Chapter 7 – A Credit Union for Countries

A Credit Union for Countries

IF EVER THERE WAS an international “villain,” it surely must be the IMF. No international institution has been more condemned over the decades for being an enemy of the poor and subjugator of the Third World.

But the power the IMF once wielded has dissipated. On most counts, it has become a paper tiger, increasingly ineffectual and irrelevant. The IMF today is disliked not only by the Third World’s populace but also by Western bankers. As a lender, the IMF never carried much weight in any case.

At the end of the 1970s, the Third World owed the IMF only $8 billion. By 1985, at the height of the debt crisis, that sum peaked at $39 billion and today, it is under $32 billion, about a sixth of the $182 billion Third World debtors owe the World Bank, and almost one-fortieth of what they owe all creditors combined.

Another Keynesian inspiration, the IMF was designed to foster free trade and global prosperity by ridding the world of the protectionist, beggar-thy-neighbor policies which had led to the Great Depression. Keynes saw the IMF as an international credit union owned by countries instead of people that would regulate exchange rates to prevent unfair competition and ensure the smooth settling of international accounts. Together, the members made the rules; as in any credit union, members who borrow money are expected to repay it.

When the IMF began operations in Washington, D.C. in May 1946, it had 39 member countries. Today it has 155, rich and poor, all subject to the same rules. As a sort of membership fee, each member deposits into the IMF a certain sum of money, called a quota subscription, based on its wealth and economic performance. Countries pay the quota — which determines their votes in operating the fund and their borrowing limit — 75 per cent in their own currency and 25 per cent in gold or in a convertible currency such as the dollar or deutsche mark.

The IMF functions primarily to ensure that its members pay their international debts. When a member country cannot earn enough foreign currency to meet its obligations to other IMF members — when it has a balance of payments problem — it can borrow from the IMF pool to tide it over. To date, the IMF has lent members some $100 billion for this one purpose — the only purpose for which it lends.

A member can borrow 25 per cent of its quota (the portion in gold or secure currency), no questions asked. To borrow more requires submitting to IMF economic reforms: at this point the borrowing country has become a bad credit risk, and the IMF wants assurances that it, too, will be repaid.

The various assurances are geared to reducing government deficits and keeping the borrower solvent: a commitment to reduce its spending, a commitment to devalue its currency, and a commitment to encourage exports. Strictly speaking, the details of the reforms — where to apply government spending cuts, how to increase exports — are left to the borrowing government. Fearing accusations of infringing on a member’s sovereignty, the IMF has as its only official concern “that the policy changes are sufficient to overcome the member’s payments problem and do not cause avoidable harm to other members.” Nevertheless, the IMF controls the purse strings. After often months of negotiations and advice from the IMF, borrowing governments well understand which reforms they need to adopt.

The IMF’s attempts to impose austerity have earned it a reputation as a heartless interventionist in the Third World’s economic sovereignty. What clout the IMF commands stems from its role as regulator and overseer of the Third World’s debt.

The IMF applies a borrowing seal of approval for foundering borrowers’ economies. Without an IMF-approved austerity package — which once demonstrated a borrower’s willingness to right its economy — few private bankers, or even the World Bank and the other regional development banks, would agree to lend more money or reschedule old debts. Third World countries on the brink of bankruptcy were thus held hostage until they agreed to an often-stringent IMF plan. But obtaining the IMF’s seal — which has failed to protect lenders even when the austerity package was strict — means less today to lenders, who want more meaningful security, and so less to borrowers, who no longer can be assured of credit by buckling under to this one agency. To most lenders, the IMF has little more influence than a rating agency such as Standard and Poors or Moody’s; lenders note the borrower’s rating, but need more than a rating agency green light to extend a loan.

Nevertheless, few Third World debtors — if they want to keep borrowing — can avoid the IMF’s recommendations, although debtors sometimes do successfully dig in their heels, and not always to the benefit of the populace: “To our distress, but not to our surprise,” said IMF Managing Director Michel Camdessus, “we have found that in the end military and security expenditures are those that resist the adjustment effort most strongly.”

WHY SOME CREDITORS continue to place faith in the IMF’s analysis, and in its prescription for recovery, is a mystery. The IMF has blundered badly, particularly in African countries which have generally sunk deep into debt, and where balance of payment problems have become too chronic for mere IMF quotas.

Even the IMF’s role as a credit union for countries has been compromised. Abandoning its traditional conservatism, the IMF has become just one more public bailout body by inventing extraordinary lending mechanisms. To its traditional quota system it layered “special” facilities upon “supplementary” facilities upon “extended” facilities upon “enhanced” facilities, all to allow member countries to borrow up to four times their quotas. Debtors can now take ten years — instead of the usual one to five years — to pay the money back, and at subsidized interest rates. And although the IMF doesn’t admit it, it now round-trips its loans, much as the World Bank does.

By relaxing its standards, the IMF’s judgment has become tarnished in banking circles. Allowing Third World governments unprecedented overdrafts on their IMF accounts, though providing temporary relief, deepened the debt crisis. The IMF now finds itself with eleven members in arrears in excess of $4 billion.

But the bankers’ scorn for the IMF reached new heights in 1989 when the IMF abandoned the sacred banking creed of pacta sunt servanda — contracts must be honored — by publicly stating that Third World countries couldn’t — and therefore shouldn’t — make good on their obligations. Many Third World countries soon stopped or further slowed their payments to the commercial banks: within two years, their interest arrears had tripled, from $7 billion to $22 billion.

The IMF generally targets heavily subsidized activities such as food and energy to bear the brunt of budget cuts. Sometimes these have favorable effects on the economy, environment, or the poor. Ghanaian farmers earned more for their crops, and Ghanaian city dwellers paid less for their rents, with the removal of price controls. But for last-minute lobbying inside Brazil, the IMF almost succeeded in canceling the Balbina dam; similar IMF pressure to remove electricity subsidies to large industries did diminish the demand for more hydrodams, saving the Brazilian economy billions. A 1991 IMF-induced austerity program in Egypt removed subsidies from fuel — protecting the environment by discouraging wasteful vehicular use.

Sometimes these budget cuts hold promise, but only in theory, of benefiting the poor. Egypt imports most of its wheat — 5.2 million of the 8.1 million tonnes it consumes — because it keeps the price of baladi (its local bread) so low. At 5 piastres, or 1.8 cents, a loaf — only enough to cover the costs of shipping the wheat from the port to the flour mills — the policy has become ludicrous: bread sells for less than wheat, leading farmers to feed it to cattle instead of feed, and making Egypt the world’s third largest wheat importer, after the USSR and China. Egypt’s IMF austerity policy will remove bread subsidies — necessary if the country is to regain its self-reliance and avoid sinking further into debt, but beneficial to the poor only if the subsidies saved on the poor’s bread consumption are redistributed to them — an unlikely occurrence, given the history of IMF adjustment programs.

IMF policies tend to be counterproductive, especially for the Third World’s poor, justifying the poor’s near-universal reluctance to accept IMF medicine for their economy’s ailments.

In a 1988 report analyzing the effect of its adjustment programs on seven Third World countries, the IMF admitted that its miscalculations affected large groups of the urban poor in Chile, the Dominican Republic, and the Philippines following currency devaluations. In the Philippines, for example, spending on health and schools was cut, import restrictions raised prices sharply, and restrictions on the money supply cost jobs and lowered wages. In the Dominican Republic, its policies led to “major social unrest” in which 50 people died in rioting.

“Although many of the major policy instruments improved the position of the dominant poverty groups in the sample countries, other poverty groups were made worse off in the short run,” the report said, adding elsewhere that in Kenya and Sri Lanka its policies may have hurt the poor in the long run as well as the short run.

IMF policies are fed through its Washington computer models, which recommend devaluations and tax hikes to fight the Third World’s rampant inflation and hunger for imports. These macroeconomic measures — utterly divorced from the actual workings of Third World economies — routinely increase inflation and lower tax revenues, as the Third World’s citizenry devise defenses against policies that attempt to manipulate them.

The IMF’s poor record, concludes Hernando de Soto, the celebrated author of the The Other Path and president of the Lima-based Institute for Liberty and Democracy, stems from its top-down approach.

De Soto lauds IMF goals such as privatization and liberalizing foreign trade, noting that they coincide with policies supported by a public groundswell. Peru’s informal transportation operators — 300,000 taxi drivers, truckers, and other private entrepreneurs — demonstrated their distaste for protectionism by successfully lobbying the government to remove tire import duties which, by inflating tire prices 250 per cent, protected only Goodyear of Peru and its local workforce of 1,258. The duties raised the public transportation costs of 5 million riders, and cost the economy over $100 million.

Such “bottom-up structural adjustment” works, de Soto says, when the citizenry’s views can be incorporated into the enactment of rules and policies. But generally, in Peru as in other places,

the state receives no input from those affected by its decisions. Thus, the state does not govern in accordance with the interests of the majority. As a result, structural adjustment “from the bottom up” is impossible. This makes the IMF and foreign governments appear “imperialistic” and causes the poor undue hardship because they do not realize who the proposed adjustments are affecting.

Chastened by its findings, the IMF has come to recognize the shortcomings of top-down structural adjustment. “Adjustment does not have to lower basic human standards,” said Camdessus in the introduction to the IMF’s 1988 report. “The more [that] adjustment efforts give proper weight to social realities — especially the implications for the poorest — the more successful they are likely to be.” Yet the IMF keeps its operations strictly off-limits to the public, determining structural adjustment packages, austerity measures, taxes, and government expenditures, behind closed doors. IMF plans — being centrally and remotely designed, without the benefit of public input and public debate, away from the homes and markets of the Third World — become prone to serious miscalculations.

The hurdle impeding a successful IMF — how to “give proper weight to social realities” in countries around the globe from its vantage point in Washington, D.C. — is almost certainly insurmountable, and does much to explain the IMF’s abject failure.

Like other public lenders, the IMF now needs a bigger pipeline to move ever larger sums of money to the Third World. Also like other public lenders, to do this the IMF has convinced its members to raise its capital base, in its case by 50 per cent to $180 billion.

But the IMF alone cannot be blamed for the failure of its economic reform packages. While it preached prudence, other lenders practiced profligacy.

Sources and Further Commentary

For basic information on how the IMF operates and its financial history see 1990 International Monetary Fund Annual Report, Washington, D.C., 1990; What is the International Monetary Fund? by David D. Driscoll, IMF, Washington, D.C. (no date); The IMF and the World Bank, How Do They Differ? by David D. Driscoll, IMF, Washington, D.C., July 1989; Ten Common Misconceptions About the IMF, External Relations Department, IMF, Washington, D.C., 1989; Helping the Poor, the IMF’s New Facilities for Structural Adjustment, by Joslin Landell-Mills, IMF, Washington, D.C., 1989; The Alleviation of Poverty Under Structural Adjustment by Lionel Demery and Tony Addison, The World Bank, Washington, D.C., 1987. See also “The International Organization of Third World Debt” by Charles Lipson in International Organization, vol. 35, Autumn 1981, for a good description of the power the IMF has wielded over the years and why.

Keynes’s thoughts turned to setting up an international monetary authority in the early 1940s. In his first draft of an international “Clearing Union” he explained: “We need a central institution, of a purely technical and non-political character, to aid and support other international institutions concerned with the planning and regulation of the world’s economic life.” After much negotiation with the other advocates of such a system, the Americans, a scheme for the International Monetary Fund emerged. For details of Keynes’s early proposal, and the negotiations over the structure of the IMF, see The Life of John Maynard Keynes by R. F. Harrod, Augustus M. Kelly, 1969.

For details of the conditions the IMF imposes on borrowers see Fund Conditionality: Evolution of Principles and Practices by Manuel Guitián, IMF, Washington, D.C., 1981. See also personal correspondence with Mr. Azizali F. Mohammed, Director of External Relations Department, November 9, 1990, including excerpts from the draft Letters of Intent for Venezuela (March 1989) and Brazil (1990). IMF Managing Director Michel Camdessus’s comment about the ability of military expenditures to survive austerity measures was made at a press conference at the annual meeting of the IMF in 1989, Washington, D.C.

Various articles have addressed the issue of the IMF’s growing irrelevance, its relaxation of banking standards, and the loss of respect for it in banking circles. They include: “Back It Or Scrap It” from Euromoney, U.K., September 1990; “The IMF Dead in the Water?” by Richard E. Feinberg and Catherine Gwin in The International Economy, September/October 1989; “Caught in the Muddle,” editorial by William A. Orme Jr. in Latin Finance, New York, no. 20, September 1990; “Fatter IMF purse won’t fatten Third World” by Alan Stoga in The Wall Street Journal, June 12, 1990; “Third World interest payments arrears have surged since Bush Plan began” by Peter Truell in The Wall Street Journal, October 3, 1990; “Still Exposed After All These Years” by Andrew Froman, in Latin Finance, New York, no. 20, September 1990; “Banker’s Tapes” in Annual Meeting News, Washington, D.C., September, 1990.

For details on the effectiveness of IMF policies, see the following: “IMF is facing the possibility of default on billions of dollars in African loans” by Art Pine in The Wall Street Journal, April 10, 1985; “Industrial nations struggle to prevent African defaults on loans from IMF” by Art Pine in The Wall Street Journal, July 25, 1985; “IMF’s debtors in Third World pay back more” in The Globe and Mail, Toronto, February 2, 1988; “Some IMF policies have hurt the poor, report acknowledges” in The Wall Street Journal, June 1, 1988; “The Politics of Bread” in A Special Supplement to Euromoney, U.K., September 1990; “A Latin American view of the Brady Plan” by Hernando de Soto in The Wall Street Journal, May 19, 1989; “Argentina’s monetary tango” by Armando P. Ribas in The Wall Street Journal, February 16, 1990. Also see The IMF, the World Bank and the African Debt vols. 1 and 2, edited by Bade Onimode, Zed Books, London, 1989 for excellent detail on the problems with IMF policies. The IMF’s near success at canceling the Balbina dam in the Brazilian Amazon is described in Dr. Philip M. Fearnside’s paper, Brazil’s Balbina Dam: Environment Versus the Legacy of the Pharaohs in Amazonia, INPA, Manaus, Brazil, 1989.

The IMF report which analyzes the effect of IMF programs in seven Third World countries is called The Implications of Fund-Supported Adjustment Programs for Poverty: Experiences in Selected Countries by Peter S. Heller, A. Lans Bovenberg, Thanos Catsambas, Ke-Young Chu, and Parthasarathi Shome, The International Monetary Fund, Washington, D.C., May 1988; also see Development Issues: Presentations to the 39th Meeting of the Development Committee, no. 26, Development Committee, Joint Ministerial Committee of the Boards of Governor of the World Bank and the IMF on the Transfer of Real Resources to Developing Countries, Washington, D.C., September 24, 1990.