Economy
IMF reform: the way forward
By Huang Ying (chinadaily.com.cn)
Updated: 2010-09-27 11:51
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The onset of the 2008 international financial crisis has revitalized the discussion on transforming the international monetary and financial system.
At the G20 summit, the premier forum for coordinating major countries' economic policies, world leaders reiterated the importance of overhauling the whole system. This, however, is a comprehensive task, including re-examining the governance structure at the corporate level, rebuilding the business model and the moral standard at the industrial level, improving the financial supervision system at national and regional levels, and mending the international financial safety net at the global level.
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The IMF was established in 1944 as one of the three main pillars of the Bretton Woods System. During the period from 1945 to 1971, it was a well-respected institution with a clear-cut mandate and a set of actionable rules. It was also successful in preserving economic and financial stability in the West. This hard-earned fame, however, was quickly squandered after the collapse of the Bretton Wood System.
Now it seems that the IMF is inflicted by at least three problems: legitimacy and representation, relevancy, and effectiveness. To solve these problems, reforms should be implemented in the following four areas.
First is the quota and voice reform. When the IMF was created, it had only 45 members. Now it has 187. Before the 2008 crisis, however, the quota and voice distribution of the IMF remained largely unchanged, little reflective of the present economic reality. For example, the BRIC countries, which have 40 percent of the world population and 15 percent of the world GDP, only had 12 percent voting rights before the reform. In contrast, America alone held 17 percent voting rights or a de facto veto right. This quota and voting rights structure weakened the legitimacy of the institution, rendering it ineffective in solving major problems the world was facing.
In 2008, the IMF began to address this issue. At the G20 Pittsburgh summit in September 2009, the leaders of the 20 countries agreed to transfer at least 5 percent of the IMF quotas to emerging markets and developing countries. At the G20 Toronto summit in June 2010, the world leaders urged the IMF to complete the reform plan before the Seoul summit in November 2010.
Although the developed countries are still quarreling over who should bear the burden to make this transfer, the decisions of the G20 meetings are propitious signs that the major countries are both wanting and willing to reform the international monetary and financial system in a coordinated and more transparent way. The positive message these signs have conveyed should not be underestimated.
Second is searching for the core mandate. What is the mandate of the IMF? In the period of the Bretton Woods System, it was to promote world economic and financial stability by guarding the dollar exchange standard. By fulfilling this mandate, the IMF helped the Western countries achieve a swift post-war recovery and a sustained economic growth.
After 1971, however，the mandates of the IMF kept expanding, to a point where the former managing director of the IMF Rodrigo de Rato even worried that the Fund might be overwhelmed by its inflating responsibilities. At the same time, the IMF is drifting away from its supposed core mission: managing the exchange rates. This change has multiple implications for the world economy and for itself.
As for the world, the dramatic changes in the exchange rates, which are disastrous for the involved economies and for the rest of the world if the involved economies are major reserve currency issuers, are not contained. Besides which, the large-scale global imbalances, which was a rare phenomenon in the 1950s and 1960s, became a permanent and seemingly incurable disease in the 21st century.
As for the Fund, because it does not wish to or believe it can play the role of an "umpire," it has been increasingly marginalized in the international economy as a steward for financial stability. Before the outbreak of the 2008 financial crisis, the IMF had issued many reports warning against expansion and the possible disruptive effects of global imbalances, but aroused little notice from the policy-makers.
To restore the IMF to the core of the international monetary and financial system, the above trend should be halted. The beauty of the rule is its simplicity and clarity. To avoid sinking into irrelevancy, the IMF should again be invested with a clear mandate, and be authorized to discharge its mission with effective tools.
Third is improving the surveillance capability. The IMF should play a proactive role, for example, to detect signs of a crisis, and to prevent crisis from erupting. The fact that the IMF failed to warn against the advent of the 2008 financial crisis reflects the fundamental defects in its risk models.
Now the consensus of the world is that we need to pay attention to the so-called systemic risks, which tend to spread among different financial sectors, and to the systemically important institutions, who have an overwhelming influence over their respective industry, and the systemically important countries, whose fiscal, monetary and exchange rate policies have huge spillover effects on the world economy. Now the importance and the potential threat of the systemic risks have been generally recognized by governments of the world.
Plans to regulate the systemic institutions are also on the top agenda of the financial supervision reform in many countries. But how can we monitor and coordinate the policies of the systemically important countries? Obviously, this task can only be carried out by an authorized international organization. In this regard, the IMF is the most qualified candidate. Before the 2008 crisis, the IMF spent too much energy on emerging economies and the least developed countries. However, detecting errors in the peripheral or rising economies does little to preserve the overall financial stability of the world.
The fact that the epicenter of the 2008 crisis was the world's most advanced economy underscores the importance of shifting the gravity center of the surveillance work from the peripheral countries back to the core economies. The encouraging news is that the IMF plans to introduce new "spillover reports" starting with five influential economies in the next year. These economies are America, the Euro area, China, Japan and Britain. However, this is only a start. There is still a long way to go from analyzing the policies of the core economies to persuading them to accept the recommendations.
Fourth is building crisis-managing capability. Since the demise of the Bretton Woods System, the world economy has entered a period of financial turbulence. Debt crises, monetary crises, banking crises, and other forms of financial crises have often captured the headlines. To solve these crises, the role of the IMF is indispensable. However, in the eyes of many crisis-stricken countries, the role that the IMF played in the last three decades was often a reluctant and belated firefighter, who tried to impose unwelcome remedies on its patients. The IMF was also criticized for the ineffectiveness of its liquidity-providing tools. Some of the tools were seldom used, while some remained shelved after invention. This may be a little exaggerated, but what can't be denied is that the IMF needed to renovate its toolkit to adapt itself to a fast-changing world.
After the eruption of the 2008 crisis, the IMF began to re-examine its tools and its lending and conditionality framework. For example, it began to provide the new flexible credit line and high access precautionary arrangements to the crisis-ridden countries. This is a very meaningful step forward.
Besides the above problem, a new factor also poses a challenge to IMF's crisis-managing capability. In fact, IMF's dwindling resources are dwarfed by the massive foreign exchange reserves accumulated by many emerging countries in the past decade.
Instead of asking the IMF for help, many countries turn to their rich neighbors. The days that the IMF acted as the only international liquidity provider are gone. Besides rich countries, whose currencies are deemed as "international reserves," many emerging countries and some regional cooperation mechanisms have also begun to assume a similar role. The Chiang Mai Initiative, which started as a net of bilateral swap arrangements among the East Asian countries, was upgraded to a multilateral arrangement after the outbreak of the 2008 financial crisis. Since its inception, this mechanism has maintained in close cooperation with the IMF. If this alliance is yet to prove its effectiveness, the joint action by the IMF and the EU in bailing out Greece from the debt crisis in May 2010 is a very good sign. It indicates that by working with regional mechanisms, the problem of moral hazard, which has obsessed the IMF for a long time, may be partly solved.
Looking ahead, there will be both challenges and risks in reforming the IMF. To restore its position in the international monetary and financial system, it needs to enhance its legitimacy, rethink its mission, renovate its working tools, and learn to cooperate with regional institutions in preserving the international financial safety net.
Huang Ying is associate research fellow of Institute of World Economic Studies, China Institutes of Contemporary International Relations(CICIR)