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IMF/World Bank: Vision quest
As Finance minister, Rodrigo de Rato helped make Spain the fastest-growing big country in Europe. Now can he restore the IMF's influence and credibility?
For the first time in years, the International Monetary Fund is preparing for its annual meeting -- to be held next month in Washington, D.C. -- without the looming threat of a financial crisis. The global economy appears to have plenty of momentum to sustain a robust rate of growth, despite some recent signs of softening. Developing nations in particular are benefiting from the global upturn and strong commodity prices and continue to have access to capital markets even as the U.S. Federal Reserve Board has begun to raise interest rates. Those factors should help Brazil and Turkey -- which needed massive bailouts just two years ago -- to largely wean themselves from IMF financing in the coming months. Even the situation in Iraq, which remains anything but the oasis of Middle East stability once envisaged by the Bush administration, is causing fewer jitters in financial markets than it did a year ago.
Yet, far from guaranteeing a pleasant respite, the relative calm is prompting fresh soul-searching among IMF officials and member governments about the institution's role -- and its use of resources. The Group of Seven is conducting a review of the IMF that aims to strengthen the organization's effectiveness without spending more money. The U.S. is pushing a proposal for the Fund to offer more policy advice to developing countries and conduct closer surveillance of their economies, also without providing new money -- a proposal viewed with skepticism by some European nations and with distrust by many emerging-market countries.
Meanwhile, efforts to reform the Fund's existing activities remain largely untested. IMF officials have tried to respond to critics of its big bailouts by drawing up stricter rules on exceptional access to its resources, but there remains a widespread assumption, both inside the organization and in financial markets, that the IMF will cough up loans if a strategically important country faces financial difficulties. And attempts to get greater private sector involvement in debt restructurings have been stymied by the failure of Argentina and its bondholders to agree on a plan to reschedule its debt.
These are long-standing problems. The greatest challenge facing the Fund, however, may lie in the developed world. For most economists, the biggest threat to the global economy today comes not from emerging markets but from the growing current-account imbalances between the U.S. and its major trading partners, particularly China. Those imbalances could trigger a collapse in the dollar if Asian countries decide to shift their massive foreign exchange reserves out of the U.S. currency, while political pressures to reduce the current-account deficit could tempt U.S. politicians to veer toward protectionist measures that would stifle world trade.
"Worrying about emerging markets as a threat is like driving a car by looking at the rearview mirror," says Mohamed el-Erian, a former Fund staffer who is now managing director for emerging markets at giant U.S. bond fund manager Pacific Investment Management Co. "The biggest risk today is the totally unsustainable pattern of payments."
Tackling those imbalances would do more to ensure sustained global growth than simply rolling over loans to developing countries, and it would return the Fund to its original role of aiding countries with payments difficulties. To succeed, however, the IMF would have to overcome strong resistance among its leading shareholders and exercise genuine influence over rich-country policies -- something it has never really achieved, not least because those countries by and large steer the Fund.
It's a daunting challenge for the IMF's new managing director, former Spanish Economy and Finance minister Rodrigo de Rato y Figaredo. Fortunately, few people could come better qualified to the job. The 55-year-old Madrid native has extensive experience with the problems of emerging markets, thanks to Spain's deep economic links to Latin America. At the same time, his background as a senior minister on the European stage and his close ties to the U.S. give him much more political clout than his predecessor, Germany's Horst Köhler.
The manner of de Rato's selection, however, revived long-simmering resentment in the developing world over the dominant influence of the U.S. and Europe, which traditionally appoint the leaders of the World Bank and the IMF, respectively. More than 100 developing countries criticized the selection process for lacking transparency and failing to consider a range of candidates; Egypt protested by formally nominating a rival candidate, Pimco's el-Erian. That unprecedented move forced the IMF board for the first time to consider two nominees, although there was never any doubt that de Rato would get the job.
"The selection process is an outrage," says Kenneth Rogoff, a former IMF chief economist who now teaches at Harvard University. "The Fund and the World Bank's future legitimacy depends on having a selection process that is more open to the views of developing countries and to people of developing countries."
Easing the tensions surrounding his appointment and providing clear leadership and direction for the IMF will be a huge test for de Rato. He acknowledged as much late last year when he was asked about his potential interest in the managing director post. "The IMF job," he replied, "is one that is impossible to do well."
De Rato moved quickly to soothe the bitterness over the selection process. Shortly after taking office on June 1, he traveled to Asia and Africa and met with leaders of many of the governments that have protested the loudest about their lack of influence and voting power at the Fund. In China he expressed support for efforts to deepen Asian monetary cooperation, a key aim of the authorities in Beijing. And in Africa he pledged to continue the Fund's involvement in debt relief and development assistance, which Köhler had rapidly expanded.
For all the criticism of the selection process, most officials and economists agree that de Rato is extremely well qualified to take on his new challenges. He studied law in Spain and obtained an MBA from the University of California, Berkeley, before entering politics. Then, after 14 years as a conservative parliamentarian, he served as Economy and Finance minister under former prime minister José María Aznar from 1996 until a new government was elected this spring.
As minister, de Rato pursued a policy of privatization and labor market deregulation that helped make Spain the fastest-growing big country in Europe and won it admission to the European Monetary Union, the group of 11 European Union nations that launched the euro. He also boasts extensive experience and contacts in Latin America -- a critical factor given the Fund's crucial role in countries like Argentina, Brazil, Mexico and Uruguay. He encouraged massive investment by Spanish companies, utilities and banks throughout the region in the late 1990s and has sought to facilitate debt restructuring negotiations between Argentina and its private sector creditors.
"He is very qualified," says el-Erian. "Had it been an open selection process, he would have won anyway. He has seen national policy up close and been involved in a very successful transformation of the Spanish economy."
De Rato's ministerial experience is a first for the IMF, whose previous leaders have been technocrats rather than politicians, and it acknowledges the highly political role of the Fund. When he was Economy and Finance minister, his close alliance with Britain on European policy issues like trade and labor deregulation won the critical support of Gordon Brown, the U.K. chancellor of the Exchequer who also chairs the International Monetary and Financial Committee, the policy-setting arm of the IMF board. De Rato's political acumen should help the Fund be more sensitive and effective in dispensing policy advice to developing countries and mediating differences between the institution's major shareholders.
Brown and de Rato "share a worldview on the importance of markets, free trade, liberalism and a desire to be internationalist through multilateral institutions," says a senior U.K. official. "As a minister, he has faced hard decisions and knows the political realities."
Washington shares this positive view of de Rato. His economic record and the strong support of the former Aznar government for the Bush administration's policies in Iraq ensured that there would be no repeat of the bungled IMF succession of 2000, when the U.S. vetoed the first European candidate, Germany's Caio Koch-Weser.
The Spaniard "is an extraordinarily good" choice for managing director, says John Taylor, U.S. undersecretary of the Treasury for international affairs. "He has experience as a minister. He's got a very good technical and economic and business perspective."
De Rato has initiated an internal review of Fund policies and is expected to outline some proposals of his own at the annual meetings of the IMF and the World Bank in Washington. So far he has offered few detailed clues about his priorities, preferring instead to solicit the views of staff, borrowers and the Fund's major shareholders. He declined to speak to Institutional Investor.
To be sure, there is no shortage of opinion about reforming the IMF. Debate about the Fund has raged since the Asian crisis of the late '90s. The IMF's role in enforcing austerity throughout the region provoked a backlash among emerging-market governments, which argued that the policy requirements imposed by the Fund deepened recessions and worsened poverty. Critics in the West blamed the IMF for destabilizing developing nations by promoting rapid capital market liberalization, and for fostering moral hazard by bailing out private sector creditors. Antiglobalization groups called for the Fund's abolition, while the Meltzer Commission, appointed by the U.S. Congress to consider reforms of the IMF and the World Bank, urged a radical overhaul that would have returned the Fund to its roots by limiting its interventions to extending short-term loans to countries facing financial crises.
The urgency of the reform debate has waned over the past two years as the risk of crisis has abated. The brighter outlook largely reflects the stronger global economy, which the Fund expects will grow by about 4.5 percent this year and next.
Raghuram Rajan, the IMF's chief economist, remains optimistic about the growth outlook despite some recent signs of weakness, including a second-quarter slowdown in U.S. consumer spending and a rise in oil prices. With recovery gathering steam in Japan and Europe, growth is more balanced than it has been in years, Rajan says, and the economy's momentum should offset the recent $10-a-barrel spike in oil prices which, if sustained for a year, would trim about 0.6 of a percentage point off growth. "At these oil price levels, we're still not overly concerned," he tells II.
A number of important policy changes in many emerging-market countries are also playing a big part in today's brighter outlook. More-disciplined fiscal policies, greater exchange rate flexibility and a lengthening of maturities on outstanding debt have reduced the risk of a sudden financial crisis. Latin America, for example, is running a balanced current account, with Brazil expected to post a surplus of nearly 1.5 percent of GDP this year, compared with a deficit of 4 percent in 1998.
"There has been an improvement in fundamentals," Lisa Schineller, director of sovereign ratings at Standard & Poor's, says of Brazil. "You have a floating exchange-rate regime that is working in concert with a fiscal framework that has a good track record."
The combination of a stronger world economy and better policy by developing countries has significantly reduced the danger of an emerging-markets crisis and made a success of the IMF's massive loans to Brazil and Turkey -- highly risky bets when they were placed just two years ago. Brazilian President Luiz Inácio Lula da Silva's government announced in June that it would not renew its $14.8 billion loan agreement with the IMF when it expires in December, while Turkey, which is enjoying robust growth and low inflation for the first time in a generation, is expected to seek a sharply reduced loan to replace the $19 billion package that ends in February.
"We are in a better position, but far from having bullet-proofed the economy," says the IMF's Rajan.
Although there are plenty of ideas about how to further reduce the risk of financial crises and increase the flow of funds to developing countries, there is little consensus on any of them. Most proposals seek to avoid bailouts by improving surveillance of developing economies to prevent crises from starting.
The most prominent idea, pushed by the U.S. as part of the G-7 review of the IMF, is for the Fund to develop so-called nonborrowing programs: IMF officials would work closely with developing countries to design the same sort of detailed economic reforms as those of countries that borrow from the Fund -- with benchmarks for inflation, primary budget surplus and other key indicators -- but not extend financing. The aim is to provide the kind of technical assistance and surveillance that now come mostly after a crisis and to enhance countries' abilities to tap the international capital markets by giving an IMF seal of approval to their policies.
Nonborrowing programs "would do all the good things without forcing countries to take money," says the U.S. Treasury's Taylor. "These are all things that these countries value a lot."
To some extent, the Fund is already moving in this direction. More than half of all current IMF programs are precautionary -- that is, countries agree to a standby arrangement with detailed economic conditions but indicate that they have no intention of drawing on Fund resources. "That's a very strong signal that there is a need for a relationship with the fund where no money is involved," says Karlheinz Bischofberger, Germany's executive director at the IMF.
But some officials believe that the similarity with existing surveillance programs argues against the U.S. proposal. Jeroen Kremers, the Dutch executive director, worries that a proliferation of program types would sow confusion. "I have not yet seen a convincing argument for nonborrowing programs," he says. "We can get almost all the way with the instruments we already have."
Many developing nations are even more skeptical of the U.S. proposal, regarding attempts to increase IMF policy oversight without augmenting financing as unbalanced. "If you're not going to give me any finance, why should you go into my books and give me advice and explain it to the rest of the world?" says one executive director who represents a number of current and former recipients of IMF funding.
Consider the case of Indonesia. The IMF has closely monitored the country's economic policies since its extended borrowing arrangement expired at the end of last year. But the type of detailed surveillance envisioned by the U.S. proposal, with explicit economic performance targets, risks undermining public support for reforms and the IMF's role in advancing them, warns Says Sri Mulyani Indrawati, Indonesia's executive director at the IMF. Many Indonesians deeply resented the Fund's high-handed dispensing of advice during the Asian crisis, and the government's efforts to reassert control have been a model of country ownership of economic policy, which IMF officials regard as critical for success.
"By having the IMF get more prescriptive, are we not undermining ownership?" asks Indrawati. "The objective may be good, but not necessarily the result."
The U.S. Treasury's Taylor acknowledges the concerns but contends that the proposal would strengthen ownership. "No one is going to force this on a country," he says. "This is for countries seeking assistance with programs they're designing."
Many IMF and country officials believe that nonborrowing programs will appeal only to heavily indebted poor countries, so-called HIPCs, and not to bigger emerging-market countries, such as Mexico or Brazil, which already have access to capital markets. Indeed, countries like South Africa and some participants in the HIPC debt-relief program, including Uganda and Rwanda, have expressed interest in the nonborrowing proposal, U.S. officials say. Still, Taylor insists that "if it's only useful for HIPC countries, that would be reason enough to do it."
In addition to improving surveillance and crisis prevention, the Fund also needs to show greater discipline, particularly when it comes to denying financing to countries with flawed economic policies.
"We clearly need a Fund that can say no selectively, perhaps more assertively, and above all, more predictably than has been the case in the past," de Rato said in June at a Madrid conference on the IMF's future. "The prospect of the Fund declining to provide financial support would help strengthen the incentives to implement sound policies, thus avoiding the need for Fund support in the first place."
Europeans traditionally have criticized Washington for using the Fund as a tool of U.S. foreign policy and backing big bailouts to strategically important allies like Turkey and Mexico. The Bush administration, however, has, at least rhetorically, moved closer to the European preference for a policy based on clear rules rather than discretion.
The Treasury's Taylor says the IMF must send the right signals to developing nations, and financial markets, by being "as predictable as possible in its attitude to funding." He draws an analogy to current central banking practice, which seeks to reassure financial markets by sending clear signals about the circumstances that could lead to a change in interest rates.
De Rato already has signaled a tougher stance toward funding in the IMF's relations with Argentina. Because of growing irritation with the country's debt restructuring offer to private creditors, the Fund's board postponed approval of a routine June review of the $13.8 billion loan granted to the country last year. The move blocked the disbursement of $720 million of IMF funds.
The Netherlands' Kremers, who was one of the few board members to vote against the previous review last fall, sees the stricter stance as a sign that major shareholders are more determined to respect the rules on exceptional access to Fund resources. "We have these rules. We should apply them," Kremers says. "It's not a goal in itself to be tough with Argentina. The Fund has to be tough with itself regarding its own role. We need a mind-set that's prepared to say no."
Getting tough in principle is one thing. Doing it in practice is another. Despite all the intentions of more-disciplined behavior, many IMF and country officials and market participants believe that the Fund will always be pressed to intervene in any crisis that involves strategically important countries.
Mahmood Pradhan, a former IMF official who was closely involved in the Fund's lending to Indonesia and more recently worked as an emerging-markets economist at BlueCrest Capital Management in London, says he rarely looked at the Fund's operating rules when trying to determine the prospects of an emerging-market bailout. "They count for very little," he says. The bailouts in recent years for Argentina, Turkey and Brazil suggest that geopolitics continues to dominate lending decisions.
"The past few years have shown me that the G-7 shareholders are not any closer to a set of rules for when a country can borrow and how much," says Pradhan. He notes that the European Union, which traditionally has criticized political influence over lending, is currently lobbying to retain an IMF role in Turkey when its existing loan program expires next year, to sustain pressure for economic reform in a country that's a putative EU candidate.
If standing up to emerging-market countries is hard, it pales in comparison with de Rato's other challenge: standing up to the Fund's main shareholders. Surveillance has long applied to these as well as to borrowing countries, but IMF officials have traditionally pulled their punches when assessing the economic policies of the U.S., Europe and Japan.
With imbalances among the major economic blocs posing the biggest risks to global growth, however, the Fund is gingerly attempting to step up its advice to rich countries despite having little record of influence. In July, for example, IMF officials issued a range of proposals for reducing the U.S. fiscal deficit, including tax increases and cuts in farm subsidies and other spending. They also called on European governments to spur growth by focusing policy on getting a greater percentage of Europeans to work.
"The U.S. has basically leveraged every available balance sheet," says Pimco's el-Erian. To sustain global growth, the U.S. needs to restrain its foreign borrowing, Europe and Japan need to stimulate faster growth, and China and other Asian nations must boost domestic demand and rely less on exports. "That's a typical coordination problem," el-Erian says. "That is what a multilateral institution is there for. The G-7 mechanism is increasingly outdated. It doesn't include China. The only mechanism is the IMF."
The idea that the Fund can exercise real influence over G-7 policies is wishful thinking, say many officials and economists. "Does anyone really believe that the IMF needs to tell the U.S. government to balance the budget? There's a lot of that news around," says Allan Meltzer, the Carnegie Mellon University professor whose commission recommended a sharp curtailment of the Fund's lending activities four years ago.
Jeffrey Schafer, vice chairman of the public sector group at Citigroup Global Markets and a former Treasury undersecretary for international affairs in the Clinton administration, notes that criticism of U.S. budget deficits by multilateral organizations in the 1980s had little if any impact. "At the end of the day, we have to be realistic about what IMF surveillance can achieve" in the major countries, he says. Instead, he argues that the only practical solution is to bring China into the G-7 and concentrate economic policy coordination among a G-4 -- the U.S., the EU, Japan and China.
The IMF's influence in major countries may be limited, but it's hardly nonexistent, supporters contend. Harvard's Rogoff notes that politicians in Europe and Japan are highly sensitive to IMF criticisms of their economic policies. If the U.S. begins having difficulty financing its current-account deficit, it will need to use the IMF as a tool for policy coordination, just as the Bush administration was obliged to return to the United Nations to gain broader support for its presence in Iraq, Rogoff asserts. Indeed, the U.S. used last year's IMFWorld Bank meeting as a forum for pressing China to drop its currency peg to the dollar and adopt a more flexible exchange rate system, which many economists regard as a key to reducing the trade imbalance between the two countries.
"It's very important that de Rato avoid letting the G-7 pigeonhole the IMF into just being a developing-country bailout fund," says Rogoff. "That would be the beginning of the end for the Fund."
De Rato appears determined not to let the IMF be pigeonholed. In his Madrid speech he cited global imbalances as one of the main issues facing the Fund. "Surveillance of the major industrial countries is critical, and multilateral surveillance, including of global capital markets, needs to be constantly strengthened," he said.
The IMF's Rajan is playing his part. His first World Economic Outlook, released in April, encouraged China to begin moving toward a more flexible exchange rate. He also is stepping up his warnings to Washington to reduce its budget deficit as a means of curbing the U.S.'s dependence on inflows of foreign capital. "As long as you're running an imbalance, you're relying on investor sentiment," he tells II. "The sooner it is narrowed, the better. Everybody should recognize that they have a role to play here."
Increasingly, that is likely to mean the IMF itself. The Fund may be little more than a bully pulpit when it comes to developed countries, but it's one that de Rato and his team are determined to use.
As Rajan says, "I wouldn't minimize the effect of shouting from the rooftop, because we are seen as an impartial observer."