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Beyond the IMF

A consensus has developed that the International Monetary Fund is not fulfilling its role prompting multiple proposals for reform. However, the focus on reform should be complemented with an exploration of alternatives outside the IMF, which hold the potential to give developing countries greater bargaining leverage with the Fund, and by increasing competition so as to spur the institution to better performance. This paper focuses on the insurance role of the Fund and argues that developing countries are turning to alternative insurance mechanisms - from a higher level of reserves, to regional co-insurance facilities, to remittances - as a counter-cyclical source of foreign exchange. The de facto exit of the IMF's clientele driven by the high political costs associated with Fund borrowing, now poses unprecedented challenges, in particular pressures on the Fund's income. In order to maintain its role as an insurance mechanism, the IMF needs to undergo a rapid restructuring and significantly cut its administrative budget, with the budget savings used to lower the interest rates charged to borrowers.

Special articles

Beyond the IMF

A consensus has developed that the International Monetary Fund is not fulfilling its role prompting multiple proposals for reform. However, the focus on reform should be complemented with an exploration of alternatives outside the IMF, which hold the potential to give developing countries greater bargaining leverage with the Fund, and by increasing competition so as to spur the institution to better performance. This paper focuses on the insurance role of the Fund and argues that developing countries are turning to alternative insurance mechanisms – from a higher level of reserves, to regional co-insurance facilities, to remittances – as a counter-cyclical source of foreign exchange. The de facto exit of the IMF’s clientele driven by the high political costs associated with Fund borrowing, now poses unprecedented challenges, in particular pressures on the Fund’s income. In order to maintain its role as an insurance mechanism, the IMF needs to undergo a rapid restructuring and significantly cut its administrative budget, with the budget savings used to lower the interest rates charged to borrowers.


he drift away from the Bretton Woods paradigm – of a world where financial markets are coordinated and disciplined by a central multilateral institution – continues. Industrialised countries long ago removed themselves from International Monetary Fund (IMF) tutoring. When it lost its original purpose, the Fund survived as a developmental institution, dedicated to the financial stability of developing countries. It became more concerned with domestic rather than international policies, and even joined the poverty alleviation crusade. During the last few years, however, emerging market countries have also been drifting away from the Fund, prepaying debts to the institution, rejecting its role as a debt arbiter, building up international reserves, and above all, reforming domestic policies to lessen the risk of financial crisis and dependence on the IMF. At the same time, the Fund has been losing its financial capacity to provide emergency funding, and its comparative advantage in human capital, acting in an advisory role. The principal reaction to this erosion of the Fund’s role has been to call for IMF reform. A succession of ingenious proposals has been put forward, designed to seduce the Fund’s main shareholders into an acceptance of the key steps required for reform – namely, a surrender of voting power and the creation of new funding for the institution.

We argue that the focus on reform – which may or may not happen – should be complemented by greater attention to the reasons for the exodus from the Fund. Starting with a checklist of core IMF functions, one would find examples of both market mechanisms and government interventions that in some measure are acting as substitutes for the IMF. These include IMF functions such as crisis resolution, exchange rate management, financial policy coordination and surveillance. At the same time, exit from the Fund is also being driven by high borrowing costs for its resources, as market rates decline relative to Fund charges.

Behind that trend is a cost crunch in the institution – a shrinking customer base means falling revenues, yet the institution has refused to adjust by cutting its administrative expenses.

One reason for a closer look at the factors that are reducing demand for IMF services is to assess the significance of a diminished IMF. How effective are those alternative mechanisms? To what extent does the absence of an IMF mean a more dangerous world? Another reason for the examination proposed here is to identify opportunities for intervention that would reduce financial vulnerability, not through the Fund but by strengthening the market and governmental substitutes for the IMF. The paper focuses in particular on the insurance role of the Fund and argues that developing countries are adopting alternative insurance mechanisms, from a higher level of reserves to regional coinsurance facilities to remittances as a counter-cyclical source of foreign exchange.

The paper is arranged as follows. We first discuss the declining relevance of the Fund in recent years. Next, we explore the alternative and supplementary mechanisms that have emerged to carry out two of the IMF’s primary functions – improving global financial stability and acting as an insurance mechanism. Following this discussion, we highlight some options available to the Fund to reduce its loss of clientele. We then elaborate on the implications of the growing number of alternatives to the Fund for developing countries and global financial stability. We conclude by suggesting areas for future research.

The Fund’s Declining Relevance

Over the last two years, respected international finance experts have stated that the IMF is rudderless and ineffective;1 that it is suffering from an identity crisis, has waning influence and a reduced role [Truman 2005a: 321], that it is on the brink of Figure: Number of IMF Programmes* and Total Fund Credithas declined any further assistance; and Serbia has announced

Outstanding**, 1970-2006

that it would not increase its borrowings. In the fiscal year 2005, just six countries had Stand-by Arrangements – the lowest number since 1975. Fiscal year 2006 was no better – barely five new Stand-by Arrangements and one new Extended Arrangement. Although new commitments rose sharply (from SDR 1.3 billion

0 10 20 30 40 50 60 70 Number of Arrangements 0 10 20 30 40 50 60 70 80 Billions of SDR

in FY2005 to SDR 8.4 billion in FY2006), this reflected a SDR

6.7 billion Stand-by for Turkey in May 2005. IMF credit out

standing at the end of the fiscal year 2006 stood at SDR 19.2

billion, a 25-year low – and sharply lower relative to the massive

growth of world trade and payments during this period. Total

new commitments under the PRGF were also meager – just SDR

128 million.

One possible interpretation is that the current decline in the



Number of Arrangements

Total Fund Credit Outstanding

Notes: * Includes stand-by, extended fund facility, structural adjustment

facility, enlarged structural adjustment facility. ** Excludes reserve tranche purchases; includes outstanding associated

demand for Fund resources is part of a cyclical process. Barry Eichengreen has pointed out that the Fund is “a rudderless ship in a sea of liquidity”, suggesting that the Fund’s raison d’être

has not changed. However, it is worth contrasting the global payment systems in the aftermath of the oil price shocks of 197374 and 1979-80 with 2005-06. In stark contrast to the earlier two

shocks, which created major global disequilibria and led many

loans from the Saudi for development.

Source: IMF Annual Report 2006.

developing countries to avail of the Fund’s facilities, there is little

irrelevance [Wolf 2006]; that, as a result, the world economy

basically is not managed at all [Williamson 2005: 22]; that the IMF has long since lost its role as the world’s central banker2 and lost sight of where it wants to go [Truman 2005a: 321]; suffers from a mismatch between aspirations and authority and instruments; and that no single step will restore the Fund to its prior respected position [Truman 2005b: 1].

In most cases, the statement is followed by a call for IMF reform, and often by specific reform proposals. For several years, the reform debate has concentrated the attention of the international finance community. Meanwhile, however, markets and governments and civil associations have been building alternative solutions to the various functional deficits that resulted from the lack of an effective IMF.

In the late 1990s, the Fund appeared to be at the zenith of its influence. Its attempt in 1997 to change the articles of agreement to make capital account liberalisation a formal goal, and its subsequent role in the financial crisis that began in Asia in 199798 and spread to the Russian Federation and Brazil in 1998-99, gave the Fund an unprecedented global role. New forays such as the poverty reduction and growth facility (PRGF) drew the institution into core development issues hitherto the preserve of multilateral development banks. These initiatives, however, did not reverse the underlying trend to irrelevance of the institution, and the PRGF may have turned out to be a pyrrhic victory.

Today, the Fund’s future appears much bleaker. Not only is the demand for its resources at a historic low but major borrowers are prepaying the institution (see the figure). In 2003, Thailand finished paying off its obligations two years ahead of schedule, while in 2004 the Russian Federation prepaid its $3.3 billion debt to the IMF. In December 2005 and January 2006, Argentina and Brazil announced their decision to repay their entire debt to the Fund ($15.5 billion in the case of Brazil and $9.8 billion in the case of Argentina). Pakistan, which owes $1.5 billion and is currently the third-largest debtor, has stated its intention to cut its dependence on the Fund; Ukraine, the fourth largest debtor, demand this time around. To be sure, this reflects structural and epistemic changes in developing countries, in which the Fund has played an important role. Greater liquidity in capital markets has given many middle-income developing countries alternatives, while low interest rates have made new financial emergencies less likely.

But there is more to the story. The Fund no longer has the mystique, and its imprimatur no longer carries the weight previously associated with the institution, despite the continuing appearance of it being an all-powerful and non-accountable institution.

For some time there has been a broad consensus on the need to reform the IMF. Ideas for reform cover virtually every aspect of the Fund, from its surveillance role to its role in debt management and emergency lending, to the nature of its advice and the functions it needs to add or discard to its governance [for a recent elaboration see Akyüz 2005; Bryant 2004; Woods 2005; Buira 2005]. However, there is little agreement when it comes to the details of the reforms. In the past quarter century, developing countries have been periodically afflicted by financial crises. Each flurry of activity has resulted in an expansion in the scale and scope of the Fund itself. Mervyn King has pointed out that instead of significant reform the Fund’s principal shareholders have merely ensured that the institution be allowed to “evolve through a series of ever more bland communiqués and meaningless statements” [King 2006].

But today the Fund faces perhaps its gravest crisis, the result not of opprobrium but of irrelevance. The realisation that if the Fund is not “kept up-to-date… [it] risk[s] suffering a lengthy senescence” [Wolf 2006] may well prompt real reforms. However, as this paper argues, while developing countries should continue to press for reforms, they should take heed of just how little change has resulted from past calls for reform. Consequently, they must complement the focus on reform with exploring alternatives outside the IMF, which could eventually increase the bargaining power of developing countries with the Fund, while at the same time spurring the institution to better performance by empowering competitive alternatives.

Economic and Political Weekly February 17, 2007

Alternatives to the Fund

Several factors have contributed to the development of alternative and supplementary mechanisms to carry out particular IMF functions. Perhaps the most important factor has been the rapid growth of financial markets, and especially bond markets, which in turn has driven the expansion of institutions that monitor and carry out continuous market surveillance, notably rating agencies and other private and governmental institutions that track financial conditions. A second factor has been an equally impressive expansion in networking and local or regional cooperation and integration. Bryant (2004) has pointed to the “multiplicity of institutional venues – consultative groups and international organisations – [that are] involved in surveillance of financial standards and prudential oversight. Similarly heterogeneous and complex institutions are involved in the nascent supranational surveillance of all other types of economic policies” [Bryant 2004:10-11]. Cerny (2002) makes a similar point, speaking of the “privatisation of transnational regulation” through the expansion of “webs of governance”, of “epistemic communities”, and “multi-level governance” involving government and private sectors and civil associations. The conception of a more flexible networked world order that uses both the traditional vertical international organisations and new, horizontal “institutions of globalisation” has also been explored by Anne Marie Slaughter (2004). The third development, closely related to the above, has been modern communications technology, which has brought about a multiplication in the volume, access and speed of information, enormously facilitating surveillance by non-official actors. These contextual trends help to explain the specific mechanisms, discussed below, that are being used to complement or substitute for particular IMF functions.

Global Financial Stability
  • (i) Crisis resolution: Although the Fund was a pivotal player in many debt and financial crises during the 1980s and the 1990s, it began to be seen by developing countries less as an impartial referee than as a debt collector for private creditors. In the late 1990s, the Fund proposed sovereign debt restructuring mechanisms (SDRM) to address this critique. Even if the Fund had been successful in implementing the SDRM, the programme would have had limited utility since debt flows were becoming a much smaller part of total financial flows. In any event, the SDRM did not go anywhere as the international community chose to pursue a more market-driven approach through the use of collective active clauses (CAC) in bond contracts. Neither debtors nor creditors appear enthusiastic about the Fund’s role in restructuring under CACs. In the end, with the advice and market soundings of a private investment bank, Argentina made a unilateral offer, which was substantially accepted by the market [Simpson 2006]. As the Argentinean and Russian defaults have shown, countries have realised that rather than perennial rounds of debt restructuring with the IMF playing a central role, countries may be better off simply ignoring the Fund. The results (at least until now) do not seem to indicate that these countries are any worse off than if they had elected to use the offices of the IMF.
  • (ii) Managing the international monetary system: The primary role of the Fund on exchange rate management vanished with the collapse of the Bretton Woods system. Consequently, its original mandate notwithstanding, the Fund has been much more
  • voluble on its member countries’ fiscal policies than their exchange rate policies. Although recent G-7 communiqués have emphasised the importance of flexibility in exchange rate systems, countries continue to peg their exchange rates and there is not much that the Fund has been able to do about it.

    Williamson (2005) has emphasised the need for the Fund to act as a referee on disputes over exchange rates and has called for the institution to develop a system of reference exchange rates to prevent unsustainable global imbalances. He argues that such a system would help secure global policy consistency. The main problem with these arguments is that the risks to global financial stability are from the systemically important countries and regions, such as global imbalances caused by the huge US current account deficit, China’s system of exchange rate management, or Europe’s rigid labour and product markets. But these are the very actors on whom the Fund has little influence and who are least likely to allow the Fund to constrain their autonomy. It is unclear why moving from the current ambiguous guidelines to more well-defined rules (through a system of reference exchange rates) would resolve the enforcement problem. That depends critically on the confidence of players in the institution itself, which in turn is singularly dependent on a perception of presumed neutrality and a referee role of the institution that few emerging markets are willing to accept, given the current governance structure of the IMF.

    Indeed, even the SDR as a notional unit of exchange now faces competition. In spring 2006, the Asian Development Bank (ADB) announced plans to launch a notional unit of exchange, called the Asian currency unit (ACU), which would help track the relative values of Asian currencies. Modelled on the ECU (the forerunner of the euro), the ACU would be calculated using a basket of 13 regional currencies, weighted according to the size of each economy. The ACU would allow the monitoring of the collective movement of Asian currencies against major external currencies, such as the dollar and the Euro, as well as the individual movement of each Asian currency against the regional average. Small borrowers are also expected to issue bonds denominated in ACUs (rather than the SDR).

    (iii) Coordination role: An important role of the Fund has been to function as “a trusted, independent and expert secretariat” for policy-makers around the globe. A very evident indication of its failure (on perhaps all three attributes) has been the proliferation of alternatives. A variety of institutional mechanisms are setting, interpreting, diffusing and enforcing rules on affecting global financial stability – ranging from purely governmental to purely private, with complex public-private hybrids added in. Ad hoc non-treaty intergovernmental groupings like the G-7, G-10 and G-20 are agenda-setting and rule-ratification institutions. Intergovernmental organisations like the IMF, World Bank, International Finance Corporation and Bank for International Settlements make some rules but more importantly, serve as transmission and enforcement mechanisms for rules developed elsewhere. Increasingly, the rules underpinning global financial governance are being set by private actors: the International Federation of Accountants, Inter-Agency Standing Committee (IASC) and groupings of national regulatory institutions such as International Organisation of Securities Commissions (IOSCO) and International Association of Insurance Supervisors. Appendix I lists the goals, representation, decision rules, and agendasetting capacity of the principal institutional underpinnings of global financial governance.

    Two features of this institutional mix are worth highlighting. One, there is considerable variation in forms of representation, goals, and authority. Two, there are overlapping jurisdictions in several areas, which is leading to the formation of “second generation” emanation institutions (the joint forum on supervision of financial conglomerates runs jointly with the Basel committee on banking supervision, IOSCO and IASC, for example). Developing countries should give greater emphasis to participating in these multiple fora rather than wringing their hands about their marginalisation in the Fund.

    (iv) Surveillance function: Besides its insurance function (emergency lending), surveillance has long been seen as the Fund’s other critical function. Compared to its early years, the very success of the Fund in ensuring greater transparency in countries’ macro accounts has meant that a variety of institutions (both private and public) play a role through their reports and analysis, which are similar to those of the Fund. Moreover, a key weakness of the Fund’s surveillance is that issues in article IV consultations are negotiated ex ante with the systemically important countries, implying that the latter exercise agenda control. The coverage of private rating agencies has grown enormously, extending to both sovereign and private debt, to most middle-income countries and even many sub-Saharan nations. In addition to wide coverage and freedom from the political inhibitions that limit the Fund, surveillance carried out by the private sector is a source of frequent and up-to-date information, in contrast to the relative infrequency of article IV consultations which occur only every 12 to 18 months and, in some cases, less frequently. The rating agencies have not improved on the Fund’s prediction record, and, like the IMF, they can be suspected of conflicts of interest, yet private surveillance is a growing industry.

    Proposals to rescue Fund surveillance stress the need to separate its surveillance and lending functions so as to avoid any perception of conflict of interest. The separation would apparently enhance the independence and credibility of the Fund’s technical judgment. However, enhanced surveillance of the global economy and a legal foundation for the international financial system require a tougher and more independent role for the Fund, a delegation of authority that is not likely to be accepted by the newly systemically important countries unless it is tied to a fairer quota allocation.

    Better surveillance could result if the Fund were reorganised to reflect the fact that much of what is called globalisation is really regionalisation. Trade and exchange-rate policies are taking on an increasingly regional character, reflecting in part the fact that international trade has grown faster within regions than between regions. The Fund could adopt an organisational structure akin to that of the Federal Reserve System, with regional branches acting as the principal regional institutional mechanisms for coordination and surveillance, leaving a smaller central core to focus on global systemic issues.

    Insurance Role

    For most developing countries, the Fund’s insurance role – short-term balance of payments (BoP) support during times of crisis when countries cannot avail of any other sources of external finance – has been its most important function. That is when the Fund has most power, and where controversy over its use has been most manifest. Thus, finding alternatives to the Fund’s monopoly in this area will do more to change the relationship between the IMF and developing countries than any other development.

    Developing countries have several external financing options in the event of a balance of payments crisis. First, they could draw up credit lines on an ongoing basis to pre-empt crises of illiquidity. But the volume depends on internal economic fundamentals, confidence in international markets, and the predisposition of the G-7.3

    A second option is self-insurance. There are two main possibilities here. The most obvious is the build-up of reserves. Indeed, the most significant sign of dissatisfaction with the Fund is the very conscious choice of developing countries to sharply increase their foreign exchange reserves in recent years (Table 1). This is even more apparent when compared to the relative size of outstanding IMF loans. What is driving this? The demand for reserves is usually modelled on the lines of a buffer stock model, whereby the macroeconomic adjustment costs without reserves are balanced with the cost of holding reserves. Another way of looking at a reserve build-up is analogous to the precautionary motive for savings traditionally put forward for explaining individual consumption (and savings) behaviour [Aizenman and Lee 2005]. Kapur and Patel (2003) extend this line of thinking by stressing two additional factors: strategic considerations arising from prevailing and likely geo-political realities, and the high prospective political price that the government of the day will have to pay if the country faces an external payments crisis (i e, if the country runs out of foreign exchange reserves).

    While in some cases (most notably in east Asia), countries have been building up their reserves to prevent appreciation of their currency, in the vast majority of cases the primary motive has been “self-insurance.” To guard themselves against external shocks, developing countries can either seek some sort of joint insurance or attempt to obtain self-insurance. The institutional mechanism for the former has been the IMF, and for the latter it has been foreign exchange reserves. The trade off between the two has been between political and financial costs. While borrowing from the Fund has lower financial costs, the political costs have been high. As conditionalities mounted so did the political costs. In retrospect, the Asian financial crisis was the turning point. Policy-makers are well aware of the humiliation heaped on east Asian economies in the course of their Fund programmes during the east Asian crisis from 1997-99. Although the Fund has changed tactics since then, its perceived lack of independence means that policy-makers would be understandably risk-averse. Developing countries appear to be prepared to pay a high financial

    Table 1: Ratio of Reserves to Imports of Goods and Services1

    Region Year
    1996 2000 2005
    Africa 24.6 39.2 60.9
    Sub-Saharan Africa 21.8 33.7 39.7
    Central and Eastern Europe Commonwealth of independent states2 32.8 14.4 34.3 30.5 38.1 80.9
    Developing Asia 42.8 49.3 82.8
    Developing Asia excluding China and India 31.0 34.8 39.6
    Middle East 69.5 75.0 91.9
    Western Hemisphere 55.0 41.7 49.8

    Notes: 1 Reserves at year-end in per cent of imports of goods and services for the year indicated.

    2 Mongolia, which is not a member of the commonwealth of independent states, is included in this group for reasons of geography and similarities in economic structure.

    Source: IMF, World Economic Outlook, 2005, 2006.

    Economic and Political Weekly February 17, 2007

    cost (estimated to be about 1 per cent of GDP of developing countries taken as a whole) to pre-empt the prospect of a ruinous political cost [Rodrik 2006].4

    Thus, the high costs of holding reserves notwithstanding, they are still more attractive options relative to availing of any contingent credit line, either from markets or the IMF. For one, the very act of securing contingent credit facilities may trigger a downward spiral of confidence that a government would want to avoid in the first place. Moreover, once a crisis builds up it is exceedingly difficult to either predict or control its momentum. High levels of uncertainty enhance the case for the status quo option (i e, hold high reserves and pay a financial premium). This is even more the case given current geopolitical realities where economic pressure – whether through international financial institutions or on trade policies or even something as seemingly mundane as travel advisories – means that a high level of reserves is essential for a country to maintain policy autonomy. Large reserves also help to reassure foreign investors that the likelihood of default on foreign currency denominated liabilities is extremely small.

    For many poorer developing countries whose exports are insufficient to build reserves, the need for insurance has been reduced by growing cash flows from their citizens abroad. Remittances have emerged as an important (in some cases, critical) source of financial flows for many developing countries. These flows come without a plethora of conditionalities, are unrequited transfers (and therefore do not require repayment), and increase in times of shocks. They are allowing many developing countries to cover their trade deficits and therefore avoid the cycle of unsustainable external borrowings to cover high current account deficits, thereby necessitating an IMF programme.

    A country’s diaspora can be a financial resource not just through accretion in the current account (in the form of remittances) but in the capital account as well. For instance in 1998, when India faced sanctions and global financial markets were in turmoil, the country raised $4.2 billion through India Resurgent Bonds. Again in 2000, apprehensive about its balance of payments prospects, India raised another $5.5 billion through the India Millennium Deposit scheme. While both issues (especially the latter) were expensive, they were less costly than any other alternative. And the experiences underscored a new possibility: a country with a large overseas diaspora could raise significant resources with relatively short notice, without having to go to the Fund. Nonetheless, there are clear limits as to the amount of money that can be raised through this route.

    Political motivations have also led to emergency financing between countries, as illustrated by Venezuela’s recent offer to Argentina to buy $3.4 billion of Argentinean government bonds, of which $1.1 billion has been disbursed thus far. Similar financing has been a long established practice between oil rich and needy Muslim nations in the west Asia and Africa.

    Developed countries established self- and joint-insurance systems decades ago. It was the establishment of the General Agreements to Borrow (GAB) among the G-10 in 1964 that undermined the Fund’s raison d’être for the industrialised countries. Following the onset of the Asian crisis, the US shot down the idea of an Asian monetary authority and severely criticised the ADB when it attempted to adopt a position different from the prescriptions of the IMF. In the last few years, Asian countries have renewed efforts at establishing swap facilities between the region’s central banks to pool resources against a speculative attack (under the so-called Chiang Mai initiative), and efforts to develop a regionwide market for local currency bonds. In the medium-term, the swap arrangements (now around $70 billion) pose a singular challenge to the Fund. If growing cooperation among central banks in the region (exemplified by central bank swap facilities) leads to an Asian equivalent of a GAB, the Fund’s importance to the region will diminish for the same reason that it has all but disappeared in the industrialised countries.

    The strong development of regional monetary and financial arrangements has been pointed out by Cohen (2003). Cohen counts four full-fledged monetary unions (involving 37 countries), 13 fully dollarised countries, five near-dollarised countries, and 10 bimonetary countries. Henning (2005) notes that the exchange stabilisation fund of the US has entered into nearly 120 agreements since its introduction in 1934.

    Some developing countries are seeking insurance by coming under the umbrella of a major power. The EU will effectively provide insurance for the new central and east European members through the Enterprise Risk Management Institute International. The liquidity provided to these countries will come from the European Central Bank rather than from the IMF.

    The cold war powerfully shaped the lending of the Bretton Woods institutions in two distinct ways. First, the prospect of a country turning to the Soviet bloc made the market for lending contestable. Second, allies of major shareholders could always expect their economic transgressions to face less opprobrium. For a while, the collapse of the Soviet Union seemed to remove any political competition but the war on terrorism and the rise of China has changed that. In Asia, Africa, and Latin America, China has mounted a charm offensive, with economic deals that eschew advice and hectoring. Its demand for raw materials from the latter two regions in particular has fuelled a new commodity boom and led China to stake strategic partnerships. China’s volume of trade with Africa has quadrupled in the past five years to reach about $37 billion.5 And the pragmatic Chinese policies are a much less constraining philosophy than that of the Fund’s major shareholders. Thus, even as Zimbabwe defaulted on its obligations to the Fund, Beijing rolled out the red carpet for president Mugabe.

    Table 2 below summarises the variety of mechanisms reviewed above that supplement the IMF’s functions or reduce the demand for insurance, and the principal mechanisms emerging in different regions.

    Organisational Changes

    The drift away from the Fund is also a consequence of the growing access that emerging markets have to private finance and the rising relative cost of Fund loans. At the same time, the Fund is not responding to the loss of competitive advantage by

    Table 2: Alternate Insurance Mechanisms for Less Developed Countries

    Region Insurance Mechanism

    Central America (including Mexico) Remittances East Asia Reserves, swap facilities East Europe ECB (through EU membership) Latin America Reserves Mid-East and North Africa Remittances Russia Reserves South Asia Remittances, reserves Sub-Saharan Africa Assistance from Asia

    reducing its administrative expenses. The resulting de facto exit of its clientele, driven by the combination of high political costs associated with Fund borrowing and growing availability of alternatives, now poses an unprecedented challenge for the Fund, in terms of the pressures on its income. We will now examine the options available to the Fund if it is to reverse its loss of clientele.

    In addition to governance reform, the Fund’s future seems to require significant cuts in its administrative budget and the use of the budget savings to lower borrower interest rates. The recent decision of Argentina and Brazil to prepay their IMF debts has meant that the Fund income will decline by $116 million in 2006. Apart from a short period in 1990, the IMF’s loan book is at its lowest in the past quarter century. To augment its shrinking income, the Fund is considering a proposal to invest some of its reserves in higher yielding longer-term securities, while another option would find a way to generate income from its gold holdings.

    One alternative that does not seem to be on the table is cuts in the Fund’s administrative expenses. The Fund, like the International Bank for Reconstruction and Development, is a costplus lender and therefore has had little incentive to make the sort of hard choices that are forced on its clients. In recent years, the cost of borrowing has increased, and along with high administrative expenditures, the financial costs of IMF loans are high. When added to the political costs, it is hardly surprising, therefore, that countries are prepaying loans.

    Unlike the World Bank, which has undergone several major and wrenching organisational changes, the Fund has enjoyed a charmed existence. The only fundamental reform occurred in the aftermath of the collapse of the Bretton Woods system in the early 1970s but even that had very modest organisational effects. However, as the discussion above has demonstrated, the Fund’s current financial situation is not the result of temporary circumstances but is being driven instead by longer-term structural factors. The income pressures facing the Fund will not be resolved by tinkering with the budget. The underlying cause of this predicament is that the Fund is losing rents that it enjoyed as a monopolist but which are dissipating as alternative sources of insurance and counter-cyclical flows become available to developing countries. Consequently, the revenue shortfalls facing the Fund are of a more permanent nature than the management appears willing to acknowledge. We believe that the Fund has little alternative but to swallow some if its own medicine, tighten its belt and reduce administrative expenditures. We believe there is considerable scope for doing so, although the Fund’s recent strategic review avoided any serious consideration of the matter. The standard cost-cutting steps required are an overhaul of compensation policies, the development of more flexible (internal) labour markets, greater decentralisation and outsourcing to lower cost locations.

    The biggest anomaly in the Fund’s compensation is its pensions, both in terms of level and structure. On level, a comparison of the pension of the median Fund staffer with other comparable places (e g, universities) is revealing of the extent to which the Fund has gone overboard: it is simply over the top. The present value of the pension due to a Fund staffer who retires at the B3-B4 level after about 25 years at the Fund is about $ 5-6 million.

    Even as the Fund’s advice recommends that countries move from a defined benefit regime to a defined contribution system, its own compensation policy remains wedded to a defined benefit pension system, one of the last bastions in the world. Even worse, the defined benefits are linked to a staffer’s last three years salary, a perverse incentive from the point of view of another favourite Fund recommendation: labour market flexibility. Its pension system actually encourages immobility because pensions increase disproportionately with years of service. In fact, there are two major career kinks, when the pension jumps discontinuously, so a staffer within sight of these kinks simply drops anchor. The Fund justifies this policy with references to the importance of factors such as experience and institutional memory. The Fund, however, stands out from other organisations that require similar skills.

    A second problem with the Fund’s compensation policies is wage compression. The Fund’s standard prescription is to argue for wage decompression to allow more flexibility to hire staff with special skills, especially at senior levels. Sadly, here too the Fund has failed to follow its own advice. Unlike most of its member states, senior Fund staff is well compensated. The wage compression arises from the fact that junior staff is compensated much too handsomely, especially when one adds munificent expatriate benefits: home leave, education, the G-5 (ability to “import” domestic help and pensions). These high salaries do not compensate for greater risk, since it is virtually impossible to be downsized from the Fund.

    A third issue is the need for greater transparency in salary structure. IMF staff receive a range of benefits in non-monetised forms from education for children to home leave travel allowances. The Fund’s message to its civil service clients around the world has been a consistent one – monetise all benefits so that they are clear and transparent. A comparison of lower level total emoluments (including the present value of pension liabilities), with his/her counterpart in comparable private/public institutions would be telling.

    Developing countries have a strong interest in pushing for organisational changes in the Fund, and in particular a major overhaul of the Fund’s personnel and compensation policies, in line with what the institution advises for everyone else. Since personnel expenses amount to about 70 per cent of the Fund’s budget (which is approaching nearly $ 900 million), there is simply no alternative but to address the size of staff and structure of compensation. Recent attempts to reform the Fund’s pension plan were scuttled when executive directors from some industrialised countries bowed to pressure from staff.6 These countries feel that few nationals from their countries would be willing to join the Fund if the compensation package were less attractive. Current policy, however, means that developing countries are subsidising the ability of rich countries to have nationals on the staff.


    The lack of voice in the IMF has been a perennial complaint of developing countries. Currently Europe (including the Russian Federation) accounts for 40 per cent of the IMF’s voting share and up to 10 of the 24 seats on the executive board. Japan, China and India and other east Asian countries account for only 16 per cent of the vote share and five chairs. The US has been pressing for European countries to reduce their share, and while current discussions indicate that Europe might be willing to give up around 2 per cent of its vote share (and perhaps one seat), this will do little to address the structural imbalance.

    However, as Hirschman has pointed out, “voice” is not the sole source of legitimacy for an organisation. If membership is

    Economic and Political Weekly February 17, 2007

    voluntary, and “exit” does not impose onerous costs, then governance by voice is not necessary for legitimacy. Private firms are not democratic but nonetheless enjoy societal legitimacy when factor and product markets are competitive, since competition gives both input suppliers and output buyers exit options. Even where factor and product markets are not competitive, legitimacy can exist if markets are “contestable” (that is, entry costs are low), or where viable anti-trust and regulatory institutions exist.

    Consequently, the possibility of exit even in the absence of voice could give the Fund greater legitimacy. Unfortunately, for virtually all developing countries exit was not a viable option. The “market” for international organisations is, for the most part, not contestable except in the few areas where both regional and global institutions exist. Thus, in development projects borrowers had some choice between a regional development bank, the World Bank, and (to varying degrees) the private sector. In some cases countries can engage in forum-shopping – for instance Canada, Mexico and the United Nations can choose between the North American Free Trade Agreement and the World Trade Organisation as dispute settlement mechanisms in cases of trade dispute resolution. But in many important areas this has not been true, especially in the case of functions and services supplies by the IMF – until now.

    Among the public goods that the Fund provides, including information, analysis, advice to individual governments, advice on coordination of policies, management of defaults and emergency lending, viable alternatives now exist for many more developing countries than ever before.

    Developing countries have been so singularly focused on the IMF’s governance and distribution of quotas that they have neglected alternatives that are both more achievable as well as potentially more important [e g, Jha 2006]. In the Fund itself, developing countries could have done much more (and still can) on pressing for drastic cuts in administrative expenditures, which would at least have resulted in lowering the cost of borrowings. Similarly they need to redirect their energies to engage the large number of financial institutional arrangements that are emerging both regionally and globally. Thus, India was so fixated on the negotiations on IMF quotas in 2006 that it was caught napping during the negotiations on the ACU, even though these were announced on sidelines of the annual meetings of the ADB held in India. Developing countries need to think of more options rather than be obsessed with the failings (real or imagined) of the Bretton Woods Institutions.


    We find a variety of initiatives and developments outside the Fund that complement or supplement the IMF’s financial coordination, insurance and surveillance functions. It seems highly likely that the cumulative effect of those initiatives has been, to some degree, to reduce the risk and potential costs of financial instability – in short, to make the world safer. However, it is difficult to arrive at a more precise assessment due to the lack of systematic data, the heterogeneous nature of the initiatives, and the fact that many have an informal character. However, the evidence suggests a growing trend that is driven both by the growth and diversification of financial markets, and by the increasing complexity of global and national governance. A September 2004 report to the IMF board, The Fund’s Strategic Direction, opens with a reference to the “tectonic shifts in the

    Appendix I: Institutions of Global Financial Governance

    Organisation Institutional Goals Interests Represented Decision Rules Agenda Setting Capacity Financial Issue Areas and Year Est

    International • Promote international • Shareholders: 184 countries • Weighted majority voting • Sets informal norms • Capital and current Monetary Fund monetary cooperation, • 24 executive board members: based on shares through technical account convertibility [1944] exchange stability, and orderly eight single country • G7 shareholders control assistance and dissemination • Exchange rates

    exchange arrangements representatives and 16 multi-46 per cent of votes • Sets rules for members • Corporate governance

  • Foster economic growth and country constituencies • Executive board appears to relying on financial • Banking regulationhigh levels of employment • Managing director is practise consensus, yet assistance through • Capital markets
  • Provide temporary financial traditionally European formal voting occurs on key conditionalityassistance to countries to help policy decisions • Influence on members not ease balance of payments seeking financial assistanceadjustment through “surveillance” is
  • quite limited

    World Bank • Sustainable development • Shareholders; 185 countries • Executive board makes • Sets rules for members • Development

    [1944] and poverty alleviation • Five largest shareholders most decisions; weighted relying on financial programmes that have appoint executive directors, majority rule based on assistance through far-reaching economic 19 others elected by groups shareholding conditionality influence of countries • G7 shareholders control • No influence on non-• Corporate governance

    • President is traditionally 44 per cent of votes borrowing members • Banking regulation

    American • Didactic role through • Capital markets technical assistance and research

    • Technical assistance

    International • Supervise management and • 24 members who are governors • Consensus but weighed in • Adjustment process • Internal monetary Monetary and adaptation of international of the IMF (generally ministers favour of G7 • Global liquidity system Financial Committee monetary and financial system of finance or central bank • IMF policies • Systemic crisis (formerly Interim governors). The membership Committee) reflects the composition of the [1999] IMF’s executive board

    Bank for • Forum of central bankers for • Until early 1990s, 11 countries • Board of directors: 19 members. • Sets standards for • Banking standards and International international monetary and from G10 (industrialised states) Two each from Belgium, Italy, industrialised states regulation (Basel Settlements (BIS) financial cooperation financial • Major expansion in 1999 to France, Germany, UK, and • These standards become standards) [1930] services for central banks include 55 central banks from US. Nine others elected from the yardstick for all other • Corporate governance

    • Implementation of OECD and larger LDCs Canada, China, Japan, countries financial conglomeratesinternational financial • General manager, traditionally Mexico, the Netherlands, through joint forum with agreements European Sweden and Switzerland and IOSCO and IAIS

    the president of the ECB.


    Appendix I: Institutions of Global Financial Governance (Contd)

    Organisation Institutional Goals Interests Represented Decision Rules Agenda Setting Capacity Financial Issue Areas and Year Est

    Organisation Club of like-minded countries in • 30 countries; initially from • Council is overriding • Information and analysis • Corporate governance for Economic an advanced stage of economic western countries in Europe committee • Development assistance • Tax havens Cooperation and development; forum for and north America, recently • Specialised committees for committee to coordinate • Corruption Development coordination of policy expanded to include Mexico, specific policy areas (trade, donor programmes (OECD) development South Korea, Poland, Hungary, development assistance, etc) [1961] and the Czech Republic

    • Development assistance Committee consists of Parisbased delegates of OECD, and permanent observers: IMF, UNDP, World Bank

    London Club • Forum for commercial holders • Private financial interests, • Consensus • Restructuring of privately • Terms of restructuring of sovereign debt especially large banks held sovereign debt privately held sovereign

    • Pressure on governments debt of country of origin (mainly G7) on sovereign-debt related issues

    Paris Club • Forum for bringing together • 19 Paris club permanent • Consensus • Restructuring of officially • Terms of restructuring

    [1956] debtors and official creditors in members are OECD countries held sovereign debt officially held sovereign a unified negotiating debt framework; to avoid default on debt

    Group of Seven • Forum for discussion of • Seven industrialised countries • Consensus • Most influential global • Broad influence in (G-7) economic and financial issues (Canada, France, Germany, body but influence waning overarching rules of global [1974] among the major industrial Italy, Japan, UK, US) financial architecture


    Group of Ten • Forum for consultation and • 11 industrialised countries (G-7 • Forum for exchange of • Reports that have an (G-10) cooperation on economic, plus Belgium, Netherlands, ideas; no explicit powers agenda setting capacity [1963] monetary, and financial matters Sweden, Switzerland) • Meets twice a year in for other international

    • Composed of finance ministers conjunction with IMF interim institutions (IMF and BIS in

    and central bank governors committee meetings; also particular) meets in smaller groups regularly through the year

    Group of 20 • Forum for discussing and • Finance and treasury officials of • No formal votes or resolutions • Reports and deliberations • Rules and standards for (Successor to G-22) forming consensus on avoiding G7 and systemically important on the basis of fixed voting have agenda setting averting and dealing with [1999] and dealing with financial crises developing economies plus EU, shares or economic criteria. capacity. financial crises

    IMF and World Bank Every G-20 member has one • Created by US treasury to limit “voice” with which it can take European influence an active part in G-20 activity

    Financial Stability • Seeks to co-ordinate the • Representatives from G7 • Forum for exchange of • Reports and • Compendium of best Forum efforts of various bodies in countries (treasury, supervisory, ideas and international recommendations from practice standards for [1999] order to promote international and central bank); World Bank, cooperation in financial working groups and forums financial institutions

    financial stability, improve the IMF, BIS, OECD, Basel supervision and surveillance have agenda setting functioning of markets, and Committee, IOSCO, IAIS – capacity reduce systemic risk. created in 1999 in a G7 initiative

    International • International cooperation on • Heads of stock markets and • Two specialised working • Professional codes of • Securities laws Organisation of regulatory standards for stock regulatory authorities from groups conduct and standards • Equity instruments Securities markets around the world •Technical committee • Advisory Commissions • Executive committee of 19, composed of 16 agencies (IOSCO) [1974] elected from regional committees from developed and

    and by general membership international emerging markets

    • Emerging market committee

    International • International insurance • Executive committee consists • Professional codes of • Insurance regulation Association of regulation of representatives from various conduct and standards Insurance regions of the world Supervisors (IAIS) [1994]

    International • Harmonising international • Private sector • IFAC council consists of 18 • Professional rules and • Auditing standards Federation of accounting standards • 155 accounting organisations members from G7 plus other standards Accountants (IFAC) • Accounting lobby from 118 countries industrialised and emerging • Lobbying [1977] market countries

    International • Benchmarks for financial • Private sector • Board consists of 16 • Professional rules • Formulating and Accounting reporting around the world • Same membership as IFAC countries (G7 plus other and standards promoting international Standards (businesses and other (automatic membership for IFAC industrialised and emerging accounting standards -Committee (IASC) organisations) members) market countries) Working for improvement (Related to IFAC) and harmonisation of [1973] accounting standards.

    Institute of • Forum for private financial • Private sector • Consensus • Actively lobbies • Data standards International community to interface with • Initially created by 38 multilateral organisations • Common criteria for Finance (IIF) public sector banks from leading and governments loan classification and [1983] • Advance common views on industrialised countries; now • Informational and non-performing loans

    global financial architecture 300 strong with increasing coordination • Risk exposure to representation from leading emerging markets emerging market financial institutions

    Source: Modified from Kapur 2000.

    Economic and Political Weekly February 17, 2007

    ground the IMF is directed to tend”, and acknowledging that “in some important measures, the Fund has lagged rather than led” [The Fund’s Strategic Direction 2004: 2]. Those lags are part of the explanation for the surge in non-Fund initiatives aimed at reducing financial vulnerability, whether as a direct intent, as in the case of regional insurance arrangements, higher reserve holdings, and increased market-based surveillance, or as an indirect effect of other governance objectives, especially the rapid growth of bilateral and regional trade agreements. However, this paper has argued that the resort to non-Fund alternatives is also driven in part by the increasing cost of Fund resources, largely explained by its very high administrative budget.

    Further analysis is needed to explore the extent to which these developments can be integrated into a new model for the management of financial instability in the world, a model that will complement the centralised decision and rule-making capacities of an IMF with the more flexible, and more participatory, decentralised governance that is being generated through the combined action of national governments, regional arrangements, market institutions, and civil associations.




    [We wish to thank Ariel Buria and participants of the G-24 spring meetings in 2006, Nancy Birdsall and the Centre for Global Development in Washington DC for comments on earlier drafts, and to Megan Crowley and Mihir Sheth for excellent research assistance.]

    1 Comments by Barry Eichengreen and Mohammed El-Erian, conference on IMF reform, Institute for International Economics, September 2005, cited in IMF Survey, October 2005: 305.

    2 Rawi Abdelal, comment at IIE conference on IMF reform, September 23, 2005.

    3 In 1995, in the aftermath of Mexico’s crash, Argentina faced a liquidity crisis and entered into $ 6.7 billion worth of “reverse repo” arrangements with 14 international banks that gave it access to liquidity in the event of a sudden large capital flight. The banks charged Argentina a fee together with Argentine bonds as collateral.

    4 Generally these costs are calculated as the difference between short-term borrowing abroad and yield of liquid foreign assets (e g, the United States treasuries) in which reserves are usually invested. One puzzle (highlighted by Rodrik 2006) is why countries in their quest to insulate themselves from financial crises choose to increase their foreign reserves rather than reduce their short-term liabilities. Rodrik notes that developing countries have resorted to the former but the optimal solution is in fact a combination of the two measures. This would not only decrease the social cost of holding excess foreign reserves but also increase liquidity to respond to external shocks. The issue is also examined by Aizenman and Marion (2004).

    5 Details of official Chinese policy can be found in “China’s African Policy”. The so-called “five principles of peaceful co-existence” enshrine mutual territorial respect, non-aggression and non-interference in each other’s internal affairs. The white paper promises that the Chinese government will now “vigorously encourage” Chinese enterprises to take part in building African infrastructure and help Africa to build its own capacity.

    6 The IMF can learn a little from its sister institution, the World Bank, which moved toward defined contribution pension schemes and more transparent, monetised benefits since 1997.


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    Aizenman, J and N Marion (2004): ‘International Reserve Holdings with Sovereign Risk and Costly Tax Collection’, The Economic Journal, 114:497, July.

    Akyüz, Y (2005): ‘Reforming the IMF: Back to the Drawing Board’, G-24 Discussion Paper No 38, UNCTAD/GDS/MDPB/G24/2005/5), United Nations, Geneva.

    Bryant, R C (2004) : Crisis Prevention and Prosperity Management for the World Economy, the Brookings Institution, Washington DC.

    Buira, A (2005): ‘The Bretton Woods Institutions: Governance without Legitimacy?’ in A Buira (ed), Reforming the Governance of the IMF and the World Bank, 7-44, Anthem Press, London.

    Cerny, P G (2002): ‘Globalising the Policy Process: From Iron Triangles to Golden Pentangles?’, Manchester Papers in Politics: CIP Series, March 7.

    Cohen, B (2003): ‘Monetary Governance in a World of Regional Currencies’ in M Kahler and D A Lake (eds), Governance in a Global Economy: Political Authority in Transition, Princeton University Press, Princeton, NJ.

    Henning, R C (2005): ‘Regional Arrangements and the IMF’, a paper prepared for the conference on reform of the International Monetary Fund, American University, Institute for International Economics, Washington DC, September.

    Jha, R (2006): ‘IMF Quota Increase’, Economic and Political Weekly, Vol XLI, pp 4103-04, September 30-October 6.

    Kapur, D (2000): ‘Reforming the International Financial System: Key Issues’ in Global Financial Reform: How? Why? When?, North-South Institute, Ottawa.

    Kapur, D and U Patel (2003): ‘Large Foreign Currency Reserves: Insurance for Domestic Weaknesses and External Uncertainties?’, Economic and Political Weekly, Vol XXXVIII, pp 1047-53, March 15-21.

    King, Mervyn, Governor, Bank of England (2006): Quoted in Financial Times, February 21.

    Rodrik, D (2006): ‘The Social Cost of Foreign Exchange Reserves’, National Bureau of Economic Research, Working Paper 11952, Cambridge, Massachusetts.

    Simpson, Lucio (2006): CEDES and University of Buenos Aires, ‘Role of the IMF in Debt Restructuring: LIA Policy, Moral Hazard, and Sustainability Concerns’, prepared for the technical group meeting of G24, Geneva, 12-17, 36-37, March 16-17.

    Slaughter, A M (2004): A New World Order, Princeton University Press, Princeton.

    The Fund’s Strategic Direction – Preliminary Considerations (2004): A report by the secretary to the international monetary committee on the Fund’s strategic direction, September 30.

    Truman, Ted (2005a): Interview in Finance and Development, October 31, p 321.

    – (2005b): Background paper for IIE Conference on IMF Reform, September 23, p 1.

    Williamson, J (2005): ‘Reforms to the International Monetary System to Prevent Unsustainable Global Imbalances’ in The International Monetary Fund in the 21st Century: Interim Report of the International Monetary Convention Project, World Economic Forum, Switzerland.

    Wolf, Martin (2006): ‘The World Needs a Tough and Independent Monetary Fund’ in Financial Times, February 22.

    Woods, N (2005): ‘Making the IMF More Accountable’ in A Buira (ed), Reforming the Governance of the IMF and the World Bank, 149-170, Anthem Press, London.

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