The Role of the IMF|
Financing and Its Interactions with Adjustment and Surveillance
In conjunction with the fiftieth anniversary of the Bretton Woods institutions, much attention has been focused on the role of the IMF; the recent economic crisis in Mexico has heightened this attention. At its meeting in April 1995, the Interim Committee, the principal governing body of the International Monetary Fund (1995c), considered a number of initiatives to strengthen the IMF's effectiveness, especially in the area of surveillance, and called for further review of the "evolving role of the IMF in an environment of increased globalization and integration. . . ." The Interim Committee (International Monetary Fund (1995c)) specifically requested the Executive Board to
continue to review the adequacy of the IMF's resources, and in connection with its review of the role of the IMF, to carry forward its work on the eleventh general review of quotas . . .
Within this very broad agenda, the present pamphlet has a relatively specific purpose: to focus on a general rationale for IMF financial support and on the relationship between such support and IMF surveillance in carrying out the IMF's responsibility to seek to avoid and help to correct maladjustments in countries' balance of payments.
In addition to financing, the IMF plays important roles in undertaking surveillance of the international economy and members' policies, in providing technical assistance, and in making statistical and other information about member country economies and the international economy available. These aspects of the IMF's activities are important independent of their interaction with IMF financing. However, in this pamphlet, these functions are considered only insofar as they interact with the IMF's role in providing financing to member countries. It would be too large a task to attempt in one paper a complete, in-depth treatment of the overall role of the IMF. Accordingly, this pamphlet needs to be viewed in the context of other related elements of the ongoing review of the IMF's activities and responsibilities. The present pamphlet does not reconsider many issues relating to the strengthening of IMF surveillance; it does not take up specific questions relating to the size and distribution of quotas, sources of IMF financing, or the scope of IMF facilities; and it largely ignores important areas of IMF activities, such as technical assistance and the provision of unconditional liquidity in the form of allocations of SDRs.
The general rationale for IMF financial support to members is characterized by Article I(v) of the Articles of Agreement:
To give confidence to members by making the general resources of the Fund temporarily available to them under adequate safeguards, thus providing them with opportunity to correct maladjustments in their balance of payments without resorting to measures destructive of national or international prosperity.
Giving "confidence to members" refers not only to actual support to members in difficulty, but also to the reasonable expectation that appropriate support will be available for members that accept the inevitable (and generally desirable) risks when they adopt more open policies. "Temporary" support "under adequate safeguards" not only protects the IMF's resources; it also assures that the expectation of support does not create an incentive for bad policies or an inducement to delay necessary adjustment. The requirement that there be a balance of payments need limits the scope for IMF support.2 The objective of avoiding "measures destructive of national or international prosperity" expresses not the forlorn hope of painless adjustment, but rather the realistic expectation that conditional support for strong adjustment programs can help to forestall adjustments that are unnecessarily disruptive to both the country involved and to its partners in international trade and finance.
In the original Articles of Agreement, the IMF's responsibility for overseeing exchange rates under the par value system encompassed what has subsequently become the function of IMF surveillance under the mixed exchange rate system that has prevailed since the early 1970s. Legally, the mandate for IMF surveillance is separate and distinct from the mandate for IMF financing, but surveillance interacts with the purposes of, and needs for, financing.3 Effective surveillance by the IMF and constructive response by members should help to avoid or diminish the severity of both general disturbances to the world economy and the specific problems in individual countries that contribute to balance of payments difficulties. Even with effective surveillance, however, countries will sometimes experience maladjustments in their balance of payments, either because of exogenous disturbances or because economic policy management is inevitably subject to human error. In such circumstances, the availability of conditional financing from the IMF can strengthen the hand of surveillance, both by providing increased leverage to motivate appropriate adjustment policies and by helping to contain the undue adverse effects of adjustment. Thus, as was conceived at the time of Bretton Woods, there remain important symbiotic interactions between IMF surveillance and financing.
The next section discusses the changing international economic environment, which is central to assessing whether and how the IMF's role should change. Greater use of exchange rate flexibility and reliance on private international capital flows have permitted industrial countries to rely much less on IMF financing than was thought likely at Bretton Woods or characterized earlier experience of the IMF. However, many IMF members do not enjoy ready access to private capital flows, especially in times of economic difficulty; the number of such countries has grown recently as new members, including the transition economies, have joined.
The following section analyzes the circumstances in which IMF financing continues to have an important role, even in a world of extensive mobility of private capital. In particular, market imperfections and indifference to some of the "public goods" aspects of financing flows explain why private capital flows cannot completely substitute for IMF financing. Through the exercise of surveillance and conditionality, the IMF can deal directly with national policy authorities to secure commitments to policies designed to correct payments imbalances. By so doing, the IMF can catalyze other sources of financing that would not be available in the absence of an IMF-supported program. Moreover, looking to the public goods aspects that are dominant in some countries that need balance of payments financing, the IMF may rationally be prepared to act in circumstances in which private sector lending decisions based solely on private financial risks and returns would lead to economically harmful inaction.
Possible lessons for the role of the IMF from the recent Mexican crisis are discussed in the succeeding section. The crisis has shown that openness to financial markets puts a premium on disciplined implementation of the right policies. Stronger surveillance by the IMF and willingness of the authorities to implement policies that are consistent with IMF advice can help to reduce the likelihood and extent of balance of payments difficulties. Provision of financial data and surveillance over the financing policies of members are particularly important. However, a costless adjustment of Mexico's overvaluation and external imbalances was unlikely even in the best of circumstances, and some degree of IMF financing might well have been necessary. In the actual circumstances, the strong adjustment program of the authorities, together with the large volume of external financial support, helped to limit the costs to Mexico and, more broadly, to the world economy.
General implications of the present discussion for the need for IMF resources and its relation to IMF surveillance are discussed in the concluding section. Although industrial countries have not made upper credit tranche purchases in recent years, the IMF must maintain adequate liquidity to meet reserve tranche use and the possibility of upper credit tranche programs. For middle-income developing countries, increasing exposure to international financial markets may increase the need for short-term IMF financing to counter the effects of possible shifts in investor sentiment. This should go hand in hand with a relevant strengthening of IMF surveillance, particularly on matters that contribute to the likelihood or severity of potential balance of payments crises. Transition economies and lower-income developing countries, which generally lack ready access to private capital flows, can reasonably be expected to continue to rely, from time to time, on IMF assistance in addressing balance of payments adjustment problems. Their special economic problems imply that IMF surveillance and IMF-supported adjustment programs (as well as technical assistance) need to give particular attention to structural issues and be closely coordinated with the efforts of other multilateral institutions. Correspondingly, the time span that is relevant for "temporary" support for balance of payments adjustment for these countries may often be somewhat longer than for other countries that generally face less daunting adjustment problems.
The pamphlet assumes that the international monetary system will continue to evolve in line with the trends of recent years.4 The predominant view is that, at least for the foreseeable future, the current decentralized system of managed flexibility among the major currencies will continue. With major reforms of the international monetary system, however, a more substantial reassessment of the role of IMF surveillance and financing would be needed.
For instance, the international monetary system could evolve in the direction of greater exchange rate fixity, with the major currencies to be linked by a system of target zones.5 TheBretton Woods Commission has suggested that the IMF take over from the Group of Seven industrial countries the responsibility for coordinating policies in order to reduce exchange rate volatility and misalignments, and perhaps eventually for moving to a system of flexible exchange rate bands.6 In present circumstances, however, it seems premature to devote much attention to these issues, given the opposition of major countries to proposals for an international monetary system based on pegged exchange rates.
A quite different direction has been suggested by others, namely, for the IMF to abandon its financing role and shift its attention almost entirely to enhancing the "market discipline" exerted by private capital flows as the means of avoiding and correcting maladjustments in countries' balance of payments. In effect, the IMF might become a kind of agency for rating countries' economic policies (see Minton-Beddoes (1995)). Moreover, it has also been proposed in this context that the IMF should play a central role in the coordination of sovereign debt restructuring as the international equivalent of a bankruptcy court (see Sachs (1995) and Minton-Beddoes (1995)).
It is doubtful that strengthened market discipline is an entirely adequate substitute for IMF surveillance and (conditional) IMF financing of payments imbalances, however. Furthermore, the IMF's role in, and relations with, member countries would change substantially if it were to act more like a rating agency. In the absence of an internationally agreed and enforceable procedure for dealing with sovereign defaults--which seems at best a distant prospect--informal mechanisms will need to continue to operate and to evolve; undoubtedly, the IMF will need to continue to play a central role (along with the Paris Club and the London Club) in such mechanisms. As at present, the IMF's role in facilitating relations between debtor and creditor countries will continue to benefit from its ability to provide financial resources. Therefore, the establishment of an international debt adjustment facility would not, in itself, be likely to imply a major change in the IMF's financing role, although it might involve a change in the nature of its policy advice and a reinforcement of surveillance (see, for instance, Eichengreen and Portes (1995)).
1Adopted at the United Nations Monetary and Financial Conference, Bretton Woods, New Hampshire, July 22, 1944. The Articles have since been amended three times, with changes coming into force in 1969, 1978, and 1992.
2The formal requirement for "balance of payments" need is contained in Article V of the IMF Articles of Agreement, which stipulates in Section 3(b)(ii) that a member is entitled to purchase the currencies of other members provided that "the member represents that it has a need to make the purchase because of its balance of payments or its reserve position or developments in its reserves."
3Article IV, Section 3 designates three general areas of responsibility for IMF surveillance: oversight of "the international monetary system in order to ensure its effective operation . . ."; general oversight of "the compliance of each member with its obligations under Section 1 of [Article IV]"; and "firm surveillance over the exchange rate policies of members. . . ."
4For a discussion, see Goldstein and others (1992).
5Proposals for a target zone system are most closely associated with John Williamson. See, for instance, Williamson and Miller (1987) and Williamson and Henning (1994).
6Bretton Woods Commission (1994). See also Bergsten (1995), de Larosière (1995), Kenen (1995), and Volcker (1995).