to give balance of payments support to some of the same, and other, central and eastern European counties (Ukraine, Latvia, Hungary, Romania, Georgia and Belarus). Facing similar problems - big current account deficits and often fixed exchange rates - these countries received a package (Latvia, $10.5bn; Hungary, $24bn; Romania, $26bn) with IMF loans backed up by money from the EU, individual European countries and the World Bank.

However, the IMF's biggest operation in Europe by far occurred in April when, after months of delays, it was finally called into Greece's €110bn rescue package, alongside the EU and the European Central Bank. It agreed it would provide €30bn of the package - an amount that was in itself controversial as it amounted to more than 3200% of Greece's quota in the institution, the largest ever loan-to-quota size in IMF history.

Moreover, to prevent financial contagion spreading to other highly indebted European countries, and to save the euro, the IMF struck an innovative partnership with the EU that IMF officials believe sets a precedent for IMF co-operation with other regional groups and for other types of regional funding. The agreement was that a regional financial stabilisation mechanism should be launched with up to €750bn in funds - equivalent to the public debt servicing needs of the eurozone's most highly indebted countries - Greece, Spain, Portugal, Ireland and Italy - until the end of 2012.

The access of eurozone countries to the funds would be conditional on an agreement to implement an IMF fiscal austerity programme along the same lines as that of Greece. Meanwhile, according to its officials, although the IMF can only contribute funds on a country-by-country basis, as set out in its founding articles, the IMF is willing to contribute one-third of the money needed in any given rescue operation involving the mechanism, just as it contributed one-third to Greece's rescue programme and to the packages with the EU in eastern and central European countries in crisis before that.

Ousmene Mandeng, a former IMF official who is now a senior adviser at Ashmore, the London-based investment house dedicated to emerging markets, says: "The role of the IMF has changed. In the 1990s and up to 2002, the IMF gained in importance because it was lending to large nations such as Brazil, Turkey and South Korea. Now we have an IMF that is basically dealing with Europe. Given the systemic implications of a sustained crisis in Europe, that is justifiable. But I can see it raising a few eyebrows."

On the rebound

Proof of the IMF's rebound is that in 2009 the institution had an all-time record in its loan commitments; and Mr Moghadam says that, during the crisis, the IMF made loan commitments of more than $220bn.

From 2002 to 2007, IMF lending dwindled to the point where the relevance of the institution was questioned. The decline was partly due to a lack of demand for IMF loans during a booming economy, but non-governmental organisations, think-tanks and emerging market experts - and even the IMF itself, which, in a 2009 review of its loan conditions admitted it made mistakes in the past - all attribute the distancing to the imposition of too many and too complex conditions on stricken countries during the 1997-98 Asian financial crisis, Latin America's 1980s debt and financial crises of the 1990s. In both regions, countries rushed to repay their IMF loans and few other nations sought new loans, relying instead on alternative arrangements or a sizeable build-up of reserves.

Mr Moghadam says one reason for the IMF's successful comeback is that under current managing director, Dominique Strauss-Kahn, "from the very outset of the crisis the IMF was proactive". He adds: "It was proactive in giving its views and advice to advanced economies [the IMF took the lead among big economic institutions to call for fiscal stimulus to help the world economy during the recession], proactive in providing an analysis of the issues to the international community [the IMF is the only economic organisation providing advice on a continuous basis to the world's 20 leading economies, the G-20] and it was proactive in working with its entire membership [187 countries]. For instance, one of our big initiatives in the crisis was providing more financing to low-income countries."

In fact, in response to a request by the G-20 to double concessional lending to low-income countries, Mr Strauss-Kahn got back to the group in 2009 with a pledge to almost treble such concessional lending through 2014, and to charge zero interest on it through 2011.

In another move, at the IMF's 2009 annual meetings in Istanbul, continuing an effort started by Horst Kohler, Mr Strauss-Kahn's predecessor but one, the managing director announced a significant overhaul and simplification of "conditionality" - the provisos the IMF attaches to its loans - particularly on the need for countries to undertake structural reforms such as privatisation and deregulation, which had caused such antagonism among Asian and Latin American borrowers in the past.

Domenico Lombardi, senior fellow at Brookings in Washington and a former IMF board member, says the fund is now more focused on member countries' different policies, paying attention to sustaining expenditures in health and education, and increasing spending on social safety nets to protect the poorest during a crisis. The IMF has also learnt it is important to come in with packages of money that are big enough to stabilise markets and contribute to a country's financial recovery.

"This is something the IMF learnt from the Asian crisis. When the IMF intervened there, often the size of the programme was not in line with the size of the financial shortfall. Capital that flowed out of one country re-flowed to others, re-creating the problems," says Mr Lombardi.

A new role

After a decade in the making, the IMF launched a new precautionary, insurance-style lending facility for middle-income countries. Mexico, Poland and Colombia were the first to sign up to it and all three have recently renewed it. The Flexible Credit Line (FCL), as it is called, was important in re-establishing the IMF's relevance in the crisis. Unlike a traditional IMF standby loan, which requires lengthy negotiations, an FCL can be approved over a weekend and gives a country the leeway to draw down substantial sums of money quickly for crisis prevention, if contagion hits. And it involves no ex-post conditionality. Instead, the conditions for the facility are the country's good policy record, established in advance.

The latter is the facility's limitation, or as Mr Strauss-Kahn put it in a speech at the Peterson Institute in Washington on June 29: "The FCL will remain a platinum brand." However, drawing on this experience, the IMF is now developing another precautionary credit line to target a wider range of countries experiencing external shocks and market jitters - countries that do not qualify for the FCL but that still have good policies in place. "The conditions for qualification would be a bit less strict than for the sister FCL but, in return, we would ask for some limited ex-post conditionality," says Mr Strauss-Kahn.

Meanwhile, in a further departure from the IMF's traditional 'lender of last resort' role - coming to the rescue of a country with a conditional loan package when it is in absolute dire need and policy adjustments have to be made - by the November G-20 summit the IMF hopes to have fully developed a systemic, multi-country swap line as a way to improve global safety nets. The advantage of this credit line, which could be applied regionally, is that it would help avert the stigma of an IMF loan and subsequent market reactions that can raise borrowing costs for countries.