It
is ironic, to say the least, that the IMF's financing
paradigm that has often been a major factor behind
the economic problems of many lower and middle income
sovereign borrowers since 1982, has landed the Fund
itself in a financial crisis. It is now official -
so far, the IMF's financial well-being has depended
on it being unsuccessful in its primary mission, which
is to prevent financial crises. This is what the Committee
to study the sustainable long-term financing of the
IMF has proclaimed in its final report submitted recently.[1]
The Committee has criticised the IMF's existing financing
model, which relies primarily on interest income derived
from lending to fund the whole range of Fund's activities
- a point that has been highlighted by international
debt analysts since the early 1990s.
IMF Chief Rodrigo Rato appointed the Committee headed
by Andrew Crockett, the former director-general of
the Bank for International Settlements (BIS), to recommend
specific income models that would avert a cash crisis
for the global lender, whose operational income is
declining as debtor nations repay their loans early.
The current income model, which has been in place
since 1981, operates on a cost-plus basis. Thus the
interest rate on credit outstanding is set at the
start of each financial year at the level needed to
cover the Fund's funding and operating costs and generate
a "net-income target" of five percent of
reserves. Apart from the income earned on the Fund's
reserves (SDR 6 billion, which were recently invested
in a separate Investment Account), the main source
of income has thus been the charges and fees on Fund
credit financed from the General Resources Account
(GRA). The latter covers the provision of credit mainly
to middle-income member countries.[2]
The current model has thus been relying mainly
on the income derived from credit operations associated
with crisis resolution to meet funding costs, cover
the expenses of running the Fund and build up reserves.
Given this financing strategy, it is no wonder that
the Fund would always insist on full repayment of
its loans, even if its erroneous policy conditionalities
caused damage to its borrowers' economies. The Fund's
own internal staff reviews have acknowledged the mistakes
in its loan conditionalities of neo-liberal market
reforms and public spending cuts, which have aggravated
post-crisis economic slowdown and increased the debt
burden of many countries in crisis. But, clearly,
the IMF can gain financially from its errors by extending
new loans necessary to repair the economic devastation
brought about by previous loans, as has long been
highlighted by several debt analysts. Even so, financial
accountability in terms of taking responsibility for
its mistakes and alleviating the drastic economic
and social consequences by accepting debt write off
or even debt reduction has totally eluded the Fund.
Thus, even though both bilateral (official) and private
creditors have accepted reductions of their claims
in various debt rescheduling/write-offs, the Fund
(along with other IFIs), very "rationally",
continues not to do so. On the contrary, it has always
insisted on its make believe "preferred creditor"
status even as there is no legal basis for this, and
have added to the payments problems of sovereigns
in crisis .[3]
The failures of the Fund to either rectify the moral
hazard problems arising from such risk-less lending,
or discard the discredited conditionalities associated
with these credit lines, or accept financial responsibility
for its policy mistakes, have therefore been central
to the disengagement of countries from the Fund. Four
of IMF's major debtors namely, Argentina, Brazil,
Indonesia and Uruguay prepaid their debts over the
last two years. The Philippines became the latest
sovereign in December 2006 to repay the Fund ahead
of schedule, in order to avoid future interest payments
and to declare independence from the conditionalities
that take away their policy autonomy. A rapid reduction
in credit outstanding to borrowing members has thus
resulted in a drop in Fund income and a base-case
projection that it will fall further.
The Fund's Executive Board agreed in March 2006 on
a two-pronged strategy to face the financing challenges.
To meet the immediate financing needs for FY 2007,
it agreed on a package of measures, including the
establishment of the Investment Account, a pause in
the accumulation of reserves and the use of the Fund's
existing reserves to meet remaining income shortfalls.
An Investment Account was established in June 2006
and funded with an amount equivalent to the Fund's
reserves in order to earn extra income from bond markets.
The second and more critical long-term aspect of the
strategy is to ensure a lasting and sustainable solution
to the institution's income needs and this has been
the Crockett Committee's mandate.
Major Recommendations
Funding Credit Intermediation
The Committee believes as a general principle that
the income from credit intermediation should not have
the objective of continuing to fund the whole range
of IMF activities, which include the provision of
public goods and bilateral services.[4]
However, on a long-term basis, lending should yield
enough to cover intermediation costs and the accumulation
of reserves, since the latter are needed to mitigate
the effects of credit losses on GRA activities. The
lending rate therefore should be set at a reasonable
level in alignment with long-term average market credit
conditions. However, the Committee has also proposed
the possibility of applying a premium on the basis
of the duration of a member's borrowing, in an extension
of the Fund's current practice of charging more for
programs involving higher level of access to its resources.
Such a proposal needs to be rejected outright since
it would be preposterous to impose heavier interest
charges on borrower countries who continue to be on
the payroll of the Fund with a series of programs,
often because of the Fund's own ideological fixations.
Funding Public Goods
Fund's public goods provision that dominates its expenditures
to the extent of up to 44 per cent consists of global,
regional and bilateral monitoring or surveillance,
as well as standards & codes and financial sector
assessments. The Committee does concede that insofar
as the Fund is providing a public good to the world
economy, it is appropriate for the public good activities
to be financed by means which derive proportionately
from resources provided by all members. It has considered
three potential sources of income to provide funding
for public goods: periodic charges levied on member
countries; investment operations; and the creation
of an endowment. Let us consider them here in the
reverse order.
(1) In the Committee's view, income from an endowment
that can be generated in an equitable way and whose
long-term real value can be preserved, could be used
to help cover administrative expenses. If the real
rate of return were, for instance 3%, each SDR 1 billion
of resources would generate SDR 30 million per year,
without diminishing the real value of the endowment.
One option would be to request a one-off contribution
from members to create this endowment. However, the
Committee thinks that this is an uncertain source
for the endowment due to the need for legislative
approval in the member countries.
According to the Committee, the most likely alternative
source of financing for such an endowment would be
the proceeds from a limited sale of Fund gold, which
should be ring-fenced to exclude further sales. The
IMF holds 3,217 tonnes of gold in total, which is
carried in its balance sheet at SDR 35 per ounce.
The committee has suggested that the IMF could sell
about 400 metric tons of gold, which has a current
market value of $6.6 billion based on a $500 per ounce
price (an average of the gold prices in a two-year
period). Assuming a real rate of return of 3%, investment
of the proceeds from the gold sale could yield an
approximate annual return of $195 million.
The Report has recommended that the impact of gold
sales on the market could be taken care of by subjecting
the sales to strong safeguards. Thus, IMF's gold sales
would need to be coordinated with the existing and
possible future central bank gold agreements to ensure
that they would be accommodated by reductions in the
amounts of gold that central banks might sell under
the Central Bank Gold Agreement.
Civil society organisations across the globe have
consistently argued that the IMF's massively undervalued
gold reserves should be put to productive use to cancel
the multilateral debt of the poorest countries. In
2004, in a paper prepared by the Fund's Department
of Finance at the request of the major creditor nations,
the Fund had in fact joined debt campaigners across
the globe by stating the technical feasibility of
gold sales very clearly and saying that these resources
could be spent on the cancellation of developing country
debt.[5]
However, the subsequent IMF board meeting saw this
proposal quashed.
In the light of this rejection earlier by the major
IMF shareholders of the proposal to use gold sales
to fund debt cancellation, the Crockett Committee's
proposal to use gold sales to fund IMF's administrative
expenditure is a definite contradiction and is totally
indefensible. The other contradiction is that while
the Committee has clearly suggested that "public
goods, by definition, cannot be financed by market
mechanisms", its suggestions for financing are
both market-based.
(2) Thus, the other major recommendation of the Committee
is that the Fund could generate additional revenue
by relaxing the restrictive mandate on the investment
of its reserves, which is currently more conservative
than those of the World Bank and other AAA-rated multilateral
development banks (MDBs). The World Bank, for instance,
can invest in government and agency obligations (AA-
and above), asset-backed securities (AAA only), and
time deposits with commercial banks. Based on returns
achieved at the MDBs on their portfolios of liquid
investments, the Committee believes that a reserve
portfolio of SDR 6 billion under "normal market
conditions" would produce an additional income
of SDR 30 million. Similarly, it is recommended that
a portion of the currencies subscribed by member countries
can also be invested in higher-yielding marketable
interest-bearing securities.
The Committee does acknowledge that returns from both
these types of investments would depend on conditions
in the capital markets at the time. Further, since
the quota resources used to fund market investment
might be needed at any point of time for lending to
member countries, a portion of the portfolio may need
to be liquidated at short notice, which may in fact
result in losses. Thus, by its own admission, the
expansion of investment activities of the Fund in
the capital markets would not provide a stable source
of income, contradicting what the Committee holds
forth as an essential characteristic of the income
flow required to fund public goods. Further, this
income model is untenable in supporting the Fund's
lender-of-last resort role.
More crucially, whether managing investments using
funds from an endowment or reserves and quota resources,
once the Fund begins investing in the capital markets
in a major way, there could be a conflict of interests
between IMF's role as a global financial supervisor
and stabiliser and its need to maximise its own investment
income. The potential for such a conflict of interests
is indeed mentioned in passing by the Report. The
Committee believes that this concern can be removed
or alleviated by "outsourcing investment activities
(as is currently done for the Investment Account)
or by establishing appropriate Chinese walls"
in case the investment activity is undertaken internally.
However, there are two processes that need to be considered
while assessing the implications of the IMF becoming
an investor in the international capital markets.
It is evident that countries are increasingly liberalising
their financial markets internally and externally,
and there is an increased reliance on capital markets
for their financing needs. It should also be remembered
that the relatively higher capital requirements prescribed
by Basel II under several categories of lending are
projected to both reduce private bank lending to developing
and less developed countries, as well as increase
their borrowing costs. This could increase their reliance
on the capital markets further.
With active IMF involvement in the capital markets
as an investor, even if the Fund would be theoretically
de-linking itself from the investment decisions through
outsourcing, it is difficult to imagine that the "rationality"
of the Fund's professional investment managers would
be different from that of a large investment fund
or pension fund manager, for whom the investment decisions
and risk (and therefore, returns) go hand-in-hand.
It is well known how various emerging country capital
markets have been subjected to manipulations by these
foreign institutional investors, who bring in and
take out very large amounts of money according to
their whims and fancies. Therefore, with a heavy reliance
on unstable international private capital inflows
together with an interest rate shock, developing countries
could find themselves in a situation similar to that
of the early 1980s and in need of the support of IMF
funding. Thus, the entry of the Fund as an investor
in the capital markets would give rise to severe conflicts
of interests, which could even possibly get emerging
market economies indebted to the Fund again![6]
(3) The Report begins by stating that the burden of
supporting the Fund's public goods provision should
be spread broadly in proportion to quotas, rather
than being put on a subset of members - the developing
country borrowers. In complete contradiction to this
stated objective in looking for alternative income
models, the Committee rejects the suggestion to collect
annual or other periodic levies from its members in
proportion to their quotas, as the UN and the OECD
do. It is suggested that periodic levies on Fund members
may not be a practical way of financing the Fund's
public good activities. The argument is that since
such levies would, in most countries, be subject to
parliamentary approval, this would subject the Fund's
expenditures to national budgetary procedures, which
in turn would threaten the independence of the Fund's
policy advice. Given that the UN does not find itself
facing such a constraint, this argument put forth
by the Committee to reject quota-based periodic levies
obviously stands on tenuous grounds.
Funding Bilateral Services
The recommendation in the case of financing bilateral
services is to impose charges for such services.
The use of technical assistance and capacity building
services offered by the Fund are relatively more utilised
by the lower income and poor countries. Since the
Committee recommends that donors should help to defray
the costs for countries unable to afford these charges,
this can be seen to have both a positive and negative
impact. Those countries who have donors backing them
in their capacity building efforts might be worse
off as, they find themselves burdened with some more
conditionalities or orthodox policymaking, as is happening
presently. On the other hand, those poor countries
that do not find donor support to pay for these Fund
services might be better off, since they would escape
policy indoctrination entrench ed in the rigid neo-liberal
framework.
Conclusion
To the extent that the Fund's search for sustainable
income streams breaks the totally illogical link between
its interest income on lending to countries in distress
and its revenue base, alternative income models should
be welcomed. However, one finds that there are inherent
contradictions in the Crockett Committee's suggestions,
which make most of them not only untenable, but even
harmful for the global financial system. Crucially,
since the markets cannot be imagined to replace the
Fund's lender-of-last resort role,[7]
which is the fundamental rationale for its continuing
existence,[8]
the market-based income models put forth by
the Committee that offer unsteady income solutions
to the IMF's financial crisis are unacceptable.
March 2, 2007.
[1] See page 5 of ‘Final Report, Committee
to Study Sustainable Long-Term Financing of the IMF',
January 31, 2007, downloaded from http://www.imf.org/external/np/oth/2007/013107.pdf
[2] The Fund's credit to its low-income
country members takes place largely through a separate
trust (the PRGF-ESF Trust) at subsidized interest
rates and does not contribute to the Fund's income.
[3] On the contrary, the IMF actually
has a statutory duty to reduce their claims. The IMF
has even published this fact on its own homepage.
See Kunibert Raffer, 2004, International Financial
Institutions and Financial Accountability, Ethics
& International Affairs, Volume 18, Number 2.
[4] See Tables 1 and 2 in Annex 5
of the Report for two types of classifications of
the Fund's expenditures. The Crockett Committee's
proposed classification of IMF activities in Table
3, namely, global public goods, credit intermediation
(consisting of both GRA credit and facilities to low-income
countries such as PRGF-ESF, HIPC and MDRI) and bilateral
services (technical assistance and external training),
is far more logical than the existing Fund classification.
[5] See EURODAD, CIDSE, AFRODAD, Jubilee
USA Network and Halifax Initiative Joint Final Policy
Brief "Sell IMF Gold to Cancel the Debt: Decision
time is now", 13 April 2005.
[6]Clearly, this could change the
baseline projection that the IMF's intermediation
income would full in the future.
[7] There is an argument that sovereigns
may no longer need Fund credit since the current spread
charged over the risk-free rate (108 basis points)
is not significantly lower than the spread for commercial
debt. The latter is currently just 184 basis points
using JPMorgan's emerging market bond index. Further,
unlike IMF loans, it comes with no policy strings
attached. (See Financial Times, December 31, 2006).
However, what is being missed by such analysis is
that for countries facing any financial distress,
markets will not offer these interest rates. Indeed,
market funding will not even be available to sovereigns
in distress.
[8] Clearly, this would be minus the
policy conditionalities, since there is no rationale
for their continuation. Further, the IMF's own role
in crisis management should be re-looked at, when
organisations such as a revamped Bank for International
Settlements (BIS) with developing country and LDC
participation, could also possibly undertake the crisis-lending
role.
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