Crisis prevention through global surveillance: a task beyond the IMF.

• Author: Aiyar, Swaminathan S. Anklesaria
• Position: International Monetary Fund - Essay

In early 2008, the future of the International Monetary Fund was in doubt. The world was awash with dollars since the United States ran an enormous current account deficit, the mirror image of which was trade surpluses in most other countries. Hence, few countries had balance of payments problems, and the IMF had few borrowers. IMF income was insufficient to meet its costs, and so it retrenched hundreds of economists, and both its relevance and legitimacy were questioned. (1) But that episode now looks like a temporary historical blip. After the collapse of Lehman Brothers--and the global financial system--in September 2008, the IMF was suddenly in more demand by governments than ever before to help finance stricken countries across continents. The G20 agreed to triple IMF resources to $750 billion, the four BRICs (Brazil, Russia, India, and China) agreed to subscribe to the IMF's first bond issue of $80 billion, and India has bought 200 tons of IMF gold. So an IMF role seems assured in future crises.

Yet, in between crises, the role of the IMF may be more limited than ever before. Global capital movements--and even labor remittances from overseas--now dwarf the IMF's resources. For instance, India's biggest-ever loan from the IMF was $4 billion in 1991. But net capital inflows were $25.5 billion in 2005-06, $45.2 billion in 2006-07, and $107.9 billion in 2007-08. Labor remittances alone fetched India $46 billion in 2007-08 and $44 billion in 2008-09.

Structural changes have also reduced the list of countries chronically dependent on the IMF. In the current crisis neither Brazil nor Argentina needed IMF money. Asian countries have built up their own foreign exchange reserves in order to avoid going to the IMF. And after the current crisis, eastern Europe will be tempted to go the Asian way. So, the IMF may in the future have longish periods of minimal business, though it will still be in demand in major crises.

Ending Reserve Anxiety

IMF Managing Director Dominique Strauss-Kahn visualizes a new and much bigger role for the IMF (see The Economist 2009). He wants to increase IMF resources massively to $2 trillion, making it big enough to offer crisis insurance--unconditional lines of credit to developing countries in a crisis. He believes this will check "reserve anxiety"--the tendency of developing countries to accumulate huge foreign exchange reserves as insurance against a future crisis, something that contributes to global imbalances. In Strauss-Kahn's scheme, countries would regard credit lines from the IMF as being as good as owned reserves, and hence refrain from excessive reserve creation.

The chances of this happening are zero. Developing countries simply do not trust the IMF. This is partly because the IMF is dominated by the West, and partly because of the IMF's track record in imposing politically humiliating and economically questionable loan conditions, especially in the Asian financial crisis. After that traumatic event, many Asian countries decided to deliberately build large reserves so that they would not have to depend on the IMF again. They launched the Chiang Mai initiative as an Asian swap arrangement to reduce reliance on the IMF. This facility was upgraded in early 2009 into the Chiang Mai Initiative Multilateralization (CMIM), aimed at turning bilateral swaps and credits into a regional reserve pool. The ASEAN countries plus Japan, China, and Korea specified contributions to their $120 billion pool, set down borrowing entitlements, and allocated voting shares. In October 2008, the Federal Reserve provided swap facilities of $30 billion to Brazil, Mexico, Singapore, and South Korea. More recently China offered swap lines to Argentina and other selected developing countries. Ml these efforts were driven by lack of faith in the IMF's capacity or trustworthiness to check the crisis.

During the crisis, Strauss-Kahn created a flexible credit line enabling pre-qualified countries to get unconditional access to IMF funds. But only three countries--Mexico, Poland, and Colombia--drew upon the facility. One reason is that the public and politicians in most developing countries view IMF loans as humiliating. Strauss Kahn would like to expand the flexible credit line to become a global insurance facility, but there is little or no political support for this scheme either in rich or poor countries.

To improve the credibility of the IMF and make it look less Western-dominated, the G20 has agreed to shift 5 percent of voting power from overrepresented to underrepresented countries. In practice the U.S. share will not be affected at all, but the European share will fall and China will be the principal gainer. While this minor reform may be politically desirable, it will not change the fact of Western domination. In these circumstances, it is a fantasy to think that developing countries will cease to build up their own foreign exchange reserves and depend instead on a bigger and supposedly trustworthy IMF.

However, the IMF has been entrusted with one new task. The G20 has decided that greater surveillance and peer review of the global economy is necessary to nip future crises in the bud. It has given the IMF the main role in this crisis-prevention surveillance. This step may suggest that the IMF now has a much bigger global role to play. In fact, it has been given a thankless job that it will not be able to perform well.

Preventing Crises through Better Surveillance

The G20 has decided that the world needs an early warning system to thwart future crises, and so constant survey and peer review of major economies is necessary. The IMF will play a key role in this surveillance, since it already has a large, highly qualified staff that has long been in the business of economic surveillance using sophisticated forecasting models.

Yet, with all its expertise, the IMF's track record in predicting crises is rather poor--not because the IMF has third-rate economists or models, but because forecasting is a very...