Now that the dust has settled over the selection of the International Monetary Fund’s (IMF) managing director, IMF can return to its core business of managing crises. Christine Lagarde, a competent and well-regarded technocrat, will have her hands full with three important challenges.
The first, and probably easiest, challenge is to restore IMF’s public image. While the criminal case against Dominique Strauss-Kahn (DSK) on sexual-assault charges now seems highly uncertain, the ensuing press focus on IMF suggests an uncontrolled international bureaucracy with unlimited expense accounts, dominated by men with little sense of restraint.
Fortunately, the truth is more prosaic. Top IMF staff face strict limits on their allowable business expenses (no $3,000 per night hotel rooms, despite reports in the press), and are generally underpaid relative to private-sector executives with similar skills and experience.
IMF, like many organizations where workers spend long trips together, has its share of intra-office romances. But the environment is professional, and not hostile to women. A previous incident in which Strauss-Kahn was let off lightly for an improper relationship with a subordinate clearly suggests that the fund needs brighter lines for acceptable behaviour and tougher punishment for transgressions. But other organizations have dealt with similar issues; IMF needs to make the necessary changes, and, equally important, get the message out that the DSK incident was an aberration, not the tip of the proverbial iceberg.
The second, and perhaps most difficult, challenge facing Lagarde, is the mess in Europe, where IMF has become overly entangled in euro zone politics. Typically, IMF assesses whether a country, after undertaking reasonable belt-tightening measures, can service its debt—and lends only when it is satisfied that it can. The entire objective of IMF lending is to help finance the country while it makes adjustments and regains access to private borrowing. This also means that a country with too much debt should renegotiate it down before getting help from IMF, thereby avoiding an unsustainable repayment burden.
Perhaps, swayed by promises of euro zone financial support (and Europe’s desire to prevent default-fuelled financial contagion from spreading to countries such as Spain and possibly Italy), IMF took a rosier view of debt sustainability in countries such as Greece than it has in emerging markets. But this has not “helped” such countries, for the availability of soft credit from the euro zone or the fund only enables a greater accumulation of debt.
Ultimately, debt can be repaid only if a country produces more than it spends. And the higher the debt, the less likely it is that the country will be able to achieve the mix of belt-tightening and growth that would enable it to generate the necessary surpluses. Delayed restructuring eventually means more painful restructuring—after many years of lost growth.
If troubled euro zone countries, especially Spain, start growing rapidly again, there is still a “muddle-through” outcome that might work. With too-big-to-save countries like Spain in the clear, the debt of highly indebted peripheral countries like Greece could be written down through interest waivers, maturity extensions, and debt exchanges. The euro zone—and the European Union—could survive its fiscal crisis intact.
But having failed to insist on an upfront restructuring, IMF will face problems. With private investors reluctant to lend more or even to roll over existing debt, the bulk of Greek debt at the time of any restructuring (or whatever it is euphemistically called) will be from the official sector. How the resulting losses imposed on debt holders will be divided between the various euro zone institutions and IMF is anyone’s guess. For the first time in its history, the fund might have to take a significant “haircut” on its loans, and it will have to prepare its non-European shareholders for it.
A greater dilemma will emerge if the muddle-through strategy does not seem to be working. At some point, IMF’s strategy, which should be focused on the distressed country’s citizens and its creditors, should depart from that of the euro zone, which is more willing to sacrifice individual countries’ interests for the larger interest of the monetary union. Lagarde’s challenge will be to chart a strategy for IMF that is independent of the euro zone’s strategy, even though she has been intimately involved in formulating the latter.
The third challenge for Lagarde concerns the circumstances of her election. It is not inconceivable that a number of emerging-market countries will get into trouble in the next few years. Will the fund require the tough policy changes it has demanded of countries in the past, or will Lagarde’s need to show that she is not biased towards Europe mean that future IMF interventions will become more expansive and less demanding? A kinder, gentler fund is in no one’s interest, least of all the distressed countries and the world’s taxpayers.
Finally, there is a challenge that seems to be pressing, but is not. In her campaign for the position, Lagarde emphasized the need for diversity among IMF’s top management. But what is really needed is the selection and promotion of the best people, regardless of national origin, sex, or race.
Clearly, IMF’s existing culture and history will bias its selection and promotion of staff towards a certain type of person (for example, holders of PhDs from US universities). That commonality in backgrounds among IMF personnel allows the fund to move fast in country rescues, not wasting time in endless debate. In the long run, more diversity is needed. But if it is attempted too quickly, in order to paper over the fact that a European is in charge once again, the fund risks jeopardizing its key strength.
IMF is, perhaps, the central global multilateral economic institution at a time when such institutions are needed more than ever. Lagarde arrives to lead it at a difficult time. We all have a stake in her success.
Raghuram Rajan, a former chief economist of IMF, is a professor of Chicago’s Booth School of Business and the author of Fault Lines: How Hidden Fractures Still Threaten the World Economy.
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