Until the outbreak of the global financial crisis in 2007, the early parts of 2000’s were a period when most nations recorded improved economic performance. The economic growth was robust; inflation rates were low; international trade was expanding, and the developing world was experiencing widespread economic advancement coupled with a significant absence of crises.
This favorable equilibrium was underpinned, though, by three trends, which appeared to be unsustainable as the global economies approached mid-2000’s. First, there were real estate values that were rising at a high rate across the globe, including in the US. Secondly, several nations were simultaneously raising current account deficits; this included the largest world economy, the US. Finally, leverage had accumulated to extremely high levels in most sectors globally, particularly among the consumers in the United Kingdom and the US. Apart from being the world largest economy, the US had the highest numbers of home ownership as well as the world’s most dynamic and deepest financial markets. These American markets, having been progressively deregulated for more than three decades, were faced by ineffective and fragmented system of governing prudential oversight. This combination of factors formed the core of the global economic crisis (Braga and Vincelette, 2010).
The Global Imbalances
The controversy remains concerning the exact connection between the global finance melt down and global imbalances. There are some economists who suggest that external imbalances had no connection with the financial crisis, and instead it was caused by the lack of efficient financial regulation and by poor policy, more so in the US. Other critics blame it on the various mechanisms of the global imbalances, which played a significant role in causing the global financial crisis. According to Henry Paulson, former US Secretary of Treasury, the high saving of oil exporters, China, and other surplus economies depressed world interest rates, which caused investors to scramble for under price risk.
It is a fact that both financial crisis and global imbalances are connected; both came from economic policies that were being followed by several economies in 2000’s. They also have a common root in the misrepresentation that impacted the transmission on such policies through the United States, and eventually through the world financial markets. The US’s capability to fund microeconomic imbalances through foreign borrowing permitted it to postpone policy choice. The financial institutes’ fixation for assets provided a ready source of external financing for the US deficit. The US was able to borrow at nominal interest rates, because of loose monetary policies. China was able to sterilize the enormous reserve purchases it placed on the United States markets, allowing it to preserve an underrated currency and suspend rebalancing its economy. Corresponding policy alterations, therefore, kept China artificially away from its reduced autarky interest rate while, at the same time, keeping the US off its higher autarky interest rates. If the lowered cost postponement was not available, then the subsequent crisis could have been mitigated. The fundamental fault in this analysis was the presumption that developed nations capital markets were perfect, hence able to withstand the increasing leverage with minimum risk. This paper describes how the global imbalances reflected the causal factors of the global financial crisis and the part played by the International Monetary Fund (IMF) (Eatwell, 2011).
The Roles of the IMF
The most recent global financial crisis that started with the meltdown of the United States subprime housing markets at the beginning of 2007 has tested the capacity of the International Monetary Fund, in its function as the global institution that oversees the world monetary systems. Although, the IMF is least likely to lend to the third world nations that are most affected by this crisis, and it must compete with other global financial institutions as a centre of policies coordination, the spillover of crisis on the developing nations is giving the IMF a chance to reassert is roles in the international economy. This chance is presented in two perspectives of the global economic crisis: first, the immediate financial crisis management and second; the long-term reform of the global financial system.
The functions of the IMF have changed dramatically since its inception in 1944. Late at the end of WWII, delegates from about 44 nations gathered at Bretton Woods, in Hampshire to seek for the way forward for Europe and to flag off a set of International institutes, which would oversee the global economic matters that had devastated the international economic systems. The same way global economic systems have changed, so has the IMF. Between 1946 and 1973, the main function of the IMF was the management of the fixed structure of the global exchange rates that had been established at Bretton Woods.
The US currency was fixed at $35 per ounce, and any other currency was fixed at US$ at differing rates. The IMF was mandated to monitor the exchange rate policies of the member nations and macroeconomic; it helped members to surmount the balance of payments crisis through short-term loans and grants. These loans brought currencies back to their determined value of exchange. However, this approach was brought to an end at the beginning of 1973, when the US floated dollar, hence introducing the contemporary system of floating the exchange rates. Since then, financial globalization and floating exchange rates have significantly contributed to the high levels of growth and substantial wealth for most nations. This has also resulted into growth of the global economy that was ruined by the exchange rate volatility and frequent economic crises. The International Monetary Fund adapted to the termination of the fixed exchange rate and became the global lender of the final resort for members distressed by such crises. The present IMF responsibilities and operations are based on three main areas: surveillance, technical assistance, and lending. Surveillance entails monitoring financial and economic developments as well as providing advice on the best financial policy to the member nations. In terms of lending, the IMF provides financial assistance under regulated conditions to help nations that might be going through crises on the balance of payments. Finally, technical assistance entails assistance on improving the effectiveness and quality of domestic policymaking (Endres, 2010).
The latest global crisis was a significant challenge for the IMF, since it is not financially capable to lend to the United States and allies, who were afflicted by the economic meltdown. By August 2008, the IMF’s financial resources were $352 billion, whereby $257 billion was usable resources. In the history of IMF lending, the highest lent during any given year was $30 billion. The Fund is utterly unequipped to provide the needed liquidity to the US and afflicted allies. In addition, the developed nations are the key contributors to the IMF financial resources, and it is least likely that these nations would seek financial assistance from the same Fund. The last time for the developed nations to borrow from the IMF was in 1973, when Spain, Italy and the US borrowed to mitigate the aftershock of high oil prices.
Since the economic crises that happened a decade ago, most emerging economies have built massive foreign reserve positions to avoid having to turn to the IMF in times of crisis. From $US1.2 trillion in 1995, the world foreign exchange reserve had grown to $US7 trillion by 2008. The developed nations’ foreign reserves were US$ 1.43 trillion compared to $5.47 trillion in the developing countries. These reserves accumulation was caused by the current account surpluses and high commodity prices coupled with increased saving rates from the Asian markets. The emerging Asian economies’ reserve accumulation benefitted from the increasing prices for the commodity prices and caused a decline in the demand for the IMF lending, which weakened the IMF’s budget. This lending ability of Fund improved during this period with its credit accumulating to $110.29 billion. By the end of 2008, the unpaid IMF loans had decreased to $17 billion from $92.6 billion over the same period. Considering that IMF earns its income from the interest paid on the loans, the lowered borrowing from IMF by the member nations caused the budget deficit in 2007. To reinstate its position, the IMF is seeking to sell a part of gold in its reserve to accumulate investment ability (Copelovitch, 2010).
The up rise of the emerging economies over a decade ago has posed a new challenge to the IMF. Most of the emerging economies believe that their stake in the IMF is not a representation of their role in the global economy. Economies from Asia and Latin America argue that their economic status and weight should be corresponding with a larger share and voice in the IMF. Additionally, most developing economies, believe that the quota system by the IMF is prejudiced against their development, by giving them insignificant voice, whereas they are the majority borrowers on the IMF. In response to these concerns, in 2006, the institute embarked on a reform process aimed at increasing the share of these emerging economies. Though the IMF has struggled to articulate its role in the global economy, the financial crisis has presented an opportunity for the institute to reinvigorate its position to play a constructive role to resolve the afflictions of the global economic meltdown through making contributions towards a long-term reform of global financial structures, and Immediate Crisis Management (Kaufman, 1999).
Immediate Crisis Management
IMF codes of engagement stipulate that member nations shall be permitted to borrow up to three times of their share over a period of three years, though this stipulation has been overlooked in several situations, where the IMF has been lending at much higher multiples of the specific quotas. Though most emerging economies in East Asia and Latin America, such as Indonesia, India, China, Mexico, and Brazil, have improved macroeconomic basics than they did previously, a sustained decline in US imports could have recessionary influences overseas. The emerging economies with less strong financial systems have been more considerably affected, more so those who depend largely on exports to the US. Increased emerging economies default risk has been seen through the spectacular rise of the credit default swap (CDS) prices for the up-coming markets sovereign bonds. The financial markets are in the process of pricing the rick, which Argentina, Pakistan, Iceland, and USraine are defaulting on their sovereign debts that are above 80%. At the end of 2008, the IMF announced an agreement on a $2.1 billion loan with Iceland that was to be paid within a period of two years. On October 2008, the IMF made a $16.5 billion loan agreement with USraine, and a $15.7 billion loan to the Hungarian government. Other nations that received loans from the IMF over the same period were Pakistan, Serbia, Estonia, Lithuania, Kazakhstan, and Belarus. The former IMF Managing Director, Dominique Strauss Kahn, had stressed that the IMF was capable to assist with the crisis loans (IMF Institute, 2008).
At the end of 2008, during the annual general meeting for the IMF, Dominique announced that the IMF had initialized its financial emergency mechanism to enhance the normal procedure for loans to the crisis afflicted member states. This mechanism was meant to enhance a rapid approval of the IMF loans once an agreement has been arrived at between the IMF and the borrowing government. Though, the normal IMF lending rules, are that member nations are allowed to borrow at most three times their quotas in a period of three years, institution has indicated in the past the will and ability to lend higher amounts where the crisis demand such an action.
Apart from the emergency mechanism, the other tool applied by the IMF to provide the financial assistance is the Exogenous Shock Facility (ESF). The ESF was initiated for the provision of policy support and financial assistance to the developing economies that are facing exogenous shocks (events that are out of the government’s control). Such events include drastic change of the commodity prices, natural calamities, and external conflict that might disrupt trade. The Facility was modified in 2008 to enhance flexibility and speed of the Fund’s response to exogenous shocks. Through this mechanism, a member state can immediately obtain at most 25% of its share in the IMF for each shock and up to 75% of its share in consequence phases over a period not exceeding two years (Jeanne, 2008).
At the end of October 2008, the IMF announced its plan to create a short-term (three-month) lending facility purposely for the emerging economies. The institution plans were to set apart $100 billion for the Short-Term Liquidity Facility (SLF). The unprecedented departure from the related IMF programs, the Short-Term Facility loans, would not have policy conditionality. The Fund does not avail the financial and policy assistance to the crisis-afflicted nations alone. The World Bank and International Finance Corporation (IFC) are also involved in rescuing the global economies. The private institutions lending to affiliate of the World Bank have launched a $3 billion fund aimed at capitalizing microfinance institutes in the developing countries, which have been affected by the global financial crisis. Again, the Inter-American Development Bank (IDB) offered a $6 billion credit line for the affiliates in the developing economies, as well as an increase in its traditional lending towards development projects. In addition to the contribution by IDB, the CAF (Andean Development Corporation) initiated a liquidity facility of $1.5 billion, while the Latin American Fund of Reserves availed $4.5 billion in contingency lines. Though, this amount may be insufficient to rescue economies of the developed nations such as Brazil or Argentina, the Funds are helpful to smaller economies from Africa, the Caribbean as well as Central America that are depending of sectors such as tourism and property investments (Nanto, 2010).
In Asia, where a decade ago most nations were left with no choice apart from going for the IMF rescue packages, the plans are under way to revive regional financial cooperation, to enable member states to avoid borrowing from the IMF, should a financial crisis occur in the region. As the outcome, of this economic cooperation is the Chiang Mai Initiative, a bilateral network arrangement for the Southern and Eastern Asian economies. In addition, South Korea, Japan, and China have supported the initiation of a $10 billion crisis fund. For this fund, contributions will proceed from the bilateral donors, the World Bank, and the Asian Development Bank. Finally, the economic conditions experienced over the past ten years, have led to the creation of a group of bilateral creditors who have challenged the role played by the IMF as the lender of the last resort (Eatwell, 2011).
The drastic increase in oil prices has resulted into the creation of massive wealth among the oil producing countries and more so among the Middle East nations. The persistency in trading surpluses, in Asia, has also created another category of the emerging creditors. In this group, either countries enjoy the foreign reserves that support their currencies in time of financial crisis, or they have the potential to lend to the afflicted countries.
Reforming Global Macroeconomic Surveillance
Apart from revising their emergency lending policy and other financial assistance policies that make the IMF’s assistance more attractive to its borrowers, the IMF has a role in a broader reforming of the world financial system. Initiatives are in progress to expand the capability of the IMF to conduct an effective multilateral supervision of the international economy. Additionally, there are efforts to improve cooperation with the global financial pace setters such as the BIS (the Bank of International Settlements), as well as the Financial Stability Forum (FSF). These efforts are also aimed at increasing IMF cooperation with various international groups such as Basel Committee on Banking Surveillance (BCBS), as well as the Joint Forum on Risk Assessment and Capital (JFRAC) (IMF Institute, 2008).
The complexity of integration in the international economies has called for increased cooperation between the individual financial-regulatory institutions and the global-multilateral surveillance - IMF. According to the IMF Article of Agreement, it necessitates that the IMF watches over the international financial system to make sure the system is operating effectively. It is also under IMF jurisdiction to supervise the compliance of the member states to their duties to the Fund. Particularly, Article 4 of IMF states that, the IMF shall bear the responsibility to supervise the exchange rate policies of the affiliate nations, and shall assume specific rules of conduct for the guidance of all its members in the light of those standards. All the IMF affiliate member states are required by the codes of engagement to consult and provide information to the Fund upon request. To meet the requirement of the Article 4, the IMF staff meets annually with every member state for consultation on monetary policies and current fiscal as stipulated in this Act. The consultation usually regards the state’s monetary policies, its exchange rate, economy, and any other issue as of interest to the IMF. Each year these consultation reports along with observations from the IMF representative from each member state are compiled and presented to the executive board of the IMF. Recommendations concerning the advancement of each state economy are also included in the annual report (Copelovitch, 2010).
Considering the complexity of the global financial system, the IMF has resorted to conduct multilateral surveillance, in addition to the biannual reports; it publishes the Global Financial Stability Report and the World Outlook. Nevertheless, these efforts at multilateral supervision, to the critics, are seen to be less effective, and too oriented towards bilateral issues. They are also criticized for failing to handle the risks of contagion that has been witnessed in the ending crisis. According to the IMF’s supervisory agencies, the Independent Evaluation Office (IEO) indicated that, multilateral supervision has failed to explore sufficiently the options dealing with policy spillover in the global context. The report states that, the voice of multilateral advice is not based on policy spillover and economic linkages, rather it is founded on the bilateral advice (Nanto, 2010).
During a conference on the future of the IMF in 2008, the participants raised a concern that developed economies had impeded the effort by the IMF at multilateral supervision. They argued that these nations disregard the bilateral surveillance of their economic policies by the IMF. They also fail to embrace the Fund’s attempt at the multilateral discussion on global imbalances in 2006. Further, economic analysts believe that developed economies have long disregarded the IMF advice concerning their economic policy, though, the same nations pressurize the IMF to supervise the exchange rates to support their foreign economic goals (Braga and Vincelette, 2010).