The International Monetary Fund has been at the center of global financial stability since its creation after World War II. In the last year it has played a central role in reducing the risk of a European financial meltdown. At the fund’s spring meetings this week, the question of whether to bolster I.M.F. resources will dominate the agenda. Yet in reality the I.M.F. faces a much greater challenge that could render additional financing a sideshow: an erosion of market belief in I.M.F. financial analysis. Such a loss of credibility threatens the fund, the nations it seeks to support, and the global financial system.
Paradoxically, the I.M.F.’s predicament arises directly from its recent success in responding to the crisis in Europe. As it continues to work with the European Commission and the European Central Bank (its partners in the “troika”), the I.M.F. risks creating the perception that it is ignoring financial realities in the face of political pressures — a perception that makes private creditors leery of investing into I.M.F.-supported countries and potentially dooms I.M.F. programs to failure.
When holders of Greek debt exchanged their bonds in March for new longer-term paper with lower yields, international institutions labeled the swap a success and the I.M.F. approved its portion of the second bailout for Greece. But then the new, supposedly safe Greek bonds plummeted to a level roughly equivalent to where pre-exchange debt had traded. This reflected the view that Greece’s financial position was no more sustainable than before, and is a direct rebuke to the I.M.F.
The episode is eerily reminiscent of the I.M.F.’s overlending to several African countries in the 1980s, the most important sustained failure in the fund’s long history. When the I.M.F., prodded by the United States and other Western donors, provided significant funding to these countries it ignored the foundation of its credibility: its financial objectivity. Prior to approving financing, the fund models a nation’s economic future to determine whether the country in question can be credibly put on a path to financial health. Only if a sustainable trajectory exists is the I.M.F. supposed to make financing available, with progress ensured by regular reviews.
If the fund’s analyses are not seen as objective, an I.M.F. program will not spur the private lending without which fund programs cannot succeed. That is exactly what happened in Africa two decades ago. The I.M.F.’s own staff warned that recipients such as the Kaunda regime in Zambia and Mobutu’s Zaire were not willing or able to undertake required reforms. Yet the Cold War political concerns of the fund’s primary donors won out, and the programs went ahead anyway.
Trumpeted by Western governments as a positive move, it became a disaster. Over time markets saw through the questionable assumptions underlying the I.M.F. programs and stopped providing financing. The result was a widespread loss of credibility both for the fund and for recipient countries, leading to large-scale debt restructurings and forgiveness in the 1990s.
Thankfully, the sums involved in the African transactions were relatively small and the fund was able to retain its broader market credibility. The scale of today’s I.M.F. programs in Europe are far larger — and far more threatening.
In working with the European Commission and the European Central Bank, the I.M.F. has been asked to reconcile its financial objectivity with its partners’ disparate agendas. With the European Commission intent on using financial crises to force political changes in the euro-zone periphery and beyond, the fund has found itself in the middle of precarious political situations.
Cooperation among the troika has been successful, and even desirable — but not to an extent that risks squandering market belief in I.M.F. independence. Few market players accept the assumptions contained in the I.M.F.’s most recent economic models for Greece, creating the vicious cycle seen in the bond exchange, in which markets do not believe in a solution that requires their confidence to be effective.
The more that political concerns are perceived to influence I.M.F. analyses, the more skeptical markets will become. With no other international institution a credible or willing financier, this scenario poses a severe threat to the global financial system. If markets lose faith in the I.M.F.’s independence, then the additional resources that the fund is seeking this week won’t be nearly enough to stem future economic crises — and maybe even the current one.
Moving forward, the I.M.F. must loosen its partnership with the commission and the E.C.B. While coordination remains critical, the I.M.F. should make clear that on financial matters, it remains in sole command of how its resources will be deployed.
In particular, the fund must present its financial analysis separately from any key political deals that might be struck by other troika members, allowing markets to assess the underlying assumptions. Only then will I.M.F. programs lend market players the confidence to re-engage with those countries that desperately need private capital. Maintaining credibility will also reassure the fund’s shareholders that I.M.F. resources are being deployed in a manner consistent with the organization’s mandate as a global financial truth-teller.
If the I.M.F. is involved, it needs to be on its own, and not anyone else’s, terms. Ignoring that truth will have dire consequences for global finance, and bolstering the fund’s resources this week won’t change that.