Credibility of IMF and World Bank may be a war casualty

Heavily influenced by Washington, international financial institutions may be irresistibly drawn in by the US-led coalition's war on terrorism. Their performance was already under scrutiny. Now it's likely they will favour countries that are strategically crucial, paying less heed to their records in economic governance and financial sector reform. Shrinking private capital flows to emerging markets may allow the IMF and World Bank to regain some lost prestige. But if they lend to uncreditworthy coalition partners, private creditors may not follow.

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The war in Afghanistan pushes more people into poverty. Politics may decide which get help from the World Bank and the IMF

Will president George W Bush risk the already fragile reputation of the IMF and World Bank to secure his war aims? On the face of it, he has already decided that he must. In an address to Congress on September 20, he declared: "We will direct every resource at our command - every means of diplomacy, every tool of intelligence, every instrument of law enforcement, every financial influence, and every necessary weapon of war - to the disruption and to the defeat of the global terror network". Country-wide, Americans lapped it up - in their homes, in briefly hushed restaurants and even sports arenas - but it set off deep and sober reflection in the international financial institutions' headquarters on H Street and 19th Street in Washington, DC.
The president didn't mention the World Bank and the IMF by name. But America is the largest shareholder in the Bretton Woods institutions and Bush clearly has the votes to work his will on their operations.
Three weeks after the outrages, World Bank president James Wolfensohn put out an estimate of the numbers of people around the world who would be thrown into poverty as a direct result of the terrorist attacks. Some 10 million more people would be forced below the poverty line of $1 a day, he said. The Bank also estimated that an additional "20,000 to 40,000 children under five could die".
The Bank's haste to make such precise economic forecasts on an emotive issue when the global repercussions had scarcely begun to unfold presented an easy target for critics who portray it as a tool of Washington in the propaganda war.

Doubts about the IFIs come at a worrying moment for emerging markets, notably Brazil, Indonesia, Pakistan and Turkey.
"I believe that the general impact on prospects for developing countries of the World Trade Centre event is very negative," says David Folkerts-Landau, a managing director at Deutsche Bank. "I would think that we will see further contraction of capital flows into emerging markets and significantly so. It's just natural particularly as the US and to some extent Europe face the prospects of being in a serious recession in the fourth quarter."
There had been a wide recognition before September 11, at least among policymakers, that opening up trade, international capital flows and labour mobility would raise living standards in countries that embraced liberalization as part of their development strategies. But now comes the terrorist, extracting what amounts to a tax on all of these flows. As Guillermo Ortiz, governor of the Banco de México, puts it: "Perceptions of higher risks from operating across borders and the resulting higher costs of doing business will tend to dampen the trend toward globalization".
Threats to market approaches
Ortiz fears that the sluggish world economy will provide those who doubt the merits of market-oriented reforms with new followers. Industries will renew their calls for protection. And politicians will find it more difficult to resist their appeals.







James Wolfensohn

"The countries most integrated with the west benefited the most on the way up and now they could be most at risk on the way down," warns Mohamed El-Erian, a fixed-income portfolio manager with Pimco in Newport Beach, California. "Governments in developing countries need to learn how to engage better in a policy dialogue with the population. Several of them don't have a tradition of doing that. They will need to explain that the right response is to live through the cyclical downturn and not to change the overall approach."
This is exactly the type of disruption in availability of finance to developing countries that could allow the Fund and the Bank to step up their involvement and regain some of the importance they lost in the last decade when private capital flows exceeded their contributions. The Fund, in particular, has tools - its contingent credit lines (CCL) and supplemental reserve facility (SRF) - to respond quickly and help developing countries deal with weaknesses caused by sudden changes in private capital flows. And the Bank could boost lending during lean times ahead, just as it did in response to the Asian crisis. But in a situation where the US expects unstinting support for its drive against terrorism there are likely to be new pressures for disbursements to be disproportionately directed towards supporters of anti-terrorist policies.
"The big question is whether the US will informally pressure the World Bank and IMF to incorporate some notion of whether a country is for us or against us on terrorism," points out Caroline Atkinson, a senior fellow at the Council on Foreign Relations who was formerly an official in the US Treasury. "I do not think that they should become involved in a political litmus test," she says, "and I am sure that management at the institutions would also strongly oppose that."
Many within emerging markets expect that it only will be a matter of time before the G7 mobilizes the Bank and the Fund. "The geopolitical position of countries regarding the war against terrorism undoubtedly will play a role," predicts Ortiz. And he calls on the institutions to follow an evenhanded approach. But one school of thought argues that it is perfectly fitting to apply a litmus test in this area because the Bretton Woods institutions have always been political instruments for achieving growth and stability in member countries.
"I think that the G7 will ask the IMF and World Bank to play a role," says Marcel Cassard, Deutsche Bank's chief economist following emerging economies in Europe. "After all, it's the shareholders' money. I expect that shareholders will put pressure on the IMF and World Bank to cut lending to countries that are not taking part in the international effort to stop terrorism. By the same token, they will call on the Bank and the Fund to recognize help from countries, such as Pakistan and Turkey, that join in the war against terrorism."
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