Dr Fred M’membe
Let’s not cheat ourselves or allow ourselves to be deceived. The International Monetary Fund (IMF) programme guarantees us nothing. We have been on this path before. Yes, the language has or is changing slightly, but the fundamentals of these programmes have remained the same. The IMF management would like recipient countries to “own” the policy conditionalities much more than they have done. But genuine ownership can only be derived if the countries themselves participate in the making of the policies; and this is generally not the case as the policies are usually imposed by the IMF, often against the wishes of the governments or people.
Still, the policies would be more acceptable if they work. But generally they have not worked. Instead of recovery, growth and getting out of debt, many recipient countries have experienced stagnation or worse, and many are still trapped in debt. Thus, more “country ownership” of IMF programmes does not simply mean improving the methods of getting countries to really accept and internalise IMF policies which, it is assumed, are good though tough. It is not a communications or public relations task.
Ownership can or should be increased only if there is genuine participation by the government and people of recipient countries; and only if the content of conditionality (i.e., the policies) are appropriate and bring about good outcomes. Thus, the key issues are the democratic (or rather non-democratic and non-participatory) process of IMF policy-making, and the appropriateness (or rather inappropriateness) of the IMF policies. Unless these issues are resolved, no amount of persuasion or arm-twisting (ultimatums such as “convince us beforehand that you are a believer or we won’t agree to giving you a loan”) will bring about genuine ownership.
The issues of non-participation and inappropriate policies are not academic but of life and death dimensions. From the mid 1980s we have lived through IMF programmes. We closely followed policy debates and policies in the different affected countries, saw the effects of the market practices and the IMF-led policies, the social and political upheavals, the traumatic economic downturn, the devastating effect on the lives of millions of people and on the viability of thousands of local firms, big and small. Due to the evidence of recent events, there is a crisis also in development thinking and the development paradigm. In the past there was a bias or blind faith in predominantly relying on the state for development. Then, there was a swing to the other extreme of having total reliance and blind faith in the private sector and on globalisation (rapid opening up to international finance and trade). Now the pendulum is swinging back.
The emerging view is that openness can have good or bad effects, depending on the specific condition and stage of development a country is in, for example, whether the local firms and banks are prepared for external competition, whether there are regulations or knowledge on managing and utilising foreign loans so that they can be repaid, whether there is reciprocal benefits from opening up, whether there are opportunities for increasing exports or if the capacity to produce and market for export has been built up, and what are the balance of payments effects of opening up given the conditions the country finds itself in. Although if conditions are right there can be many benefits from opening up, there are also great risks and costs to be borne if the conditions are not right. For many countries, the conditions are not or may not be right, at least not yet. If they nevertheless open up, they may suffer the risks and the costs.
Thus, the balance, degree, timing, sequence of liberalisation must be tailored to each country. Though it may become the new wisdom in rhetoric, this principle has not yet been translated into policy by international agencies like the IMF, nor into national policy of most developing countries. Many countries are unable to do so, even if they want to, due to conditionality or binding rules. Many, if not most, developing countries are neither growing nor developing. The situation is bleak for many. Business as usual cannot be the response, as it has generally failed. The issue of conditionality and ownership should be viewed in a broad perspective, and this includes looking critically not only at the roads taken by the IMF but also at the roads not taken.
The raison d´etre of the IMF at its creation and in the era of the Bretton Woods system is to ensure global financial stability. This arose from the recognition that left to itself the financial institutions, markets and players, can become a too-powerful force with the potential of destabilising the financial system itself as well as undermining the real economy. The IMF’s implicit mission included taming and regulating global and national finance so that finance would serve the real sector objectives of growth of output, income and employment.
The original Post WW2 framework supported this function. It included a system predominated by fixed exchange rates (which could be adjusted with IMF assistance when needed by objective conditions), BOP adjustment through country-IMF discussion when needed, limited crossborder financial flows, and the normality of national capital controls.
Policy was influenced by an understanding of the need for caution on the potential for instability, volatility and harm to the real economy that can be caused by unregulated finance and by speculative activity.
This regulatory system and the period of relative financial stability ended with the 1972 Smithsonian Agreement. Floating replaced fixed exchange rates, financial deregulation and liberalisation took off in the OECD countries, new financial instruments developed, there has been a massive explosion in crossborder short term capital flows and in speculative financial activity.
There has also been the spread of capital liberalisation to developing countries, to which advice from developed countries and from the IMF contributed. These developments underlie the frequent occurrence of financial crises.
The failure of the IMF and other international financial agencies to prevent such crises should be recognised as one of its major flaws, and this should be rectified. Indeed, the failure of the IMF in preventing the global financial system from going down the road of such rapid deregulation and liberalisation (with the consequences of currency instability, volatility of capital flows and financial speculation), and instead presiding over this road that was taken, is a major mistake. It also goes against the original role of the IMF to establish and maintain a stable financial order.
There needs to be a backtracking to the crossroads and take a new turning which is more true to the IMF’s original mission of establishing financial stability. That is the road of crisis prevention through establishment of greater stability through better understanding and regulation of capital flows and capital markets; and a more stable system of exchange rates (including among the major reserve currencies, and in the currencies of developing countries). There is need to understand capital markets and the role and methods of players like highly leveraged institutions (for example hedge funds) which are now non-transparent and unaccountable but have major impact on global and national finance and real economy. There is need especially to curb manipulative financial activity. There is need to understand the behaviour and potential and real effects of various kinds of capital flows to developing countries – including credit (to the public and private sectors), portfolio investment, foreign direct investment (and its varieties, such as mergers and acquisitions, Greenfield investment, and FDI that produces for the domestic or the foreign market).
There is need to look at inflows and outflows arising from each, including the potential for volatility of each and the effects, especially on reserves and the balance-of-payments.
What are the implications for policy and what guidelines should be given? For example, when should (or should not) a government or company borrow in foreign currency? Regulations and guidelines are needed because the market lacks a mechanism that can ensure appropriate outcomes. One guideline that is most relevant could be that local companies should be allowed to borrow in foreign currency only if (and to the extent) the loan is utilised for projects that earn foreign exchange to repay the debt.
The potential for devastating effects of short-term capital flows should be recognised and acted on, to prevent developing countries from the dangers of falling into debt traps. The IMF must recognise this and have an action plan (or at least be part of a coordinated action plan) that:
(i) regulates global capital flows, through international regulations or through currency transaction taxes;
(ii) establishes surveillance mechanisms and disciplines on countries that are major sources of credit so that the authorities in these countries monitor and regulate the behaviour and flows emanating from their capital markets and institutional sources of funds;
(iii) provides warnings for developing countries of the potential hazards of accepting different types of capital inflows and provides guidelines on the judicious and careful use of the various kinds of funds ;
(iv) educates members and the public on how capital markets work and establishes surveillance and accountability mechanisms to guide and regulate the workings of the markets;
(v) appreciates and advises countries on the functions and selective uses of capital controls at national level, and helps them establish the capacity to introduce or maintain such controls;
(vi) identifies and curbs the use and abuse of financial instruments and methods that manipulate prices, currencies and markets, and prevents the development of new manipulative or destabilising instruments and methods;
(vii) stabilises exchange rates at international and national levels, which could include mechanisms to stabilise the three major currencies, and measures that can provide more stability and more accurate pricing of currencies of developing countries;
(viii) provides sufficient liquidity and credit to developing countries to finance development.
The prevention of crises through a more stable global financial order is more beneficial and cost effective than allowing the continuation of a fundamentally unstable and crisis-prone system which would then throw up the need of frequent bail-outs with accompanying conditionality.
IMF conditionality policies have come under severe criticism for at least three reasons:
(i) that there has been “over-reach” in that the conditions widened in range through time to include “structural policies” not needed for managing the crisis;
(ii) that the policies in the core economic and financial areas of IMF competence have also been inappropriate as they were contractionary and did not generate growth; and
(iii) that the policies were designed in ways insensitive to social impacts, and the burden of adjustment fell heavily on the poor and at the expense of social and public services.
The scope of IMF policy conditions has been increasing through the years and has become far too broad. Many of the conditions were not relevant or critical to the causes or the management of the crisis the countries found themselves in. Some of these conditions were put into the conditionality package under the influence or pressure of major IMF shareholders for their own interest or agenda, rather than in the interests of the debtor country. On many areas where conditions are set, neither the IMF nor the World Bank has the expertise to give proper advice, and thus the potential to commit a blunder is high and the negative effects can also be high. This includes the area of political conditionality and issues relating to “governance”. In many countries, import liberalisation has led to domestic firms and industries having to close down as they were unable to compete with cheaper imports, and de-industrialisation has been the result.
There is now strong emerging evidence that trade liberalisation can successfully work only under certain conditions. Factors for success or otherwise include the ability of the country’s enterprises and farms to withstand import competition, its production and distribution capacity to export, as well as the state of commodity prices and the degree of market access for its products. In the absence of positive factors, import liberalisation may cause the country into deeper problems.
The implications for conditionality are significant. Evidence is emerging that wrongly sequenced and improperly implemented trade liberalisation is adding to developing countries’ trade deficits. The IMF should thus review its trade liberalisation conditionality to take account of the need to enable countries to tailor their trade policy to their particular conditions and their development needs. In areas of its core competence, there are also serious problems with IMF policies. The problems with conditionality do not lie only in “new areas” outside the traditional areas of the IMF’s concern. The criticism is now widespread that even in the areas of the IMF’s core competence (macroeconomic, financial, monetary and fiscal policies), there are major problems of appropriateness of policy and conditionality.
Policy objectives and assumptions and policy instruments on how to obtain them are under question, given the poor record of outcome. This questioning of the appropriateness and outcomes of policy had already been going on for several years (especially in relation to policies and results in Africa), but the doubts and criticisms grew much more intense as a result of the IMF handling of the Asian crisis.
The IMF policies tend to be biased towards restrictive monetary policies (including high interest rates) and fiscal contraction, both of which tend to induce or increase recessionary pressures in the overall economy. The contraction in money supply and high interest rates decrease the inducement for investment as well as consumption (thus reducing effective demand). The high interest rates also increase the debt-servicing burden of local enterprises and cause a deterioration in the banking system in relation to non-performing loans.
The Fund has also maintained the strong condition for financial liberalisation and openness in the capital account. Thus, the country is subjected to free inflows and outflows of funds, involving foreigners and locals. The country’s exchange rate is in most cases open to the influence of these capital flows, to the level of interest rate, and to speculative activity. Often, there are large fluctuations in the exchange rate. Given the fixed assumption that the capital account must remain open, there is thus the need to maintain the confidence of the short-term foreign investor and potential speculators. A policy of high interest rate and lower government expenditure is advised (imposed) in an effort to maintain foreign investor confidence. But since this policy causes financial difficulties to local firms and banks, and increase recessionary pressures, the level of confidence in the currency may also not be maintained.
The narrow perspective on which the restrictive policies are based neglects the need to build the domestic basis and conditions for recovery and for future development, including the survival and recovery of local firms and financial institutions, the encouragement of sufficient aggregate effective demand, the retention of the confidence of local savers, consumers and investors.
Most IMF policies imposed on countries that face financial problems and economic slowdown are opposite to the policies adopted by (and encouraged for) developed countries, such as the US, which normally reduce interest rates to as low a level as needed and which boost government expenditures, so as to increase effective demand, counter recessionary pressures and spark a recovery.
Thus there have been criticisms by mainstream and renowned Western economists (including Paul Krugman and Joseph Stiglitz) that criticise the IMF for imposing policies on developing countries that are opposite to what the US does when facing a similar situation.
Since the type of policies that are linked to IMF conditionality have been increasingly criticised for not working, including because they are contractionary and recessionary in nature and effect, it is no wonder that there is a lack of credibility and confidence in the substance of IMF conditionality, even in its core areas of competence. There is thus a need for IMF to review its macroeconomic package, re-look the policy objectives and assumptions, compare the trade-offs in policy objectives with the number and effects of policy instruments, and widen the range of policy options and instruments. This review should be made in respect of government budget and expenditure, money supply, interest rate, exchange rate, and the degree of capital account openers and regulation.
The IMF has also been heavily criticised, especially by civil society, for the inappropriate design of their policies from the viewpoint of social impact, including reducing access of the public to basic services, and increasing the incidence of poverty. The adverse social impacts are caused by several policies and mechanisms. The contractionary monetary and fiscal policies induce recessionary pressures, corporate closures, lower or negative growth rates, retrenchments and higher unemployment. Cutbacks in government expenditure lead to reduced spending on education, health and other services. The switch in financing and provision of services from a grant basis to user-pay basis impacts negatively on the poorer sections of society. The removal or reduction of government subsidies jacks up the cost of living including the cost of transport, food, and fuel.
These and other policies have contributed to higher poverty, unemployment, income loss and reduced access to essential goods and services. It is not a coincidence that countries undergoing IMF conditionality have been affected by demonstrations and riots (popularly called “IMF Riots”). The social impact of IMF policies is another major cause of the crisis of credibility in IMF conditionality. It must be recognised by the IMF that the major problem with its conditionality is that the policies associated with it are seen to be inappropriate and harmful. This view is not confined to critical academics or NGOs but is now adopted by renowned mainstream scholars, by parliamentarians of many countries, and also by policymakers of the countries taking IMF loans and undergoing IMF conditionality.
The growth of the criticism is caused mainly by the poor record of the policies adopted, and not so much by the lack of implementation of the policies. Therefore, the most urgent task is not so much to “sell” the old conditionality better to the client governments or to the public, but to review the content of conditionality itself and to come up with a better and more appropriate framework and approach. For years the IMF had been advocating that developing countries open their capital account, which would open them more directly to the forces of international capital markets. Also, there were strong moves to add capital account liberalisation to the mandate of the IMF through an amendment to the articles of association.
This advocacy that developing countries open themselves to the full force of global capital markets, when the Fund itself had inadequate knowledge of the capital markets, was surely remarkable, and in hindsight a great mistake with so many adverse consequences.
With the recent admission of lack of knowledge, let us hope the Fund is starting a learning process that will lead to recognition of previous errors and a more appropriate, cautious approach with a change in policy advice to developing countries.
It should go without saying that appropriateness of conditionality policies in terms of being in the interests of the debtor countries is the key issue to be resolved. “Acceptance” of externally imposed conditionality by the debtor countries is secondary and dependent on it. Moreover, the right to participate in policy making, and thus genuine ownership, is a critical element in ensuring appropriate conditionality and its implementation.
The role of the major shareholder countries is even more important. The public perception is that they would like to make use of the Fund for their interests, often at the expense of recipient countries and their people. The perception is that the major shareholders (who are also the home countries of the major creditor and investor institutions) make use of their position to skew the policy conditions in a manner that is biased in favour of creditors and investors. Is there a conflict of interest in their making use of the vulnerable state that debtor countries find themselves in, as leverage for imposing policies that are in their own narrow interests, even if these are against the interests of the debtor countries?
Finally, it is difficult or even impossible to ensure that the interests of debtor countries will be adequately reflected in conditionality and Fund decisions when the voting rights in the Fund are so skewed towards the creditor countries. Thus, the issue of the relationship between ownership and conditionality has to face up to the issue of the ownership of the IMF itself.
When decision-making rights are so imbalanced as they now are, it is not a wonder that the developed countries are perceived to be controlling the Fund’s policies, and in a manner that reflects their own interests rather than the interests of the whole membership. This situation is likely to continue until there is a fairer balance in the decision-making system.
There is a dire need for the modernisation and democratisation of the governance system, including a revision of the quota and voting system. This can be accompanied by genuine reform of IMF policies and priorities. The issue of “ownership and conditionality” can then be better resolved in that context.
Fred M’membe