The IMF Undergoing Change

Helene Kronholm Bohn-Jespersen, Economics

INTRODUCTION AND SUMMARY

Towards the end of 2008, the escalating global financial crisis brought the International Monetary Fund (IMF) back into focus in international economic-policy cooperation. The EU and G20 discussions on reforming the international financial system showed broad support for the IMF as a central institution in the efforts to design a more effective global finan cial architecture. Since the Annual Meetings of the IMF and the World Bank held in Washington in October, a number of countries that have been particularly severely hit by the crisis, including Ukraine, Hungary, Iceland and Pakistan, have concluded agreements with the IMF on large-scale loans. After several years of futile deliberations, the IMF intro duced a new lending facility in October, the Short-Term Liquidity Facility (SLF), which provides large short-term loans without the normal binding economic-policy requirements. The facility is aimed primarily at emer ging market economies with track records of sound economic policies.

The increased focus on the IMF follows a period characterised by historically low levels of new IMF lending commitments, cf. Chart 1. Until recently, new lending commitments were largely limited to concessional loans to low-income countries.

The low-lending environment called for a reform of the IMF's finances. Furthermore, adjustments of the influence the IMF's 185 member coun tries in the organisation to better reflect their relative weight in the world economy characterised the IMF's work in 2007 and the first half of 2008. The quota and voice reform was adopted by the IMF's Board of Governors in the spring of 2008. The required amendments to the IMF's Articles of Agreement are now awaiting approval by the member coun tries before the reform can be implemented. Denmark approved the proposed amendments to the Articles of Agreement on 2 October 2008.

The IMF has been modernising its activities over the last couple of years according to a medium-term strategy. Attention has mainly been focused on the framework for ongoing surveillance, analysis and advice in relation to both individual member countries' economies and the world economy. The aim has been to strengthen financial stability sur veillance and increasingly to include developments in financial markets and financial systems in macroeconomic analysis. Additionally, focus on the countries' external stability has been sharpened. The financial crisis has emphasised the need for the IMF to improve its ability to detect danger signals earlier and to provide advice on the best possible inter vention methods.

The IMF's management has also undergone substantial changes over the past year. On 1 November 2007, Dominique Strauss-Kahn, former French finance minister, assumed office as the new Managing Director of the IMF. He replaced former Spanish finance minister Rodrigo de Rato, who held the office for only about three years out of the normal five-year term. In connection with the reform of the IMF's own finances and the slimming of the organisation, the managements of most depart ments were replaced during the past year. Moreover, a new chairman, Egyptian finance minister Youssef Boutros Ghali, was appointed for the IMF's advisory committee, the International Monetary and Financial Committee, IMFC. He is the first IMFC chairman elected outside the in dustrialised countries.

This article outlines the development during the past year¹ and the priorities of the IMF's work programme for the near future.

THE IMF QUOTA AND VOICE REFORM

Following protracted and often complex negotiations the IMF's Execu tive Board managed to reach an agreement on a quota and voice reform in March 2008. The reform increases the relative voice in the IMF of the emerging market economies and the poorest countries, thus acknow ledging that a larger number of countries will play key roles in the global economic development now and in the future. The decision ended the process that was launched at the IMF Annual Meeting in Singapore in September 2006 where the member countries, including Denmark, approved an immediate increase in quotas for China, Korea, Mexico and Turkey. The reform is outlined in Box 1.

The reform will result in an overall shift in quota shares of 4.9 percent age points and a shift in votes of 5.4 percentage points. 54 countries will get a quota increase, while 135 countries will be given greater voting power; the tripling of the basic votes will be of great consequence. The reform means a shift in quota shares of 1.1 percentage points from the industrialised countries to the emerging market economies and low-income countries and a shift in votes of 2.7 percentage points. The EU will see its total voting power decline, thus contributing the bulk of the quota shift to the emerging market economies and low-income coun tries. China, Korea, India, Brazil and Mexico are among the countries whose voting power will increase the most as a result of the quota re form, cf. Chart 2. The reform will mean a minor decrease in the Nordic-Baltic constituency's total voting power. Denmark's voting power will in crease from 0.76 per cent to 0.78 per cent.

No country got everything it wanted during the complex negotiations and particularly the wish for a more transparent and simple formula could not be met. However, all countries got a globally improved repre sentative institution, which will support the IMF's legitimacy and effi ciency. Moreover, the decision is dynamic, given the requirements for further adjustment every five years.

REFORM OF THE IMF'S FINANCES

Low demand for IMF loans in recent years has caused the IMF's revenue base to dwindle, as a large proportion of IMF's administrative costs are financed by interest-rate margin on lending. In 2006, the IMF adopted temporary measures to address the declining revenue base, including drawing on its reserves. Furthermore, an investment account was estab lished with a view to obtaining a higher return on the reserves. In 2007, discussions were initiated for more permanent solutions to ensure the revenue base, on the basis of a report prepared by an external commit tee chaired by Andrew Crockett. The report's starting point was a new IMF income model with separate financing of the IMF's three core ac tivities (surveillance, lending and technical assistance). The provision of public goods such as surveillance was to be financed by the member countries in general, while lending was still to be financed by the interest-rate margin on lending. Other bilateral services, e.g. technical assistance, were to be financed by the recipients and/or by bilateral donors².

Based on the recommendations of the report, the IMF's Executive Board adopted an overall package in April 2008 concerning new sources of revenue of approximately 300 million dollars per year. The key elem ents of the income reform are described in further detail in Box 2. At the same time agreement was reached on spending cuts of approximately 100 million dollars over the next three years. Staff reductions by just under 400 employees (out of some 2,900) will account for the major part of these savings, while the rest will be achieved by streamlining and reprioritising the Fund's tasks. The staff reduction has proved to be at tainable by voluntary retirement to be completed by 1 May 2009.

The overall income reform was approved by the Board of Governors on 5 May 2008. Following the Board of Governors' approval, as was the case of the quota reform, the IMF member countries have to express whether the required amendments to the Articles of Agreement are ac ceptable to them. The amendments will not enter into force until they are accepted by at least three fifths of the IMF members representing at least 85 per cent of the votes. In this respect it should be mentioned that in the case of the USA, some of the proposals, including the IMF's gold sales, have to be approved by the US Congress. Denmark approved the amendments to the Articles of Agreement on 2 October 2008.

The proposed amendments will have no direct impact on Denmark, which supported the efforts to stabilise and increase the Fund's income during the negotiations.

The income reform was launched at a time when lending was low, and in the light of the many recent loans, the premises of the reform may become less relevant. Nevertheless, implementing the reform will reduce the IMF's dependence on the credit requirements of its member countries.

STRENGTHENING THE IMF'S MACROECONOMIC AND FINANCIAL SURVEILLANCE

In September 2008, the IMF's Executive Board conducted a comprehen sive evaluation of the IMF's macroeconomic and financial surveillance experience during the Triennial Surveillance Review. The review gave rise to discussions of the implementation of the new framework for the IMF's bilateral surveillance of its member countries that was adopted in 2007, and the preparation of surveillance guidelines for the coming years.

The implementation of the 2007 decision aimed to make the IMF surveillance more efficient and transparent and to strengthen the focus on external stability, including the exchange-rate policies of the member countries. However, implementing the decision turned out to be more difficult than expected. For example, China's economy has not been discussed in the IMF for more than two years despite its key importance to the world economy. The difficulties are to some extent attributable to the inadequacy of the existing analysis tools to assess whether a coun try's exchange-rate policy creates external imbalances. In particular, it has proved difficult to determine whether a country's exchange rate is fundamentally misaligned, which is an exceptionally sensitive topic. The IMF is in the process of improving the methodological framework for exchange-rate assessment and has introduced further measures, includ ing the special ad hoc consultation option, to improve the imple mentation of the 2007 decision. In addition, there is increasing support for the view that excessive focus on the exchange-rate policy should be avoided, and that it is vital to ensure overall consistency in stability- oriented economic policy.

The evaluation of the IMF's surveillance resulted in a statement of sur veillance priorities for 2008-11. The key elements of the statement, which was approved by the IMFC at its meeting in October, are pres ented in Box 3. The IMFC emphasised the IMF's key role in providing the member countries clear and early warning about risks and vulnerabilities in terms of financial and macroeconomic stability.

For Denmark the most recent IMF visit took place in the autumn of 2008. The visit concluded with the head of the IMF mission announcing a number of recommendations regarding the Danish economy³. Based on this visit, the IMF will prepare a more detailed report on the Danish economy. The report is expected to be discussed by the IMF's Executive Board around the turn of the year.

THE IMF's ROLE DURING THE FINANCIAL CRISIS AND IN THE FUTURE

During the Annual Meetings in October the IMF was invited to play a leading role in helping the member countries to handle the current financial crisis and in activities to strengthen the global financial architecture. The universal membership of the IMF and its vast macro economic and financial expertise provide a good foundation for draw ing lessons from the financial crisis and recommending effective meas ures to restore confidence and stability. At the same time importance was attached to enhancing cooperation with the Financial Stability Forum (FSF), the G20 and other key players.

Since the Annual Meetings Ukraine, Hungary, Iceland and Pakistan, which have been particularly severely hit by the crisis, have concluded agreements with the IMF concerning large-scale loans, cf. Box 4.

The loans are all significantly above the normal access limit of 300 per cent of the quota and have thus been approved under the special fast-track Emergency Financing Procedures. The procedure was previously used by four countries during the Asian crisis in 1997 and by Turkey in 2001. It is used when a member country is facing an exceptional situ ation that threatens its financial stability, and where immediate action is crucial for damage control purposes.

After several years of futile discussions about a new insurance facility without special conditionality, the IMF introduced a new facility in Octo ber 2008, the SLF, which provides large short-term loans without the normal binding economic-policy requirements. The facility is aimed pri marily at emerging market economies with track records of sound econ omic policies. It is intended exclusively for use by countries that have previously had access to international capital markets, and whose exter nal position was sustainable until the onset of the crisis. The current ac count deficit is therefore required to be self-correcting. The total amount made available under the arrangement will be up to 500 per cent of the quota. The intention is to make this amount available imme diately on approval by the IMF's Executive Board, with a limit of three drawings over each 12-month period. At the same time each drawing is to be repaid after just three months. A country that has utilised its three drawing rights and needs continued support must change to a standard Fund arrangement. The decision includes a provision to the effect that the IMF's Executive Board will reconsider its decision if lending under this facility reaches 60 billion SDR (approximately 100 billion dollars) or about half of the IMF's lending capacity of approximately 200 billion dollars, to which should be added the IMF's GAB and NAB financing ar rangements of approximately 50 billion dollars. So far, no countries have applied for support under the facility.

On 15 November 2008, the G20⁴ leaders of the largest industrialised countries and emerging market economies met in Washington to discuss the international financial crisis. The declaration and action plan from the meeting represent a step towards enhanced international cooper ation with a view to handling the global financial crisis and preparing reforms to prevent similar crises from recurring.

In relation to the implementation of the action plan from the meeting, the IMF will play a prominent role in strengthening the early warning system in case there are indications that a crisis is imminent. The IMF's role as macrofinancial advisor is to be enhanced, and the IMF is to help coun tries overcome the crisis. Furthermore, the IMF will play a key role in the international efforts to design a better global financial system for the 21st century. In this connection the G20 invited the IMF to play a leading part in drawing lessons from the financial crisis. Before the meeting, the IMF had been encouraged by the IMFC to play a leading role in relation to the above issues, which is also reflected in the work programme of the IMF's Executive Board that was presented at the end of November.

The G20 leaders supported the SLF and a review and possible simplifi cation of the IMF's lending instruments. The G20 undertook to ensure that the IMF has sufficient resources to discharge its duties⁵. At the meeting, all G20 countries accepted to let the IMF review their financial sectors under the Financial Sector Assessment Program, FSAP. Of the G20 member countries, four have not yet been through an FSAP, including the USA. An FSAP was carried out for Denmark in 2006⁶.

Finally, a wish was expressed for the World Bank and the IMF to better reflect the change in the global economy by increasing the influence of the countries playing a more central role today. The Managing Director of the IMF has already set up a committee headed by South African fi nance minister Trevor Manuel with a view to recommending measures to strengthen the IMF's decision-making structures and enabling the IMF to carry out its global mandate more effectively. The Committee's report is expected to be available in April 2009.