The members of the International Monetary Fund (IMF) met from Saturday to Monday this week, even as the institution is in peril of losing relevance in a new global economy in which countries such as India and China are more important than ever before and where private flows have become the largest source of foreign capital for the developing world.
IMF has traditionally been run by a European, part of a deal through which an American gets to run the World Bank. This unwritten charter to share the top jobs has come under attack in recent months, and rightly so.
The fund has a complicated system to determine a country’s voting rights. These are based on a quota a country has, which determines how much it can borrow from the fund, the subscription it has to pay and its voting rights. Each member country has 250 basic votes. It gets one additional vote for each 100,000 special drawing right (SDRs) of quota. An SDR is IMF’s accounting unit.
Given their rising importance in the global economy, countries such as India and China have been demanding more voting rights on the IMF board. These rights are skewed at the moment. For example, the US outvotes Brazil, Russia, India and China by 7.16%. China and India are almost at par with Italy and the Netherlands, the latter being much less dynamic economies. This asymmetry between economic strength and voting power on the IMF board has robbed the latter of legitimacy in the eyes of most countries.
Finance minister P. Chidambaram echoed this sentiment when he spoke on Saturday on behalf of Bangladesh, Bhutan, India and Sri Lanka. He said unless the impasse on reforms was broken by Spring 2008, the credibility of IMF as a relevant multilateral institution would get further eroded, perhaps irreversibly.
Then there are the problems related to the relevance and capability of the fund. First, private players and capital markets deliver money at a much cheaper rate than IMF. This is not only in terms of borrowing costs, but also what is perceived to be the opportunity cost of borrowing from the fund. Along with the borrowing come “conditionalities” that are unacceptable to most nations today. These represent a big opportunity cost; in democracies or in authoritarian settings, the cost of implementing conditionalities is the raising of political temperature in the recipient country. This is unacceptable to most, if not all, countries.
Secondly, post-1991, with worldwide financial liberalization, the world is financially much more complex than in Jacques Polak’s time, when the IMF monetary model was invented. In a seamless financial world, a model tailored to control macroeconomic variables in a single, autarchic, country no longer works—as the Asian, Russian and Brazilian crises of the 1990s painfully showed.
When a financial crisis quickly engulfs many nations simultaneously, coordination among nations is a must to control the situation from getting out of hand. It is here that IMF has failed. Its original mandate was to keep worldwide financial stability, but it failed at that very moment when it was most needed.
This requires a blend of political and macroeconomic coordination that the fund was not designed to undertake. This is essential now, given the little understood problems that financial markets may throw up.
There is a question mark on IMF’s preparation to handle complex economic problems. Examples include valuation and managing of the risk that accompanies layered financial products that are created in one country and issued in another; the rating of complicated financial products by rating agencies, and managing sovereign wealth funds, among a host of other issues that were non-existent a decade ago.
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