If major economies had not tipped into negative growth territory, it was mainly because of the buoyancy of the consumer spending in the US backed up by cheap credit and the rising prices of houses. The financial sector has held up rather well - without any major banks declaring bankruptcy - mainly because the banks have learnt to off-load risk to the others that have sprung up in the fast evolving financial sector. But how long will this situation be sustained Whether the house price boom and the consumer spending will continue to hold up or not is a matter for debate. The little growth that is there is proving to be jobless growth. Will the whole financial system unravel as housing prices collapse, and the new credit risk bearers find that they can no longer sustain their operations
When the Governors of the Fund and the Bank meet next week, one hopes they will concern themselves with these hugely important questions. But will they The irony is that the Fund which was set up mainly to safeguard the macro-economic health of the international economy by preventing beggar-thy-neighbour policies - and provide liquidity to ward off deflationary policies in times of crisis - has for some time abdicated its role as the guardian of global stability. It is now mainly an instrument of fire-fighting operations in respect of debt-ridden middle income developing countries such as Argentina, Brazil and Turkey. The role of macro-coordination among the major industrial countries has lapsed by default: the G7 countries - and the G10 - try to do a bit of this, but off late the G7 countries have become less sanguine in using their forum for coordinating their economies. It now mainly serves as a club of the rich, more political than economic.
The Governors of the IMF should be addressing these lacunae next week: they should be concerned with the external impact of the policies of the major industrial countries - not only on each other, but also on the developing world. But the Funds surveillance discussions with major industrial countries seem to shy away from that original purpose. What we now have is bilateral diplomacy, such as the US Treasury Secretarys call on Asian countries - particularly China - to revalue their currencies - so that the US can ward off the deflationary threat through better trade prospects. The ability of the Fund to get the industrial countries to consider the impact of their policies on each other and in particular on the developing countries seems to be limited.
This inability is partly linked to the lack of effective developing country voice in the decision making bodies of the Washington institutions. The present quotas in the Fund, which in turn decide the voting strength of different constituencies, are heavily lop-sided, giving the US and Europe more than due proportion of voice in the running of these institutions. There was some discussion of how to strengthen the developing country voice in the spring meetings in Washington. An idea that India and many others have been interested in is to recalculate quotas on the basis of GDPs valued at purchasing power parities (PPP) that would correct some of these anomalies.
For example, China which has a GDP at ppp that is more than one-and-half times that of Canada, has a voting strength that is similar to that of Canada. The US and European countries have been resisting reform in this area. One reason cited is that creditor countries should have a weight - as ultimately, the health of the IMF will determine whether they will get back their money. This is flawed on two grounds. Firstly, the IMF does not exist just to lend money: it is a forum where countries - both surplus and deficit - should come together to discuss global coordination and modify their policies in the interests of global stability and growth. Secondly, the IMF should be allowed to create its own liquidity through the issue of SDRs in meeting the vastly increased need for emergency financing in the face of expanded and volatile capital flows in the world today. The idea, therefore, that IMF can operate only if some countries lend money to it is somewhat weakened.
A major pre-occupation in the Fund is the question of how to prevent financial crises that affect not only the countries in which they originate but also the wider world. For this purpose it is following a three track approach:
First, it is promoting Standards and Codes in the banking sector coupled with a financial sector assessment programme, with the overall objective of promoting healthy financial sectors. Having standards and codes issued does not bypasses the problem of systemic failure; a rigorous enforcement of codes and standards could even make banks behave in a pro-cyclical manner! There is also the possibility that the codes and standards, when rigorously enforced, might induce such a degree of belief in the underlying safety and health of financial capital, it could accentuate short term capital flows across the globe, only ready to stampede out at the slightest hint of trouble - thus exacerbating the problems of the developing world. Perhaps, there is some thing to be said for a little bit of sand in the system, keeping in mind the law of unexpected consequences that is always at work in human affairs!
Second, to improve the global system for handling the debt crises it is getting the private sector to bear some of the risk of lending they undertake by involving it in developing debt-restructuring packages, so that they bear some of the risk of non-payment. The international banking community sees the IMF as its debt-collector, and the IMF has indeed been behaving that way in the name of preserving financial stability and keeping the credit lines open to developing country borrowers. The result is that bankers are happy to lend recklessly, in the expectation that the IMF would bail them out should things go wrong. The IMF is now trying to the development of collective action clauses and the like are meant to advance the involvement of the private sector lending to market led solutions - but as yet this is not making much headway.
Third, to prevent crises it is providing contingent credit, so that developing countries could borrow at the hint of trouble much in the way a commercial bank can borrow from the central bank of its country in times of a run on it. But the Contingent Credit Line established by the Fund in 1999 remains unutilised to date: no one wants to give hint of trouble by approaching the Fund to prevent a possible crisis! Such is the value of transparency in international relations!
(The writer is Visiting Professor, Administrative Staff College of India, Hyderabad, and was formerly a Director at the Commonwealth Secretariat, London)