Trends and Analysis: IMF’s Policy Support Instrument (PSI), old pressure in a new package

NewAge, September 18, 2007

As more countries are amassing their own foreign reserves and choosing not to seek its assistance, the International Monetary Fund has come up with a new trick – the Policy Support Instrument – to retain its influence even without monetary assistance to poor countries, writes Tanim Ahmed*

To begin with an unavoidable cliché, one cannot but appreciate the irony that an institution professing to foster global monetary cooperation, secure financial stability, facilitate international trade and help out countries with balance of payments crisis is itself in a financial crisis. The International Monetary Fund currently has an operational loss of $100 million, which is set to reach $365 million by the 2010.

A perverse incentive structure
On May 18, 2006, the IMF managing director, Rodrigo de Rato, appointed a committee of eminent persons to study ‘sustainable long-term financing’ of the multilateral lending agency. In other words, the committee was to suggest alternative income sources for the cash-strapped Bretton Woods institution. Andrew Crockett, president of JP Morgan Chase International, headed the committee, which included such people as Alan Greenspan, former chairman of the US Federal Reserve Board, Guillermo Ortíz, governor of the Bank of Mexico, and Jean-Claude Trichet, president of the European Central Bank. The committee pointed out the rather perverse incentive structure for the IMF and its staff arising from the fact that the lending agency performed rather well when its clients were in crisis since it could then increase its lending – which happens to be its only source of income – and thereby boost its revenues. Noting that it was a weakness for the agency to have its earnings concentrated to a single source, the Crockett committee said: ‘It [the IMF income model] has the curious feature that the Fund’s financial well-being depends on it being unsuccessful in its primary mission, which is to prevent financial crises.’

A report of the Economist, published February 3, headlined ‘Funding the Fund’ reads: ‘It is the mirror image of the unseaworthy economies it used to bail out.’ It says during the stormy period between 1994 and 2002, the agency called on the ‘quotas’ of hard currency pledged to it by its big shareholders to make large loans to troubled economies and since it charged its borrowers more than it paid its creditors, it could afford a big expansion of operations. ‘The fund’s retinue of economists, managers and other professionals grew from 1,488 in 1997 to 1,999 in 2005. Its administration costs more than doubled,’ says the report. But, as has been noted and reported widely, the agency’s sources of interest earnings are drying up as increasing number of clients, especially large ones, are paying their debts early and bidding farewell to it. It struggles to find new clients who would take loans. ‘Instead of relying on the fund, emerging economies are insuring themselves by amassing reserves of their own. Some, such as Brazil, Argentina and Indonesia, have paid off their IMF loans early, at a cost, to rid themselves of its “stench”, as some people put it. Now, a loan to Ankara accounts for two-thirds of its credit outstanding: the IMF is, in effect, the Turkish Monetary Fund.’

Although Thailand was the first one to exit from the fund’s programme, the rot began at the end of 2005, when on December 13 Brazil decided to pay off its IMF debts and refusing to renew their arrangement. Since then Argentina, Bolivia, Serbia, Indonesia, Uruguay, the Philippines and Venezuela have taken a similar path. Notably these include three of the agency’s largest debtors.

Another report that created quite a bit of sensation was by an external review committee headed by Pedro Malan, former Brazilian finance minister, to evaluate the relationship between the World Bank and the IMF. The committee, appointed jointly by the two lending agencies in April 2006, gave its report on February 27, 2007. The report suggested, among others, that since the IMF was not equipped to operate as a development institution, it should stop making loans to low-income countries, leaving that responsibility to the World Bank. The suggestion was thus to suspend the agency’s poverty reduction programme, styled, ‘Poverty Reduction and Growth Facility’, which is currently running in Bangladesh too. The Malan report also observed that the fund had shifted away from its core area of responsibilities and encroached upon those of the bank.

IMF conditionality so far
When Thomas Rumbaugh, an adviser for the IMF’s Asia-Pacific region, was in Bangladesh the last time for another round of consultations in April this year, he made a series of recommendations that not only lacked vision but would ensure that the poor are further taxed. Besides the regular prescriptions to increase oil and power prices, the IMF also recommended that the government scrap its tax holiday scheme for investors. There were recommendations to introduce taxes in the transport sector as well.

When AB Mirza Azizul Islam, the finance and commerce adviser to the current military-driven interim government, proposed a sweeping tariff regime during his budget speech, it took the business community as well as economists by surprise. Mirza Aziz proposed increase in import tariffs on capital machinery, industrial raw materials and primary and intermediate goods on the one hand and decrease in the import tariffs on finished items and luxury goods on the other. Quarters privy and close to the budget preparation process admitted privately that such sweeping measures were not expected, and were certain that those had been incorporated at the recommendation of the lending agencies.

Subsequently, the interim government directed the central bank to follow a contractionary monetary policy despite the advice of a number of economists to the contrary. This was once again supposedly at the advice of the IMF. Such prescriptions, to tighten money supply in inflationary times, have been a typical response of the fund during similar crises in other countries previously. A number of economists pointed out that the current inflation was not a supply-side problem but a demand-side problem and tightened money supply would not cure the problem. Consequently, the economy has been going through the classic signs of stagflation, typified by stagnant growth and high inflation.

In the guise of promoting fiscal austerity, the IMF, almost as a routine, imposes caps or ceilings on public expenditure, especially on wages of public servants. According to a briefing of Action Aid Bangladesh, published in December 2005, the agency recommended to the government, during consultations with a visiting delegation in April that year, that it should not implement the new wage scale for public employees. This new pay scale would have included public schoolteachers and increased their salaries which, according to the lending agencies, would have disrupted fiscal discipline of the government by increasing its expenditure.

The state-owned banking system is in the middle of being completely dismantled and it has only been an outcome of prescriptions put forward by the IMF. The Rupali Bank is set to be sold off to a Saudi prince while the other three – Sonali, Agrani and Janata – are expected to be eventually bought by large corporations. But the IMF itself has shown that foreign ownership of banks is associated with steep reductions in credit for the private sector, accompanied by falls in the number of bank accounts and bank branches per head, as shown in a working paper (WP/06/18) of the agency by Enrica Detragiache, Thierry Tressel and Poonam Gupta, titled ‘Foreign Banks in Poor Countries: Theory and Evidence’ of January 2006.

The state-owned banking system also has a central role in the country’s development programmes because successive governments have found it convenient to disburse credit through the extensive network of the four nationalised commercial and the two specialised agricultural banks. These are only a few examples from the recent past to provide an idea of the role that the agency has played in Bangladesh. Thus far the agency’s conditions came with a payoff. Successive governments that accepted loans and renewed financial lending arrangements with the IMF were made to swallow their prescriptions or not receive payment, as has been the case with the recent lending arrangement that has expired for not being able to fulfil some conditions. The Poverty Reduction and Growth Facility, which happened to be the main lending mechanism of the IMF, had a host of conditions. But central among them was a continuous pressure to increase prices of fuel and gas in order to reduce the government’s expenditure, by way of subsidies. According to a study of Eurodad – European Network on Debt and Development with the involvement of some 53 non-governmental organisations from 16 European countries, there are on average 11 conditions imposed on poor countries in each PRGF review. But since 2003, when Bangladesh signed the new arrangement, it has hardly faced any balance of payment crisis and currently boasts about $5 billion dollars in foreign reserve, thanks to a vibrant expatriate community.

As the Economist report stated, countries are amassing their own foreign reserves and choosing not to seek agency assistance, which precludes the scope for the IMF’s involvement in policy setting of the developing world. The Policy Support Instrument, it appears, has been designed to take care of just that – retain IMF influence even without monetary assistance to poor countries.

Enter PSI
The Policy Support Instrument was introduced in October 2005, and as the name suggests, it aims to provide ‘policy support’ to poor countries. This programme also involves more frequent assessment – once every six months – of the client countries and when deemed on track and so announced by the IMF, it would act as signal for other agencies, institutions and countries about the creditworthiness of the host country. According to the agency’s relevant webpage, updated April 11, 2007, the instrument ‘encourages countries to deepen and broaden policy ownership’ and ‘signals that a country’s economic policies have been discussed with the IMF.’ It says this policy support instrument was created to provide a ‘support framework for low-income-countries that no longer need IMF financial assistance but want Fund endorsement of their economic policies. The PSI, which is voluntary and demand-driven, is well suited to countries graduating from Poverty Reduction and Growth Facility arrangements.’

Pointing out that a client ‘on track’ in the policy instrument programme would have rapid access to the agency’s new fund for exogenous shocks, the agency states that the reform agenda of Policy Support Instruments ‘often includes measures to improve public sector management, strengthen the financial sector, and move forward in other areas consistent with the IMF’s medium-term strategy’. The requirement for this programme is a letter of intent from a client, following which there will have to be a submission of a reform agenda in line with its ‘domestic’ or ‘home-grown’ poverty reduction strategy. In the case of Bangladesh, if it were to send a letter of intent, the policies would be based on its ‘home-grown’ poverty reduction strategy, which is hardly locally owned and was entirely the result of the World Bank’s pressures to receive further funds.

There would naturally be recommendations regarding public sector reform, which only means further privatisation. There would also be issues relating to monetary policy and fiscal measures where the IMF would push for further liberalisation and thereby increase import dependence of the country.

This assessment would work as a ‘signal’ for others whether they should lend to Bangladesh. Thus the fund would still retain its influence in Bangladesh’s policy matters without providing any loans to Bangladesh.

The Bank Information Center, a non-governmental organisation, in a briefing observes, ‘Critics suspect the PSI is little more than a new way to extend IMF domination.’ The 50 Years is Enough, a coalition of over 200 US civil society organisations, finds the Policy Support Instrument to be no different than a standard IMF programme, except that there are no loans. Instead of releasing the next tranche of loans, the IMF would in this merely publish its findings which would tell other lenders that the client is indeed progressing in their desired direction with the structural adjustment provisions, privatisation, liberalisation and spending cuts.

The signalling element, as has been pointed out by a number of critics, was implicit in the staff reviews, but with the establishment of the new instrument becomes more concrete and explicit, which many consider is the most powerful device that the fund wields to have its client listen to it. The dangers of accepting this new programme are that on the one hand it will deter countries from becoming really free from the clutches of the fund and would only confirm the fund’s position as the ultimate authority over a country’s economic policies which would certainly be driven towards market fundamentalism that the lending agencies preach.

The Bretton Woods Project, established by a group of British non-governmental organisations and currently a network of over 7,000 organisations and individuals, in an analysis of the existing Policy Support Instruments — all of them are in Africa — found that the number of structural conditionalities imposed in each assessment, almost 12 on an average, were more than those imposed under the poverty reduction programmes, about 11 as mentioned before.

There have been four countries that ‘volunteered’ for this new instrument. In case of Nigeria, which was the first country to accept PSI, it was in fact a prerequisite for the Paris Club to write off 60 per cent of its debt, equivalent to some $18 billion. The Paris Club required validation that the kind of programmes it desired was indeed in place and thus the Policy Support Instrument had been imposed upon Nigeria. While the element of coercion is obvious in this case, the other three, Uganda, the IMF poster boy, Cape Verde and Tanzania have all asked for the programme. But that is more due to the political establishments’ intention to demonstrate to their respective constituencies that the country is indeed heading towards better economic governance.

The case of Bangladesh
There is an IMF delegation currently in the country. It was initially expected that this delegation would leave after sealing a new agreement with the military-driven regime enrolling it into the new programme. It appears the deal has not yet been made but would surely be pursued at a later and more appropriate time. It is merely an inevitability since without this new instrument and without any need for Bangladesh to seek more funds for balance of payment problems, there would be no role or business of the fund in Bangladesh. That would mean that the agency would not have any authority to dictate the country’s economic policies, which it simply cannot allow, as it is losing ground all over the world anyway.

There are several things to consider at this juncture. The first is naturally whether Bangladesh really needs foreign grants and loans, which hardly make up for 2.5 per cent of the GDP currently. Several quarters would assert, and reason convincingly, that the country does not require loans or credit from the international financial institutions. In the case of foreign direct investment or funds for research and development, however, the argument does not appear to be as assertive or convincing. Quarters do point out that investment in the current terms as stipulated by the investment is meaningless and would not add to the country’s development by way of employment generation, local value addition or better wealth distribution, which is quite another issue. But as far as foreign investment is concerned, the IMF signal would surely be projected as an important one only to justify enrolment in the new programme.

In this case, one only needs to remember that the IMF has been guilty of putting out growth projections with political bias in the case of Argentina when it refused to carry on with the fund. The robustness and authenticity of the fund’s research and signals are thus not beyond question at all and quite evidently susceptible to its own political bias. If there is indeed a ripe environment for investment in Bangladesh, entrepreneurs would come, with or without, IMF endorsement. Malaysia is a case in point.

This decision to enter into a new programme with the IMF, however, should be left to a representative government as it will affect economic policies for several years to come. But given the Bretton Woods twins’ bias and preference for autocratic and unrepresentative regimes, it is likely that the incumbents would be seriously pursued to volunteer for a Policy Support Instrument.

The choice would eventually depend on the political compulsion of the incumbents and the desire of its support base.

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