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UNITED NATIONS CONFERENCE ON TRADE AND DEVELOPMENT

G-24 Discussion Paper Series

UNITED NATIONS

Reforming the IMF: Back to the Drawing Board

Yilmaz Akyüz

No. 38, November 2005

G-24 Discussion Paper Series

Research papers for the Intergovernmental Group of Twenty-Fouron International Monetary Affairs and Development

UNITED NATIONSNew York and Geneva, November 2005

UNITED NATIONS CONFERENCEON TRADE AND DEVELOPMENT

INTERGOVERNMENTALGROUP OF TWENTY-FOUR

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Reforming the IMF: Back to the Drawing Board iii

PREFACE

The G-24 Discussion Paper Series is a collection of research papers preparedunder the UNCTAD Project of Technical Support to the Intergovernmental Group ofTwenty-Four on International Monetary Affairs and Development (G-24). The G-24was established in 1971 with a view to increasing the analytical capacity and thenegotiating strength of the developing countries in discussions and negotiations in theinternational financial institutions. The G-24 is the only formal developing-countrygrouping within the IMF and the World Bank. Its meetings are open to all developingcountries.

The G-24 Project, which is administered by UNCTAD�s Division on Globalizationand Development Strategies, aims at enhancing the understanding of policy makers indeveloping countries of the complex issues in the international monetary and financialsystem, and at raising awareness outside developing countries of the need to introducea development dimension into the discussion of international financial and institutionalreform.

The research papers are discussed among experts and policy makers at the meetingsof the G-24 Technical Group, and provide inputs to the meetings of the G-24 Ministersand Deputies in their preparations for negotiations and discussions in the framework ofthe IMF�s International Monetary and Financial Committee (formerly Interim Committee)and the Joint IMF/IBRD Development Committee, as well as in other forums.

The Project of Technical Support to the G-24 receives generous financial supportfrom the International Development Research Centre of Canada and contributions fromthe countries participating in the meetings of the G-24.

REFORMING THE IMF:BACK TO THE DRAWING BOARD

Yilmaz Akyüz

G-24 Discussion Paper No. 38

November 2005

Reforming the IMF: Back to the Drawing Board vii

Abstract

A genuine reform of the IMF would require as much a redirection of its activitiesas improvements in its policies and operational modalities. There is no soundrationale for the Fund to be involved in development and trade policy, or in bailoutoperations in emerging market crises. It should focus on short-term counter-cyclicalcurrent account financing and policy surveillance. To be effective in crisis preventionit should help emerging markets to manage unsustainable capital inflows bypromoting appropriate measures, including direct and indirect controls. It shouldalso pay greater attention to destabilizing impulses originating from macro-economic and financial policies in major industrial countries. Any reform designedto bring greater legitimacy would need to address shortcomings in its governancestructure, but the Fund is unlikely to become a genuinely multilateral institutionwith equal rights and obligations for all its members, de facto as well as de jure,unless it ceases to depend on a few countries for resources and there is a clearseparation between multilateral and bilateral arrangements in debt and finance.

Reforming the IMF: Back to the Drawing Board ix

Table of contents

Page

Preface .......................................................................................................................................... iii

Abstract ......................................................................................................................................... vii

A. Introduction ............................................................................................................................. 1

B. The original rationale and the postwar evolution of the IMF ............................................ 2

C. Mission creep into development finance and policy ............................................................ 5

D. Trespassing in trade policy ..................................................................................................... 7

E. Crisis management and resolution: bailouts or workouts? ................................................ 9

F. Restructuring IMF lending and supplementing resources ............................................... 12

G. Ineffectiveness and asymmetry of Fund surveillance ....................................................... 15

H. Governance: making the Fund a genuinely multilateral institution ............................... 19

I. Summary and conclusions ................................................................................................... 21

Notes ......................................................................................................................................... 22

References ......................................................................................................................................... 25

A. Introduction

There have been widespread misgivings aboutinternational economic cooperation in recent yearseven as the need for global collective action hasgrown because of recurrent financial crises in emerg-ing markets, the increased gap between the rich andthe poor, and the persistence of extreme poverty inmany countries in the developing world. Perhapsmore than any other international organization theIMF has been the focus of these misgivings. Severalobservers including former Treasury Secretaries ofthe United States, a Nobel Prize economist and manyNGOs have called for its abolition on grounds thatit is no longer needed, or that its interventions inemerging market crises are not only wasteful but also

harmful for international economic stability, or thatits programmes in the third world serve to aggra-vate rather than alleviate poverty.1 Others want theIMF to be merged into the World Bank because theysee them as doing pretty much the same thing withthe same clientele.2 Many who still wish to keep theFund as an independent institution with a distinctmission call for reform of both what it has been do-ing and how it has been doing it.3 All these groupsinclude individuals across a wide spectrum of po-litical opinion, ranging from conservative freemarketers to anti-globalizers.

The principal rationale for global collectiveaction in financial matters and for institutions neededto facilitate such action is market failure. More spe-cifically, international financial markets fail to

REFORMING THE IMF:BACK TO THE DRAWING BOARD

Yilmaz Akyüz*

* Former Director, Division on Globalization and Development Strategies, UNCTAD. This work was carried out under theUNCTAD Project of Technical Assistance to the Intergovernmental Group of Twenty-Four on International Monetary Affairs andDevelopment with the aid of a grant from the International Development Research Centre of Canada. An earlier version waspresented at a technical group meeting of G-24 in IMF on 16 September 2005. Comments and suggestions by Ariel Buira, AndrewCornford, Richard Kozul-Wright and the participants of the G-24 Technical Group Meeting are greatly appreciated. The usualcaveat applies.

The best reformers the world has ever seenare those who commence on themselves.

George Bernard Shaw

2 G-24 Discussion Paper Series, No. 38

provide adequate liquidity and development financ-ing for a large number of countries, and they are themain source of global economic instability. Thesehave repercussions not only for the countries directlyconcerned but also for the international communityas a whole because of the existence of internationalexternalities. Furthermore, due to cross-border inter-dependence, pursuit of national interests by individualcountries in macroeconomic and financial policiescan result in negative global externalities, and pre-venting conflicts and collective damage calls for acertain degree of multilateral discipline over nationalpolicy making as well as economic cooperation.4

Such concerns in fact provided the original ra-tionale for the creation of the IMF and the WorldBank with a clear division of labour between thetwo. However, these institutions have gone throughconsiderable transformation in response to changesthat have taken place in the world economic andpolitical landscape in the past sixty years. In particu-lar, the Fund is no longer performing the functions itwas originally designed for; namely, securing mul-tilateral discipline in exchange rate policies andproviding liquidity for current account financing.Rather, it has been focusing on development financeand policy and poverty alleviation in poor countries,and the management and resolution of capital ac-count crises in emerging markets.

This paper argues that there is no sound ration-ale for the Fund to be involved in developmentmatters, including long-term lending. This is alsotrue for several areas of policy closely connected todevelopment, most notably trade policy which is amatter for multilateral negotiations elsewhere in theglobal system. On the other hand, while the manage-ment and resolution of financial crises in emergingmarkets constitute a key area of interest to the Fundin the context of its broader objective of securinginternational monetary and financial stability, thereis little rationale for financial bailout operations thathave so far been the main instrument of the Fund�sinterventions in such crises. The original considera-tions that precluded IMF lending to finance capitaloutflows continue to be equally valid today sincesuch operations do not correct but aggravate marketfailures. There are other institutions and mechanismsthat can serve better the objectives that may be soughtby such lending. By contrast the Fund should paymuch greater attention to two areas in which its exist-ence carries a stronger rationale; namely, short-term,counter-cyclical current account financing, and ef-

fective surveillance over national macroeconomicand financial policies, particularly of countries whichhave a disproportionately large impact on interna-tional monetary and financial stability. In otherwords, a genuine reform of the Fund would requireas much a redirection of its activities as improve-ments in its policies and operational modalities.However, none of these would be possible withoutaddressing shortcomings in its governance structure.

The purpose of this paper is not to provide ablueprint for the reform of the Fund, but to discussand elaborate a number of broad issues that wouldneed to be taken into account in any serious attemptto make the Fund a genuinely multilateral institu-tion with equal rights and obligations for all itsmembers, in practice as well as in theory. The nextsection will give a brief description of the originalrationale for the Fund, its evolution in the past sixtyyears and current focus. This is followed by a dis-cussion of what the Fund is but should not be doing;that is, development policy and financing, and tradepolicy. Section E makes a critical assessment of theFund�s role in crisis management and resolutionwhile section F turns to issues related to the reformof its lending policy and resources. This is followedby a section on the Fund�s surveillance function.Section H focuses on governance issues, notably theprerequisites for a genuinely symmetrical and mul-tilateral financial institution. The paper ends with asummary of the main proposals.

B. The original rationale and thepostwar evolution of the IMF

The main objective pursued by the architectsof the postwar economic system with the creationof the IMF was to avoid the recurrence of a numberof difficulties that had led to the breakdown of in-ternational trade and payments in the interwar pe-riod. These difficulties arose in large part becauseof lack of multilateral arrangements to facilitate anorderly payments adjustment in countries facinglarge external debt and deficits. Under conditions ofexcessively volatile short-term capital flows and inthe absence of any obligation on the side of the sur-plus countries to share the burden of adjustment,deficit countries had been forced to undertake de-flationary measures, or resort to trade and exchangerestrictions and competitive devaluations in order to

3Reforming the IMF: Back to the Drawing Board

protect economic activity and employment, therebygenerating negative externalities and frictions ininternational economic relations.

Arrangements for multilateral discipline overexchange rate policies, provision of adequate inter-national liquidity, and restrictions over destabilizingcapital flows were thus seen as essential for interna-tional monetary stability and prevention of tensionsand disruptions in international trade and payments.The IMF was designed to ensure an orderly systemof international payments at stable but multilater-ally negotiated, adjustable exchange rates underconditions of strictly limited international capitalflows. A key task of the Fund was to provide inter-national liquidity in order to avoid deflationary anddestabilizing adjustments and trade and exchangerestrictions in countries facing temporary balanceof payments deficits. Although the responsibility foraddressing the problems associated with fluctuationsin export earnings of developing countries effectivelyfell under the IMF�s role for the provision of liquid-ity, the Fund was created primarily for securing thestability of external payments and exchange rates ofthe major industrial countries, rather than for thestabilization of balance of payments of developingcountries.

There was a certain degree of creative ambiguityin the way the Fund�s Articles were drafted in orderto reach consensus. This was the case for exchangerate arrangements which sought to reconcile multi-lateral discipline with national autonomy. Countriesundertook obligations to maintain their exchangerates within a narrow range of their par values andwere allowed to change their par values under fun-damental disequilibrium, but the latter was neverdefined in the Articles of Agreement. An unauthor-ized change in par value was not a violation of theArticles, but would enable the Fund to withhold themember�s access to its resources and even to forcethe member to withdraw (Dam, 1982: 90�93).

This was also the case with arrangements re-garding the modalities for the provision of liquidity,one of the most controversial issues during the ne-gotiations. Keynes strongly argued that membersshould have unconditional access to the Fund withinthe limits of their quotas and that �it would be veryunwise to try to make an untried institution too grand-motherly� (IMF, 1969, Vol. 1: 72). However, theUnited States resisted unconditional drawings ongrounds that it would be the only source of net credit

in the immediate postwar era since the dollar wasthen the only convertible currency. The compromiseagreed to in Article V entitling members �to pur-chase the currencies of other members from theFund�, together with the absence of the language ofcredit from the Articles, had the connotation thatmembers would have the right to determine howmuch they would draw within the limits of their quo-tas, treating their subscriptions as their own reserves(Dam, 1982: 106; and Dell, 1981: 4�5). Most coun-tries believed that this formulation gave membersunconditional drawing rights, though there was con-siderable room for other interpretation.

Access to the Fund was restricted to currentaccount financing. The Fund was prohibited to lendto meet sustained outflow of capital and empoweredto compel a member to exercise capital controls as acondition for access to its resources. In effect, thesearrangements discouraged reliance on private flowsfor balance of payment financing. During the nego-tiations for the Bank there was considerable debateon whether the task could be effectively performedby private lenders, but this was not the case for IMFfinancing. Although there were some instances ofcurrency stabilization in interwar years supportedby officially arranged private lending (Oliver, 1975:12�15), it was almost taken for granted that com-mercial banks could not be relied on for such a task,particularly given the high degree of volatility ofshort-term capital flows during interwar years andpro-cyclical behaviour of private lending.

The members� contributions to the Fund, theirdrawing rights and voting rights were all linked to asingle concept of quotas, determined through ahighly politicized exercise so as to give an effectiveveto power to the United States over key decisions.5

This has been an important factor in the evolutionof the Fund over subsequent years, particularly withrespect to conditions governing the members� draw-ings and the operational procedures followed.6

The process of legitimizing and ratchetingconditionality started soon after the Bretton WoodsConference. A key decision in 1952 formally adoptedconditionality and introduced standby arrangementsas the central operational modality (IMF, 1969,Vol. 3: 228�230). This was followed by a 1956 de-cision on the phased drawings in order to betterenforce conditionality with loans disbursed intranches, contingent on satisfactory achievement ofagreed targets, and proliferation of performance cri-


teria.7 Although the Board decided in 1968 to limitthe number of performance criteria after developingcountries argued that the minimum conditionalityapplied to the drawing by the United Kingdom in1967 should become the norm, in practice there wasno easing of conditionality, particularly after it wasgiven legal sanction in 1969 through an amendmentof the Articles.8

As a result of these changes, automatic draw-ing has been confined to the reserve tranche withhigher tranches bringing tighter conditionality. Thus,the Fund has moved away from provision of liquid-ity, that is, finance available on short notice andvirtually unconditionally, towards finance suppliedon the basis of negotiated conditions and made avail-able through successive tranches.9 And since the IMFquotas have considerably lagged behind the growthof world trade, countries� access to balance of pay-ments financing has come increasingly under IMFpolicy oversight.

But perhaps one of the biggest divergences fromthe Bretton Woods objectives has been in the con-tent of conditionality rather than the principle.Through conditionality the Fund has effectivelysought to impose exactly the kind of policies thatthe postwar planners wanted to avoid in countriesfacing payments difficulties � austerity and de-stabilizing currency adjustments. Austerity has beenpromoted not only when balance of payments diffi-culties were due to excessive domestic spending ordistortions in the price structure, but also when theyresulted from external disturbances such as adverseterms of trade movements, hikes in international in-terest rates or trade measures introduced by anothercountry. Furthermore, the distinction between tem-porary and structural disequilibria has becomeblurred, often implying that a developing countryshould interpret every positive shock as temporaryand thus refrain from using it as an opportunity forexpansion, and every negative shock as permanent,thus adjusting to it by cutting growth and/or alteringthe domestic price structure.

The evolution of IMF conditionality has beenshaped by shifts in economic and political condi-tions and interests of its major shareholders. Initiallythe United States had insisted on some form ofconditionality to stem excessive reliance on dollarcredits. Subsequently, it used conditionality to pur-sue its national interests. Europe, notably the UnitedKingdom, initially resisted conditionality because of

its need to draw on the Fund�s resources. Subse-quently, when they no longer relied on the Fund,conditionality ceased to be a problem for the Euro-pean countries, including for the smaller ones whichtook refuge in the European Monetary System, losingmonetary autonomy vis-à-vis Germany but gainingconsiderable protection from Fund conditionality.10

A major transformation of the Fund took placewith the breakdown of the Bretton Woods exchangerate system brought about in large part by inconsist-encies of policies among major industrial countriesand rapid growth of international financial marketsand capital movements. While floating was adoptedwith the understanding that its stability dependedupon orderly underlying conditions, the obligationsundertaken by countries were, as pointed out byTriffin (1976: 47�48), �so general and obvious as toappear rather superfluous� and the system �essen-tially proposed to legalize � the widespread andillegal repudiation of Bretton Woods commitments,without putting any other binding commitments intheir place.� This in effect meant that currency sta-bility ceased to be a key objective of internationaleconomic cooperation. It also meant that there wouldno longer be any mechanism to ensure effectivemultilateral discipline over the policies of non-bor-rowing members of the IMF.

In its operations in developing countries thefocus of the Fund was initially on short-term cur-rent account financing. The Compensatory FinancingFacility (CFF) introduced in the early 1960s as aresult of a UN initiative enabled countries facingtemporary shortfalls in primary export earnings todraw on the Fund beyond their normal drawing rightswithout the performance criteria normally requiredfor upper credit tranches (Dam, 1982: 127�128).However, automaticity was effectively removed bya subsequent decision of the Fund (Dell, 1985: 245),and the �reforms� introduced in 2000 tightened fur-ther the circumstances for unconditional access toCFF (IMF, 2004b: 10).

A number of other similar ad hoc facilities havealso been discontinued, including the buffer stockfinancing facility introduced in the late 1960s. Thisis also true for the two oil facilities of the 1970swhich constituted exceptional steps in IMF lendingpractices as they had been introduced as deliberatecountercyclical devices to prevent oil price hikesfrom triggering a global recession.11 They also allowedthe kind of automaticity of drawings advocated by


Keynes during the Bretton Woods negotiations (Dell,1986: 1207).

The breakdown of the Bretton Woods exchangerate system together with the graduation of the Eu-ropean countries from the Fund pushed it closer todevelopment issues. In this respect the creation ofthe Extended Fund Facility (EFF) in 1974 marks aturning point. It was established as a non-concessionallending facility to address persistent and structuralbalance of payments problems.12 This was followedby the Structural Adjustment Facility and the En-hanced Structural Adjustment Facility, whichprovided concessional lending to low-income coun-tries for structural change. As a result of increasedemphasis on poverty reduction, the latter was re-placed in 1999 by a Poverty Reduction and GrowthFacility (PRGF), a concessional window for low-income countries.

In perhaps an even more important shift, theFund has become a crisis lender and manager foremerging markets. This role effectively started withthe outbreak of the debt crisis in the 1980s whenmany developing countries borrowed heavily frommultilateral sources to finance debt servicing to pri-vate creditors (Sachs, 1998: 53). And with therecurrent financial crises in emerging markets in the1990s, crisis lending has become the dominant fi-nancial activity of the Fund. The SupplementalReserve Facility (SRF) was created in response tothe deepening of the East Asian crisis in December1997 in order to provide financing above normalaccess limits to countries experiencing exceptionalpayments difficulties, notably in servicing their ex-ternal debt to private creditors and maintainingcapital account convertibility, under a highly condi-tional standby or Extended Arrangement.

Thus sixty years after its inception, the IMF isnow quite a different institution from the one cre-ated by the architects of the postwar internationaleconomic system. It �has adjusted to the changingeconomic conditions by sponsoring amendments toits Charter, by liberal interpretations of the Charter�sprovisions, and in some cases by ignoring limita-tions imposed by the Charter.�13 It is now deeplyinvolved in development issues, providing long-termfinancing on concessional terms as well as assist-ance on HIPC: currently the number of low-incomecountries which are covered under financial arrange-ments for PRGF and HIPC assistance exceeds thenumber of countries with standby arrangements by

a factor of four (IMF, 2005a). It started out as aninstitution designed to promote global growth andstability through multilateral discipline over ex-change rate policies, control over capital flows andprovision of liquidity for current account financing.It has ended up focusing on the management andresolution of capital-account crises in emergingmarkets associated with excessive instability of capi-tal flows and exchange rates, allocating a largeproportion of its lending for financing capital out-flows: during the financial year ended 30 April 2004,over 85 per cent of total purchases and loans wereaccounted for by crisis lending to Argentina, Braziland Turkey (IMF, 2004a, table II.6). More impor-tantly, originally all members of the Fund had equalde jure and de facto obligations for maintaining sta-ble exchange rates and orderly macroeconomicconditions. With the breakdown of the BrettonWoods exchange rate arrangements, the establish-ment of universal convertibility of the currencies ofmajor industrial countries, and the emergence of in-ternational financial markets as a main source ofliquidity for advanced economies, the Fund�s policyoversight has been confined primarily to its poorestmembers who need to draw on its resources becauseof their lack of access to private sources of finance.

C. Mission creep into developmentfinance and policy

Much of the recent debate on the role of theIMF in development has focused on three issues.First, there has been widespread criticism of rapidderegulation and liberalization promoted by the Fundin developing countries because of their adverse re-percussions for economic growth and poverty.Second, the conditions attached to Fund lending havebeen under constant fire on grounds that, inter alia,they interfere with the proper jurisdiction of a sover-eign government and leave little room for manoeuvreto national policy makers. Finally, there is a broadconsensus that financing provided in support of suchprogrammes, including in the form of debt relief, ishighly inadequate.

There has been less emphasis on whetherthe Fund should really be involved in developmentfinance and policy, and poverty alleviation, particu-larly given that there are other multilateral institu-tions exclusively focusing on these issues, including


multilateral development banks and various UN tech-nical assistance agencies. Nevertheless, there aresome notable exceptions. For instance the MeltzerCommission (2000) unanimously recommended thatthe IMF should restrict its financing to provision ofliquidity, and stop lending to countries for long-termdevelopment assistance and structural transforma-tion. Accordingly, the PRGF should be eliminatedand long-term institutional assistance to foster de-velopment and encourage sound economic policiesshould be the exclusive responsibility of the WorldBank and regional development banks. Similarly,according to the former World Bank chief econo-mist Joseph Stiglitz (2002: 232) �a broad consensus� outside the IMF � has developed that the IMFshould limit itself to its core area, managing crises;that it should no longer be involved (outside crises)in development or the economies of transition.�

There are indeed no compelling reasons whythe IMF should deal with structural problems in de-veloping countries. As noted, the Fund movedtowards developing countries in large part becauseit was no longer needed by industrial countries as asource of liquidity and it lost leverage over exchangerate and macroeconomic polices of these countries.Sticking to its original mandate for facilitating pay-ments adjustment through provision of liquidity tomeet temporary current account deficits would nothave generated much business for the Fund in devel-oping countries given that their balance of paymentsdifficulties were structural and durable, rather thancyclical and temporary. This, together with the ex-pansion of IMF membership in Africa, was the mainreason why the Fund introduced long-term facilitiesand concessional lending. In doing so, however, ithas gone right into the domain of development sinceovercoming structural payments deficits calls forreducing both savings and foreign exchange gaps,including chronic public sector deficits, which, inturn, depends on structural and institutional changesand economic growth, rather than demand manage-ment. But these are exactly the kind of issues dealtwith by multilateral development banks, and involveaction in wide areas of policy including agriculture,industry, trade, investment, technology, finance, thelabour market and the public sector.14

That external disequilibrium in developingcountries is structural does not justify the Fund go-ing into long-term balance of payments supportbecause this is exactly what the World Bank has beendoing since the early 1980s when it shifted its lend-

ing from project financing to structural adjustmentand development policy loans which now constituteabout half of total Bank lending. Furthermore, theBank is doing this for all developing countries whilesuch long-term balance of payments support in theFund is limited to low-income countries eligible toPRGF. This is an ad hoc arrangement without a soundrationale, since there are many middle-income coun-tries with chronic payments deficits and excessivedependence on foreign capital, notably in LatinAmerica, in need of long-term support to strengthendomestic savings and export capacity. This incon-sistency should be addressed not by bringing themunder the IMF, but taking the others out to the Bank.

As part of its work on development and povertyalleviation, the Fund�s programmes and structuralconditionality have addressed almost all areas ofdevelopment policy. This is problematic for severalreasons. First of all it is not clear that the Fund hasthe necessary competence and experience in suchcomplex issues. Certainly, the kind of expertise indevelopment policy resulting from research and prac-tical experience, and access to a significant amountof information on institutions and policy environmentexpected from the Bank do not define the existingcapabilities of the Fund.15 Nor are they needed forthe Fund to function effectively in its areas of corecompetence. Furthermore, there are serious risks inentrusting development matters to an organizationpreoccupied with short-term financial outcomes andsusceptible to strong influences from sudden shiftsin market sentiments about the economies of its bor-rowers. Finally, there is no doubt that what the IMFdoes or should be doing for promoting monetary andfinancial stability has consequences for poverty anddevelopment, but this does not provide a rationalefor the Fund to work in these areas. Such inter-dependencies exist in many areas of policy affectingpoverty and development, including trade, labour,health, environment and security, both at the nationaland international level. What is needed is close co-operation and coordination with the institutionsspecialized in these matters with a view to attainingcoherence and consistency, not duplication.

The Bank and the Fund have taken great painsto show that they are closely coordinating in orderto minimize overlap and duplication (IMF/WB,2004), but in reality much of what is being done indevelopment by the Fund could easily be transferredto the Bank. This overlap has in fact given rise tocalls to merge the Fund with the World Bank, in-


cluding by George Shultz (1998), former Secretaryof the Treasury and Secretary of State of the UnitedStates, arguing that their activities are becomingincreasingly duplicative even though basicallyuncoordinated.16 More recently a former German Ex-ecutive Director for the World Bank Group andExecutive Secretary of the Development Commit-tee (Fischer, 2004) argued that while complete fusionof the BWIs under a new charter would be the opti-mal solution, politically and practically a morefeasible step would be to combine the administra-tion and the boards of the two institutions, and toreshape the single board in such a way as to givegreater voice to developing countries. This wouldreduce extensive duplication at the administrativelevel, bring greater consistency in policy advice andalleviate the pressure on poor countries with limitedadministrative capacities in coordinating measurespromoted by the Fund and the Bank in overlappingareas of policy. According to one estimate a com-bined administration with a single board would reducethe personnel and other costs in the administrativebudget by at least 25 per cent (Burnham, 1999) �costs which are now effectively paid by debtor de-veloping countries through charges and commission.

While it is often argued that the Fund and theBank should be merged because they are effectivelydoing the same thing, what is argued here is thatthey should remain separate institutions doing dif-ferent things. In fact there are many areas in whichtheir activities do not and should not overlap. Crisismanagement and resolution, surveillance over macro-economic and exchange rate policies, and provisionof international liquidity are areas where the Fundshould have a distinct role and competence. By con-trast, the Fund should transfer development-relatedactivities and facilities to the Bank. This would notlead to a significant retrenchment of Fund lending;at the end of 2004 outstanding PRGF credits wereless than SDR 7,000 billion or 10 per cent of totaloutstanding credits (IMF, 2004a, table II.8). Norwould it entail a major expansion in outstanding IDAcredits which currently are around $90 billion. Thelegal difficulties that might be involved in trans-ferring the resources currently located in the Fundcould be overcome once the principle is accepted(Ahluwalia, 1999: 22).

In a recent statement the Managing Directorhas argued in favour of deepening the Fund�s workon low-income countries and expressed his disagree-ment with the view that the �Fund ought to get out

of the business of supporting low-income countries�on grounds that they �need macroeconomic policyadvice from the Fund and they often need financialsupport from us� (De Rato, 2005: 4). However, theissue is not about whether or not the Fund should beinvolved in policy design in and provision of financeto low-income countries, but the context in whichsuch activities should be undertaken. As discussedin subsequent sections, a major task of the Fundshould be to provide counter-cyclical current accountfinancing to low-income countries facing excessiveinstability in export earnings. Again, macroeconomicconditions that may need to be attached to short-term lending and Article IV consultations would givethe Fund ample opportunity to provide macroeco-nomic policy advice to low-income countries. Noneof these would require the Fund to be involved indevelopment matters.

D. Trespassing in trade policy

The Fund, as a monetary institution, was not tobe involved in trade issues even though its Articles,in effect, authorized, through the scarce currencyclause, trade measures against surplus countries un-willing to undertake expansionary measures byallowing discriminatory exchange restrictions (Dam,1982: 233). In the event, however, the Fund has gonein the opposite direction, putting pressure on deficitdeveloping countries to undertake payments adjust-ment despite mounting protectionism in industrialcountries against their exports, forcing them to re-sort to import compression and sacrifice growth(Akyüz and Dell, 1987: 54). More importantly, asthe Fund became deeply involved in developmentissues, it increasingly saw trade liberalization as animportant component of structural adjustment totrade imbalances. As noted in a report by a group ofindependent experts, IMF surveillance has expandedinto trade liberalization, partly as a result of pres-sure from the United States as part of conditions forits agreement to quota increases (IMF/GIE, 1999:61). Trade liberalization has also been promoted incertain emerging market economies in response tosurges in capital inflows as a way of absorbing ex-cess reserves and preventing currency appreciation(IMF/IEO, 2005: 8�9 and 59, table 3.2).

Although greater openness to foreign competi-tion has also been one of the pillars of the adjustment


programmes supported by the Bank, the Fund isknown to have played a more important role in thisarea. Low-income countries and LDCs working un-der Fund programmes have been encouraged andeven compelled to undertake unilateral trade liberali-zation, putting them at a disadvantage in multilateraltrade negotiations. Indeed the consequences of uni-lateral trade liberalization by developing countriesoutside the WTO framework are often discussed inrelation to Fund programmes (see e.g. WTO, 2004a,section II.A).

An implication of unilateral liberalization is thatthe industrial countries would not need to lower theirtariffs in areas of export interest to developing coun-tries in order to secure better access to the marketsof these countries in the WTO where trade conces-sions are based on some form of reciprocity.Liberalization without improved market access inthe North creates the risk of deterioration in theirtrade balances, hence leading either to a tighter ex-ternal constraint and income losses, or to increasedexternal debt. Indeed there is an asymmetry in themultilateral consequences of trade policy actionstaken by developing countries in the context of Fund-supported programmes. A country liberalizingunilaterally acquires no automatic rights in the WTOvis-à-vis other countries, but it could become liableif it needs to take measures in breach of its obliga-tions in the WTO.17

Although this is generally recognized to be aproblem and discussed during the Uruguay Round,no mechanism has so far been introduced in the WTOfor crediting developing countries for their unilat-eral liberalization in the context of Fund-supportedprogrammes. Furthermore, arguments are advancedthat this should not affect the position of developingcountries regarding their obligations in the WTOsince what matters there is not applied but boundtariffs. However, for a number of reasons, includingpressures from financial markets and major tradingpartners, developing countries find it difficult to raisetheir tariffs once they are lowered. More importantly,applied tariffs are now providing a benchmark inbinding and reducing tariffs in the current negotia-tions on industrial tariffs in the WTO. For instance,paragraph 5 of annex B of the so-called July packagewhich provides a framework for these negotiationsbased on proposals made by industrial countries takesthe applied rates as the basis for commencing re-ductions for unbound tariffs in developing countries(WTO, 2004b). It also proposes to give credit for

autonomous liberalization by developing countriesprovided that the tariff lines were bound on an MFNbasis. However, it is not clear that a line-by-line com-mitment is necessarily in the best interest of thesecountries, or that the kind of unilateral liberaliza-tion agreed under IMF pressure would be consistentwith their bargaining positions in multilateral nego-tiations (Akyüz, 2005b).

Despite the difficulties confronting developingcountries in trade negotiations, the Fund staff havebeen advancing arguments in favour of unilateralliberalization in these countries that go even beyondthe positions advocated by major developed coun-tries in the current negotiations on industrial tariffs.For instance a recent Fund paper argues that Afri-ca�s interest in the Doha Round would best be servedby its own liberalization, and that African countries,including the LDCs, should bind and reduce all tar-iffs, even though the July package exempts LDCsfrom tariff reductions and recognizes the need forless-than-full reciprocity.18 The First Deputy Manag-ing Director of the IMF has encouraged developingcountries to undertake unilateral liberalization onseveral occasions, arguing that �countries that pressahead with unilateral liberalization will enjoy enor-mous benefits and they will not be penalized byfurther multilateral liberalization- quite the opposite.Countries that open up unilaterally help themselves�(Krueger, 2005: 5). The Fund has recently introduceda Trade Integration Mechanism to mitigate concernsamong some developing countries that their balance-of-payments position could suffer as a result ofmultilateral liberalization in the current round ofnegotiations, insisting that such shortfalls would besmall and temporary (IMF, 2005b), despite mount-ing evidence that rapid liberalization in poorcountries can raise imports much faster than exportsand that the external financing needed can add sig-nificantly to the debt burden.19

The Fund staff have been advocating bindingtariffs closer to their applied levels on grounds thatthis would increase trade by reducing uncertainty oftrade policy and hence transaction costs (see e.g.Yang, 2005: 9). This may well be the case, but it isnot a matter that should be of primary concern tothe Fund. The international trading system no doubtneeds greater predictability and stability, but discre-tion over tariffs by developing country governmentsis not the most serious source of disruption. As therecent experience regarding the movement of thedollar shows once again, exchange rate instability


and misalignments are an equal and even more im-portant source of uncertainty and friction in theinternational trading system. This was recognizedby the architects of the postwar international eco-nomic system, including Lord Keynes: �Tariffs andcurrency depreciations are in many alternatives.Without currency agreements you have no firmground on which to discuss tariffs ... It is very diffi-cult while you have monetary chaos to have orderof any kind in other directions.�20 It is thus advis-able for the Fund to focus on its core responsibilityof ensuring stability and better alignment of ex-change rates, rather than narrowing the policy spacefor developing countries in matters related to tradeand pushing trade liberalization as if a consistentinternational monetary order existed.

As the Fund transfers its work on developmentto the Bank, it should also stop being involved intrade policy issues or undertake activities that inter-fere with multilateral trade negotiations. Its relationto the WTO should be confined to areas explicitlystated in the General Agreement on Tariffs and Trade(GATT), notably in Article XV on exchange arrange-ments. These include consultations and supplyinginformation on monetary reserves, balance of pay-ments and foreign exchange arrangements in orderto help in matters such as the determination ofwhether balance of payments and reserve conditionsof countries would entitle them to apply the provi-sions of Articles XII and XVIIIB of GATT andArticle XII of GATS in order to avoid sacrificinggrowth and development as a result of temporarypayments difficulties (see Das, 1999, chap. III.3; andAkyüz, 2002: 124�125).

E. Crisis management and resolution:bailouts or workouts?

There is a consensus that crises in emergingmarkets will continue to occur because of financialmarket failures as well as shortcomings in nationalpolicies and international surveillance mechanisms.There is also a wide agreement that the IMF shouldbe involved in the management and resolution ofsuch crises in order to limit the damage to the econo-mies concerned, prevent contagion and reducesystemic risks. However, there is considerable con-troversy over how the Fund should intervene.

Until recently the Fund�s intervention in finan-cial crises in emerging markets involved ad hocfinancial bailout operations designed to keep coun-tries current on their debt payments to privatecreditors, to maintain capital account convertibilityand to prevent default. IMF rescue packages amountedto several times the accepted quota limits (an an-nual limit of 100 per cent of a member�s quota and acumulative limit of 300 per cent), and were in certaininstances combined with funds from developmentbanks and bilateral contributions from major indus-trial countries. IMF rescue packages for 6 emergingmarkets (Mexico, Thailand, Indonesia, the Repub-lic of Korea, the Russian Federation and Brazil)between 1995 and 1998 reached $231 billion, ofwhich 44 per cent came from bilateral donors, 38 percent from the IMF, and the rest from developmentbanks (Ahluwalia, 1999: 55, table 1). From 1995until the end of 2003 IMF exceptional financing for9 emerging markets (the above six plus Argentina,Turkey and Uruguay) amounted to SDR 174 billion,with an average of 637 per cent of quota (IMF, 2005c,table 10). Such lending is the main source of incomefor the Fund to support its operational expenses,which stood at some SDR 1.5 billion at the end ofFY2004. Thus, ironically, in the absence of finan-cial crises and bailout operations in emergingmarkets, the Fund can cease to be a financially vi-able institution.

Crisis lending was combined with monetary andfiscal tightening in order to restore confidence, butthis often failed to prevent sharp drops in the cur-rency and hikes in interest rates, thereby deepeningdebt deflation, credit crunch and economic contrac-tion. Such interventions took place not only whenthe country concerned was facing a liquidity prob-lem, as in the Republic of Korea, but also when therewere signs of a problem of insolvency. Originallyrescue packages involved short-term, temporary fi-nancing but more recently the Fund has providedmedium-term financing, including to governmentsfacing domestic debt problems such as in Turkey(Akyüz and Boratav, 2003).

In addition to the SRF noted above, the Con-tingency Credit Line (CCL) was created in Spring1999 in order to provide a precautionary line of de-fence in the form of short-term financing whichwould be available to meet future balance-of-pay-ments problems arising from contagion.21 Countrieswould pre-qualify for the CCL if they complied withconditions related to macroeconomic and external


financial indicators and with international standardsin areas such as transparency and banking supervision.However, this facility discontinued in November 2003as countries avoided recourse to it owing to fearsthat it would give the wrong signal and impair theiraccess to financial markets.22

There have also been suggestions to turn theFund into an international lender of last resort witha view to helping prevent crises (Fischer, 1999). Itis argued that if the IMF stands ready to provideliquidity to countries with sound policies, they wouldbe protected from contagion and financial panic sothat a lender of last resort facility would have a pre-ventive role. Clearly, such a step would involve afundamental departure from the underlying premisesof the Bretton Woods system. The report of theMeltzer Commission (2000) virtually proposes theelimination of all other forms of IMF lending, in-cluding those for current account financing whichshould, in their view, be provided by private mar-kets.23 Such a shift in IMF lending would imply thatonly a small number of more prosperous emergingeconomies would be eligible for IMF financing(Summers, 2000: 14). More importantly there aredifficulties in transforming the IMF into a genuineinternational lender of last resort, and proposed ar-rangements could compound rather than resolvecertain problems encountered in IMF bailouts.

The effective functioning of such a lenderwould require discretion to create its own liquidityin order to be able to provide an unlimited amountof financing. This problem could, in principle, beresolved by assigning a new role to the SDR, whichcould also help promote it as a true fiduciary asset.24

Proposals have indeed been made to allow the Fundto issue reversible SDRs to itself for use in lender-of-last-resort operations, that is to say the allocated SDRswould be repurchased when the crisis was over.25

However, the real problem relates to the termsof access to such a facility. Genuine lender-of-last-resort financing (namely lending in unlimitedamounts and without conditions except for penaltyrates) would need to be accompanied by tightenedglobal supervision of debtor countries to ensure theirsolvency, and this would encounter not only techni-cal but also political difficulties. Pre-qualification,that is allowing countries meeting certain ex anteconditions to be eligible to lender-of-last-resort fi-nancing, as in the case of ill-fated CCL, involvesseveral problems. First, the IMF would have to act

like a credit-rating agency. Second, it would be nec-essary to constantly monitor the fulfilment of the termsof the financing to ensure that the pressures on thecapital account of a qualifying country have resultedfrom a sudden loss of confidence amongst investorstriggered largely by external factors rather than mac-roeconomic and financial mismanagement. In theserespects difficulties are likely to emerge in relationsbetween the Fund and the member concerned.

Perhaps the most serious problem with rescuepackages is that they tend to aggravate market failuresand financial instability by creating moral hazard.This is more of a problem on the side of creditorsthan debtors since access to lender of last resort fi-nancing does not come free or prevent fully theadverse repercussions of financial panics and runsfor debtor countries. The main difficulty is that bail-outs undermine market discipline and encourageimprudent lending since private creditors are notmade to bear the consequences of the risks theytake.26 A dose of constructive ambiguity by leavinglender discretion might help in reducing moral haz-ard, but at the expense of undermining the objectivesought by establishing such a facility.

There has been growing agreement that orderlydebt workout procedures drawing on certain princi-ples of national bankruptcy laws, notably chapters 9and 11 of the United States law provide a viable al-ternative to official bailout operations.27 These shouldbe designed to meet two interrelated objectives. Onthe one hand, they should help prevent financialmeltdown and economic crises in developing coun-tries facing difficulties in servicing their externalobligations � a situation which often results in a lossof confidence of markets, collapse of currencies andhikes in interest rates, inflicting serious damage onboth public and private balance sheets and leadingto large losses in output and employment and sharpincreases in poverty, all of these being part of actualexperience in East Asia, Latin America and else-where during the past ten years. On the other hand,they should provide mechanisms to facilitate an eq-uitable restructuring of debt which can no longer beserviced according to the original provisions of con-tracts. Attaining these two objectives does not requirefully-fledged international bankruptcy proceduresbut the application of a few key principles:28

� A temporary debt standstill whether debt isowed by public or private sector, and whetherdebt servicing difficulties are due to solvency


or liquidity problems � a distinction which isnot always clear-cut. The decision for a stand-still should be taken unilaterally by the debtorcountry and sanctioned by an independent panelrather than by the IMF because the countriesaffected are among the shareholders of the Fundwhich is itself also a creditor. This sanctionwould provide an automatic stay on creditorlitigation. Such a procedure would be similarto WTO safeguard provisions allowing coun-tries to take emergency actions to suspend theirobligations when faced with balance-of-paymentsdifficulties (Akyüz, 2002: 124�125). Standstillswould need to be accompanied by exchangecontrols, including suspension of convertibil-ity for foreign currency deposits and otherforeign exchange assets domestically held byresidents.

� Provision of debtor-in-possession financingautomatically granting seniority status to debtcontracted after the imposition of the standstill.IMF should lend into arrears for financingimports and other vital current account trans-actions.

� Debt restructuring including rollovers andwrite-offs, based on negotiations between thedebtor and creditors, and facilitated by the in-troduction of automatic rollover and collectiveaction clauses (CACs) in debt contracts. TheIMF should not be involved in the negotiationsbetween sovereign debtors and private creditors.

These principles still leave open several issuesof detail, but they nonetheless could serve as the basisfor a coherent and comprehensive approach to crisisintervention and resolution. The Fund appeared tobe moving in this direction at the end of the last dec-ade with rising opposition to bailout operations fromEuropean and other governments and the increasedfrequency of crises in emerging markets. The IMFBoard first recognized that �in extreme circum-stances, if it is not possible to reach agreement on avoluntary standstill, members may find it necessary,as a last resort, to impose one unilaterally�, and thatsince �there could be a risk that this action wouldtrigger capital outflows � a member would need toconsider whether it might be necessary to resort tothe introduction of more comprehensive exchangeor capital controls.�29 Although the Board was un-willing to provide statutory protection to debtors inthe form of a stay on litigation, preferring instead

�signalling the Fund�s acceptance of a standstill im-posed by a member � through a decision � to lendinto arrears to private creditors�, the Fund secretariatmoved towards establishing a formal mechanism forsovereign debt restructuring to �allow a country tocome to the Fund and request a temporary standstillon the repayment of its debts, during which time itwould negotiate a rescheduling with its creditors,given the Fund�s consent to that line of attack. Dur-ing this limited period, probably some months induration, the country would have to provide assur-ances to its creditors that money was not fleeing thecountry, which would presumably mean the imposi-tion of exchange controls for a temporary period oftime.� (Krueger, 2001: 7).

However, the provision for statutory protectionto debtors in the form of a stay on litigation is notincluded in the proposal for Sovereign Debt Restruc-turing Mechanism (SDRM) prepared by the Fundmanagement because of the opposition from finan-cial markets and the United States government. Theproposed mechanism also provides considerable lev-erage to creditors in seeking their permission ingranting seniority to new debt needed to prevent dis-ruption to economic activity. It gives considerablepower to the Fund vis-à-vis the proposed SovereignDebt Dispute Resolution Forum in determining debtsustainability.30

The SDRM proposal contains innovativemechanisms to facilitate sovereign bond restructur-ing for countries whose debt is deemed unsustainablein bringing debtors and bondholders togetherwhether or not bond contracts contain CACs, in se-curing greater transparency, and in providing amechanism for dispute resolution. It could thus con-stitute an important step in the move towardsgeneralized CACs in international bonds. However,it only addresses part of the problem associated withfinancial crises. First, it would not apply to coun-tries with sustainable debt but facing liquidityshortages. Secondly, it focuses exclusively on inter-national bonds as a source of financial fragility eventhough vulnerabilities associated with internationalbank debt, currency risks assumed by the domesticbanking system, and public domestic debt playedkey roles in most recent crises in emerging markets.In the presence of such vulnerabilities bond clausesalone cannot stem currency attacks or prevent finan-cial turmoil. While the SDRM includes a provisionto discourage litigation by bondholders (through theapplication of the so-called �hotchpot� rule), such a


rule cannot address the problem of how to stop fi-nancial meltdown, since in a country whose debt isjudged unsustainable, currency runs could take placewhether or not bondholders opt for litigation.

More importantly, the SDRM proposal does notfundamentally address the problems associated withIMF bailouts. It is based on the premise that coun-tries facing liquidity problems would continue toreceive IMF support and the SDRM will apply onlyto those with unsustainable debt. As part of its pro-motion of the SDRM the IMF has argued thatunsustainable debt situations are rare. That meansin most cases business as usual. In any case, it canreasonably be expected that countries with unsus-tainable debt would generally be unwilling to declarethemselves insolvent and activate the SDRM. In-stead, they would be inclined to ask the Fund toprovide financing. But in most cases it would be dif-ficult for the Fund to decline such requests ongrounds that the country is facing a solvency prob-lem. Here lies the rationale for limits on IMF crisislending whether the problem is one of liquidity orinsolvency: with strict access limits creditors can-not count on an IMF bailout, and debtors will beless averse to activating the SDRM and standstillswhen faced with serious difficulties in meeting theirexternal obligations and maintaining convertibility.This means that to encourage countries to movequickly to debt restructuring, the SDRM should becombined with limits on crisis lending. But this couldbe problematic unless private sector involvement issecured through a statutory standstill and stay on liti-gation.

Even this watered down version of the SDRMproposal could not elicit adequate political supportand has, at the time of writing, been put on thebackburner. Indeed, the impetus for reform has gen-erally been lost since the turn of the millenniumbecause of widespread complacency associated withthe recovery of capital flows to emerging markets.This recovery has been driven by a combination ofhighly favourable conditions including historicallylow interest rates, high levels of liquidity, strongcommodity prices and buoyant international trade.Private capital flows to emerging markets appear tobe in the boom phase of their third postwar cycle:the first began in the 1970s and ended with the debtcrisis in the early 1980s, and the second began inthe early 1990s and ended with the East Asian andRussian crises.31 Total inflows in the current boomappear to have exceeded the peak observed in the

previous boom, and almost all emerging marketshave shared in this recovery. However, as noted bythe Institute of International Finance, the system isbecoming more fragile once again: �there is a riskthat the pickup in flows into some emerging marketassets has pushed valuations to levels that are notcommensurate with underlying fundamentals.� (IIF,2005a: 4). Thus, a combination of tightened liquid-ity, rising interest rates, slowing growth and globaltrade imbalances can reverse the boom, hitting par-ticularly countries with weak fundamentals andincomplete self-insurance (IIF, 2005b; Goldstein,2005b).32 Under these conditions if the recent con-sensus against large-scale bailout operations isadhered to, countries that may be facing rapid exitof capital and unsustainable debt burdens could beforced to undertake action for unilateral standstill,creating considerable uncertainties and confusion inthe international financial system. If not, we will beback to square one.

F. Restructuring IMF lending andsupplementing resources

The arguments developed above imply that theFund should return to its original mandate for theprovision of short-term current account financing andshould no longer be engaged in development financeor financial bailout operations. This means abolish-ing the facilities designed for these purposes includ-ing the EFF, SRF and PRGF. Despite the rapiddevelopment and integration of international bank-ing and credit markets, there is still a strong rationalefor the Fund to have a role in providing liquiditybecause of pro-cyclical behaviour of financial mar-kets and increased volatility of global economic en-vironment. Such financing should be made availablein order to support economic activity, employmentand trade when countries face sharp declines orreversals of private capital flows, or temporaryshortfalls in external payments as a result of tradeshocks which cannot be met by private financing. Inboth cases access to credit tranches through stand-by agreements should be the main instrument forthe provision of liquidity. Greater delineation ofBank-Fund activities requires that such financingshould be the sole responsibility of the Fund, andthe Bank should stay out of provision of short-termfinance.33


While it has to be recognized that money isfungible and in practice it is not always possible toidentify the need catered for by a particular loan, itis important to ensure that IMF lending to countervolatility in private capital flows should aim at main-taining imports and the level of economic activityrather than debt repayment to private creditors andcapital account convertibility. Such lending shouldbe available to countries facing cutback in credit linesdue to contagion as well as those facing currencyand debt crises. To ensure that such lending doesnot amount to bailouts for private creditors, thereshould be strict limits to IMF crisis lending sinceotherwise it would be difficult to ensure private sec-tor involvement.

This approach of constraining IMF lending toencourage private sector involvement in the resolu-tion of international financial crises has beensupported by some G-7 countries including Canadaand England.34 It has also been supported in a reportto the Council on Foreign Relations which arguedthat the IMF should adhere consistently to normalaccess limits and that only �in the unusual case inwhich there appears to be a systemic crisis (that is amulticountry crisis where failure to intervene threat-ens the performance of the world economy and wherethere is widespread failure in the ability of privatecapital markets to distinguish creditworthy from lesscreditworthy borrowers), the IMF would return toits �systemic� backup facilities� (CFRTF, 1999: 63).However, exceptions to normal access limits couldleave considerable room for large-scale bailout op-erations and excessive IMF discretion in assessingthe conditions under which exceptional access incapital account crises are to be granted.35 It wouldalso allow room for considerable political leveragein IMF lending decisions by its major shareholders,as was seen in the differential treatment of Argen-tina and Turkey after the attacks of September 2001.Requiring supermajority for access to exceptionalfinance, as recommended by CFRTF (1999: 63) andGoldstein (2005a: 299�300) would certainly be animportant step, but it may not always prevent largescale bailouts driven by political motivations. In anycase, the Fund should provide liquidity to countriesfacing cutback in private lending in order to supportproduction, employment and trade, and should notbe expected to help float imprudent internationalinvestors and lenders� a task that should fall on na-tional authorities in creditor countries. On the otherhand, the problem of inadequacy of normal lendinglimits for current account financing should be ad-

dressed by reforming quotas and access policy notby making exceptions to access limits.

Exceptional current account financing may beneeded at times of a contraction in world trade andgrowth, and/or sharp declines in capital flows todeveloping countries, as was the case in the early1980s and after the East Asian and Russian crises.The Fund�s regular resources may not be adequatefor dealing with such cases because they are not largeor flexible enough. This can be handled by a globalcountercyclical facility based on reversible SDR al-locations, which could be triggered by a decision ofthe Board on the basis of certain predetermined cri-teria regarding global trade and output and privatecapital flows to developing countries. Again countriescould be permitted to have access to such a facility ona temporary basis within predetermined limits.

Fund lending in response to trade shocks isneeded when financial markets are not willing toprovide counter-cyclical finance. As noted the CFFwas established in 1963 as an additional low-conditionality facility to help developing countriesexperiencing temporary shortfalls in export earningsdue to external shocks in order to avoid undue re-trenchment. Modifications made over the years havetightened conditions attached to the CFF, and thefacility has not been used since the last review in2000 despite two recognized temporary shocks in-cluding the attacks of September 2001 which affectedearnings from tourism in the Caribbean region (IMF,2004b). A major problem is that in order to havelow conditionality financing under CFF (the so-called stand alone CFF purchases) a country wouldneed to have a viable payments position except forthe effects of the shocks, but such a country wouldnormally have access to alternative sources of fi-nance. On the other hand, countries with structurallyweak payments usually have other forms of high-conditionality Fund financing including the PRGFor emergency assistance (IMF, 2004b). Under cur-rent arrangements the facility serves no useful purposeand many Executive Directors called for its discon-tinuation during the recent review, arguing that theCFF is not an attractive option for low-income coun-tries given its non-concessional nature (IMF, 2004c).

It is generally recognized that IMF quotas haveconsiderably lagged behind the growth of globaloutput and trade. According to one estimate, in 2000they stood at 4 per cent of world imports comparedto 58 per cent in 1944 (Buira, 2003b: 9). It is, how-


ever, often argued that this does not imply that thesize of the Fund would need to be raised consider-ably in order to keep up with growth in world tradebecause closely integrated and rapidly expandingfinancial markets now provide alternative sourcesof liquidity, and the move to floating together withthe universal convertibility of several currencies havereduced the need for international reserves. Whilethis may well be so for more advanced countries,many developing countries continue to depend onmultilateral financing since market liquidity tendsto disappear at the time when it is most needed. Thesecountries are also more vulnerable to external shocks,be it in trade or finance.

An across the board increase in the size of theFund may not address the problems faced by manydeveloping countries because of the small size oftheir quotas. It is known that the current distributionof quotas does not reflect the relative size of theeconomies of the countries member to the IMF, anda redistribution of quotas based on actual shares ofcountries in aggregate world output would raise theproportion of IMF quotas allocated to developingcountries, particularly if incomes are valued at pur-chasing power parities (PPP) rather than marketexchange rates (Buira, 2003b). However, this wouldonly address a small part of the problem: accordingto the IMF World Economic Outlook, the share ofadvanced countries in aggregate GDP at PPP is closeto 58 per cent while their share in IMF quotas is justover 60 per cent. For developing countries thesenumbers stand at around 38 and 30 per cent respec-tively. Moreover, a redistribution of quotas wouldnot produce a tangible increase in the share of low-income developing countries which do not haveadequate access to international financial markets.

One way to tackle the problem would be toadopt differential treatment of poorer countries inthe determination of their drawing rights. Underexisting arrangements quotas determine simultane-ously countries� contributions to the Fund, votingrights and drawing rights. But this is not the bestpossible arrangement and the use of a single quotato serve three purposes was rightly criticised as �bothillogical and unnecessary� (Mikesell, 1994: 37).Putting a large wedge between countries� contribu-tions and voting rights by subjecting them to totallydifferent rules may be problematic, but there is noreason why drawing rights should not be based ondifferent quotas from contributions.36 After all non-reciprocity between rights and obligations for poorer

countries has been an agreed principle in multilat-eral arrangements in other spheres of economicactivity, notably trade, and such an approach wouldalso be consistent with concessionality applied tolending to such countries by the Bretton Woods In-stitutions. This may be arranged by setting differentaccess limits to different groups of countries accord-ing to their vulnerability to external shocks andaccess to financial markets, which in effect impliesthat, under current arrangements, countries wouldhave different quotas for their contributions anddrawing rights. Income shares can be taken as thebasis for contributions while export earning volatil-ity and access to private finance could be used ascriteria for determining drawing limits. Such a need-based approach to access to IMF resources wouldmake even greater sense if, as proposed in sectionH, the IMF ceases to be funded by its members, re-lying instead on SDRs for the resources needed.

An overall expansion of Fund quotas, togetherwith its redistribution in favour of developing coun-tries, would increase unconditional access throughreserve tranche purchases. However, automatic ac-cess would also be expanded beyond the reservetranche for the poorer countries if quotas for draw-ings are differentiated from those for contributions.On the other hand, once the Fund stops dealing withdevelopment and poverty, structural conditionalityshould no longer be applied for access to upper credittranches. Conditionality would then be restricted tofiscal, monetary and exchange rate policies � theFund�s core areas of competence.

Increased resources at the IMF should be ex-pected to help strike a better balance betweenfinancing and macroeconomic adjustment. In anycase, the kind of conditions to be attached to lend-ing should depend on the nature of paymentimbalances. If the shortfall is due to temporary tradeand financial shocks, then it is important to ensurethat the Fund do not act pro-cyclically and imposepolicy tightening. In such cases the balance betweenpolicy adjustment and financing should be tilted to-wards the latter. If expansionary macroeconomicpolicies and excessive domestic absorption are at theroot of the problem, then financing would need tobe accompanied by realignment of monetary, fiscaland exchange rate policies. However, if it turns outthat payments equilibrium can only be sustained atpermanently depressed rates of economic growth, thisis a matter that should be addressed by multilateraldevelopment banks through provision of develop-


ment finance and promotion of structural policies,including in areas affecting government revenues andspending, rather than by IMF lending or macroeco-nomic policy prescriptions for demand management.

An issue here is whether it would be possibleto distinguish between temporary and permanentshocks or between structural and cyclical deficits(see e.g. IMF, 2004b: 10). There are no doubt diffi-culties in making judgment in these areas, which callfor prudence. However, such judgments are alsonecessary under current arrangements in order tostrike a balance between adjustment and financing,and between structural and macroeconomic condi-tionality. Moreover, the Fund is engaged in makingjudgments in areas that involve even higher degreesof uncertainty such as debt sustainability and pros-pects of the country regaining access to privatefinance as part of the criteria to be met for excep-tional access in capital account crises (IMF, 2005c: 4).Placing macroeconomic and structural aspects ofpayments adjustment in different institutions is nomore problematic than combining them under thesame roof. It would also have the additional advan-tage of reducing the imbalance between adjustmentand financing since structural adjustment needs tobe supported by a lot more financing than macroeco-nomic adjustment, and the IMF programmes tend torely heavily on macroeconomic tightening to reducepayments imbalances even when they are structuralin nature.

G. Ineffectiveness and asymmetry ofFund surveillance

The architects of the Bretton Woods systemrecognized the role of surveillance over nationalpolicies for international economic stability. But itwas only after the collapse of the fixed exchangerate system and the expansion of capital markets thatIMF surveillance gained critical importance. Withthe second amendment of the Articles of Agreementthe Fund was charged to exercise firm surveillanceover members� policies at the same time as mem-bers were allowed the right to choose their ownexchange rate arrangements. Its objective, as for-mally adopted, was limited to surveillance overexchange rate policies, focusing primarily on thesustainability of exchange rates and external pay-ments positions, and on the appropriateness of theassociated economic policies, particularly monetary

and fiscal policies, of individual countries. However,its scope and coverage have expanded over time intostructural policies, the financial sector and a numberof other areas (IMF/GIE, 1999: 21; Mohammed,2000). The guidelines established in 1977 made anexplicit reference to the obligations of members toavoid manipulating exchange rates or the interna-tional monetary system to gain an unfair competitiveadvantage over other members.37 In the 1980s themajor members of the Fund came to favour a broaderinterpretation and recognized that �to be effectivesurveillance over exchange rates must concern it-self with the assessment of all the policies that affecttrade, capital movements, external adjustment, andthe effective functioning of the international mon-etary system.�38 After a series of emerging marketcrises the Interim Committee agreed in April 1998that the Fund �should intensify its surveillance offinancial sector issues and capital flows, giving par-ticular attention to policy interdependence and risksof contagion, and ensure that it is fully aware ofmarket views and perspectives.�39 Various codes andstandards established on the basis of benchmarksappropriate to major industrial countries for macr-oeconomic policy, institutional and market structure,and financial regulation and supervision have be-come important components of the surveillanceprocess (Cornford, 2002: 31�33).

However, the Fund�s intensive bilateral surveil-lance of developing countries� policies has not beeneffective in crisis prevention in large part because ithas failed to diagnose and act on the root causes ofthe problem. Indeed, according to an independentassessment of Fund surveillance, policy makers in-terviewed had important reservations regarding thequality of the Fund�s analysis of capital account is-sues (IMF/GIE, 1999: 13). Experience since the early1990s shows that preventing unsustainable surgesin private capital inflows, currency appreciations andtrade deficits holds the key to preventing financialcrises in emerging markets. However, as recognizedby the IMF�s Independent Evaluation Office (IEO),there is a consensus that none of the standard policymeasures recommended by the Fund for this pur-pose, including countercyclical monetary and fiscalpolicy and exchange rate flexibility, is a panacea,and each involves significant costs or otherwisebrings about other policy dilemmas (IMF/IEO,2005: 60). Sterilization through issuing governmentpaper, raising reserve requirements or generatingfiscal surpluses runs up against a host of problems.While fixed or adjustable peg regimes tend to en-


courage short-term inflows by reducing perceivedcurrency risks, the floating regime, which has cometo be favoured by the Fund after recurrent crises inemerging markets, does not provide a viable alterna-tive. As shown by the post-Bretton Woods experienceof advanced industrial countries and the more recentexperience of several emerging market economiesfloating does not prevent excessive inflows of capi-tal, misalignments in exchange rates and unsustainabletrade deficits; nor does it always secure an orderlycurrency and payments adjustment.40 Similarly, pru-dential regulations can help contain the damagecaused by rapid exit of capital, but they are not al-ways effective in checking the build-up of externalfragility even when countercyclical adjustments aremade to rules governing loan-loss provisions, capitalrequirements, collateral valuation and other meas-ures affecting conditions in credit and asset marketsin order to limit the cyclicality of the financial sys-tem.

All these imply that direct measures of controlover capital inflows that go beyond prudential regu-lations may become necessary to prevent build upof financial fragility and vulnerability to externalshocks.41 Developing country governments havegenerally been unwilling to slow down excessivecapital inflows using, instead, the opportunity topursue pro-cyclical fiscal policies. Taiwan Provinceof China is a notable exception with effective re-strictions over arbitrage flows which protected theeconomy from the East Asian crisis in 1997�1998.42

Again Chile and Colombia employed un-remuneratedreserve requirements in a counter-cyclical manner,imposed at times of strong inflows in the 1990s andphased out when capital dried up at the end of thedecade. This was a price-based, non-discriminativemeasure which effectively taxed arbitrage inflowswith the implicit tax rate varying inversely with ma-turity. These measures were effective in improvingthe maturity profile of external borrowing but not inchecking aggregate capital inflows. The Fund hasbeen ambivalent even towards these market-basedmeasures, questioning their rationale and effective-ness (IMF/IEO, 2005: 46, box 2.3). This is largelybecause, as noted in an independent report on sur-veillance, the Fund has generally been optimisticregarding the sustainability of capital inflows toemerging markets (IMF/GIE, 1999: 44, box 3.2). Ithas been averse to temporary control measures evenwhen there were clear signs that surges in short-termcapital inflows were leading to persistent currencyappreciations and growing trade deficits, advocat-

ing, instead, fiscal tightening and greater exchangerate flexibility (IMF/IEO, 2005: 8�9 and 59, table 3.2).

The Fund has little leverage over policies inemerging market economies enjoying surges in capi-tal flows, since they rarely need the Fund at suchtimes of bliss. It cannot act as a rating agency andissue strong public warnings about sustainability ofeconomic conditions in its member countries becauseof their possible adverse financial consequences. Butit is also notable that the Fund refrains from request-ing policy changes and effective capital accountmeasures to slowdown speculative capital inflows,check sharp currency appreciations and growingcurrent account deficits even in countries withstandby agreements. This was certainly the case in the1990s when it supported exchange-based stabilizationprogrammes relying on short-term capital inflows.More recently Turkey has also been going through asimilar process of continued appreciation and grow-ing current account deficits under a floating regime,brought about, in large part, by a surge in arbitrageflows encouraged by high interest rates. Althoughits external conditions appear to be highly fragileand unsustainable, the Fund has done little to checkthis process; it has actually given a further momen-tum by constantly praising the policies pursued underits supervision.43 Ironically, the Fund also seems tobe aware of the risks and vulnerabilities created bythe current boom in capital inflows to emergingmarkets; as noted, it has been simulating scenariosfor a group of �21 vulnerable emerging market coun-tries� to predict the financial gap that could emergein the event of �financial drought and poor economicconditions� (IMF, 2005c: 8).

According to the recent report by the IEO �theIMF has learned over time on capital account issues�and �the new paradigm � acknowledges the use-fulness of capital controls under certain conditions,particularly controls over inflows�, but this not yetreflected in policy advice because of �the lack of aclear position by the institution� (IMF/IEO, 2005: 11).The report goes on to make recommendations tobring about greater clarity in policy advice and therole of capital account issues in IMF surveillance,but it is not clear if these would lead to the kind offundamental changes needed in the Fund�s approachto capital account regimes.

The Articles allow the Fund to request mem-bers to exercise control on capital outflows andrecognize the right of members to regulate interna-


tional capital flows. The 1977 surveillance decisionmentions, among the developments that might indi-cate the need for discussion with a member, thebehaviour of the exchange rate that appears to beunrelated to underlying economic and financial con-ditions including factors affecting competitivenessand long-term capital movements while the 1995amendment explicitly refers to �unsustainable flows


cles in capital flows to developing countries andmajor international financial crises are typically con-nected to large shifts in macroeconomic and financialconditions in the major industrial countries. Thesharp rise in the United States interest rates and theappreciation of the dollar was a main factor in thedebt crisis of the 1980s. Likewise, the boom-bustcycle of capital flows in the 1990s which devastatedmany countries in Latin America and East Asia werestrongly influenced by shifts in monetary conditionsin the United States and the exchange rates amongthe major reserve currencies (UNCTAD, 1998, PartTwo, chap. IV; and 2003, chap. II). Again much ofthe current surge in capital flows to emerging mar-kets is driven by financial market conditions inindustrial countries, including historically low in-terest rates and ample liquidity, rather than byfundamentals in recipient countries, and a reversalof these conditions could trigger serious instabilityin several emerging markets.

It has often been argued that the problems re-garding the quality, effectiveness and evenhandednessof surveillance could be addressed by overhaulingand downsizing the Board to make it more repre-sentative and effective, and giving greater independ-ence to Executive Directors vis-à-vis their capitalsand to the IMF secretariat vis-à-vis its governingbodies.46 This view has been taken further by a sen-ior British Treasury official who argued in favour ofa formal separation of surveillance from decisionsabout programme lending and the use of IMF re-sources so as to establish the Fund as independentfrom political influence in its surveillance of econo-mies as an independent central bank is in the opera-tion of monetary policy (Balls, 2003). It is arguedthat the current structure of the IMF treats pro-gramme design as an extension of surveillance, butthe lack of a clear distinction between lending andsurveillance activities creates the wrong incentivesand diminishes the effectiveness of surveillance.Moreover, there is currently no formal regularmechanism for assessing whether the Fund is pro-viding objective, rigorous, and consistent standardsof surveillance across all member countries � pro-gramme and non-programme countries. While re-sponsible for ensuring the effectiveness of the Fund�sactivities, Executive Directors also have responsi-bilities to their authorities. This creates a conflict ofinterest where Executive Directors tend to colludein surveillance in defence of the countries they rep-resent, turning peer pressure into peer protection.

Surveillance should thus rest with authorities whoare independent of their governments and who arenot involved in lending decisions, making it impar-tial, legitimate, authoritative, transparent and ac-countable. This would also have the advantage ofprotecting the Board and IMF management frombeing dragged into decisions, which � on the basisof objective evidence � they would not want to takeor publicly justify.

Such a step could indeed help improve thequality of surveillance for both programme and non-programme countries in identifying risks and fra-gilities and the policy measures needed. However,it is not clear if it could really secure evenhanded-ness between programme and non-programme coun-tries. For programme countries, it would not bepossible to delink lending decisions from surveil-lance. Indeed, if the proposed arrangements are toimprove the quality, authority and credibility, resultsof surveillance should provide a sound and legiti-mate basis for lending decisions by the Board. Butfor non-programme countries there would be no suchmechanism to encourage governments to heed thepolicy advice emerging from the surveillance proc-ess. Publication of surveillance reports and a widerdebate over policy could help prevent build up offragilities and vulnerabilities by providing signalsto market participants and creating public pressureon governments in need of corrective action, but evenan independent body responsible for surveillancecannot be expected to issue public warnings sincethey can become self-fulfilling prophecies. For G-1or G-3 countries whose policies set the terms andconditions in global financial markets, even suchwarnings may be of little use in encouraging policyreorientation or coordination.

Therefore, while independent surveillance mayimprove its quality, credibility and impact for non-programme countries, it cannot be relied on forbringing greater symmetry between creditor anddebtor countries. Such a step may need to be sup-plemented by reforms in many areas of governanceto be taken up in the following section. However,given the limits to improving significantly the lev-erage of the Fund over non-borrowing countries,evenhandedness may only be possible by minimiz-ing conditionality for programme countries andincreasing the degree of automaticity of their accessto the Fund in the ways discussed above.


H. Governance: making the Fund agenuinely multilateral institution

The debate over governance of the IMF hasfocused mainly on issues raised by exercise of powerby its major shareholders, particularly the UnitedStates. The most frequently debated areas of reforminclude the procedures for the choice of the Manag-ing Director and, more importantly, the distributionof voting rights. Shortcomings in transparency andaccountability are also closely related to �democraticdeficit� within the governance structure of the Fundresulting from the quota regime.

The postwar bargain struck between the UnitedStates and Western Europe for the distribution of theheads of the Bretton Woods institutions between thetwo shores of the Atlantic has survived widespreadpublic criticism and initiatives taken by developingcountries. The latest selection of the Managing Di-rector was again business as usual despite theapparent consensus reached during the previousround by the Board that the decision for selectionwould be based on a wide and open discussion in-volving all members of the Fund.47

There is a consensus among independent ob-servers that the present distribution of voting rightslacks legitimacy not only because it does not meetthe minimum standards for equity due to erosion of�basic votes�, but also because it no longer reflectsthe relative economic importance of the membersof the Fund.48 The existing distribution of votingrights, together with the special majority require-ments for key decisions, effectively gives a vetopower to the United States in matters such as adjust-


The proposals for reform for reducing thedemocratic deficit fall into two categories. First,changes could be made to special majority require-ments in order to remove the veto power of theFund�s major shareholders over key decisions. Sec-ond, and more importantly, voting rights could bereallocated so as to increase the voice of developingcountries. This could be done by increasing the shareof the basic votes in total voting rights and/or byreallocating quotas on the basis of PPP. The mainloser would be the European Union, which collec-tively holds almost twice as many votes as the UnitedStates, far above the level justified by the share ofthe region in the world economy. According to aproposal for restoring basic votes to its original shareof around 11 per cent of total votes and allocatingquota-based votes on the basis of PPP, the share ofindustrial countries would fall from over 62 per centto 51 per cent while that of developing countrieswould rise from around 30 per cent to 42 per cent(Kelkar, Yadav and Chaudhry, 2004, appendix 1).

There can be little doubt that a reform alongthese lines would constitute an important step inimproving the Fund�s governance. It would rectifyanomalies such as Canada holding the same numberof votes as China or smaller European countries in-cluding Belgium and the Netherlands holding morevotes than India, Brazil or Mexico, making the Fundlook a more participatory and democratic institution.Nevertheless, it is unlikely to make a significantimpact on the political leverage of its major share-holders or reduce the imbalance between its creditorand debtors.

The problems of governance and lack of uni-formity of treatment across members cannot be re-solved as long as Fund resources depend on thediscretion of a small number of its shareholders.Reserve currency countries are the principal credi-tors to the Fund and their quota subscription pay-ments provide the only usable international assetssince there is no demand for national currencies paidin by developing countries. Moreover, the Fund bor-rows not from international financial markets, butfrom a minority of its members under two standingarrangements, GAB and NAB. It is true that the dis-tinction between creditor and debtor countries is notthe same as that between industrial and developingcountries, and at the end of 2004 of the 45 creditorcountries to the Fund 9 were developing countries.However, unlike industrial countries, developingcountries� net financial position in the Fund has been

highly volatile. Almost all of the 44 countries whichhave switched, at least once, over 1980�2004 be-tween being net financial contributors to the Fundand being debtors, and back, are developing coun-tries (Boughton, 2005: 4). With increased frequencyof financial crises in emerging markets, this classi-fication, like international credit ratings, has becomehighly unstable. For instance the Republic of Ko-rea, Malaysia, Mexico and Thailand now are amongthe creditors of the IMF while they were heavilyindebted a few years ago. Again there is no guaran-tee that countries such as Chile and China whichhave been IMF creditors for some time will remainso in the years ahead.52

In trade, bilateralism is often seen as a threat tomultilateralism because of the preferential treatmentit accords to some countries at the expense of theothers in violation of the MFN principle, and therole played by political considerations in bilateraland regional trade arrangements. In the sphere offinance, by contrast, bilateral and multilateral ar-rangements are often seen as complementary. Asalready noted, in several instances the Fund�s inter-ventions in emerging market crises were combinedwith bilateral contributions from major industrialcountries, notably but not solely the United States,particularly where political, economic and militaryinterests were involved. Again, official debt reduc-tion initiatives combine bilateral and multilateraldebt, as in HIPC, and bilateral lenders often insistthat any talks in the Paris club should be precededby a formal IMF programme. Since bilateral lend-ing is driven largely by political considerations(Gilbert, Powell and Vines, 1999; Kapur and Webb,1994; and Rodrik, 1995) and bilateral debt negotia-tions rarely satisfy uniformity of treatment of debtors,such arrangements serve to subvert the governanceof the Fund further, thereby enhancing the scope tomake it an instrument for major industrial countriesto pursue their national interests.

A reform that would translate the Fund into atruly multilateral institution responsible for interna-tional monetary and financial stability with equalrights and obligations of all its members, de facto aswell as de jure, would call for, inter alia, an interna-tional agreement on sources of finance that do notdepend on the discretion of a handful of countries aswell as a clear separation of multilateral financialarrangements from bilateral creditor-debtor relations.The potential sources of genuinely multilateral fi-nance are twofold. First, an agreement could be


reached on international taxes, including the currencytransaction tax (the so-called Tobin tax), environ-mental taxes and various other taxes such as thoseon arms trade, to be applied by all parties to the agree-ment on the transactions and activities concerned(Atkinson, 2003; Wahl, 2005). A common featureof these is that they are all sin taxes which wouldprovide revenues while discouraging certain globalpublic bads such as currency speculation, environ-mental damage or armed conflict and violence.However, these sources of revenue are more appro-priate for development grants to poorest countriesor for the provision of global public goods ratherthan provision of liquidity for temporary paymentsimbalances.

A more appropriate source of funding for theprovision of international liquidity is the SDR. Un-der present arrangements the IMF may allocate SDRsto members in proportion to their quotas, but not toitself. Members obtain or use SDRs through volun-tary exchanges or by the Fund designating memberswith strong external positions to purchase SDRs frommembers with weak external position. When mem-bers� holdings rise above or fall below their allocationthey earn or pay interest respectively. These arrange-ments would need to be changed to allow the SDRto replace quotas and GAB and NAB as the sourceof funding for the IMF. The Fund should be allowedto issue SDR to itself up to a certain limit whichshould increase over time with growth in world trade.The SDR could become a universally acceptedmeans of payments, held privately as well as by pub-lic institutions. Countries� access would be subjectto predetermined limits which should also grow overtime with world trade. The demand for SDRs can beexpected to be inversely related to buoyancy in glo-bal trade and production and the availability ofprivate financing for external payments. Thus, itwould help counter deflationary forces in the worldeconomy and provide an offset to fluctuations inprivate balance of payments financing.

Several issues of detail would still need to beworked out, but once an agreement is reached to re-place traditional sources of funding with the SDR,the IMF could in fact be translated into a techno-cratic institution of the kind advocated by Keynesduring the Bretton Woods negotiations.53 Its fund-ing would no longer be subjected to arduous andpolitically charged negotiations dominated by ma-jor industrial countries. The case for creating SDRsto provide funding for the IMF for current account

financing is much stronger than the case for usingthem to back up financial bailouts associated with apotential lender of last resort function advocated bysome observers (e.g. Fischer, 1999) in so far as itcould help improve the governance of the Fund andreduce the imbalance between its creditors and debt-ors. Such a step, if supplemented by the kind ofreforms regarding its mandate, operational modalitiesand governance structure discussed earlier, wouldgive the Fund a chance to operate as an institutionfor all countries, rather than as an instrument of some.

I. Summary and conclusions

A genuine reform of the international financialsystem generally and the Fund particularly dependson developing countries forming a coherent view ona broad range of issues which, in turn, calls forgreater understanding of various options as well asextensive deliberations and consultations. This pa-per aims at contributing to this process. A mainconclusion that emerges from the discussions aboveis that the original rationale of the Fund, namely tosafeguard international monetary and financial sta-bility, is now even stronger than in the immediatepostwar era given the size and speed of internationalcapital flows and their capacity to inflict damage onthe real economy. Thus the Fund needs to go backto its core objectives and focus on preventing mar-ket and policy failures in order to attain greaterinternational economic stability and facilitate expan-sion of employment, trade and income. Realizationof this objective calls for reforms on several fronts:

� The Fund needs a greater focus. It should stayout of development finance and policy and pov-erty alleviation. This is an unjustified diversionand an area that belongs to multilateral devel-opment banks. All facilities created for thispurpose should be transferred to the World Bankas the Fund terminates its activities in devel-opment and long-term lending.

� A major task of the Fund is to promote a stablesystem of exchange rates and payments to en-sure a predictable trading environment. In thistask the Fund should focus on macroeconomicand exchange rate policies and stay away fromtrade policies. The attempts by the Fund to pro-mote unilateral liberalization in developing


countries drawing on its resources underminethe bargaining power of these countries in mul-tilateral trade negotiations.

� Crisis management and resolution is an increas-ingly important area of responsibility of the Fund.However, the Fund should not be allowed tobail out lenders and investors since such op-erations prevent market discipline and createlenders� moral hazard. Accordingly, thereshould be strict limits to the Fund�s crisis lend-ing. Instead, the Fund should help develop or-derly workout mechanisms for sovereign debtboth to prevent financial meltdown and torestructure debt which cannot be serviced ac-cording to its original terms and conditions.Temporary debt standstills and exchangerestrictions should thus become legitimate ingre-dients of multilateral financial arrangements.

� The Fund should focus on lending to financetemporary current account imbalances result-ing from external trade and financial shocks aswell as from domestic policy imbalances. Thereshould be greater automaticity in meetingpayments imbalances resulting from externalshocks and less emphasis on policy adjustment.Conditionality should not be extended to struc-tural issues but confined to macroeconomic andexchange rate policies.

� The Fund�s resources need to be increased tokeep up with growth in international trade.Access of countries to Fund resources shouldbe based on the principle of need, not on coun-tries� contribution to the Fund or their relativeimportance in the world economy.

� Fund surveillance has been ineffective in pre-venting emerging market crises. While theprimary responsibility for avoiding crises lieswith individual countries� own policy choices,the Fund has contributed to increased vulner-ability and fragility of emerging markets bypromoting premature capital account liberali-zation and failing to alert countries againstunsustainable surges in capital inflows, currencyappreciations and current account imbalances.Progress on this front depends on a fundamen-tal change in the approach of the Fund to capitalmarket issues. The Fund should improve itsability to identify risks and fragilities, and de-velop policy tools to prevent unsustainable

capital flows to emerging markets, includingdirect and indirect control mechanisms, andprovide policy advice.

� The Fund surveillance has also been unable toprevent destabilizing impulses originating frompersistent trade imbalances and exchange ratemisalignments in major industrial countries.This too is partly due to the poor quality ofpolicy analysis and assessment of market con-ditions. Separating surveillance from lendingdecisions and assigning it to an authority inde-pendent of the Board could improve its quality,legitimacy and impact. However, such a reformalone is unlikely to increase significantly theleverage of the Fund over non-programmecountries and eliminate the imbalance betweenthe Fund�s debtors and creditors.

� Any reform designed to bring greater author-ity and legitimacy would need to address short-comings in the Fund�s governance in severalareas including the selection of its head, thedistribution of voting rights, transparency andaccountability. However the Fund is unlikelyto become a genuinely multilateral institutionwith equal rights and obligations for all itsmembers, in practice as well as in theory, aslong as it depends for resources on a handfulof industrial countries and its financial activi-ties are intimately linked to bilateral debtor-creditor relations between donor and recipients.These problems could be overcome if the IMFceases to be an institution funded by its mem-bers, and relies on SDRs for the resourcesneeded.

Notes

1 The abolitionists include Walters (1994); Shultz, Simonand Wriston (1998); and Schwartz (1998). Friedman(2004) argues for closing down both the World Bankand the IMF on grounds that �they have done more harmthan good, and have the capacity for continuing to domore harm than good�.

2 See e.g. Clark (1990), Crook (1991), Shultz (1998),Burnham (1999) and Fischer (2004).

3 The list of reformists is much longer. The better knowninclude the report by the Meltzer Commission (2000)and suggestions made by the former Chief Economist ofthe World Bank, a stern critique of the Fund, JosephStiglitz (2002, particularly chap. 9; and 2003). See also


Boughton (2004) and a number of other articles in thesame issue of Finance & Development prepared on theoccasion of the 60th anniversary of the Bretton WoodsConference. For a review of several reports on the roleand reform of the IMF see Williamson (2001). The Groupof 24 research programme has produced several paperson the reform of the IMF, now jointly published byUNCTAD and G-24 and placed on their respectivewebsites. There are also many NGOs in the group ofreformists demanding profound transformation of boththe IMF and the World Bank.

4 For a discussion of the rationale for multilateral finan-cial cooperation and the Bretton Woods Institutions seeAkyüz (2005a, section I).

5 According to Raymond Mikesell, who was actually giventhe task of calculating the quotas: �Assigning quotas inthe Fund was the most difficult and divisive task of theconference ... The quota formula was not distributed, andWhite asked me not to reveal it ... I tried to make theprocess appear as scientific as possible, but the delegateswere intelligent enough to know that the process wasmore political than scientific.� Mikesell (1994: 35�36).

6 For an excellent account of the rationale and evolutionof IMF conditionality see Dell (1981). For more recenttrends see Jungito (1994), Kapur and Webb (2000), andBuira (2003a).

7 Performance criteria are specific preconditions for dis-bursement of IMF credit. Quantitative performance cri-teria include macroeconomic policy variables such asinternational reserves, monetary and credit aggregates,and fiscal balances. Structural performance criteria varywidely, but could include specific measures to restruc-ture key sectors such as energy, reform social securitysystems, or improve financial sector operations (IMF,2002).

8 After the 1969 amendment Article V, Sec. 3(c) statedthat the �Fund shall examine a request for a purchase todetermine whether the proposed purchase would be con-sistent with the provisions of this Agreement and the poli-cies adopted under them, provided that requests for re-serve tranche purchases shall not be subject to chal-lenge.�

9 This distinction is made by Helleiner (1999: 7) in thecontext of crisis lending. See also Mohammed (1999)who distinguishes between conditional and unconditionalliquidity in the same context.

10 See Akyüz and Flassbeck (2002: 98). The last standbyagreements with industrial countries were with Italy andthe United Kingdom in 1977 and Spain in 1978; see Fi-nance and Development. September 2004: 15.

11 In effect from 1974 to 1976, the oil facilities allowed theIMF to borrow from oil exporters and other countries ina strong external position and lend to oil importers; seeMohammed (1999: 53).

12 See Dam (1982: 284). For the implications of this mis-sion creep for Bank-Fund relations see Ahluwalia (1999).

13 Mikesell (2001: 1). For a discussion of mission creepsee Babb and Buira (2005).

14 For a view that the Fund does not provide developmentfinance but payments support see Boughton (2005: 10).

15 See Rodrik (1995) and Gilbert, Powell and Vines (1999).However, it is not clear if the Bank really meets theseexpectations; see Akyüz (2005a).

16 For an earlier call for merger see Crook (1991).

17 The most interesting example is the case of the Republicof Korea. In that country financial restructuring under-taken with the support of the Fund in response to the1997 crisis naturally resulted in an increase in govern-ment equities in financial institutions. This became abasis for a legal challenge in the WTO on grounds thatsuch measures constituted actionable subsidies: see WTO(2003, paras 8�10).

18 Yang (2005). See also Chauffour (2005). Interestinglythe benefits claimed from liberalization is very small,around $0.5 billion for entire sub-Saharan Africa exclud-ing South Africa (Yang, 2005, table 7), or on averagearound $10 million per country per annum, certainly notworth giving up policy options regarding tariffs. For acritical assessment of the costs and benefits of trade lib-eralization in the context of the current negotiations onindustrial tariffs see Akyüz (2005b).

19 See UNCTAD (1999, chap. IV), Santos-Paulino andThirlwall (2004), UNCTAD (2004, Part Two, chap. 5)and Kraev (2005).

20 Keynes (1944: 5). The same point is made by Shultz(1998: 15) who suggested that the IMF should meet inWTO setting rather than with the World Bank since �ex-change rates and trade rules are the two sides of the samecoin�.

21 IMF Press Release No. 99/14, 25 April 1999.22 For an earlier assessment along these lines see Akyüz and

Cornford (2002: 135). See also Goldstein (2000: 12�13)and IMF (2003a).

23 The dissenting members of the Meltzer Commissionpointed out that the most damaging proposals relate tothe IMF�s role in financial crises (Fidler, 2000); see alsoEichengreen and Portes (2000) and Wolf (2000). In thisrespect the Commission Report is not consistent. Aspointed out by DeLong (2000: 2) while it assigns a lenderof last resort role to the Fund for solvent but illiquidgovernments, it condemns the Fund for its loans toMexico in 1995 and recommends against any increasein the IMF�s resources. See Meltzer (2001) for his com-ments on the critics.

24 A suggestion along these lines was made by the Manag-ing Director of the IMF to the Copenhagen Social Sum-mit in March 1995, when he stated that an effective re-sponse to financial crises such as the Mexican one de-pended on �convincing our members to maintain, at theIMF level, the appropriate level of resources to be ableto stem similar crises if they were to occur�, adding thatthis should lead to a decision in favour of �further workon the role the SDR could play in putting in place a lastresort financial safety net for the world� (IMF Survey,20 March 1995). See also Mohammed (1999).

25 See Ezekiel (1998); United Nations (1999); and Ahluwalia(1999).

26 For a survey of empirical evidence on the effect of IMFintervention on debtor and creditor incentives see Haldaneand Scheibe (2003) who �find concrete evidence ofcreditor-side moral hazard associated with IMF bail-outs�(p. 1). See also Mina and Martinez-Vazquez (2002) whoconclude that IMF lending generates moral hazard in in-ternational financial markets from the perspective of thematurity composition of foreign debt.

27 The list of institutions and experts who put forward vari-ous proposals for mechanisms to overcome moral haz-ard and involve the private sector in the resolution of


financial crises includes the Group of 22 (1998), theCouncil of Foreign Relations Independent Task Force(CFRTF, 1999), the Emerging Markets Eminent PersonsGroup (EMEPG, 2001) and the High-Level Panel on Fi-nancing for Development (Zedillo, 2001). For a discus-sion of issues in bailouts and reform see Goldstein (2000),Haldane (1999), Akyüz (2002) and Eichengreen (2002).

28 A proposal to apply bankruptcy principles was made byUNCTAD (1986, annex to chap. VI) during the debt cri-sis of the 1980s. It was subsequently raised by Sachs(1995) and revisited by UNCTAD (1998: 89�93) duringthe East Asian crisis. For a further discussion see Radelet(1999) and Akyüz (2002). The idea of establishing or-derly workout procedures for international debt goesback even further. In 1942, in a report by the UnitedStates Council on Foreign Relations attention was drawnto interwar disputes between debtors and creditors andthe need was recognized for exploration of the possibili-ties of establishing �a supranational judicial or arbitralinstitution for the settlements of disputes between debt-ors and creditors� (Oliver, 1971: 20).

29 See IMF (2000). For further discussion of the debate inthe IMF see Akyüz (2002: 123�128).

30 See IMF (2003b) for a description of the SDRM andbackground information.

31 Boom-bust cycles characterize not only the postwar ex-perience, but almost the entire history of private capitalflows to developing countries. The boom in private flowsto Latin American countries that started soon after theirindependence around 1820 was followed by widespreaddefaults and disappearance of international liquidity tothe region until around 1850. Again the boom of the1920s was followed by widespread defaults and cutbacksin private lending in the 1930s. For a more detailed ac-count of these cycles see UNCTAD (2003, chap. II, andpp. 129�132), UNCTAD (1998, Part One, chap. III) andKregel (2004).

32 A �harsh economic scenario� recently simulated by theIMF (2005c: 8�10) includes a 30 per cent contraction inprivate flows to emerging markets, increased spread, dis-orderly dollar depreciation, lower growth and weak com-modity prices.

33 This view is also held by the majority in the MeltzerCommission (2000: 11). See also Gilbert, Powell andVines (1999: 622) who note that during the 1998 crisis�the Bank provided around $8 billion in short-term li-quidity in the packages of lending to Thailand, Indone-sia and Korea. This �defensive� lending had little to dowith promoting development (in the normal sense of thatexpression). If it were to be repeated, such emergencylending could severely destabilise the Bank�s normal de-velopment lending�.

34 See the joint paper by two senior officials of Bank ofCanada and Bank of England, Haldane and Kruger(2001).

35 These include a high probability that debt will remainsustainable and good prospects for the member to re-gain access to private financial markets within the timeFund resources would be outstanding (IMF, 2005c: 4) �conditions that failed to hold in the case of Argentina.

36 For a similar proposal see Kelkar, Yadav and Chaudhry(2004) who argue that contributions should be based on

member�s capacity to pay; access to resources should bebased on need; and voting rights should balance the rightsof creditors with the principle of sovereign equality.

37 See Executive Board Decision no. 5392-(77/63) adoptedon 29 April 1977.

38 Group of Ten (1985, para 40). For further discussion seeAkyüz and Dell (1987).

39 IMF Interim Committee Communiqué of 16 April 1998,Washington, D.C.

40 For the recent experience see Goldstein (2005b).41 For a discussion of policy issues in securing greater fi-

nancial stability see Kindleberger (1995), McCauley(2001), BIS (2001, chap. VII) and Akyüz (2004).

42 Because of such regulations Taiwan Province of China hasso far been denied the developed market status by FTSE,the global index provider jointly owned by the FinancialTimes and the London stock Exchange; see Hille and Song(2005: 3).

43 In a recent study of vulnerability of emerging markets toadverse global financial conditions, potential exchangerate problems and fiscal and monetary policy challenges,Turkey heads the list; see Goldstein (2005b, particularlytable 11). On external financial fragility of the Turkisheconomy see also UNECE (2005, chap. 4).

44 Indeed management of external liabilities was a key partof the report of the Financial Stability Forum on capitalflows. For a discussion see Cornford (2000).

45 See remarks by Camdessus on �How Should the IMF beReshaped?� Finance and Development. Sept. 2004: 27.

46 For a discussion of these issues see Cottarelli (2005);van Houtven (2004); Kelkar, Chaudhry and Vanduzer-Snow (2005); and Kelkar, Chaudhry, Vanduzer-Snow andBhaskar (2005). Some of these elements of governancereform have also been emphasized, to varying degrees,by the three former Managing Directors of the Fund, DeLarosière, Camdessus and Köhler; see �How Should theIMF be Reshaped?� Finance and Development. Septem-ber 2004: 27�29.

47 See IMF Press Release 99/56, 23 November 1999.48 See e.g. Woods (1998, 2001), Mohammed (2000), Buira

(2003b, and 2005), Kelkar, Yadav and Chaudhry (2004),and Kelkar, Chaudhry, Vanduzer-Snow, and Bhaskar(2005).

49 IMF (2004a: 72). For the definition of net financial po-sition in the IMF see Boughton (2005: 4�5)

50 The former Managing Director Köhler argues that �it�scritical for the IMF to maintain the spirit of consensus� [and] this is more important than numerical represen-tation�, while another former Managing Director DeLarosière confirms that this is indeed the case: �Duringmy years as a Managing Director, I do not rememberthat we ever counted votes.� Finance and Development.September 2004: 29.

51 See Buira (2003b: 4). Currently there are 30 developingcountries represented by EDs from industrial countries(12 by Australia, 10 by Canada, 6 by Spain, and one byItaly and Belgium each).

52 Mohammed (2000: 208) uses �structural debtors� and�structural creditors� to make the distinction betweenindustrial and developing countries.

53 For a brief history of the debate over IMF governancesee Cottarelli (2005: 6�9).


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