Is the IMF fit for purpose?

Jamie Martin writes ✍️ :
Last summer, after months of unusually heavy monsoon rains, and temperatures that approached the limits of human survivability, Pakistan experienced some of the worst floods in its history. The most extensive destruction was in the provinces of Sindh and Balochistan, but up to a third of the country was estimated to be submerged. The floods killed more than 1,700 people and displaced a further 32 million. Some of the country’s most fertile agricultural areas became giant lakes, drowning livestock and destroying crops and infrastructure. The cost of the disaster runs to tens of billions of dollars.
Inlate August, as the scale of this catastrophe was becoming clear, the Pakistani government was trying to avert a second disaster. It was finally reaching a deal with the International Monetary Fund IMF) to avoid missing payment on its foreign debt. Without this agreement, Pakistan would probably have been declared in default an event that can spark a recession, weaken a country’s long-term growth, and make it more difficult to borrow at affordable rates in the future. The terms of the deal were painful: the government was offered a 1.17bn IMF bailout only after it demonstrated a commitment to undertaking unpopular austerity policies. But the recent fate of another south Asian country appeared to show what happens if you put off the IMF for too long. Only weeks before, the Sri Lankan government, shortly after its own default – and after months of refusing to implement IMF-demanded reforms – was overthrown in a popular uprising.
The correlation of Pakistan’s crises – exceptionally devastating floods and the threat of economic meltdown – was partly bad luck. But it was also emblematic of a challenge faced by many countries at the forefront of the climate crisis: how can they afford to deal with extreme weather events and prepare themselves for the coming disasters, while suffering under crippling debt loads and facing demands for austerity as the price of relief? Pakistan and Sri Lanka are only two of the many countries currently facing conditions of severe debt distress. Covid-19 delivered a major blow to many low- and middle-income countries that had borrowed heavily during the era of low interest rates beginning with the 2008 financial crisis. As the costs of public health and welfare rocketed, economies were locked down and tourism collapsed, which meant that tax revenues plummeted. The pandemic also disrupted global supply chains, leading to shortages of many goods and higher prices. These inflationary pressures were then exacerbated by Russia’s invasion of Ukraine. Meanwhile, the decision of the US Federal Reserve to raise interest rates to reduce US inflation has pushed the value of the dollar to its highest level in 20 years. This has made the debt of countries that borrowed in dollars – many do – more expensive since their currencies are worth less, while further increasing the cost of their imports. Rising US interest rates have also encouraged investors to pull capital out of riskier emerging markets at a historic rate, since safer dollar investments now produce higher returns.
The result is that the world economy faces the possibility of one of the worst debt crises in decades, threatening deep recessions, political instability and years of lost growth. At the same time, the increase in extreme weather events stronger hurricanes, recurring droughts – makes life even harder for states that already dedicate a large portion of their revenues to servicing foreign debt. In the midst of this turmoil, the IMF has become more involved in bailing out countries than it has in years. Over the past few months, the value of its emergency loans reached a record level, as a growing number of states turned to it for help, including Bangladesh, Egypt, Ghana and Tunisia.
Broadly speaking, the way the IMF works is by collecting financial resources from members and then offering them short-term assistance in the case of financial hardship. Based in Washington DC, the institution is staffed by representatives of ministers of finance and central bank governors from around the world. Because voting power is weighted by each state’s financial contribution, the US, as the IMF’s largest shareholder, exercises outsized influence over its major decisions and can veto proposed reforms to its governance. But as an international body that counts nearly every sovereign state as a member, the IMF plays a unique role in the world economy. It’s the only institution with the resources, mandate and global reach to help almost any country facing severe economic distress.
But in exchange for its help, the IMF typically insists governments do what they find most difficult: reduce public spending, raise taxes and implement reforms designed to lower their debt-to-GDP ratios, such as cutting subsidies for fuel or food. Unsurprisingly, politicians are often reluctant to undertake these measures. It’s not just that the reforms often leave voters worse off and make politicians less popular. National pride is also at stake. Bowing to demands from an institution dominated by foreign governments can be seen as humiliating, and an admission of domestic dysfunction and misgovernance.
On the rare occasions that the IMF criticises the policies of a wealthy European state, this too can embroil the institution in domestic political conflicts. In September, the IMF’s criticism of Liz Truss’s proposed tax cuts provided ammunition to her political opponents and contributed to a slump in the pound’s value. The decision to sack chancellor Kwasi Kwarteng was taken while he was attending the IMF’s annual meeting in Washington DC, where the institution’s leading officials did little to mask their disapproval of his policies. In future histories of the fall of Truss, the IMF is likely to play a not insignificant role.
Despite all this, the IMF is not the kingmaker it once was. After reaching the height of its powers in the 90s, when its name became synonymous with the excesses of neoliberal globalisation and US overreach, it has faced increasing resistance. It’s still the only institution that can guarantee assistance to nearly any country experiencing extreme financial stress. But the decline of US power, emergence of alternative lenders, and the IMF’s reputation as a domineering taskmaster has left it an anomalous position. It is much needed and little loved, enormously powerful and often ineffectual in getting states to agree to its terms. If predictions are correct that the world is entering an extended period of economic turmoil, this will only increase the need for some kind of global lender of last resort. Whether the IMF is up to the task depends on whether it has learned from its chequered history.
One of the most remarkable aspects 0 of the IMF was what, in theory, it was supposed to accomplish when it was established – and how quickly it departed from this initial vision.
The creation of the IMF was agreed at the Bretton Woods Conference of July 1944, when representatives from more than 40 countries met to rewrite the rules of the world economy. Led by the world-famous British economist John Maynard Keynes and his US counterpart Harry Dexter White, their aim was to create an international monetary system that stabilised currencies and facilitated a return to freer trade. National currencies would be set at fixed but adjustable rates to the dollar, which was in turn convertible to gold at a fixed rate of $35 per ounce.
The role of the IMF in this system was to help member states suffering from short-term balance-of-payments problems, while its partner organisation, the World Bank, made long-term loans for reconstruction and development.
Courtesy: The Guardian