IMF policies make patient sicker, say critics
Perhaps the most devastating criticism of the IMF in the present situation of the Asian crisis, is that its policies imposed on South Korea, Thailand and Indonesia are wrongly designed and have further worsened the situation. Instead of quietly encouraging the international banks and the rich countries to extend more credit to the affected countries and boost investor confidence, the IMF chose to squeeze the countries further, thus driving their banks and corporations to deeper crisis, and worsening investor confidence.
by Martin Khor
PENANG: In its handling of the Asian crisis, the International Monetary Fund (IMF) is coming under severe attack for its objectives, the substance of its policies, and its institutional processes.
Questions are also being asked about its inability to manage global financial stability and prevent crises due to its almost religious belief that the market can do no wrong and its stubborn refusal to recognize the need to supervise market forces.
US has major say in IMF's policies
One thing is clear: the IMF has become an even more powerful agency, deciding the policies and economic fate of hitherto high-growth South Korea, Indonesia and Thailand, in addition to the 80 other developing countries that come under its "structural adjustment" loans.
Which is why its governance and method of operations is a great source of concern. The IMF, like the World Bank, is controlled by a few rich countries by virtue of their overwhelming share of the Fund's total capital, since voting is weighted according to the capital shares that countries own.
With 28% of the capital, the US has a dominating say in the IMF's overall policies and direction.
The IMF Secretariat in Washington works in secret, drawing up policies for the 80 countries under its control, largely without their participation and without the knowledge of the world. The IMF "agreements" with the countries are not normally, publicly revealed.
The IMF's monopoly of power over policies (with no prior open professional or public debate over their theoretical or practical basis) and its almost total lack of "transparency" in decisions and decision-making process is in ironic contrast to its shrill preaching to its client states to fully open up to competition and transparency.
In a devastating attack, an editorial in the Asian Wall Street Journal (AWSJ) of 24 November 1997 says, the Fund is "one of the most secretive institutions this side of the average missile base."
Lack of transparency
The IMF has 2,300 staffers in Washington, representatives in Central Banks of troubled countries, and sends forth teams of analysts, advisers and overseers.
"But what they do, or learn, or exactly what guides their decisions, is largely kept secret," says the AWSJ. This leads to confusion, for example, when the Fund supports Hong Kong and Argentina in pegging their currencies, but favours currency floats in South-East Asia. "How the Fund decides in a given case is anyone's guess."
The editorial says similar mysteries shroud the IMF's rescue packages for Thailand, Indonesia and South Korea, even though a vigorous public debate is now needed. It concludes: "Fund officials, as well as their colleagues at the US Treasury, have recently been touting the virtues of transparency...Start by uncloaking the IMF."
In the Financial Times of 11 December 1997, the head of the Harvard Institute for International Development, Jeffrey Sachs says the IMF pays lip service to transparency, but offers no public documentation of its decisions, except brief press releases without the details needed for professional evaluation of its programmes. IMF staff are unaccountable for their decisions.
"The people most affected by these policies have little knowledge or input," adds Sachs. "In Korea the IMF insisted that all presidential candidates immediately "endorse" an agreement which they had no part in drafting or negotiating, and no time to understand. The situation is out of hand...It defies logic to believe the small group of 1,000 economists on 19th Street in Washington should dictate the economic conditions of life to 75 developing countries with around 1.4 billion people."
From criticisms of how the Fund works, many economists are now also attacking the substance of the IMF's policies for Asia.
Sachs estimates there is an average of seven IMF economists dealing with a country, too few for the IMF to get a sophisticated view of what is happening. "The IMF threw together a draconian programme for Korea in just a few days, without deep knowledge of the country's financial system and without any subtlety as to how to approach the problems."
In its annual report just three months ago, the IMF directors "welcomed Korea's continued impressive macro- economic performance and praised the authorities for their enviable fiscal record". The report also said "directors strongly praised Thailand's remarkable economic performance and the authorities' persistent record of sound macro-economic policies."
Sachs attacks IMF Managing Director, Michel Camdessus, who "with a straight face... now blames Asian governments for the deep failures of macro-economic and financial policies that the IMF has discovered."
Implying that the IMF has its diagnosis and cure all wrong, Sachs says a basic truth about the Asian situation is that "there is no fundamental reason for Asia's financial calamity except financial panic itself. Asia's need for financial sector reform is real, but not a sufficient cause for the panic, and not a justification for harsh macro-economic policy adjustments.
"Asia is reeling not from a crisis of fundamentals, but from a self-fulfilling withdrawal of short-term loans, one that is fuelled by each investor's recognition that all other investors are withdrawing their claims. Since short-term debts exceed foreign exchange reserves, it is 'rational' for each investor to join in the panic."
Sachs attacks the IMF for making the situation worse. Without wider professional debate, it imposed a severe economic contraction in these economies on top of the market panic.
With an unrealistically low inflation target, the IMF imposed a brutal monetary squeeze in Korea, causing its interest rates to jump. The Fund argues these measures are to "restore and sustain calm in the markets", but Sachs says it is hard to see how recessionary monetary policies will restore calm.
"Indeed the panic has so intensified since the signing of the agreement that Korean banks may now be on the verge of outright default."
The IMF also told Korea to tighten fiscal policy by 1 to 1.5% of GDP, reduce growth and suspend nine merchant banks. None of this overkill makes sense for a country with sound macro-economic policies.
A better IMF approach suggested
According to Sachs, a better IMF approach should have stressed Korea's strengths rather than weaknesses, thereby calming markets rather than further convincing them to flee the country. Months ago, the IMF could have encouraged Japan, US and Europe to give credit support to the Bank of Korea, and encouraged major banks to roll over short-term debts.
With confidence-building measures, Korea could probably have got by with a modest growth slowdown, no credit crunch and complete financial reforms in a few years.
Sachs concludes that the IMF should not be given so much power, that its Board should oversee rather than rubber-stamp the staff's proposals and consult outside expertise, and its operations should be made public and subject to professional review and debate.
Making many similar points was Financial Times columnist, Martin Wolf on 9 December: "Like deer, investors graze happily for a while, ignoring the perils of predators asleep nearby. Then, when startled, they stampede. These are the skittish beasts that the IMF is trying to cajole back to their wonted East Asian feeding ground. The question is whether it is doing this in the best possible way. The answer is no."
Wolf describes three objections to what the IMF is doing. Firstly, by imposing a tough economic squeeze in affected countries, the IMF risks undermining, not restoring, investor confidence. Secondly, by insisting on faster liberalisation of capital inflows, the IMF may exacerbate financial vulnerability. Thirdly, these vast bailouts may encourage further folly, mainly by lenders.
For Wolf, the Asian crisis was not the result of economic basics (which were sound) but "partial integration into a world financial system unable to evaluate risk either intelligently or consistently." This exacerbated the ill effects of financial weaknesses, policy errors (adherence to fixed exchange rates) and turbulence abroad.
"Capital first flowed in on a flood tide, then poured out, leaving devastation in its wake."
Wolf attacks the IMF for imposing an unnecessarily severe economic squeeze. Since the illness is debt deflation, a slowdown must worsen the patient's condition.
"High real interest rates in heavily indebted economies are dangerous," writes Wolf. "For the IMF to treat deflation as if it were a traditional ill such as high inflation and fiscal profligacy is little more scientific than for a doctor to bleed his patients."
The IMF's Korea policies of raising interest rates, maintaining low inflation despite the depreciation and fiscal tightening would have this result: "However sick Korean companies and banks may now be, they will soon be sicker."
Wolf warns against further liberalization of financial transactions, domestic and foreign. "Partial liberalization of transactions within unreformed and undercapitalized financial systems has been at the root of the crisis. Any such combination is a recipe for disaster."
He thus criticizes the IMF decision in Korea to open domestic money and bond markets to foreign investors as "highly questionable in current circumstances" and the elimination of restrictions on foreign borrowings by local firms as "dangerous."
IMF policies have also been attacked by analysts and economists in the affected countries. "Is the IMF doctor mistreating its Thai patient?" asks a front-page analysis in Thailand's daily, The Nation.
The authors, Vatchara Charoonsantikul and Thanong Khanthong, answer "yes." They say the IMF package for Thailand seeks only to cure the balance of payments crisis without addressing the financial crisis. Thus, Thailand is asked to tighten its fiscal and monetary policy, to raise interest rates and close down weak finance companies and banks.
"IMF officials believe once its prescription of an austere economic programme is followed strictly, confidence will return and capital will flow back...But this wishful thinking has not happened, with the country still paralysed by capital continuously flowing out of the system."
Interested only in nominal targets, the IMF is heartless in the consequences of its policy prescriptions, say the authors. It wants Thailand to stick strictly with high interest rates (to strengthen the baht) but "Thai financial institutions and corporates have been squeezed tighter as their access to capital has been cut off. Without capital, Thai business in general is heading for a breakdown. Good companies have turned bad and bad companies have grown worse."
Indonesian financial consultant, Steven Susanto, writing in the Far Eastern Economic Review (11 December 1997), criticized the IMF, World Bank and ADB for advising Indonesia to save itself by reining in inflation through contractionary policies that curtail economic activity.
"In truth, the prescribed moves are unlikely to be effective in combating inflation and the continuing downward pressure on the rupiah. As such the result may be that the Indonesian economy will be doubly cursed with high unemployment and low rates of capacity utilisation."
Revisions needed in IMF programme in Indonesia
The IMF programme in Indonesia needs two major revisions, says Susanto. Firstly, it should apply expansionary fiscal and monetary policies, for example, public investment to offset the ongoing economic contraction, and expansionary monetary policy to ease liquidity and lower interest rates.
Secondly, an income policy to resolve supply-side problems such as disparity in incomes, low domestic demand and low productivity.
The focus should be to eliminate abnormal profit derived from the high prices set by producers and sellers.
The above survey of recent criticisms is a lesson not only for the affected countries but also for countries like Malaysia which are seeking to solve their own problems without resorting to IMF assistance.
For with its current process of exclusive decision-making by its staff, its susceptibility to influence by its major shareholders (the rich countries), the secrecy of its operations and, most frighteningly, the wrong policies making the situation worse, the IMF is bad news for any country needing its rescue.
Just as a patient can have his condition worsened, or even be killed, by a bad doctor or by the wrong medicine, a country whose finances have already been weakened by currency speculators and by investors fleeing on herd instinct, can have its economic prospects and long-term development crippled further by the IMF. (Third World Economics No.176, 1-15 January 1998)
Martin Khor is the Director of Third World Network.