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Impasse over IMF finance at awkward time for world economy

Impasse over IMF finance at awkward time for world economy

Growing international frustration over US stance 

by David Marsh

Mon 14 Apr 2014

The impasse in the US Congress over extra powers and money for the International Monetary Fund (IMF) may go down as one of the more costly mistakes in the 70-year-old history of the institution at the centre of world finance.

The stand-off with the US has caused great bitterness and frustration among important emerging market economies led by China and India. It could leave the IMF perilously short of funds at a time when heavyweight countries such as Brazil, Turkey and South Africa may all need some form of official financial support over the next 12 to 24 months to ward off risks from capital outflows caused by the shift towards tighter US monetary policies.

The worries about financing vulnerable emerging market economies are an additional factor overhanging stock markets which look set to suffer a major contraction in coming weeks from overdone highs driven by excessive bullishness over corporate valuations.

Among other negative factors, residual concerns over the euro area – where underlying tensions are still strong, despite last week’s capital market return of serial economic policy offender Greece – loom large.

There is considerable nervousness about China – where more bond defaults in coming weeks could drive further pessimism about the short-term growth outlook. Of all these different concerns, the unfavourable nexus between US monetary tightening and capital withdrawal from emerging economies is probably the most pressing – and most intractable.

In Washington for the annual spring gatherings of the IMF and World Bank, the main industrialised and developing economies meeting as the G20 issued a communiqué saying they were ‘deeply disappointed’ by failure to implement changes agreed in 2010. They gave the US until the end of the year to do so, threatening otherwise to leave America out of new changes.

Developing countries worry that they have become hugely vulnerable to inflows and outflows of footloose, herd-like international capital, much of it looking for short-term speculative profits.

During the earlier period of US monetary loosening, speculators made money in dual fashion, by driving up both equity prices and exchange rates in leading emerging market economies. Now the tide has turned, and capital is deserting these nations, investment managers are applying the same dual-purpose approach, making profits by ‘shorting’ both equity and currency markets.

Developing countries’ frailty has been partly compounded by the growing popularity among investment funds of emerging market local currency debt. Countries issuing such debt are no longer vulnerable to an increase in debt service costs when their exchange rate falls, as in previous occasions when they relied overwhelmingly on foreign currency debt, mostly in dollars.

But they do suffer from excessive declines in their own exchange rate, and a corresponding increase in local bond market interest rates, when foreign fixed income investors withdraw capital, as has been happening in recent months.

To give vulnerable countries the firepower to withstand such pressures, finance ministers want the IMF to command resources of $1tn that could be applied in a variety of ways. This could flow partly through pre-emptive loans with relatively slender conditionality to counter early sources of pressure before any crisis develops.

The planned Fund changes would double the IMF’s quota – approximating to its equity capital – to $720bn, shifting six percentage points of total quota to emerging market economies.

The US is the sole hindrance to the IMF reforms, explaining frustration over Washington’s behaviour that unites all parts of the world. Even though the Obama administration backs the changes, it has been unwilling to meet the high political price demanded by Republicans to get them through Congress in a year when the US mid-term elections take place.

Despite the end-2014 ultimatum, the next steps are far from clear. China, which is increasingly flexing its muscles at the IMF, has issued a veiled threat that it could lead other Asian countries in a ‘go-it-alone’ stance, possibly by building up a separate Asian Monetary Fund. This is hardly likely in the shorter term, given disagreement and rivalry over these issues between China, Japan and India.

Moreover, the US has (and will continue to have) a blocking minority of votes at the Fund – which is the reason its inaction has delayed the reforms in the first place. Tharman Shanmugaratnam, the Singapore finance minister, who is one of the most influential voices at the IMF, said yesterday in Washington that, in view of the growing weight of the developing countries, the US had to move in line with the rest of the world’s wishes or else risk ‘disruptive change’ in the next 10 years.

The stakes are undoubtedly high. But the IMF remains mired in stalemate, at a highly awkward time for the world economy.

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