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The long, hard road to reform: under-represented countries' patience with IMF runs thin

The IMF's quota system – which heavily favours the G7 countries – has long been deemed outdated by the BRICS countries, among others. But with any hope of immediate reform being held up in US Congress, and alternative institutions being established, the IMF's battle to remain globally relevant is under threat.
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In tune with the beat of 2015 being a pivotal year for development, the International Monetary Fund (IMF) – which is holding its annual meetings with the World Bank in Peru from October 7 to October 9 – is expanding its mandate in support of growth and stability to longer term development goals.

Simultaneously, the fund is taking steps to try to defuse criticism from emerging market economies and developing countries, many commentators say. One concern of these members is that the IMF has allegedly been over-lending in Europe during the eurozone crisis, especially in Greece and, more recently, Ukraine.

Additionally, there is mounting frustration among middle- and low-income countries over continued delays in the implementation of governance modernisation reforms.

Stuck in the past?

The latter stems from the IMF’s quota-based structure. When the institution was founded in 1944, it led to the world’s leading economies at the time: the US and western Europe (and, later, Canada and Japan) – the so-called G7 rich, industrialised countries – having easily the biggest quotas, or subscriptions. This determined both the large size of their shares, or votes, and – in theory at least – the total amount that they could borrow from the fund.

A new chief economist 

When China devalued its currency twice in August, following several economic setbacks, the move sent shockwaves through global markets, pummelling shares in other Asian, European and US stock markets, pushing international commodity prices even lower, and triggering declines in other emerging country currencies.

So what better time for Maurice Obstfeld to take over as the International Monetary Fund's (IMF’s) chief economist as of September 1?

The 63-year-old former Berkeley University economics professor, and member of the White House’s Council of Economic Advisors, is an internationally recognised economist and co-author of several books on spillovers – or how the economic and monetary policies of one country can impact upon others around the world. 

His knowledge will help the IMF warn its 188-member countries about the risks of further currency devaluations, following those in China, and of the fallout from the US Federal Reserve’s first interest rate increase in nearly a decade.

Some Fed officials had indicated that this could happen at a policy meeting on September 16 and 17. But now, because of the strengthening in the value of the US dollar, and in the wake of China’s devaluations, the Fed’s 'lift off' may be postponed, some economists and commentators believe.

Since the financial crisis, the IMF, at the request of the G20 group of leading economies, expanded its oversight to the global economy as a system, rather than focusing principally on the economies of member states. The IMF’s Spillover, External Sector and Financial Stability reports have become important tools when the fund advises member countries facing the challenges of a world in which growth tendencies, interest rates and capital flows diverge. 

Examples of market turbulence have multiplied. As well as the financial crisis, there was extreme volatility related to the eurozone’s sovereign debt crisis and the 2013 'taper tantrum', for instance.

David Lipton, the first deputy managing director of the IMF, believes the new global interconnectedness and the extreme sensitivity to policy distortions that the various incidents of volatility highlight have important lessons for the fund.

“Our task, number one, is to make the case that globalisation can be good for countries,” he says. “So that’s where… when working on issues related to banks and the capital markets, we need to find ways to make sure there’s sufficient stability so countries feel comfortable maintaining the openness of the international system.”

Otherwise, he says, there is a risk of “seeing some kind of a repeat of a retreat from globalisation, like we saw before the IMF was created [in the 1940s]”.

Fast-forward 71 years, and the IMF now has a 188-country membership. However, the G7 countries still have the biggest shareholdings and a dominant hold on decision making – in spite of periodic reviews meant to adjust the quotas to reflect the changes in the relative importance of member countries in terms of the world’s economy. 

Some of the imbalances were due to start changing with a 2010 reform, which would shift some 6% of quota shares from over-represented countries (mainly western European nations) to under-represented countries – notably the BRICS (Brazil, Russia, India, China and South Africa).

Moreover, says Amara Bhattacharya, a senior fellow at Washington’s Brookings Institution: “When the 2010 reform was negotiated – it was meant to be completed by January 2013 – the BRICS countries went along with it, with a very explicit understanding that this would be followed by a subsequent round of quota realignments, which should also have also been implemented by now.” 

Marilou Uy, director of the Group of Twenty-Four leading emerging market and developing countries, says: “Every time there is a delay, this has a domino effect on the entire process.”

Congress hold-up

The irony is that President Barack Obama’s administration is eager to see the 2010 quota and governance reforms ratified. But what is halting progress is opposition by the majority Republican Party in the US Congress. The US has easily the biggest quota share in the IMF – about a 17% voting share – giving it veto power. Consequently, without US Congressional approval, it is impossible to muster the 85% votes the IMF needs for ratification.

David Lipton, the IMF’s first deputy managing director, says: “The reform has to happen or under-represented members will feel that this really isn’t their institution – that it isn’t an even-handed institution.”

Mr Bhattacharya says: "Frustration with the kind of existing multilateral system – meaning the IMF – has certainly been a motive in the BRICS' decision last year to establish the Contingent Reserve Arrangement (CRA).” This is a monetary pool that duplicates the IMF’s role as a global safety net, but on a considerably smaller, BRICs-countries-only scale. 

Sargon Nissan, a senior manager at the Bretton Woods Project, a London-based non-governmental organisation, believes the idea of such an institution being an alternative to the IMF is misconceived. “Whether they are a BRICS country in the CRA, or a south-east Asian nation in the Chiang Mai monetary pool [which comprises the 10 Association of South-east Asian Nations countries plus China, Japan and South Korea] these countries can still borrow from the IMF," he says. "Should the BRICS want to do a really large operation involving a BRICS country, they would still have to do this in conjunction with an IMF facility, as the CRA’s resources now amount to only about $100bn.”

Mr Lipton says: “There are issues around the IMF’s medium-term legitimacy and around our medium-term financing.” This is because the 2010 reforms also doubled the fund’s quota resources, Special Drawing Rights (SDRs), its international reserve asset, from SDR238.5bn to SDR477bn – close to $700bn at current exchange rates. The increase’s objective is to make sure the IMF is in a strong position in the medium term, so it can fulfil its role as global lender of last resort and have the firepower needed when future financial crises and market turbulence strike. (Currently, according to IMF officials, the fund’s total lending capacity of $925bn is sufficient in the short term.)

Enough is enough?

Now, however, under pressure from many member states, the IMF appears to have decided enough is enough. According to Mitsuhiro Furusawa, the IMF deputy managing director with responsibility for quota and governance matters, the IMF board has said that if the US Congress does not pass the 2010 reforms by September 15, the board will decide on a specific “interim solution” before the end of the month. It will work on making “meaningful progress” towards the objectives of the 2010 reforms, in terms of realigning quotas and voting shares, and ensuring that the fund has sufficient resources. This work is set to be completed by no later than mid-December.

China's renminbi push 

A major prize for the Chinese financial system, as it seeks to increase its influence globally, would be the inclusion of the renminbi in the International Monetary Fund's (IMF's) Special Drawing Rights (SDR) basket. 

The SDRs, a basket of international reserve currencies created by the IMF in 1969 to supplement members' official reserves, currently has a value based on four currencies: the US dollar, the euro, the pound sterling and the Japanese yen.

Every five years the basket is reviewed to ensure it reflects the relative importance of major currencies in the world’s trading and financial system. Following a decision by the MSCI, the index provider, not to include the renminbi in a global stock index, however, the IMF said in August that it would not include the Chinese currency in the SDR basket for at least one more year.

For the renminbi to be included, two considerations come into play, according to IMF officials. The first has to do with how substantial the trade and exports of a country are within the global economy. China, the world’s second largest economy, meets that criterion. But additionally, there are several financial criteria that need to be met, related to how widely a currency is used in international trade and finance, and how widely it is traded in principal exchange markets. 

David Lipton, the IMF’s first deputy managing director, says: “The Chinese have made a commitment to us that they will undertake a set of liberalisation and policy changes in order to improve their performance under those criteria.” For instance, he says, it is important that central banks around the world can set up accounts in Beijing, where they can deposit and withdraw renminbi; and that they can have access to renminbi around the world.

The renminbi also needs to have a reference interest rate, which has to be a market interest rate and based on an instrument that is sufficiently liquid and deep so that it is reliable rate for an investor, according to Mr Lipton.

“We’ve focused on what liberalisations need to be in place for the world to feel comfortable, including the renminbi in the SDR. The question is, has it crossed that threshold?” he asks.

Meanwhile, according to the IMF, Beijing’s decision to twice devalue the currency in August has “no direct implications for the criteria used in determining the composition of the SDR basket". “Nevertheless, a more market-determined exchange rate would facilitate SDR operations in case the renminbi were included in the currency basket going forward,” the IMF said.

On this matter, Mr Furusawa says: "Any interim solution is not a substitute for the 2010 quota reform. The hope is that the US will still ratify the reform,” he says. “Hope springs eternal,” adds Mr Bhattacharya, wearily.

Meanwhile, one IMF initiative welcomed by the Group of Twenty-Four is that the fund has started to review its lending policies for countries facing sovereign debt crises, to learn from recent experiences in the EU, and make reforms affecting the entire membership.

The move follows several years during which the IMF granted Greece and other EU countries 'exceptional access', meaning they were allowed levels of borrowing well in excess of their quota amounts (3200% in the case of the IMF’s stand-by arrangement with Greece – an all-time record). Additionally, the IMF has had very big exposures in the EU. In Greece, Portugal and Ireland in 2010 and 2011, it lent a total of about $90bn, while in March this year it pledged $17.5bn in assistance to Ukraine. According to the fund's critics, that lending occurred in spite of the fact that these countries were insolvent or had a high risk of insolvency at the time, and ignored previous IMF rules.

To get around this rule, during the eurozone crisis the IMF's largest shareholders introduced a 'systemic exemption', which allows the fund to continue lending even when a country is in a sovereign debt sustainability crisis, if helping the country is considered important for broader global stability reasons. For instance, in the case of Greece, the argument has always been that there could be a lot of negative contagion in the rest of Europe – and globally – if Greece defaults.

The approach has provoked a lot of criticism from the BRICS and developing countries. A frequent accusation is that Greece and the rest of the eurozone have recourse to funds outside the IMF, such as the European Central Bank – one of the world’s largest central banks – or the recently established EU firewall, the European Financial Stability Mechanism. But for developing countries, ”the IMF is pretty much the only game in town", says Mr Bhattacharya.

Moreover, in contrast to what many BRICS and developing countries consider to be over-lending by the IMF in Europe, when it comes to the world’s poorest countries, it is alleged that IMF lending is too small.

In order to help remedy that, in July this year the IMF announced that it will expand access to all its concessional facilities for eligible low-income and fragile and/or post-conflict states. So, for instance, a sub-Saharan African country that was previously able to borrow up to only 25% of its quota – its debt limit – can now borrow up to 50% of its quota.

Systemic exemption

But the change that will have the biggest impact in sovereign debt negotiations will come if the IMF decides to relinquish the 'systemic exemption' (which allows the safeguard on debt sustainability to be relaxed when there is a concern that debt restructuring will trigger volatility in other countries’ debt markets), according to Mr Lipton. Instead, he believes, it could more quickly and effectively address all sovereign debt sustainability cases, putting them into one of three categories.

The first is where the IMF simply lends to a country without requesting any treatment of its debt because its debt is sustainable. The second is where the IMF considers that the debt is unsustainable, or not likely to be sustainable – in which case it will recommend that the country seek debt restructuring talks with creditors.

“But what we are talking about now," says Mr Lipton, "is countries that are in the middle, a third category. They are in a kind of grey zone where it’s not clear whether they will grow into a position of being able to service their debt or not.” 

“And in that category, we would want the option to be [that the countries can reschedule] their debt [with creditors], for temporary rather than permanent relief, to a time when we could see whether our helping them, and the steps they took, rekindled growth enough to be able to service all their debt or, at the end of the day, a more thorough treatment of their debt problems was needed.”

A new agenda

Against this background, another significant change is that in July the IMF launched a new Financing for Development agenda, which expands its gamut of services – loans, analysis, policy advice and training – in poor and middle-income countries. The agenda’s stated purpose is to help members attain new 2016-2030 Sustainable Development Goals (SDGs), which are due to be formally announced at a UN summit in New York in late September. Another driver is the international conference – and a possible world agreement – on climate change in Paris in mid-December.

Mr Bhattacharya says: “An interesting feature of the SDGs is that on one level they are more ambitious than the Millennium Development Goals (MDGs) that preceded them, but they are also different, more comprehensive, and cover issues that go beyond a narrow poverty focus – for instance, sustainable infrastructure.” By this, he means infrastructure development that does not contribute to climate change.

Furthermore, many issues in the new agenda – domestic resource mobilisation (DRM), expenditure efficiency and effectiveness, the prudent expansion of public investment, attracting and managing capital flows and international policy issues (such as international tax cooperation and maintaining global financial stability) – are already a fundamental part of the IMF’s mandate.

Min Zhu, the IMF deputy managing director who has overall responsibility for the agenda, says helping a country on any DRM issue can have enormous ramifications in terms of it being able to make investments in health, education and infrastructure that raise living standards and economic growth. For instance, Peru had a tax revenue-to-gross domestic product ratio of just 7% in 1996, one of the lowest in the world. But following an IMF programme, the country managed to raise its domestic tax revenue ratio to 13% in 2005, and this year the ratio is 17%, says Mr Zhu.

Macro-critical issues

But by far the biggest novelty of the new agenda is the expansion of the IMF’s attention and work, with middle-income and poor countries, to more 'macro-critical issues'. For the first time, the IMF is going to start helping members to directly tackle income inequality, gender discrimination and climate change – each of which, according to recent IMF literature, adversely impacts growth and stability.

IMF quotas for large economies

For instance, a recent IMF study examining Saudi Arabia, Japan, South Korea, Brazil and other countries that have a low percentage of women in the workforce concluded that having more female workers is an increasingly important issue in terms of generating growth – especially in countries where the proportion of the elderly in the population is increasing. “So then we asked, how can we improve the female labour market participation [in such countries]? How can we help that?” says Mr Zhu.

The new focus is drawing the IMF ever deeper into policy advice in member countries, on fiscal and tax policies and on education, as well as legal and labour market policies, according to Mr Zhu. 

Commentators say it is too soon to say whether the IMF’s significant shifts on the three new issues will actually translate into operational policies on the ground, and Mr Bhattacharya and Ms Uy both believe the jury is still out on this matter. 

But in response, Mr Bhattacharya points to the issue of climate change. “Today, serious analysts and thinkers do not question the IMF’s relevance on the matter. A lot of the policies that affect climate change fall within the IMF’s mandate: everything from fiscal policy to budget management to energy subsidies, carbon pricing and carbon taxes. And, ultimately, the impact of climate change is very significant macroeconomically,” he says.

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