A Step in the Wrong Direction

This week’s International Monetary Fund meeting in Washington is likely to be a repeat performance of the “Seattle fiasco”. An unholy alliance of social justice activists and champions of protectionism are creating confusion. The IMF has, critics claim, lost its way and needs to be reformed. The recent report by the Meltzer Commission was designed to address this issue, but failed to produce a convincing set of proposals.

Many of its ideas create, rather than resolve, problems. On debt reduction, the commission recommends a complete write-off of the debts of the world’s poorest countries, most of them in Africa. Market adherents and social activists have hailed the proposal as groundbreaking. But an unconditional write-off will neither foster growth nor help the poor.

As the report stresses, no country will grow without good governance: the rule of law, property rights, and uncorrupted public leadership. This is as true in Congo, Zambia and Nigeria as anywhere else. Without a minimum standard of good governance, a debt write-off will only finance a new round of waste and corruption.

Ironically, it will do more for the balance sheets of the international organisations—to whom much of the debt is owed—than for the world’s poor. It would be far better, and more “compassionate”, to tie debt reduction to serious commitments, such as providing fundamental social services.

This policy would avoid the moral hazard of “easy money”, which the Meltzer group attributes to the IMF. It would protect the poor from the corruption of their own governments; and it would make the financial institutions more accountable for loans that have failed to achieve their objectives.

As for World Bank lending to middle-income emerging market economies, the commission recommends that the World Bank and the regional banks, such as the Inter-American Development Bank, phase out lending to countries with investment grade ratings.

Countries such as Brazil, Mexico, Thailand and South Africa fall into this category: they can borrow on the capital markets. But the interest rates they pay are high and volatile, and reliable access to private credit is by no means assured. When the Russians defaulted on their domestic debt in 1998, even the most creditworthy countries of Latin America could not borrow—except, of course, from the World Bank and the IDB.

When global market turmoil requires these countries to reduce government spending to rebuild credibility with private lenders, it is the international banks that provide credits to sustain their education and health programmes.

Many developing countries cannot issue debt for terms beyond five years, because international capital markets have no appetite for long-term emerging market debt. Yet development investments—in schools and infrastructure—have much longer gestation periods.

The commission’s idea of restricting development bank lending might help private international banks in their pursuit of short-term profits: their lending business will benefit from the IMF’s withdrawl. But it would put at risk the long-term effort of building institutions in those countries which have yet to achieve sustainable market development.

On the issue of IMF lending to low-income countries, the commission echoes a proposal by Laurence Summers, the US treasury secretary. The IMF, it says, should get back to its core business: lending to countries with payments and liquidity problems, leaving long-term development aid and poverty reduction to the World Bank and the regional development banks.

That is a good idea. But there can be complex trade-offs between short-term stability and long-run development. IMF insistence on fiscal cutbacks to solve short-term liquidity problems and to calm panicky investors and depositors has too often come at the expense of steady public investments.

On this point, the commission’s call for penalty interest rates on limited duration crisis loans is a step in the wrong direction. It will eliminate the financial support and advice for countries struggling to navigate through short-run crises.

Instead of being scrapped, IMF short-term lending should be subsidised—possibly through medium-term lending and grants administered by the development banks. Instead, in an apparent effort to disband the IMF, the commission seems prepared to abandon low-income countries altogether.

Both the members of the Meltzer Commission and the protesters are united in their call for fundamental reform of international financial institutions. But the development business is complicated. An elegant argument on the one hand, and street demonstrations on the other—no matter how well-meaning—should not trump realism.