TCS Daily

The IMF's Asian Challenge

By Desmond Lachman - August 22, 2006 12:00 AM

What a difference ten years make to the global economic landscape. Almost a decade ago, Asia was engulfed in a major economic and financial crisis that forced many Asian countries to go as supplicants to the International Monetary Fund (IMF). Today, as the IMF prepares for its Annual Meeting next month in Singapore, the tables are completely turned. It is the IMF that is now desperately seeking to restore its legitimacy with a radically recharged Asia. And it is the IMF that now has to persuade Asia on the merits of cooperating to address today's large global payment imbalances.

The IMF's present lack of legitimacy in Asia is to a large degree the fall out of the high-handed way in which the IMF treated many Asian countries during the 1997 financial crisis. Still etched in Asian memories is the photograph of a self-satisfied and standing Michel Camdessus, the IMF Managing Director at the time, watching with folded arms as a seated and dejected President Suharto of Indonesia was forced to sign the humiliating terms of an IMF stand-by arrangement.

At a more substantive level, the IMF's lack of legitimacy in Asia mirrors Asia's chronic under-representation at that institution. As recently noted by the Brussels Brueghel Institute, whereas the United States, the European Union, Japan, and China each account for around 20 percent of world GDP at purchasing power parity, their respective representation at the IMF could not be more unequal.

Indeed, the 25 countries of the European Union occupy no fewer than 7 of the 24 seats on the IMF's Executive Board, exercise more than 30 percent of the IMF's votes, and effectively select the IMF's Managing Director. By contrast, despite having a GDP roughly twice as large as that in Europe, China and Japan, together, exercise only 9 percent of the IMF votes, have but two seats on the IMF's Executive Board, and have virtually no say in the appointment of the IMF's Managing Director.

The IMF now recognizes the urgency of dealing with its basic governance issue with Asia. It does so since it realizes that the governance issue is very much linked to the IMF's present exercise of "enhanced multilateral surveillance", which will be another major item on the IMF Annual Meeting agenda.

Through "enhanced multilateral surveillance", the IMF is hoping to address the issue of global payment imbalances by focusing on the systemic dimension of each of the major countries' balance of payments positions. It is doing so since those global payment imbalances, which are presently epitomized by an unprecedented US external current account deficit of around 7 percent of GDP, are correctly perceived as threatening the global economic recovery.

The IMF is painfully aware that Asian cooperation, especially in the area of allowing greater exchange rate flexibility, is vital to any effort to redress in an orderly manner today's global payment imbalances. For the main counterpart to today's outsized US external current account deficit is a corresponding record Asian current account surplus. China alone is recording an annual current account surplus of over US$150 billion, which is around a fifth the size of the US current account deficit.

In a recent speech, Mr. Rodrigo de Rato, the IMF's Managing Director, strongly expressed the view that now was the time to recognize the rising weight in the global economy of the Asian economies. To that end, he envisaged tackling the Asian under-representation issue with a two-year and two-stage program of action beginning with some key decisions at the IMF's Annual Meeting in Singapore next month.

Without being specific, Mr. de Rato indicated that his proposed program would call for immediate action on IMF shareholding increases for a few emerging market countries, whose IMF shareholdings are most clearly out of line with their weight in the global economy. Beyond that he would also seek agreement in Singapore to move during the next two years on a more fundamental round of ad hoc shareholding increases by early 2008 for those countries that are under-represented at the IMF

Mr. de Rato's proposals to restore balance in IMF representation are steps in the right direction. However, they would seem to be too timid in pace and too limited in scope to mollify the Asian countries over the next few years. His proposed immediate adjustment in shareholdings would apply only to a limited number of countries whose shareholdings are most grossly out of line with their relative economic importance. Such an adjustment is likely to leave the remaining under-represented Asian countries dissatisfied, while the likely limited size of the proposed initial adjustment is not likely to go far enough to satisfy those countries that would be the beneficiaries of the adjustment.

As to the proposed more fundamental adjustment of IMF shareholdings over the next two years, past experience at the IMF would suggest that these adjustments will be the subject of heated and protracted political debate. In that debate, it is far from clear that the European countries will yield much ground. Mr. de Rato has further reduced prospects for getting a satisfactory arrangement for the Asian countries by insisting that the least developed countries in Africa should also gain voice in the IMF despite their relative economic insignificance.

When the world's finance ministers meet in Singapore for the IMF meetings next month, one must hope that they do so both in the spirit of cooperation and with a sense of urgency. For experience suggests that dollar crises do not have the habit of waiting for the multilateral agencies to get all their ducks in a row. With the very real prospect of a slowing in the US economy that might trigger such a dollar crisis, the need for prompt action on the IMF's governance issue could not be more urgent.

Desmond Lachman is a resident fellow at the American Enterprise Institute.


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