“Getting the IMF’s Groove Back”

Eswar Prasad says the IMF needs two reforms in order to be more effective:

Getting the IMF’s groove back, by Eswar Prasad: The worldwide financial crisis … should be the perfect opportunity for the International Monetary Fund to get its groove back. Indeed, a strong multilateral institution with teeth is essential to promote international financial stability. But it will take some radical changes for the IMF to fill that role. …

The IMF faces two big problems. First, its capital base is small relative to the size of global capital flows… A lending capacity of $250bn doesn’t amount to much in a world of $700bn bailouts and cross-border capital flows amounting to trillions of dollars. It is not easy for the IMF to raise capital — the begging bowl has to be taken around to all its member countries. One recalcitrant member such as the US can block the whole plan.

Second, the IMF has a huge credibility problem. It is seen as mostly taking orders from the US. The voting structure gives the US, which has a 17 per cent share, a veto over important decisions that require an 85 per cent super-majority. Meanwhile, even large emerging economies such as China and India have modest shares of 3.5 and 2 per cent respectively. But “governance” reforms to set right such imbalances have been fraught and painfully slow as redistribution of voting rights is a zero sum game.

Here are two ideas that, together, would increase the IMF’s capital and strengthen its role in overseeing the global economy and financial system…

First, proportionately shrink the voting share of existing members by 20 per cent… Then, auction off to sovereign governments the … 20 per cent, with two provisos: no country can more than double its present quota or have more than a 14.9 per cent share.

Isn’t this tantamount to selling off the IMF? Yes, economically more powerful countries would presumably pay more and have a larger say in the IMF’s policies. But this is exactly the way the IMF was set up—with voting rights determined by economic factors rather than a one-country-one-vote principle. Moreover, the auction could entice sovereign wealth funds to contribute to the global pool of capital by offering them a safe and liquid investment opportunity with a decent yield. There aren’t many such opportunities for wealth funds flush with cash, so this should provide a nice boost to the IMF’s capital. …

The second idea is to impose conditions on voting rights, rather than just on loans. Each country would get a list of criteria (e.g., a lower budget deficit, a more flexible exchange rate) that it would have to fulfill or have a plan for making progress towards. The IMF already jawbones its member countries, but only countries that borrow from it take its recommendations seriously.

The large countries routinely ignore the IMF’s advice with no consequences…, but why should poorer countries be subject to harsher IMF scrutiny? After all, US or Chinese economic mismanagement can have much larger global consequences. …

What’s needed is to get incentives right and let a market mechanism achieve an efficient solution. Governments that take the IMF’s advice more seriously and contribute more to its capital should have a bigger role in fashioning its policies. It is time for a radical overhaul … at the … IMF…

Originally published at Economist’s View and reproduced here with the author’s permission.

3 Responses to "“Getting the IMF’s Groove Back”"

  1. Anonymous   November 2, 2008 at 9:11 am

    The U.S. is currently the world’s largest debtor nation and has a huge budget deficit. The U.S. needs some big IMF loans.

  2. Guest   November 2, 2008 at 10:01 am

    God save us all from these people….

  3. Guest   November 4, 2008 at 10:12 am

    I agree that some form of governance reform is needed in order to restore the IMF’s credibility, even though right now, a substantial quota (and voting rights reform) isn’t the first order priority: increasing the lending capacity is. It may, but may not, require a major voting rights reform. After all, the biggest blow to the credibility of the Fund in recent years was the US totally ignoring all IMF’s advice and warnings, and this can be changed at a negotiation table without much real action. The effect would be short-term only but it may last long enough to get us over the worst turmoil. To me the second proposal above seems very improbable, impractical — and, most likely, irrelevant, given the mechanism of decision-making in the Bretton-Woods Institutions. (Voting is extremely rare, most decisions are taken by consensus — even though the fact that voting could take place if consensus-building takes too much time, is quite an effective stick.) On both proposals, I see the US as extremely unlikely to give up its effective veto power as yet.There are other options, too. The complicated, yet long tested, IDA (International Development Association) model with its gradual adjustment of voting powers based on the country’s share on replenishments may be one of them, in particular given that the Fund needs to increase its lending capacity. Perhaps most likely though, we may see brand new “New Agreements to Borrow”, or enlargement of the existing one by new countries. In my view, last week’s steps by the Fed (allowing more countries to participate in the currency swaps) and by the Fund itself (significant relaxation of conditionality after many years of firmly insisting on it) might have caused some recent leaders of the fight for the quota reform to reconsider how hard they are going to push.