IMF policy needs a serious rethink

The first major jolt to the International Monetary Fund’s (IMF’s) thinking regarding pursuing austerity policy came in the inability of austerity policy to neither allow eurozone area to reach needed macroeconomic stability, nor enable providing stimulus to effectively deal with the aftermath of the global financial crisis 2007/08.

Yet, while internal research at the IMF reached this understanding, in addition to seeing practice of austerity increasing income inequality, and poverty levels, and encouraged IMF to avoid pursuing procyclical policies, especially during a low economic growth, higher inflationary and debt levels situation, especially in developing countries, yet the same is yet to effectively get reflected in policy prescription by the IMF — both generally and with even more pressure through conditionalities to programme countries like Pakistan.

The IMF’s procyclical-, austerity policy stance, in an overall neoliberal thought process-based mantra of the Washington Consensus on one hand, and policy choices influenced by the same mindset carried by policymakers at the back of their education in mainstream western universities – and a number of local universities wrongly aping the same over the years – producing ‘Chicago Boys’-styled economists led to a number of generalised consequences across already economically fickle programme/prolonged users of IMF resources.

Firstly, limited government as mainly ‘facilitator of private sector’, and less regulation under the wrongly coveted held notion of ‘market fundamentalism’ misguided investments – foreign and domestic alike – into activities that brought quick profits, but which weakened the capacity of governments mainly at the back of years of outsourcing, and limited sphere of activity to deliver services like infrastructure, education and health effectively, deeply, and broadly to make the economy much more resilient against shocks like the Covid pandemic, related supply shocks, which were accentuated by another shock of the war in Ukraine.

Secondly, at the back of seeing inflation mostly as a monetary phenomenon, especially when traditionally inflation in developing countries with quite shallow financial depth, meant that it was at least equally a fiscal/governance related phenomenon.

In addition, more recently, with strong supply-side shortages – at the back of pandemic, and the war in Ukraine exposing years of less regulation, and role of weak and limited governments under the overall neoliberal assault keeping economic sectoral linkages weak in the face of shocks - significantly feeding into cost-push inflationary channel overall meant the need to adopt a more balanced policy approach.

Yet, IMF policy conditionalities, and neoliberal thought process dominance at major central banks globally, on the contrary, led to a lopsided usage of monetary tightening, which not only has not allowed lowering of inflation effectively in either global North or South, so to speak.

Hence, while cost-push inflation increased almost everywhere, in the case of developing countries, overboard monetary tightening caused significant imported inflation at the back of capital flight, weakened domestic currencies; while debt distress in developing countries also increased.

Nobel laureate in economics, Joseph E. Stiglitz, in his recent article ‘All pain and no gain from higher interest rates’ published in Project Syndicate (PS) – and based on a recent thorough research analysis ‘The causes and responses to today’s inflation’ by Joseph E. Stiglitz, and Ira Regmi, and published by the Roosevelt Institution – criticised this wrongly placed monetary tightening approach of going overboard with it – especially given the strong supply-sided nature of inflation – to the extent of putting in strong long-term recessionary currents globally.

He pointed out in this regard in the article that ‘Central banks’ unwavering determination to increase interest rates is truly remarkable. In the name of taming inflation, they have deliberately set themselves on a path to cause a recession – or to worsen it if it comes anyway.

Moreover, they openly acknowledge the pain their policies will cause, even if they don’t emphasise that it is the poor and marginalized, not their friends on Wall Street, who will bear the brunt of it. …The Roosevelt report also dispenses with the argument that today’s inflation is due to excessive pandemic spending, and that bringing it back down requires a long period of high unemployment.

Demand-driven inflation occurs when aggregate demand exceeds potential aggregate supply. But that, for the most part, has not been happening. Instead, the pandemic gave rise to numerous sectoral supply constraints and demand shifts that – together with adjustment asymmetries – became the primary drivers of price growth.’

This policy of excessive aggregate demand squeeze through pursuing/recommending procyclical/austerity policy by the IMF and by central banks, especially by countries currently under IMF programmes and facing its conditionalities, needs to be revisited by the IMF.

As has been indicated by Stiglitz above — among many other voices for some time now – has indicated that monetary tightening has gone much more overboard than needed, and given the fact that it works with a significant time lag, longer recessionary, and in many places stagflationary currents will have to be dealt with as a consequence of this policy.

This is in addition to the higher debt repayments levels, and greater cost of borrowing that countries, especially a number of developing countries, will continue to face; in turn, keeping default risks higher for a number of developing countries, including Pakistan, and leaving little fiscal space with them to make the needed stimulus and development spending otherwise needed for moving towards a green, resilient, inclusive, and higher levels of economic growth.

If this much economic misery was not all that the developing countries in particular had to face, especially in the wake of lack of enhanced special drawing rights (SDRs) allocation by the IMF while calls for allocation in this regard are being made widely for a number of months now, and inadequate provision of debt moratorium/relief provided to them, the IMF, including a number of its main shareholders on its board, continue to not cancel the unjustified policy of charging ‘surcharges’ on late payments of IMF loans by borrowing countries; especially in the wake of the pandemic, climate change related disasters, and the war in Ukraine.

An article ‘IMF shareholders deeply divided over Pakistan, other countries request to suspend loan surcharges’ carried by this newspaper on December 13, pointed out in this regard: ‘The International Monetary Fund’s executive board on Monday discussed the surcharges it collects from mostly middle- and lower-income countries on larger loans that are not repaid quickly, but failed to agree to launch a formal review.

Argentina, Pakistan and others are pushing the IMF to drop - or at least temporarily waive - the surcharges, which the IMF estimates will cost affected borrowers $4 billion on top of interest payments and fees from the start of the COVID-19 pandemic through the end of 2022.

The United States, Germany, Switzerland and other advanced economies oppose a change, arguing that the fund should not change its financing model at a time when the global economy is facing significant headwinds.’

It is indeed strange, and makes no sense at all that possible dangers are being seen to be posed to global financial stability by not charging these surcharges, given while they meaningfully add to the already high debt burden of many developing countries, these amounts are quite insignificant in the global context of trillions of dollars of flows; not to mention that the practice of charging ‘surcharges’ from already financially vulnerable countries that borrow from the IMF to avoid serious balance of payments and/or debt repayment stresses, are a totally unjustified policy by IMF.

Moreover, even seen from the need of the IMF to build its ‘precautionary balances’ a December 8, Center of Economic and Policy Research (CEPR) published article ‘IMF surcharges can be removed as precautionary balances are safely within target’ the current amounts already received in this regard leaves no further need to continue this practice; in addition to the fact that money accrued from surcharges have a very insignificant contribution to IMF’s overall lending pool of resources.

The article pointed out in this regard: ‘Surcharges are additional fees that the IMF charges countries with relatively large and long-term loans; they significantly increase the debt payments that these countries must make to the Fund, siphoning away scarce foreign exchange and budget resources. When the IMF has positive net earnings, they are retained and added to its “precautionary balances,” a subsection of its capital reserves.

The Fund has an indicative target in the range of SDR 20–25 billion ($26.0–32.5 billion) for its precautionary balances, and a floor of SDR 15 billion ($19.5 billion). As of April 2022, the Fund’s precautionary balances were SDR 20.9 billion ($28.1 billion). Based on its first quarter net operational income and this year’s gross lending income, I estimate that as of November 2022, the IMF’s precautionary balances have reached SDR 23.0 billion ($30.2 billion). …Yearly surcharge income is an almost negligible 0.18 percent of the IMF’s total resources available for lending. The Fund’s lending power is not genuinely impacted by surcharges.’

Hence, it is important that the policy of surcharges should be immediately discontinued, as the same CEPR published article further indicated in this regard: ‘In the context of rapidly rising interest rates, the IMF’s basic lending rate is increasing and, with it, its regular lending income. Surcharges are an unnecessary burden on debtor countries.

The IMF does not publish country-by-country details on surcharge payments, but it is clear that the marginal interest rate of the main surcharge-paying debtors is now over 6.8 percent. Surcharges are not mentioned anywhere in the IMF’s Articles of Agreement. To the contrary, the founding treaty establishes a unique, de facto senior-creditor-status rate of charge for all debtor countries.’

At the time of enhanced SDR allocation in August 2021, where most allocation went to rich, advanced countries, although it was the developing countries that needed this allocation the most, serious logical flaws in the way quota sharing formula existed at the IMF came into focus, but nothing has been done in this regard insofar as this writer’s knowledge on this matter is concerned.

It is, therefore, exceedingly important that the IMF should revisit the policy of quota sharing, so that it does not work on the principle of how much an individual country contributes to IMF’s overall pool of resources, which is intrinsically flawed, given those who can contribute more need less support.

Hence, SDR allocations should appropriately reflect ‘needs’ rather than ‘contribution capacity’ of countries, especially in the wake of climate change related shocks being faced by developing countries, a number of which are highly vulnerable in this regard, whereby countries need adequate level of enhanced SDR allocation as was done for pandemic, and as being suggested under ‘The Bridgetown Initiative’ that SDR allocations are made an annual feature for climate change preparedness by countries, especially vulnerable, developing countries.

A December 8, ‘Bretton Woods Project’ published article ‘IMF quota review: putting climate at the core of IMF governance reform’ provided some suggestions with regard to quota sharing reforms as follows: ‘To give more decision-making powers to countries most impacted by climate change and incentivise all countries to cut emissions, we propose a necessary update to the International Monetary Fund’s (IMF) quota formula by adding a variable representing member states’ share of cumulative (i.e. historical) carbon dioxide (CO2) emissions. …Calls for a new $650 billion SDR allocation have been backed by over 150 civil society organisations.

The issuance is a decision made by the IMF Board of Governors. Furthermore, climate-linked SDRs would benefit vulnerable countries of the Global South the most, but the voting power needed to reach that decision rests with advanced economies of the Global North. …Terms of lending directly impact low- and middle-income nations’ fiscal ability to combat climate change, and their low voting power prevents them from influencing how the IMF will incorporate climate-related risks into its operations.

From a fiscal perspective, higher quotas would increase developing countries’ debt-free SDR financing in a new allocation and would increase their access to conditionality-free rapid emergency loans.’

Copyright Business Recorder, 2022