Wednesday, March 28, 2007

How has IMF become irrelevant?

In a very good article written in ET, Swaminathan S Anklesaria Aiyar writes some cogent reasons. Read it in full here.

It is a pity that the very institution which used to advice various governments about how they should handle their affairs has fallen on bad days and is doing what it would never have advised the governments in the first place. It is digging into its reserves to bridge its revenue deficit instead of conserving them for loan losses.

The IMF seems to have lost its relevance. He says that there are both cyclical and structural reasons.

The cyclical reason: The world economy is booming for the fourth year in a row. The global boom has been financed in large measure by the enormous trade deficit of the United States (about $800 bn). This is injecting more liquidity into the global economy than the IMF ever did or could. This cyclical upturn is not bound to last forever. There is going to be point when the global economy will turn downward, balance of payment crises will recur and the IMF will be relevant again.

But the structural reasons suggest that the IMF will be less relevant, even when the world economy takes a downward path. Look at how…

The structural reasons:

  1. The four key functions of the IMF – crisis resolution, exchange rate management, financial policy coordination and country surveillance – are now being increasingly done by institutions and actors other than the IMF. The debt crisis ridden 80’s, the transition of countries from communism to market driven systems of the 90’s have all witnessed the emergence of alternative institutions and arrangements.
  2. While IMF was originally a government solution for a market failure (weak or missing markets), today the world capital markets are deep and willing to invest in instruments and countries which were earlier perceived as too risky. Private equity, hedge funds, pension funds, central banks (notably China) are generating trillions of dollars of funds flows that dwarf the $20 bn that the IMF could provide.
  3. Fear or dislike of the IMF loans has engineered a fiscal change in many countries. FRBM (Fiscal Responsibility and Budget Management) legislations have been introduced across the globe. This is bound to reduce the crises and need for IMF rescue.
  4. Labour remittances from migrants to poor countries have far outstripped the lending volumes that either the World Bank or IMF could provide in their peak years.
  5. Rapid growth of financial markets has created a veritable army of experts who do the economic surveillance that the IMF used to believe as its USP (Unique Selling Proposition).
  6. With the beginning in the 1970’s of the floating rate exchange rate regime, the IMF lost its clout in exchange rate management.
  7. Emergence of a variety of policy co-ordination mechanisms like the G-8, G-20, Cairns Group and the European Union have further eroded the IMF’s role.

Conclusion: The IMF still has a residual role as a lender of last resort in crises, especially to poor countries. But it is a pale shadow of what it used to be.


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