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TWN Info Service on Finance and Development (Aug07/04)

16 August 2007


PROPOSED IMF QUOTA REFORMS “WON’T BENEFIT DEVELOPING COUNTRIES”, SAYS LEADING DEVELOPING COUNTRY REPRESENTATIVE

The current proposals for reform at the International Monetary Fund (IMF) will not bring about benefits for the majority of its developing-country members, nor will they restore the Fund’s credibility or improve its efficacy as a multilateral financial institution, according to a leading developing- country representative at the IMF.

In a journal article, Hector Torres, an Alternate Executive Director of the IMF, and representative of the Group of 24 of developing countries, said that the “quota and voice” reform process launched at the IMF in September 2006 is unlikely to redress the dysfunctional nature of the Fund’s governance structure or correct the power imbalances which lead to its ineffectiveness in both its regulatory as well as lending roles.

Below is a report on the article in the upcoming issue of the Journal for International Economic Law. It was published in the SUNS #6314, Wednesday 15 August 2007.

With best wishes
Martin Khor
TWN

Proposed IMF Quota Reforms “Won’t Benefit Developing Countries”, says Leading Developing Country Representative

By Celine Tan

The current proposals for reform at the International Monetary Fund (IMF) will not bring about benefits for the majority of its developing-country members, nor will they restore the Fund’s credibility or improve its efficacy as a multilateral financial institution, according to a leading developing- country representative at the IMF.

In an article published in the upcoming issue of the Journal for International Economic Law, Hector Torres, an Alternate Executive Director of the IMF, and representative of the Group of 24, said that the “quota and voice” reform process launched at the IMF in September 2006 is unlikely to redress the dysfunctional nature of the Fund’s governance structure or correct the power imbalances which lead to its ineffectiveness in both its regulatory as well as lending roles.

The reform process launched in Singapore in September 2006 is not likely to help the Fund to recover credibility or improve efficiency, writes Torres. Referring to the discussions to revise the quotas allocated to IMF members, Torres commented: “At the Board, we are just tinkering with the variables used in the current flawed quota formula and preparing ourselves to horse-trade on the weight that should be given to those that better accommodate narrow national interests.

“At most, it will result in giving some more votes to a few successful emerging economies, already weaned off the Fund’s financial support, at the expense of other less successful developing countries that remain to be potential borrowers. This will not bring additional effectiveness or credibility to the Fund.”

As Alternate Executive Director on the IMF Board, Torres, an Argentinean, represents six Latin American countries (Argentina, Bolivia, Chile, Paraguay, Peru and Uruguay). As Argentina is currently the Chair of the Group of 24 (which is the most representative grouping of developing countries at the IMF), Torres is also responsible for the day-to-day coordination of the G24.

The article, ‘Reforming the IMF - Why its Legitimacy is at Stake’, is written in Torres’ personal capacity. The journal is published by Oxford University Press. Most of the article concentrates on why the IMF lacks legitimacy, with a section on the topical issue of the current reform process.

The article is an important contribution to the on-going discussions on the current state of the Fund and especially on the reform process and its effects on developing countries’ voice and participation in the IMF.

“The Fund’s capacity to influence its key members’ policies through its advice, and to give confidence to potential borrowers by offering opportune and meaningful financial assistance in case of trouble, has been seriously put into question,” says a summary of the article.

“Its governance structure is inconsistent with its multilateral nature and is dysfunctional to its purpose. There is also an ideological bias in its policy advice that prevents the Fund from being responsive to citizens’ concerns and challenges posed by globalization. The ongoing reform process is tinkering on the margins and if not redressed will fail to bring additional credibility and effectiveness to the Fund.”

In his section on the IMF’s reform process, subtitled ‘More Noise Than Nuts’, Torres remarks that the IMF Managing Director Mr Rodrigo de Rato launched the Fund’s Medium-Term “strategic” reform “in implicit recognition that the Fund either changes or fades away into irrelevance”.

The first result of that reform process, supposedly to give developing countries more “quotas and voice” in the IMF, was seen in the IMF’s 2006 Annual Meetings in Singapore.

The Fund’s Governors decided to grant four countries (China, Korea, Turkey and Mexico) the right to modestly increase their quotas in a total of 1.8% in the overall capital of the Fund.

With such a modest increase, “the start has not been bright and many developing countries voted against the reform or supported it only after strong lobbying from the Fund’s management,” writes Torres.

As for the basic votes, the IMF Board decided that they would “at a minimum” be doubled and thereby the “existing voting share of low income countries as a group” should be protected. The 2006 meeting did not decide on the actual amount of increases in basic votes nor on the second round of quota increases. It was agreed that both issues would be defined together no later than by the 2008 annual meetings.

Torres reveals that many developing countries initially opposed the modalities for the current two-stage reform process adopted by the IMF Board of Governors.

A significant number of developing countries (23 in total, including Argentina, Brazil, Chile, Colombia, Ecuador, Egypt, India, Iran, Peru, Qatar, Sri Lanka, Trinidad and Tobago, Uruguay, and Venezuela) voted against the reform and other developing countries supported it only after the IMF management strongly lobbied them.

This was confirmed to Torres by several of his colleagues on the Board who found that “against their own advice, their governors had been lobbied to vote in favour of the resolution”.

“The actual implementation of both the increase in basic votes and the aforementioned second round of quota increases will, however, take some time,” writes Torres. Increasing basic votes will require an amendment to the Articles of Agreement of the Fund and a second stage of more meaningful quota increases will only come after the adoption of a new quota formula.

This is compounded by the fact that the increase in basic votes will depend on a successful amendment to Article XII, Section 5(a) of the IMF’s Articles of Agreement.

 Since such a constitutional amendment requires 85% of the total voting power, it will be the national legislatures in the current majority shareholding countries which ultimately decide whether the reforms are implemented or not.

“As the US holds more than 15% of the total voting power, this means that ultimately, the US Congress holds the key of the reform initiated at Singapore,” notes Torres.

According to Torres, the reservations that several developing countries had with the Singapore decision on the reform process were two-fold. Firstly, “the reform foreshadowed in that Decision may result in more, not less, quotas and voting power for the most advanced economies”, with developed countries already dominating the discussions for a revision of the quota formula.

Developed countries have already put forward GDP and openness to external trade as two variables that should bear more weight (in considering the new quota system).

“This was a bad start, as including reference to other variables which better capture likeliness to borrow would have presented a more promising reform for the majority of developing countries,” says Torres.

“However, front-running GDP and openness is made even worse by the insistence of the most advanced economies in using market exchange rates to calculate GDP (rather than Purchasing Power Parity) and that of EU members of factoring in their intra-Euro trade as part of their ‘openness’ to the world.”

According to Torres, the US indicated that it wanted only to restore the voting power it had before the token quota increase approved in Singapore; the Europeans did not join the US in its pledge; while Japan made clear that it would not forgo any increase in quotas which it may be entitled to under a new quota formula.

Torres remarks that reform on quotas and voice on this basis “that would further deteriorate the already minority position that developing economies hold in the Fund’s aggregate voting would be clearly at odds with the objective of giving additional legitimacy to the Fund and reinforcing multilateralism”.

The second and more important reason behind developing countries’ opposition or reservations about the Singapore decision is that the “drafting of that Decision creates a very high risk that even if advanced economies were not to increase their current share in quotas and votes, the end result of the reform could allow for the increase of the quotas of a handful of successful emerging economies at the expense of middle-income countries”, says Torres.

He said that an increase in the quotas for the most dynamic emerging economies will not come at the expense of advanced economies “because they have the necessary voting power to prevent it” and it will not come at the expense of the low-income countries as the Singapore Decision guarantees against an erosion in their basic votes.

Thus, it would necessarily come at the expense of middle-income developing countries.

This is ironic, because it is the middle-income developing countries that are most likely to remain as the Fund’s potential borrowers, since many emerging markets (such as China, Korea and some ASEAN countries) seem to be graduating from the potential use of Fund resources, thanks to their persistent current account surpluses.

As quotas also determine borrowing entitlements as well as voting power at the IMF, Torres argues that it would be “self-defeating” for the Fund to reduce the relative weight of middle-income countries’ quotas.

“Indeed, this would encourage this large group of countries to set up policies of self-insurance, shoot for depressed exchange rates that allow them to accumulate more reserves and build up new (or reinforce existing) regional reserve pooling arrangements.”

Torres further argues that while he was not against such arrangements in principle, he was “wary of a world that resorts to bilateralism or regionalism as an alternative to inefficient and unreliable multilateral institutions”.

 Torres also remarks that it makes little sense to allot higher quotas and thus higher access to the Fund’s resources to wealthy countries as they do not need to borrow from the Fund.

“As quotas are used to calculate access to Fund resources (and of course also votes), the result is that those countries that are less likely to need the Fund’s support are those with more access to its credit (and more capacity to shape conditionality imposed on others to their national interests), whereas the potential borrowers see their access limited to a percentage of their meagre quotas,” writes Torres. This forces developing countries in need of financial support to apply for “exceptional” access (beyond the limits set by their quotas), but exceptional access comes with exceptional financial and political costs.

He says that the current governance structure of the Fund is not just inconsistent with the multilateral nature of the institution but it also prevents the institution from carrying out both its regulatory and lending roles effectively and with legitimacy.

“A promoter of international monetary and financial stability requires the capacity to perform and put forward un-compromised arms-length assessments of the economies of its members and blow the whistle (loud and clear) when domestic policies are systematically disruptive,” argues Torres.

“The fact that its decision-making process is dominated by its largest and most powerful members, precisely those whose domestic policies have systemic implications, attempts against the independence of the Fund’s assessment and its capacity to police compliance with its obligations. This handicap is compounded by the fact that two of its members, the US and the EU, can veto its most important decisions,” he adds.

Torres recommends that instead of the current governance reform proposals which will “neither recover credibility nor improve efficiency” of Fund operations, a double-majority system of decision-making should be put in place instead.

Such a system, he argues, will be a compromise “between regulatory capacities that call for an even distribution of votes among members with the need to accommodate the reality of members with very unequal economic weight”.

He suggests that the double-majority system - “in which an economically-weighted majority is complemented by a one-country one-vote majority” - can assist in bringing both “additional sense of ownership for its policies and effectiveness” among Fund members by combining the recognition for differences in relative economic weight with the equality of rights and obligations of all its members.

This system has already been implemented in other international organizations, such as the Global Environment Facility (GEF), the European Union Council and the African Development Bank (ADB).

In other sections, the paper deals with other aspects of the IMF’s legitimacy. It says that the independence and objectivity of the Fund’s policy advice and conditionality are also questionable. For example, it highlights the fact that the Fund lavishes praise on countries implementing orthodox economic policies.

However, redressing the Fund’s underlying “ideological bias” in its policy prescriptions to developing countries (as a condition of financing) will require more than “a fairer and more functional distribution of votes and quotas”, argues Torres.

This problem compounds the issue of legitimacy and credibility of the Fund as a multilateral institution and highlights the concerns associated with the asymmetrical governance structure. It can only be resolved with greater accountability of Fund operations.

“It will require making the Fund more accountable and responsive to citizens’ concerns, as its policy advice and conditionality has direct implications on their income. We should start by recognizing that policies recommended or ‘conditioned’ (i. e. imposed) in Fund programmes are not technically neutral but imply trade-offs in terms of social justice and should, therefore, be subject to democratic accountability,” said Torres.

The article by Torres is a valuable contribution to the on-going discussion on the IMF reform process, especially as it carries the views of an important representative and coordinator of the G24.

The reform process will be intensifying in the months ahead, as the IMF Executive Board is scheduled to come up with a revised quota formula by the IMF’s Spring meetings in April 2008, and a decision will have to be made on the second round of quota increases plus the increase in basic votes no later than the Annual Meetings in the autumn of 2008.

 


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