The International Monetary Fund (IMF) may be so conscious of having handed out bad advice to needy countries in the past that it isn’t offering them enough guidance now.
The Washington-based lender is combating the worst financial turmoil in its 64-year history with more than $55 billion in loans for nations from Pakistan to Serbia. As the fund prepares to lend even more, it is retreating from its practice – carried out with adverse effects a decade ago in Asia – of demanding that governments overhaul their economic systems in return for aid.
The risk is that without more-stringent loan requirements, borrowers won’t reform their foundering economies, leaving investors to enforce the discipline – and delay recovery – by shunning the nations’ debt and currencies.
So far, aid packages from the IMF have buoyed markets in some emerging economies. But if governments don’t improve their fiscal policies, investors will deprive their economies of capital and punish their bonds, stocks and currencies, says Win Thin, senior currency strategist at Brown Brothers Harriman in New York.
“We cannot see investors piling back into the emerging-market countries with the worst fundamentals, even if the global crisis continues to abate,” Thin says.
Economists from countries now receiving aid say the fund is missing an opportunity to force lasting reforms. Among the economies whose markets may be most vulnerable are those in eastern Europe, such as Latvia and Hungary, say Brown Brothers Harriman and Royal Bank of Scotland Group.
“The pendulum may be swinging too far,” says Claudio Loser, former head of the fund’s Western Hemisphere department and now a fellow at the Inter-American Dialogue in Washington. “There was a strong perception that the IMF used to ask too much of countries. Now there is a major danger it’s moved too far in the direction of not setting enough conditions.”
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Little more than a year ago, the IMF –which will convene its spring meeting in Washington on April 25 – lacked both relevance and resources. Now its lending firepower is being tripled to $750 billion by the Group of 20 nations. The G-20 also agreed to give the IMF another $250 billion in Special Drawing Rights, an overdraft facility for its 185 members.
“The IMF needs to adapt,” Dominique Strauss-Kahn, the fund’s managing director, said in an April 16 speech. “Its lending must become more flexible and better tailored to a country’s circumstances.”
The fund said last month that it would set fewer goals for nations to commit to in return for aid and would place less emphasis on structural reforms such as overhauling banking or tax systems. It also eased terms for a credit line introduced in October that is now attracting interest from Mexico and Poland.
“There’s lots of money but little pressure for economies to adjust,” says Kenneth Rogoff, former IMF chief economist and now a professor at Harvard University in Cambridge, Massachusetts. “It’s much more fun being Santa Claus than Scrooge.”
Elsewhere, the fund has eased its embrace of free markets and aversion to big government spending, while increasing its emphasis on social programmes. For its $7.6-billion loan package, Pakistan was given the goal of tripling spending for the poor to 0.9 per cent of GDP.
Asad Farid, an economist at AKD Securities in Karachi, says the IMF lacks a “long-term policy” that would encourage Pakistan to cut its trade deficit and increase capital investment.
The biggest test for the IMF’s new strategy may come in Turkey, where aid talks collapsed in January. Economic Minister Mehmet Simsek said on March 26, after the talks resumed, that he expected the fund to show more flexibility.
“It would be positive if the new approach means there’s a new perspective” on the size of the spending cuts the IMF will seek, he said.
Still, the fund’s shift signals recognition that it went too far in the 1990s demanding free-market policies that often deepened crises and alienated it from nations it sought to help.
In 1997, the IMF pushed sweeping spending cuts and interest-rate increases on Thailand in return for a $3.9-billion loan. Within six months, the fund conceded it had been too aggressive as Thailand’s growth and tax revenue plunged.
Riots flared in Indonesia when the government carried out the IMF’s call to eliminate fuel and food subsidies for the poor.