It’s time for real IMF reform

Over the past five years, the U.S. Congress has been repeatedly browbeaten by the administration as well as by a chorus of international leaders for its opposition to International Monetary Fund (IMF) reform proposals agreed to by the Group of 20 (G-20) in 2010. However, over the same period, there have been a number of major developments that must raise serious questions as to the appropriateness of the IMF reform package currently on the table. This could offer the opportunity to craft a new IMF reform proposal that would be both more palatable to the U.S. Congress and more suited for the effective operation of the IMF.

{mosads}Two principal factors have motivated the G-20 in agreeing to a basic overhaul of the IMF. The first was the recognition of the increased relative importance of major emerging market economies like Brazil, China and India. After more than a decade of very rapid economic growth, those countries had become grossly underrepresented in the IMF’s governance structure. The second was the belief that in the aftermath of the Lehman Brothers crisis, the IMF needed additional permanent lending resources to fulfill its mandate of promoting external financial stability.

The essence of the 2010 IMF reform proposals was to increase the relative representation of the emerging market economies. This was to be achieved by trebling the overall lending capacity of the IMF to $750 billion and by having the emerging market economies make a disproportionately large share of the country quota contributions to achieve that result.

The increase in the emerging market countries’ relative representation in the IMF’s governance was to be achieved at the expense of the European countries, which were generally considered to be grossly overrepresented in the IMF. By contrast, the United States’ relative IMF voting position was to be little changed, which would allow the United States to maintain its effective veto power on key IMF decisions.

Since 2010, the case for increasing the voice of the emerging market economies at the IMF to reflect their greater relative clout in the global economy has increased. For, while in the aftermath of the Great Economic Recession there was a pronounced slowing in the industrial countries’ economic growth, the emerging market economies retained their vigor. If the trend toward the formation of regional financial institutions was to be arrested, the emerging market economies needed to be better represented at the IMF.

While over the past five years the case for greater emerging market representation has strengthened, the case for a bigger IMF has been considerably weakened. In 2010, at the start of the European sovereign debt crisis, it could be argued that one needed a very much larger IMF to support Europe’s beleaguered economic periphery, since Europe did not have the financial instruments in place to provide that support.

However, much has changed since then. In June 2012, Europe established a 500 billion-euro European Stability Mechanism to support eurozone member countries. More important yet, in September 2012, the European Central Bank (ECB) introduced an Outright Monetary Transaction Mechanism that would enable the ECB to do “whatever it took” to save the euro. With Europe now more than in the position to take care of its own problems, and with the Asian and Latin American countries still highly reluctant to submit themselves to IMF loan conditionality after their respective crises in the late 1990s, could one still really argue that the IMF needed an additional $500 billion in lending capacity?

Further substantially weakening the case for a larger IMF has been the way in which the IMF has abused its “exceptional access” lending policy over the past five years. This policy, which effectively removes any reasonable limit on the amount that the IMF can lend to an individual country, has allowed the IMF to lend very large amounts without precedent to countries with dubious economic fundamentals like Greece, Ireland, Portugal and Ukraine. As current events in Greece are now underlining, not only does such lending expose the IMF to large loan losses, which could put U.S. taxpayers’ money at risk; it has also unduly delayed debt restructuring that might have given IMF programs in those countries a better chance of success.

Recognition of post-2010 developments would suggest that the IMF should go back to the drawing board on its proposed reforms. A new IMF reform package might still seek to increase the relative voice of the key emerging market economies in the IMF’s governance structure. However, this should not be achieved through an increase in the IMF’s lending capacity. Indeed, there is the strongest of cases that the IMF’s “exceptional access” lending policy be terminated and that the IMF return to its original role of a catalytic lender. Such a reform package would offer the IMF a very much better chance of getting the U.S. Congress on board than the package currently on the table.

Lachman is a resident fellow at the American Enterprise Institute. He was formerly a deputy director in the International Monetary Fund’s Policy Development and Review Department and the chief emerging market economic strategist at Salomon Smith Barney.