A V Rajwade: The 60-year-old twins

WORLD MONEY

The Washington Fund Bank meetings earlier this month were the first after 60 years since the Bretton Woods conference that gave birth to both the International Monetary Fund (IMF) and the International Bank For Reconstruction and Development (IBRD) "" to give the World Bank its formal name.

The Bretton Woods conference also envisaged a third international institution "" the World Trade Organisation (WTO); it was however almost half a century later that the WTO came into being.

While the Group of Seven (G7) industrial countries have long dominated the functioning of the IMF and the World Bank, (the former traditionally headed by a European, the latter by an American), they have also deliberated amongst themselves, outside the formal meetings, more important issues.

As reported last week ("Flexible exchange rates", October 18), this time China was invited for a discussion on its exchange rate policy. Given China's growth, in terms of both GDP and share of world trade, in the not-too-distant future, the G7 may well be replaced by a G4 "" the US, the Eurozone, Japan and China.

But this apart, there have been significant changes in the roles of the twins. For one thing, the IMF's function as the administrator of the fixed exchange rate system collapsed 30 years ago: today, it has little say over exchange rate policies of major economies.

To be sure, it does influence the policies of its borrowers. Second, relative to the size of the world economy, trade and capital flows, the resources of the two institutions have come down sharply, even as the amounts needed for bailouts of individual countries have grown rapidly. For instance, in the second half of the 1990s, there were almost half a dozen BoP rescue packages, each of around $ 50 billion (Mexico, south-east Asia, Korea, Brazil, Russia and so on). In comparison, the resources at the command of the IMF are just about $ 150 billion.

On the question of resources, the World Bank is in no better position than the IMF. Today, except for countries with no access to international capital markets, its loans are now dwarfed by private flows; take India, for instance.

In 2003-04, gross "external assistance" including loans from the World Bank, was $ 3.4 billion (net $ 2.7 billion) as against total capital inflows of $ 83 billion (net $ 22.1 billion).

Another noticeable feature of the IMF's functioning is that countries politically important to the US "" Russia, Turkey and Argentina "" get a more flexible treatment in terms of loan conditionality and compliance. To take a recent case, one of the tenets of IMF lending has been that it would not give money to countries in default unless they are negotiating with private creditors "in good faith". Many observers believe that this rule has been flouted in the case of Argentina.

Still on conditionality, the IMF has faced strong criticism from eminent economists like Joseph Stiglitz about its record in south-east Asia and, once again, Argentina.

They contend that the crisis in south-east Asia was unnecessarily prolonged because of the IMF's insistence on tight monetary and fiscal policies; and that, in Argentina, the IMF persisted with its support of the Currency Board system long after it was evident that the peg with the dollar was not sustainable.

The World Bank also has its own critics. A recent book (The World's Banker by Sebastian Mallaby) criticises the Bank and its president for accommodating environmental lobbies to an extent where needed dams or roads are not being financed or built.

We have our own examples, of course. Through agitation and court cases, NGOs have delayed the construction of the Sardar Sarovar Dam in Gujarat by years, and added thousands of crores to its cost. They also persuaded the World Bank to withdraw its commitment to finance the dam. One wonders whether the delay in benefits from the dam, the extra cost and so on has been compensated by a corresponding benefit "" at least to somebody!

At the present time in their illustrious history, the twins face several challenges and policy issues such as:

Orderly handling of defaults; collective action clauses; an international bankruptcy court?

Conditionality "" macro or micro?

World Bank and International Development Association (IDA) "" should they lend to countries like India that have access to private capital markets?

Debt relief to the 27 identified HIPCs (heavily indebted poor countries); IDA's assistance in the form of grants rather than loans?

How far should corruption in borrowing countries influence lending?

Cause and effect: In financial markets, it is often difficult to distinguish between cause and effect, even for professionals of long standing in the field.

I recently came across an article by Joachim Fels, a managing director of Morgan Stanley, in the Financial Times, about inflation outlook and monetary policy. At one place Fels argued that, "this year's oil shock was largely driven by stronger-than-expected physical and speculative demand for oil, both of which are side-effects of easy monetary policies around the world."

In other words, he seems to blame easy monetary policies for the oil price shock.

Just a paragraph down the line, however, he says, "the US Federal Reserve again seems to believe that the best response to an oil shock is to accommodate the negative effect on demand", which seems to imply that monetary policy is not responding to the oil shock, thus turning the earlier argument on its head! Or is it yet another example of George Soros' "reflexivity"?

Email: avrco@vsnl.com