With market turbulence exposing fault lines in parts of the international financial system, the IMF wrapped up its 2007 Annual Meetings amid calls for the multilateral institution to strengthen its role as a global financial watchdog and revamp its governance.
Finance ministers and central bank governors from around the world met October 20-22 in Washington, D.C., for the IMF-World Bank meetings at a time of renewed concerns about the fallout from the U.S. subprime mortgage meltdown. Outgoing IMF Managing Director Rodrigo de Rato told delegates from the 185 member countries on October 22 that the resulting market turbulence was akin to “an earthquake in the credit markets.”
The meetings also coincided with a watershed in global economic growth. Three major emerging markets—China, India, and Russia—now account for more than half of world growth, according to the just-released IMF World Economic Outlook.
This development puts into sharp focus the intended reform to give emerging markets a bigger say in the IMF, where representation, as with many international institutions, still reflects a post-World War II balance of power.
De Rato stressed that the question now is whether the global economy has reached a turning point after five years of strong growth. The IMF is predicting that world growth will slow from 5. 2 percent in 2007 to 4.8 percent in 2008, compared with 5.4 percent growth in 2006. So far, the emerging markets have largely escaped the fallout from the U.S. and European credit crunch. In fact, de Rato noted, “emerging economies have become a source of stability in the global economy—something that would have been unthinkable a few years ago.”
The Group of 24 developing countries also pointed out that “developing countries are a new driving force as well as a stabilizing factor in the world economy,” and called on the IMF to strengthen its surveillance of financial systems in advanced economies.
Financial stability ‘genies’
Tommaso Padoa-Schioppa, chair of the IMF’s policy guiding committee—the International Monetary and Financial Committee (IMFC)—told reporters that although recent market turbulence had been countered by determined action by several central banks, it had also “revealed a number of problems that may be deeper than the specific episode that triggered the tensions.”
“There are developments in the financial system which are like genies which moved out of the bottle and are hard to follow,” he stated. “There is a clear need for supervisory bodies, and even for the very financial institutions which create these new instruments, to understand better what their creatures are doing out in the market. This is clearly a reason for concern.” But he added that the good news was that the disturbance had occurred at a time of abundant liquidity around the world when economies were strong.
“Emerging economies have become a source of stability in the global economy—something that would have been unthinkable a few years ago.”
Many of the discussions over the three days—both in the official meetings and in seminars lined up by the IMF and World Bank and nearby think tanks—centered on what lessons could be drawn from the recent turbulence, the global economic an financial outlook, and the next steps in the agendas of the Fund and the World Bank.
The IMFC said financial innovation and securitization, while having contributed to enhanced risk diversification and improved market efficiency, had also created new challenges “that need to be properly addressed.” It pinpointed five areas to be addressed, in particular: risk management practices related to complex structured products; valuation and accounting for off-balance-sheet instruments, especially in times of stress; clarifying the treatment of complex products by ratings agencies; addressing basic principles of prudential oversight for regulated financial entities; and liquidity management.
The IMFC asked the IMF—working with the Financial Stability Forum, the Bank for International Settlements, and others—to deepen its work on these issues and report back at the next IMFC meeting, which will be held in Washington on April 12, 2008. It encouraged the IMF to continue to “broaden and deepen its financial expertise to identify future issues.” It asked the Fund to better integrate the findings of its surveillance of the global economy into its monitoring of individual economies and regional groups. In addition, it welcomed the IMF’s ongoing work on sovereign wealth funds.
A louder voice
A major focus of the IMFC meeting was progress on the IMF’s two-year program to reform the system of quota shares to better reflect members’ evolving weight in the global economy. The program, which was launched in Singapore one year ago, began with an ad hoc increase for the four most underrepresented countries: China, Korea, Mexico, and Turkey. Many emerging markets and developing countries expressed concerns about the depth of the reform and the likelihood that they would secure sufficient voice in the running of the institution.
Padoa-Schioppa told reporters that enough progress had been made over the past year to give hope that the essential elements of a reform package could be worked out by the Spring Meetings in April 2008. There is now agreement on the need for a shift in voting shares toward emerging and developing countries as a whole, a total quota increase of about 10 percent, and at least a doubling of basic votes to protect the position of low-income countries. The intention is to achieve final consensus on the reform at the Annual Meetings in October 2008.
The IMFC stressed that the second round of reforms should “be a further increase in the voting share of emerging market and developing economies as a whole.” Such a shift will be based on a simpler and more transparent quota formula—the key outstanding item. The IMFC said it supported the inclusion of the following items in a quota reform:
• a GDP variable as the most important element;
• a role for GDP to be measured at purchasing power parity (instead of at just market exchange rates); and
• a role for a compression factor to moderate the influence of economic size.
One other key element of the reform is an overall increase in quotas—which the IMFC said “should be of the order of 10 percent.” The IMFC also stressed the importance of enhancing the voice and representation of low-income countries, and called for at least a doubling of basic votes to protect the voting share of low-income countries as a group.
Other aspects of reform
The IMFC discussed other areas in which the IMF has stepped up its reforms to cope with a world of highly interconnected markets and ever-expanding capital flows.
Income. The IMFC welcomed the progress made in developing operational guidelines to implement the recommendations of the Committee of Eminent Persons chaired by Andrew Crockett. It noted that both income and expenditure need to contribute to putting the Fund’s finances on a sustainable footing. On the spending side, it noted the Fund’s ongoing efforts to reduce administrative expenditures but said it saw a need for greater efficiency and saving through Fund-wide priority setting. The IMFC called for specific proposals on the new income model by the 2008 Spring Meetings and agreement on a medium-term budgetary envelope for the FY2009 budget that is consistent with the emerging income and expenditure model. The IMF has already embarked on a 6 percent cut in expenditures in real terms during 2006-08.
“There are developments in the financial system which are like genies which moved out of the bottle and are hard to follow.”
Surveillance. The IMFC welcomed the progress on strengthening IMF surveillance, including the June 2007 decision on bilateral surveillance—which involves the advice (including on exchange rates) that the IMF offers its 185 member countries.
Emergingmarkets. The IMFC said it supported the priority being given in the Fund’s policy advice to emerging market economies “in working with them on the timely identification of vulnerabilities, the strengthening of debt management practices and deepening of local capital markets, and the design of policy responses in the face of large capital flows.” It noted the work on designing a new liquidity instrument and asked the Executive Board to continue its work on the instrument’s design.
Low-incomecountries. The IMFC welcomed progress on clarifying the IMF’s role in low-income countries. This included well-designed financial and policy support in the context of surveillance, Fund arrangements, and technical assistance.
Transition and expenditure restraint
Former French Finance Minister Dominique Strauss-Kahn, who takes over from de Rato on November 1, will have to spearhead the quota reform effort, along with other IMFC requests—including putting the IMF’s finances on a sustainable footing.
Strauss-Kahn will be working closely with two other newcomers: World Bank President Robert Zoellick, who took over the reins of the IMF’s sister institution four months ago, and Italy’s Economy and Finance Minister, Padoa-Schioppa, who was selected last month to succeed the United Kingdom’s Gordon Brown as IMFC chair.
IMF External Relations Department