Who is going to clean up the inevitable financial mess in emerging markets if persistent inflation forces the US Federal Reserve to start raising interest rates significantly? The International Monetary Fund, normally tasked with pulling countries back from the brink, seems disenchanted with the job. Rather than embracing its traditional role of helping troubled debtor countries help themselves, the IMF has been attempting to morph into an aid agency.
Of course, it is more fun to be Santa than Scrooge, and rich countries give far too little in foreign aid. I have long advocated establishing a world carbon bank to channel grants and technology. Likewise, the case for funding a restructured World Health Organization to fight pandemics is compelling. But in a world where private capital flows far outweigh official lending, traditional IMF programmes still have a critical role to play in mitigating and managing financial crises.
That role has been abandoned during the pandemic, and re-establishing it will be difficult. Handing out funding with few strings attached made sense in the initial phase of the Covid-19 crisis. But because the IMF is still very much structured as a lending agency, it eventually will have to be repaid or go bankrupt itself. To get a sense of what that might look like, consider the tensions with Argentina, which received a massive US$57 billion loan in 2018 with uncharacteristically weak IMF conditions attached and is now balking at repaying.
The lack of conditionality in some recent cases has been appalling. Should the IMF really be furnishing virtually unconditional loans to a government that is restricting food imports to an under-nourished population, thereby exacerbating the problems caused by the government’s own exchange rate controls? It has done so in Nigeria in 2020. In other cases, the fund has been extraordinarily generous in its normally cautious surveillance assessments, giving its gold seal of approval to countries with exploding debt-to-GDP ratios that stabilize only under very optimistic assumptions.
The 2021 Article IV report for Ghana is a case in point. And the fund has been even more sanguine about large emerging markets, such as Brazil and South Africa, again arguing that dealing with the pandemic is the absolute top priority, despite soaring debt levels, rising inflation and simmering banking problems.
This lack of conditionality has been by design. During the pandemic, the fund massively expanded use of its Rapid Financing Instrument, a lending facility that does not require countries to enter into a “full-fledged” adjustment programme (and that in practice requires few conditions or none at all). Even more visibly, it has persuaded its members to approve an emergency issuance of US$650 billion in special drawing rights (SDRs, the fund’s reserve asset), which also have essentially no conditions. SDRs are basically direct aid that goes to every IMF member, including Russia and Iran. And yet, owing to the instrument’s arcane structure, developing economies stand to receive only a small fraction of the pot.
There are strong arguments for revamping the financial structure of the IMF and its sister organization, the World Bank, so that the vast bulk of the funding they provide takes the form of outright grants, rather than loans. I have been advocating such a transformation for decades, and recently the idea has started to receive serious attention. Because the IMF is currently structured as a revolving fund, it would quickly run dry if it forgave all its loans, as some non-governmental organizations are always asking it to do. The only way this would not happen is if the advanced economies agreed to replenish the well, which they seem loathe to do.
One key condition should be that IMF funds are not used simply to repay private creditors. Researchers have shown clearly that this happened during the 1980s, and again more recently. State-owned Chinese banks that charge private-market interest rates also are now a factor to consider. There should be ways to ensure that IMF loans do not go to pay off Chinese ones.
There are striking parallels between a well-meaning IMF and a well-meaning Fed that now wants to foster greater equality. After long arguing that sharply rising inflation is transitory, the Fed now faces a dilemma. Unless it tightens monetary policy sufficiently over the next year (a much bigger risk than official rhetoric acknowledges), inflation could become embedded. If it tightens too fast, there will be a recession. Stagflation is also a real possibility.
The IMF similarly needs to pivot in its core surveillance functions. The dire plight of emerging markets and developing economies commands great sympathy, but the IMF is not the World Bank, which really is an aid agency. Instead, forceful IMF conditionality is essential to establish financial stability and ensure that its resources do not end up financing capital flight, repayments to foreign creditors, or domestic corruption. The pandemic is not going away; nor should the traditional IMF.
Kenneth Rogoff is a professor of economics and public policy at Harvard University and a recipient of the 2011 Deutsche Bank Prize in Financial Economics. He was the chief economist of the International Monetary Fund from 2001 to 2003.
Copyright: Project Syndicate