|
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.”
That said, countries might provide moral and practical support for this so-called war against terror but might not be managing their own economic and financial systems in a way that is acceptable to the international financial institutions.
Senior managers at the IFIs are wary of falling into the trap that this creates. “I think that it would be a very hazardous road for us to go down to convert the international agencies into instruments of political will,” Wolfensohn warned during an interview in early October. “I hope that World Bank policies don’t change very much because we’re not an agency that just hands out money to try to get political actions that we want. That doesn’t work. What we need to do is focus our policies on governments that are doing the right thing in terms of their economic and social policies. My hope is that we can stay focused on the main game: getting good governance, getting equity and fighting poverty.”
In fact, these institutions have been politicized from the start – they were instruments in the Cold War – and Wolfensohn himself is a very political animal. But they are now supposed to lend only to countries that follow sound economic management.
The Fund has publicly signalled that it plans to stick to its existing policies. “The IMF is prepared to play its role of providing advice and additional financial support, where necessary, to those members that have, or adopt, suitable policies, as part of a joint international effort to strengthen confidence in the global economy,” managing director Horst Köhler told the IMF executive board in early October. “The Fund has appropriate tools and flexibility to respond to a weakening world economy.”
In any case, large bureaucracies can’t turn on a dime – not even the US Treasury. And there’s no evidence, so far, that shareholders have told them to change course. But that may not last. Every Friday since the end of September the heads of all the multilateral development banks together with Köhler have been meeting to discuss how to coordinate their response. Enrique Iglesias of the Inter-American Development Bank and Köhler go to the World Bank’s headquarters in Washington for these meetings and Jean Lemierre (European Bank of Reconstruction and Development), Tadao Chino (ADB) and Omar Kabbaj (African Development Bank) join in via a satellite hookup. The IMF, meanwhile, has been busy checking its projections for the world economy as new data comes in.
“Prior to September 11,” says Desmond Lachman, chief emerging-market strategist at Salomon Smith Barney, “you had a US Treasury that was relatively tight-fisted. They wanted to go in a different way from the Clinton administration. They thought that IMF programmes should be small and only for countries that were in relatively good shape or were doing the right things. They were trying to remove moral hazard from the system. September 11 changed the balance inside the US administration toward those who favour using the multilaterals as instruments to build up good will.”
There are two potent new influences at work here that may subvert efforts to push developing governments to do the right things. First is the pressure on the IFIs to lend on the basis of countries’ commitments to the coalition against terror, and not on the basis of their commitment to economic and financial reform; second is the global slowdown. This will make it very difficult for developing countries to bear the pain of economic restructuring, which always comes at a short-term cost, typically of reduced growth.
Mexican central bank governor Ortiz puts it this way: “The Fund recognizes that under the present situation of weak global demand and given the potential widespread impact of the attacks on September 11, it would not be advisable for a large group of countries to rely on a very fast pace of adjustment through contraction-oriented policies or by depreciating their currencies. The worst risk in a situation like the one being faced by the world economy is inaction.”
But views on the issue tie in with questions about the severity of the current crisis. World Bank and IMF lending would have changed little, if at all, if September 11 had turned out to be a uniquely horrific but isolated incident. And there can still only be a dim understanding of how the world has changed. As events from the Middle East to Northern Ireland show, it is clear that fundamental geopolitics as well as global economics and finance have altered. “It would be naïve to think that the unfolding struggle represents anything less than a worldwide war against militant pan-Islamic fundamentalists who use terror as a weapon to bring about a withdrawal of secular western powers from Islamic countries,” says Deutsche Bank’s Folkerts-Landau.
This view holds that moderate Arab states – particularly Saudi Arabia, Kuwait and Egypt – as well as Pakistan are currently in the cross-hairs. But the fundamentalists ultimately aim to bring territories with minority Muslim populations under their control in central and south-east Asia as well as north Africa. The conflicts in Bosnia, Kosovo, Chechnya, Afghanistan, Kashmir, the Philippines, Lebanon, Kenya and Sudan as well as the Gulf War and now the attacks on the US will all be increasingly seen as part of this larger strategy. The most dangerous threat lies in the prospect of unifying Muslims globally around this revolutionary drive and wielding the oil weapon to force a retreat by the west.
“A stable geopolitical stand-off with the fundamentalists, like the stand-off with the communists during the Cold War, will require an extensive financial and military build-up as well as proactive leadership,” predicts Folkerts-Landau. “The west will need to reshape its key political, military and economic alliances. It also will be forced to redirect the global, post-World War II institutions such as the WTO, the IMF, the World Bank and the aid institutions.”
The impact of all of this on Bank and Fund operations could be pervasive. And the worry is that these institutions could end up stamping their imprimatur on extremely unsound economic policies. Quite apart from lending approvals by the executive boards of these institutions, there could be new pressures on IMF mission teams to water down their advice to politically crucial member countries during the periodic Article IV consultations. Some also fear that forces could work to slant reports coming out of the institutions to serve the security interests of dominant shareholders, confusing market participants.
But more official largesse, even in these times, doesn’t go down well, particularly with American conservatives. Take the International Development Agency, the World Bank’s concessionary loan window. “Why link IDA resources to fighting terrorism,” asks Adam Lerrick, director of the Gaillot Center for Public Policy at Carnegie Mellon University and senior adviser to the Meltzer Commission that Congress set up to review US participation in the multilateral financial institutions. “The mandate of IDA is to reduce poverty in the poorest countries. Reducing poverty in poor countries is an extremely worthy goal in and of itself. The benefits are manifold and manifest.”
Lerrick says that policymakers are refusing to recognize that the money they make available to the IFIs will all be wasted until their programmes are effective. “It sounds great in a headline to give another $2 billion to the IFIs to help poor people combat terrorism. But if it is all squandered on programmes without results or it all winds up in Swiss bank accounts, that’s not so wonderful. My general view is that the floodgates will open and the reform process will be put on hold.”
The IFIs have adjusted their lending policies to extraordinary circumstances in past conflicts. One element of the IMF’s contingent financing facility (CFF) that helped oil-importing countries during the 1990-91 Gulf War, may be revived if oil prices soar. The IMF attached few, if any, additional conditions to CFF lending, thereby helping oil importers with otherwise sound policies deal with sudden increases in the cost of energy.
“That’s not a common feature of the on-going CFF but we have inserted it in the past and we can consider doing it again if the situation demands,” says Jack Boorman, director of the IMF’s policy development and review department. “Of course, the base line expectation now is that oil prices will remain low rather than spike, unless there is a further aggravation of the situation in the Middle East or other political developments that might give rise to supply problems that could force the price up.”
A wider mandate
Many have criticized the Fund for the proliferation of conditions involved with its lending programmes. And Köhler committed himself to cutting back in this area when he took the helm last year in May. But the post-September 11 environment will probably drive him in the opposite direction – a switch that comes with risks of its own. “Outsiders have spent a lot of time telling the Bank and the Fund to narrow their mandate and to do only what they know well,” observes Deutsche Bank’s Cassard. “Then, at times like these, we tell them to look at other issues such as terrorism, money laundering and corruption. I don’t think that they’re qualified to assess these issues and incorporate them adequately in their programmes.”
| Jack Boorman | ||||||
Anna Schwartz, a long-time critic of the IMF and co-author with Milton Friedman of A monetary history of the United States: 1867-1960, puts it this way: “It’s quite likely that the overriding concern now is to enlist countries that are not creditworthy in the effort to contain terrorism and in that sense lenders will overlook the fact that these countries shouldn’t be borrowing.”
Schwartz thinks that the IFIs should deny any kind of financial assistance to countries that sponsor terror. “That’s not an easy thing to achieve because countries are entitled to ask for assistance, if they’re members of an IFI. The only way I can see it happening in the IMF is if the executive directors can be induced to oppose a loan that the IMF otherwise would extend.”
The US State Department currently lists seven countries – Cuba, North Korea, Iran, Iraq, Libya, Sudan and Syria – as sponsors of terrorism. North Korea and Cuba aren’t members of the IMF or the multilateral development banks so they don’t receive aid.
Schwartz points out that the attacks will have a harmful effect on productivity – resources that would hitherto have been used to raise output will go on improving security. “Welfare measured in a standard way would decline even though improving security is clearly a benefit,” she notes. “The Bank therefore should be willing to extend loans for improving security even though improved productivity isn’t among the benefits.”
Folkerts-Landau thinks that the markets will make allowances for a shift in the IMF’s approach towards such countries as Pakistan and Egypt. But three big cases – Argentina, Brazil and Turkey – promise to shape judgments about the Fund’s usefulness in sending proper signals about countries. There was has long been room for improvement on this score. “It obviously would be good if IMF lending were a signal that investors should return to a financially stricken country because it was in much better shape,” says Atkinson. “IMF lending has not proved to be a particularly good signal of that just recently.” Now the danger is clearly growing that if IFI lending is seen to be politically motivated, private-sector capital flows may not follow it.
Pulling bilateral levers
Pimco’s El-Erian thinks that the Bush administration recognizes the risks to the credibility of the Bank and the Fund and therefore will be pulling other levers. “The US moved very quickly on Pakistan in terms of taking off sanctions, which signalled early on an emphasis on using bilateral instruments.”
El-Erian points out that a mix of bilateral instruments – foreign aid, trade concessions and debt forgiveness – is available to donor countries. “The mix that makes the most sense in the long term would focus on trade. They already approved concessions for Jordan and are talking about others for Latin America. The problem is that trade concessions take time to have an effect and they’re not as visible as bilateral aid or debt forgiveness. So, I think you need some combination of the three.”
The outlook is for significant further differentiation of prospects among emerging-market countries. Turkey is expected to get more support in the form of a fairly large IMF package, driven by concern about the country’s internal stability. “I believe that they will avoid a massive domestic restructuring that they otherwise would need to do,” predicts a former IMF staff member. “The new package will be interpreted as a sign of confidence, a strong signal that the international community is willing to assist Turkey through its difficulties.” El-Erian, however, is among those who think that it is important for Turkey – along with Pakistan and Indonesia – to make reforms in order to support more borrowing from the IFIs.
Argentina has become a landmark case. “One can stand in awe of the sacrifice that Argentina has been making,” Folkerts-Landau continues, “and, to some extent, it is a sad spectacle to see that it hasn’t been enough to turn the country around. Whatever promises the authorities make, investors will be sceptical about their ability to deliver in the current situation.” As Euromoney went to press a long-awaited Argentine debt restructuring looked imminent.
Emerging debt market participants do not expect the Fund to be very sympathetic to additional requests over and above what’s already in the pipeline for Argentina until it reaches a deal with private creditors. “This is clearly a case where the IMF has lent all the money you would want to lend to see them through their difficulties,” one emerging-market economist says, “and now you have to let the political process do what it has to do. Everybody involved realizes that something has to be done about external debt, be it through another mega swap, pushing out the maturities or otherwise changing the payments profile.”
Many think that Brazil’s economy, under finance minister Pedro Malan and central bank president Arminio Fraga, will turn out to be a much more interesting test of Horst Köhler’s IMF. “There’s a real choice in the sense that, at least from the market’s point of view, Brazil’s domestic policy is pretty good and Fraga has done an outstanding job in running the central bank,” Folkerts-Landau says. “But Brazil has been very severely impacted by the uncertainty spilling over from Argentina and that deserves serious consideration for additional IMF funding. The ring-fencing approach of insulating countries like Brazil from contamination is a good one.”
A number of factors, meanwhile, will badly hurt the non-oil producers of the Middle East. Declining tourism is going to set back such countries as Morocco, Egypt, Jordan, Israel and Turkey. “To the extent that lower revenues from tourism weaken the recovery, there will be a more serious problem involved with managing Turkey’s domestic debt,” says Jeffrey Anderson, lead economist for the emerging European countries at the Institute of International Finance
Reduced capital inflows are going to hurt many of these same countries. Several had been aiming to carry out fairly large scale privatizations that would have benefited from more robust financial markets. And the economic downturn in the US as well as the EU will put a damper on exports.
But there are other things that will be working in their favour. “Egypt starts with a relatively strong base, having benefited from a 50% debt write-off in 1991 after the Gulf War,” says Pimco’s El-Erian. “This is a country that’s equipped to deal with the down side. Egypt and Morocco both have access to the capital markets, but they don’t need funding.”
Interest rates and oil prices, meanwhile, have been dropping. And import prices for non-oil commodities may also remain depressed. Inward remittances – an important part of the balance of payments for many countries in the Middle East – probably won’t be much affected in the short term. “Several Middle Eastern countries have been through programme relationships with the Fund, but take pride in the sense of having ‘graduated'” says Howard Handy of the Institute of International Finance. “They would be reluctant to resort to the Fund again due to what they perceive as the negative connotation of a [Fund] programme in the eyes of market participants. Morocco, Egypt and Algeria fall into this category. Egypt, for example, has access to fairly substantial financing, particularly from the US government, on more attractive terms. For its part, the World Bank is not a major player in most of the Middle East. Middle East oil exporters – Saudi Arabia, Kuwait and the UAE – start with very substantial surpluses and large positive financial balances. Much would need to change before they start running into problems.”
Jordan, however, has an IMF programme. It is generally considered to have a well-managed economy with good prospects. “They’ve been building a lot of hotels and were buoyed up by the peace process last year, but the escalation of violence in the neighbourhood has created new challenges for them,” Handy points out. “These problems were very much on the radar screen before September 11, but Jordan now has been hit with another exogeneous shock. So, there may be a case down the road for an augmentation of its IMF programme.”
By contrast, Sudan remains an international pariah. “It has made so many political mistakes and has such a huge overhang of arrears to the Fund as well as to other lenders that it would have an awfully long way to go before it could get anything out of the IFIs,” says Handy.”
China’s prospects may be brighter. Many expect its economy to grow at about 7% a year for the foreseeable future. Re-engagement with the US will be highly favourable for it. The country also has the potential to compete with Malaysia, Singapore and Taiwan in the production of IT-related goods and China will probably overtake them to become the exporter of choice in Asia before long. “It faces political challenges,” says Folkerts-Landau, “but unless they get that totally wrong I would have thought that the prospects for China are probably the best of any country in Asia.”
India lost ground as a result of September 11. The US had been moving diplomatically much closer to it, recognizing its status as the world’s biggest democracy. But US efforts to accommodate Pakistan will be at India’s expense, at least in terms of the money available from official sources. “Pakistan has asked for $30 billion to $40 billion in debt relief,” says Greg Fager, an expert on the region at Washington’s Institute of International Finance. “There’s only so much to go around. But that probably won’t lead to a significant drop in India’s GDP. India’s large domestic economy and strong growth performance makes it less vulnerable to external shocks. Both Indonesia and the Philippines also seem to be in line for more aid coming from the IFIs.”
Some see a silver lining in the situation. “The whole spectacle of the anti-globalization movement has blown up and I think that is a very good thing,” says Folkerts-Landau. “That is such a nonsensical movement that I’m glad that this event put it out of its misery.” Whether it will indeed kill off the movement for good remains to be seen.
Optimists argue that the recent events of could in the long term promote both trade and capital flows. US policies had become increasingly introverted and isolationist in the months before the attack. “What happened on Tuesday, September 11 completely threw that out the window,” says a leading private-sector economist. “There’s now a realization in the US, at all levels, that you simply cannot stand away from the global environment and expect to be protected just because you have an ocean on either side. You need help from lots of countries in order to combat the current challenge. That is undoubtedly going to be very helpful to the globalization of financial markets and to some extent to trade as well. The WTO ultimately will benefit.”
Others believe that the impact on globalization and the debate about it won’t be as sweeping. “I think this may take a little of the wind from the sails of the louder critics of globalization, in the very near term” says Atkinson, “because the emotion behind some of their argument was linked to the supremacy of the US economy and perhaps to an apparent smugness of the US. That’s obviously changed, although this may not last, especially as the bombing continues.”
A lot, of course, will depend on what happens next. Atkinson thinks that the debate may go back to where it was, if the anthrax and terrorist attacks in the US are contained and if there is a finite military engagement in Afghanistan. As for globally active investors: “I think there inevitably will be a kind of drawing in of horns,” she says, “partly just from more limited physical movement and partly because of increased risk aversion. But I think the way forward is to accept that the world is integrated and to try to make globalization work better for the more vulnerable. I very much hope there won’t be a retrenchment but think that we are facing huge uncertainties now. The links between countries are such that globalization is here to stay.”
And the economic picture could be worse – much worse. “If I were responsible for risk management at the Fund,” says a source, “my number one scenario would be a situation where some of the moderate Arab states come under significant pressure and there is political change in Egypt or Saudi Arabia with a significant threat to oil supplies. That is absolutely the goal of the bin Laden people. Can we cope with a very serious hike in oil prices, given that US equity markets may still be overvalued?”
In the meantime, countries that are crucial to the fight against terrorism will almost certainly have an easier time when they go knocking on the IFIs’ doors. And it’s going to be much harder to link those flows to performance on the part of governments. “The antiterrorism effort is extremely important, a lot more important than some other issues, but you still need to be a little bit careful,” cautions Morris Goldstein of the Institute for International Economics. “We also need to think about what happens after the campaign against terrorism when we’re still going to need the Fund and its credibility.”
