Michael Kuhn: New, diversified income model is "more robust, stable, and sustainable." (photo: IMF)
INTERVIEW WITH MICHAEL KUHN
The package picked up on many measures that had been proposed in early 2007 by the Committee of Eminent Persons—which was headed by Andrew Crockett and created to help the IMF design a new income model.
The new income model should last for years to come, IMF Finance Department Director Michael Kuhn tells IMF Survey online.
IMF Survey online: Will the new income model that you've developed—together with the planned expenditure cuts—help solve the IMF's income problem?
Kuhn: Yes. The package just endorsed is a major achievement—it puts the Fund on an entirely different financial footing. We're moving away from relying almost entirely on income from lending to a more diversified income base that is more robust, stable, and sustainable. It's the first major change in the way we generate our income since the IMF was founded.
IMF Survey online: What are the new income model's main elements?
Kuhn: The first element is the expansion of the IMF's investment authority, allowing it to generate higher returns. The Fund currently has a very restrictive investment authority. The change requires an amendment of the IMF's Articles of Agreement. It will bring us in line with the practices of other international financial institutions.
The second element is the funding of an endowment through a sale of a portion of the IMF's gold holdings. The sale is limited to the 403 metric tons of gold that the Fund has acquired since the date of the Second Amendment of the Articles of Agreement. The sale should provide a substantial endowment. We plan to invest the proceeds from the sale in such a way that the real value of the endowment is maintained. This means that only a portion of the endowment is made available to finance expenditures each year, the so-called payout ratio. We have a currently targeted payout ratio of about 3 percent, which should give a significant boost to the Fund's income.
"A limited sale of gold will provide a substantial endowment for the IMF."
The third element is the reinstatement of the long-standing practice of recovering the costs that the Fund incurs in administering the trust fund for concessional lending to low-income countries, by reimbursing the Fund's General Resources Account (GRA) for these costs. This reimbursement has taken place since the Fund began to provide concessional lending services when the original Trust Fund was created in 1976, except in recent years, when the same amount of resources was temporarily redirected for debt relief under the HIPC Initiative. I would want to emphasize that resuming reimbursement has no impact on low-income countries themselves. Moreover, even though demand for lending under the Poverty Reduction and Growth Facility is currently relatively low, the Board has established safeguards to ensure that this cost recovery will not affect the Fund's ability to provide concessional lending to its poorest members in the future.
The new income model will take time to implement. Both the expansion of the investment authority and the gold sales will take some time. The amendment will need to be approved by our members' national legislatures, and the gold sales will be phased to avoid the risk of disrupting markets. So we won't see the full effect immediately, but we estimate that 3 or 4 years from now, we should be back in the black.
IMF Survey online: What is the timetable for implementation?
Kuhn: First, the Executive Board has just endorsed the proposal to amend the Articles of Agreement to expand the IMF's investment authority. This amendment needs to be approved by the Board of Governors, and then make its way through national legislatures. I believe that a year was the shortest time for entry into force of an amendment of our Articles.
For the gold sale, we need an 85 percent majority of the IMF's Executive Board. In the case of gold sales, the 85 percent majority has a twist, because the U.S. Executive Director can vote in favor of the gold sale only if she has first obtained approval from the U.S. Congress.
As for the modalities of the gold sales, we will either sell to a central bank that is willing to buy gold, or sell in conjunction with the already established official gold sales program—the Central Bank Gold Agreement. We will coordinate with other official holders of gold to sell in such a way that we do not increase the overall amount of official gold sales into the market. Naturally, the sales will be conducted within a strong framework for governance and controls, and with a high level of transparency. We are the world's third largest holder of gold, and we are keenly aware of our responsibility not to disrupt the gold market.
IMF Survey online: What is the IMF's revenue objective from the endowment?
Kuhn: Our objective would be to generate returns that would allow us to pay out 3 percent of the endowment while maintaining its real value in the long term. Annual investment returns will, of course, vary. Indeed, much of our income will come from investment returns from the endowment and from the reserves previously placed in the investment account. We will deal with fluctuations in investment returns like any other institution that lives off an endowment—by determining a medium-term payout ratio that can be sustained. The returns will depend on the risk-return profile of the asset allocation the Executive Board will be comfortable with, and a full assessment of acceptable levels of different types of risk will be undertaken given the public nature of the funds to be invested. We will need to tread carefully in implementing the new investment authority, which opens up a range of new investment assets—stocks, a more globalized portfolio, etc. For example, we will need to take great care to avoid any actual or perceived conflicts of interest. And we also intend to start with a more passive investment strategy relying on widely used benchmark indices.
IMF Survey online: Given that we're making a loss right now, do we have to repay that money once the new income model is in place?
Kuhn: The loss is right now reflected, like the financing of our lending operations, in the ups and downs of the currency balances we hold with our member countries. We currently finance a loss by drawing down these balances, which increases our interest expenses and reduces our reserves. While there's no requirement to pay it back, once our income rises, any surplus will help increase those balances and rebuild our reserves.
IMF Survey online: Will the IMF be able to maintain a steady level of reserves?
Kuhn: We would hope to increase the level of reserves over time, though there will be fluctuations from year to year. We could have years where we nominally have a decline in reserves. That would not worry me if the overall basis on which we generate income is sufficiently large and robust so that we can offset any declines in subsequent years. For the investment strategy, the IMF's Executive Board will make the choices on how much risk the Fund is willing to incur for additional potential investment returns.
IMF Survey online: Which parts of the Crockett Report did you decide not to use?
Kuhn: We did not have the requisite amount of support for the proposal to invest part of our quota resources—that is, to draw on our currency balances with members and invest that money. The countercyclical aspect of that proposal was appealing—in periods of low lending, you could compensate by investing quotas. Overall, the Board thought it wasn't necessary at this stage to adopt that recommendation. We'll have an endowment, and while the endowment will not make us super rich, it will be adequate.
IMF Survey online: The IMF established an investment account two years ago to address the projected income shortfall following the decline in IMF lending. How is that going?
Kuhn: Very well. When we first opened up the investment account in mid-2006, we placed our then-existing reserves into that account (just below SDR 6 billion), with targeted earnings of 50 basis points over the SDR interest rate on average. We didn't do that well in the first year, but we're doing quite well this year. The earnings we're receiving so far in this financial year are about 200 basis points above the SDR interest rate. Given the very limited instruments we can invest in under the existing investment authority—only government bonds and deposits and medium-term instruments from the Bank for International Settlements—this return is quite good.
IMF Survey online: How much does the IMF currently lend?
Kuhn: Our lending is currently on the order of $10 billion. It's not insignificant. Income from lending continues to make a contribution to help pay our overall budgetary expenses, and I would see lending of that order of magnitude to be maintained in the future, though with fluctuations.
IMF Survey online: Is the IMF doing enough to cut back on the expenditure side?
Kuhn: I think so. We are cutting expenditures by approximately $100 million annually in real terms over the medium term, relative to a previous budget that already had a reduction in real terms. But we are not simply cutting back—we are undertaking exceptional reforms to refocus and modernize the Fund. I'm gratified that all members have accepted the idea that the Fund is an important institution, that what we do is critical to the stability of the international financial system, and that we need to be financed properly.
IMF Survey online: In the meantime, is there any risk for the IMF if it doesn't have this income?
Kuhn: We have significant reserves. And they'll help get us through the time it takes to put the elements of the new income model fully in place. The losses we currently do run have been mitigated to a large extent by the measures being taken on the expenditure side. Would I like to have everything in place tomorrow? Of course. But a few years of losses are manageable, since we now have a model in place that's properly funded and has the support of the membership—a model that will last us for decades to come.
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