TWN Info Service on Finance and Development (Nov10/03)
9 November 2010
Third World Network

G20 agrees on IMF quota revisions, work on reducing imbalances
Published in SUNS #7026 dated 26 October 2010

Geneva, 25 Oct (Chakravarthi Raghavan*) - Finance Ministers (and Central Bank governors) of the Group of 20, who conferred at Gyeongju in Korea, have agreed to bring about a "reform of IMF governance": by doubling the quota and a six percent shift of the quota allocation from the developed (Europe mainly) to the "Emerging economies", with the quota shares of India and Brazil to be increased (expected to get enough quota shares to be members of the Executive Board in their own right), and Europe giving up two of its members on the Executive Board.)

Both these need amendments to the IMF articles and thus have to be formulated and accepted by two-thirds of the IMF membership accounting for 85% of the total voting power or 111 members with 85% voting power; it has then to be ratified or accepted, and in many cases, may require legislative affirmation. The earliest this could be achieved, as indicated by the IMF Managing Director, Mr. Dominique Strauss-Kahn, at his press briefing in Gyeongju, will be in 2012.

The other major agreement to emerge, as Strauss-Kahn outlined at his media briefing, is an enhanced role for the IMF and its staff in the so-called Mutual Assessment Process (MAP) - assessment by the IMF of the "external sustainability on the monetary and the fiscal policy, and finally providing the G20 with advice and policies so that the different questions [that] the global economy is facing can be addressed."

The IMF is also to formulate, and expects this to be agreed at the G20 summit in November, a "financial safety net" (that Strauss-Kahn hopes will enable the Asians to renew their relations with the IMF and have less reliance on their own reserves. The Asians after their experiences with the IMF in the 1997-98 crisis, decided to build their own reserves and rely upon themselves, rather than seek IMF help and accept its unacceptable and draconian conditionalities).

The G-20 Finance Ministers also promised that they will "move towards more market determined exchange rate systems that reflect underlying economic fundamentals and refrain from competitive devaluation of currencies".

Towards this end, they have also agreed to work to reduce global trade imbalances and maintain them at sustainable levels, with specific guidelines on achieving this yet to be formulated and agreed upon. The IMF is expected to work on this and come up with recommendations.

As the G20 finance ministers (a self-appointed group, lacking democratic legitimacy and attempting to take over the role of the IMF's own more legitimate International Monetary and Finance Committee) dispersed from Gyeongju, and prepare to meet again at summit level next month, they (including the US and China) would do well to refresh themselves with the history of the postwar monetary and financial system and its various travails - starting with the proposals and negotiations between Dexter White and John Maynard Keynes, through the collapse of Bretton Woods I, the Smithsonian accord, the work and report of the Committee of 20 (C-20), and its aftermath.

Most of the history of these efforts (under the Bretton Woods systems), and the documents, are in the three-volume official history of the IMF of that period (Margaret Gerritsan de Vries Vols 1, 2 and 3; the C-20 efforts and documents are in Vol.3). Some details of the US efforts after the collapse of Bretton Woods I, and how the efforts of the Committee of 20 failed are in Kenneth Dam's book, Rules of the Game.

All of these proposals were spurned and turned down by the US (in its pursuit of free capital movement and convertibility and ensuring its own unilateral determinism and the benefits flowing from the US dollar as the global reserve and transaction currency and numeraire - with surplus countries having to hold US Treasuries as assets). The patchwork compromises of the Jamaica Agreement and the Bretton Woods II (non-system) which too is now collapsing, if not collapsed, is forcing the US to seek the same remedies as in 1973-75, but with a weaker hand.

For the moment, judging by the Gyeongju G20 communique, and remarks there and on the way home by some of the participants, they are ignoring the lessons of the last three years (showing up the fiction of the Chicago school's efficient financial market theories). Those at the top of the global economic system are still pursuing what John Quiggin of the University of Queensland calls "Zombie economics ideas" -- The Great Moderation (macroeconomic stability of the mid-80s could endure indefinitely), the "Efficient Markets Hypothesis" (the prices generated by financial markets represent the best possible estimates of any investment), the "Trickle-Down Hypothesis", and Privatization (any governmental function can be done better by private firms).

During the C-20 Committee process and negotiations, the US had floated the idea of targeting reserves (surpluses or deficits exceeding a percentage) and those with surpluses and deficits adjusting. Among other things, it ran into several problems - whether gross or net surpluses should be the yardstick and the yardsticks for excesses. And all these also involved issues of data and statistics.

Now, instead of the focus on reserves as it did in 1975, the US has focussed on current account balances. By definition, this is the sum of the balance of trade (exports minus imports of goods and services), net factor income (such as interest and dividends, royalties) and net transfer payments (such as foreign aid).

Given the state of the data on trade in services (see Chakravarthi Raghavan, 2002, "Developing Countries and Services Trade: Chasing a black cat in a dark room, blindfolded"), with financial services accounting for the major part of the world trade in services, and recent continuing disclosures about the unreliability of the audited accounts (revenues, expenses, profits, balance sheets, assets valuation etc) of financial firms in the US, it will be difficult for any reliance to be placed on them in national or global accounts and balances.

And the fallback position is that of the Extended Balance of Payments statistics of the IMF (which, however, only records transactions between residents and non-residents, and thus do not cover services transactions among residents, whether national or foreign).

As a result, the BOP (balance-of-payments) data which the IMF could use, underestimate the services transactions data, and also the US incomes on payments for royalties on TRIPS, often routed through tax-havens to hide real incomes and profits.

In the runup to the G-20 Finance Ministers' meeting, the US (as also host country Korea) promoted the idea of targeting current account balances, and suggested a four percent target (those in excess or deficit by four percent to change currency values and adjust). Since the US trade deficit is less than four percent of GDP, and the Korean surplus less than four percent, the two conveniently don't need to adjust.

The US-Korean proposal, and numerical targets, understandably ran into opposition from Germany and Japan, among others.

And in using such targets, as Mr. Strauss-Kahn noted at his briefing, a specific target has advantages, but also problems. And since it involves balances as a proportion of GDP and exchange rates, this creates further problems vis-a-vis the Euro-zone and its constituents.

Running through all these are the issues of asymmetry and adjustments (by the surplus and deficit economies) within the system, and the incompatibility of simultaneously working for "market-determined exchange rates", "trading money" across frontiers and free movement of capital and convertibility and maintaining an open rules-based multilateral trading system.

Having spurned (at Dumbarton Oakes and Bretton Woods) Keynes' attempts at symmetric adjustments (with both surplus and deficit countries having to adjust), by the time of the Smithsonian agreement for currency revaluation by the G10 countries and the setting up of the Committee of 20, the United States began to work for adjustment by the surplus countries - but also for free convertibility of capital and ability to trade money internationally.

As for IMF surveillance and the guidance principles it can evolve, in relation to its surveillance role (Art. IV consultations), in Nov 2006, an IMF research department paper (for the Consultative Group on Guidelines for Exchange Rate Arrangements), approved by then chief economist Mr. Raghuram Rajan, suggested three methodologies to provide complementary perspectives on exchange rate assessments.

The paper said these three, taken together, and combined with additional country-specific information, can help staff reach informed judgments about medium-term real exchange rates and current account balances, weighing the relative importance of a number of economic factors affecting these key variables.

The paper added a qualification that while adopting different empirical methodologies goes some way towards strengthening the robustness of exchange rate assessments, it should be recognized that such assessments are unavoidably subject to "large margins of uncertainty", due to a number of factors, such as the potential instability of the underlying macroeconomic links, differences in these links across countries, significant measurement problems for some variables, as well as the imperfect "fit" of the models.

"Some of these problems," the paper added, "may be more severe for emerging market economies, where structural change is more likely to play an important role and where limitations in terms of data availability and length of sample are more acute."

And if persistent interventions in currency markets by China is to be viewed as currency manipulation, the US Federal Reserve's announced intention of "QE2" (a second bout of quantitative easing, by printing dollars and buying up bonds) has also the result of devaluing the value of the dollar vis-a-vis other currencies - already seen in foreign exchange market quotations.

With the G20 meeting already easing concerns about what has been described by the media as "global currency war", and traders taking the outcome as a green light for more dollar selling, according to a Financial Times report Monday on the markets, the US currency is down 0.6 per cent on a trade-weighted basis. The Federal Reserve meeting at which a further bout of quantitative easing is expected to be announced - recognised by many as the primary cause of dollar weakness - is now barely a week away.

And as for the IMF's own surveillance activities and Art. IV and other consultations with member countries, while effective with deficit emerging market countries, have long been ineffective against the strong, a point conceded by Mr. Strauss Kahn in his briefing. And as other commentators have noted, it has been more so vis-a-vis the US, where in the meetings, treasury officials give a polite hearing, but do nothing.

At a media briefing at the conclusion of the G20 meeting, IMF Managing Director Strauss-Kahn and First Deputy Managing Director John Lipksy, highlighted three issues that fell within the mandate of the IMF.

The G20 ministerial has supported the process of the MAP, launched in Pittsburgh, with a first run in Toronto, and became only a normal part of the G20 at this meeting. All of the discussion about the exit rate, about the current account surpluses and deficits, about external sustainability, finally ended in the G20 calling on the IMF to provide within the MAP an assessment of external sustainability on the monetary and the fiscal policy, and finally providing the G20 with advice and policies so that the different questions the global economy is facing can be addressed.

The main question now, Strauss-Kahn said, is the question of global imbalances. "This question has been fairly and straightforwardly discussed during the day with, I think, rather strong language in the Communique and the will by all parties to put in place policies that may converge and limit excessive risk in terms of external sustainability."

He has had discussions on this in Beijing just two days before Seoul, and has also had a lot of discussions with the Americans in Washington and also with the European and the Japanese. Clearly, all the partners want to do their best even if they may have somewhat different views, to keep the recovery on track, understanding that the main threat to this recovery would be to enter an endless fight on current account surpluses and exchange rates.

So the first point is the importance of the MAP, recognized by everybody as a guideline for economic policy. The IMF was asked to assess and monitor what's going on with external and internal sustainability. That's the first resolve of the day.

The second topic, also very important to the IMF, is the recognition of the building of the financial safety net... And the Communique commends the IMF for having created new facilities, after the FCL (flexible credit line), the PCL, the precautionary credit line, which are the two bricks which allow us to create this safety net. And I think it's very important that this has been almost completed, and it will be totally completed by the leader's summit in Asia.

This idea has been discussed in July here in Korea in Daejeon, when we had this big conference with all Asian countries, where the idea was how can the IMF and Asian countries renew their relationship. And one of the answers given by a participant was, "You need to build something that will be useful for Asian countries, or that can be useful for Asian countries." And what was this? It was this financial safety net likely to be used by a group of countries together either at the level of the flexible credit line (FCL), which already has been used by three countries as you know, or at the level of the precautionary credit line (PCL), which is brand new and still not in use by any country.

This is very important, too, because it is a way for the IMF to begin to change the international monetary system. The FCL and the PCL have this capacity to limit reserve accumulation and to prevent countries from accumulating too large reserves are part of this change in the international monetary system. So this is the second thing, which is also a big change in the view we may have on the role of the IMF.

But then we have the third thing, which was completed today, which is the governance reform. The decision is a decision of increasing the flexible resources of the Fund, which is to pool our resources by 100 percent, so by doubling the size of the Fund, to do it in a way that will exceed the expectation from Pittsburgh. The Pittsburgh expectation was a shift to dynamic emerging economies, and also a shift from over-represented to under-represented countries by 5 percent. We do more than 6 percent in both cases.

And on top of that, which is for me probably the most important thing, the ten biggest members of the Fund in terms of quota will be those who deserve to be the biggest members. So we will recreate the normal order with the US and Japan, the four BRICs (Brazil, Russia, India and China), and four Europeans. And that's the leading group of the institution, at least in terms of quota which now represents the reality of the global economy. From this point of view, a lot of criticism has been made in the past, which was fair, saying well, the institution is not totally legitimate because the shareholders are not really represented -- shareholders is not the right word -- but the membership and the quota of the membership are not really representing the importance and the weight of the countries in the global economy. Now it's done...The ten most systemic countries in the global economy.

But this is a huge change, a huge change, and this change has as a companion different other changes, one of which is that we will move to an all elected board. You know that the Board of the IMF was partly appointed -- five of them, and partly elected. It was a bit old-fashioned. It is clearly more democratic to have a totally elected Board so we will move to a totally elected Board. And at the same time, the governance reform includes a reform of the composition of the Board, which has been triggered by a decision by the United States in the beginning of August to stop the ongoing process and to ask for a reform.

The Europeans committed themselves to reducing their presence on the Board by two chairs, which is a huge effort, permitting two emerging countries to be new members of the board, which also increases the legitimacy of the institution.

So when you take this all around, the shifts of re-balancing the power in the IMF is bigger than expected. The change in the composition of the Board was not expected at all three months ago. The decision to move to a more realistic formula to compute or to assess the size of the countries is a very important decision, too, because everybody understands that this formula is a bit complicated. So we achieved today the most important reform in the governance of the institution since its creation, but it doesn't mean that there won't be any reform going forward. The world is changing. There will be other reforms. But certainly today we put an end to a discussion which has been in the headlines for decades about the legitimacy of the institution. Today, or more precisely when the decision will be voted on by the Board, but today it has been decided by the G20 to propose to the IMF Board a reform, both of the quota and of the Board, which is a historic decision which recreates the total legitimacy of the institution.

So the role of the IMF and the MAP in assessing what has to be done on the currency side, and the creation of the financial safety net as a beginning of a change in the international monetary system, and the renewal of the legitimacy of the institution makes this day clearly an IMF day in Asia. Now if you have some questions, I will be happy to answer them.

Asked what two European countries will renounce their seats and how this will be done - whether by redrawing the constituencies, or just giving up their seats to members, Strauss-Kahn said that the Europeans will do it, and they have some time to do it. It will be done no later than the implementation of the quota reform. This may take one year, one year and a half, it depends. It's always rather long. And that's the time the Europeans have to rebuild their own system and to decide how they want to give up these two chairs. So there's no immediate answer.

Asked whether the IMF has now pulled off enough political backing to talk to big countries like China where it's very sensitive to set the level, Strauss-Kahn said: "The IMF is a multilateral institution, but we don't have real teeth. We cannot oblige a country to do something, but what we can do is to notice that a country has commitment and fulfills or not a commitment. Until now, the commitment of the country was about their current account and their domestic policy, and that's the agreement. If we want the IMF not to have very strong teeth, but nevertheless to have some teeth, and to be able to say to a country publicly What you're doing is wrong', we probably need to extend the mandate of the IMF. And to be clear for those of you who are specialists, and I know some are, what we do until now is follow the Article IV of our treaty, the Bretton Woods Treaty. What we need is certainly to enhance the Article VI, which will give us more strength to do what you say."

"But, you know, those are the formal parts. The formal thing is important, and it will probably be useful in the coming years. It will take time to change the Articles of Agreement, to extend the mandate of the Fund. But we're not going to wait for years, so we need to work now. And then it's not a formal question, but a political question. I think that the answer to your question is yes, we have now the political strength to do it, and the proof of that is the agreement by the five major systemic countries of our new spillover reports.

"What are the spillover reports? What we are doing in the IMF with the membership since the beginning is mostly bilateral surveillance. It means that the IMF is working with country X, assessing the economic policy of the country and seeing in which respect this economic policy is likely to deliver what the government is expecting in terms of fiscal sustainability, monetary policy, and so on. But there were very little analyses of the consequences of what this country is doing not for itself, but the consequences of what the country is doing for others. That's what we call the spillover report, and we now have the agreement. It hasn't been so easy to get it, but the fact that we have it answers your question. The agreement of the five big currencies -- the dollar, the euro, the renminbi, the yen, and the sterling -- to make this five spillover reports where we will look at the consequences of the domestic economic policy on the rest of the world.

"For example, to be clear, the US monetary policy is done in the interest of the US economy, that's normal. What are the consequences of this US monetary policy on the rest of the world? Many say it has its problems. Another example, the renminbi and the value of the renminbi is managed by the Chinese authority in the interest of China. What are the consequences on the rest of the world? And many say it creates a problem. So this kind of spillover report is exactly what is needed for what we have been asked to do. And the answer to your question is that the fact that these five countries -- well, not five countries because the euro is a lot of countries -- these five currencies have accepted the spillover report despite the fact that they understand that sometimes it will be a bit problematic for them because we will say things they don't like. The fact that they have accepted it answers your question about the political weight that we have to do it.

"We will start momentarily. The idea was that the spillover report will be discussed at the same time as the Article IV for the countries. But for the US and for China as well as for UK, the Article IV is in July, so it's late. On the other hand, for the European Union, the Article IV is in a couple of weeks. It's too soon. So it means that if we don't do it now and we don't have time to do the spillover report for the end of November for the European Union, we'll have to wait one more year.

"So finally, we will have a discussion with the Board to know if we have to do it exactly at the same time as the Article IV. My view is that the sooner, the better. Of course, it takes time. It's not a report that you can write overnight. It's a lot of work. It will use a lot of resources -- human resources, financial resources -- in the Fund, and we need several months to do it, but we will start immediately."

QUESTIONER: The emerging market countries are very keen for this formula review to be done in 2013. What do you expect could be achieved? What do you think could happen? How can the quotas be changed again?

MR. STRAUSS-KAHN: "What has been decided is that we will by the beginning of 2013, January 2013, we will have changed the formula, reviewed the formula, and that the next round to take into account new data will be for 2014, and three years from now probably a review of the formula because it will have been done in between. My wish is that we will obtain something which is simpler than the formula we have today, which will present more clearly the GDP of the countries, and will be more directly linked to the economic weight of the countries. But this will be the discussion of the coming two years, so I cannot anticipate too much. I guess that everybody will agree with a simpler formula. You know, it's a difficult exercise. So the more it will be the formative, the more it will be just running with the new data and just seeing what the changes are, the better it is. The less it will be a negotiation. I will be better because this bargaining is very difficult to manage. You have to take into account the interests of all the countries. Everyone has good arguments to explain why it shouldn't go down and why it should go up. So take in all the arguments together, you may finally have no possible solution, and I was worried during the summer that maybe there was no possible solution. Finally, we find one and we were able to convince the Ministers to accept the solution, and I'm very grateful that they did, and grateful to the Korean Presidency for its help. But it's better to have something which will be simpler and more formative. That's the direction in which I hope we can go to maintain in the future the legitimacy of the Fund, which has been renewed with this reform." ...

QUESTIONER: The Japanese Finance Minister told us that the target of 4 percent had been floated for the current account, so the deficit is seen as 4 percent. Now we're talking about guidelines. Do you think that by sooner or later a precise target will include a directive for a range or is that now ruled out completely?

MR. STRAUSS-KAHN: "Well, it's possible. There are advantages and drawbacks to this idea of a target. The advantages are obvious. It's simple and so you may assess very simply if a country's fulfilling its commitment or not. If everybody can commit itself to have a surplus, for instance, or a deficit, same thing, assessed below 4 percent, it's easy to say if the 4 percent is reached or not. The problem is that 4 percent doesn't mean the same thing for different countries. Look at countries like oil exporters. They have a big surplus, just normal. It's not the same kind of surplus of other countries. So finally when you dig a little into the problem, you see that it's not that obvious.

"Look at the deficit side. Some countries have big deficits, but maybe very different deficits. When you're a developing country, an emerging country, it's just fine to have a deficit in the current account, which is financed by capital inflows. When you're a developed economy, you should have less of a deficit. So the same figure doesn't mean the same thing for a different situation in a different country. That's why there are merits in a band like minus four plus four, but there are also drawbacks. And wisely, the Communique this time decided to say that we are going to work very seriously and have other countries commit themselves to restrain the surplus or the deficit. But we're going to work more to see if it's possible to define a target that has taken into account the different kind of countries that are concerned."

Asked how the four percent target would be done in the eurozone, and whether the eurozone is one whole country, Strauss-Kahn said there has been no decision on the four percent. If there was a decision about a simple figure like this, one of the problems would be exactly the one mentioned. "If you're looking at a difference of surpluses and deficits and the exchange rate, then the eurozone has to be considered as one for obvious reasons. On the other hand, if you're looking at imbalances in the economic policy put in place by the different countries, then you may say that Germany within the eurozone should correct that policy. That's why the question is a little more complicated than just giving a figure, and that's why as I said even if this idea of the figure has been floated in the beginning, finally the Ministers decided rather than giving a figure like this, to commit themselves to a policy and to ask the IMF to make a more sophisticated assessment because your example is a very good example. You cannot just say the surplus of Germany is more than 4 percent so it's a problem because the currency by itself has almost no surplus, and the eurozone is more or less balanced."

(* Mr Chakravarthi Raghavan is the Editor Emeritus of the SUNS. He contributed this article to the SUNS.)