Taming tigers from a machan

IN THE days of the Raj our maharajas and their colonial cohorts would hide on machans and shoot tigers. Photographs and celebrations would follow. We are all conservationists now and no longer believe in shooting tigers. Rather, we would like to tame them and live with them.

The International Monetary Fund has caught on to this idea and announced a proposal with fanfare. It is establishing a new department called International Capital Markets Department to tame ``tigers" from its machan in Washington. The new director (yet to be named) would cleverly host some tigers in his perch, study their moods or habits and use the ``intelligence" so gained to evolve methods to tame other tigers roaming in the jungle.

Mr. Horst Kohler was serious when he detailed the scheme at a press briefing on March 1. He explained that the idea in establishing a new department was to enhance the Fund's surveillance, crisis prevention and crisis management activities. It will consolidate the activities and operations now spread over many departments. By this move, ``it is envisioned the new unit will have enhanced capabilities, including systematic liaison with the institutions that supply the bulk of private capital worldwide."(Emphasis added.)

The step is seen as a vital part of the ongoing efforts to strengthen the financial architecture and the Fund's role in crisis prevention. Among other advantages, the department is expected to deepen the Fund's understanding of capital market operations and the forces driving the supply of capital. It will enable the Fund to have more effective surveillance at the national and international levels and thus enhance its capabilities in providing early warning of potential stress in the financial markets. It will also help the Fund to access private capital resources for developing countries since it has no resources of its own.

On the surface, the proposal appears to be simple and as one involving administrative changes within the Fund. The real implications however run deeper.

Admission of failure?

Is there an admission here that the Fund has failed in the past in its efforts at surveillance, early warning and crisis prevention and is in search of newer ways? And, how effective will this move be in facilitating its role in all these areas?

On the issue of the Fund's capabilities, what surprises one most is that over the years, especially since the time it became nearly the only source of sustenance to the developing countries, the Fund's staff appeared so assured and assertive in their prescriptions. However, there was suspicion in some quarters that the Emperor did not have clothes. A broad-brush record of events might bear this out.

The Fund did not foresee the oncoming Latin American debt crisis until Mexico sought a moratorium in 1982. Around that time, it was the Bank of International Settlements (BIS) which had a better database on loan liabilities. In the later half of the Eighties, the relations between the U.S. and BIS became normal and this resulted, among other things, in the issue of capital adequacy guidelines (Basel Guidelines) to ensure the stability of global banks. It was the joint effort of the FED and the Bank of England and the Fund had no role.

In the Eighties the U.S. Treasury took the initiative in rescheduling the debt of the Latin American countries. The FED orchestrated all the packages with major American banks and the Fund's role was subsidiary.

In later years, on issues like debt remission or relief, the initiative was of the U.S. Treasury. It led ultimately to the flotation of the Brady bonds. The Fund was busy holding conferences and workshops on the debt hang and did not come up with any proposal until the U.S. Treasury showed its willingness.

The scene shifts to 1994-95 and the location is again Mexico. Mexico was by now seen as a star performer and had even been admitted into the NAFTA (North American Free Trade Area). While economists outside the Fund worried over the foreboding crisis, Fund economists continued to debate whether the Mexican peso had 'appreciated' or was only 'overvalued'. Speculators began to attack and the peso lost half its value in one month threatening the country's banking system and companies. It is on record how the U.S. Treasury rushed through a $50 billion bailout package. (In the press briefing, Mr. Fischer of the Fund did concede that the Fund had not seen the Mexican crisis coming.)

The Fund also did not foresee the Asian crises. By the early Nineties, economists like Dr. Allwyn Young and Dr. Paul Krugman had analysed the trends and predicted that the high Asian growth might not be sustainable. Surprisingly, in the Fund quarters there was euphoria over the high growth rates and strong economic fundamentals. While the slowdown of the economies since 1996 was observed by them, it was presumed to be cyclical in nature which would get corrected in the next phase. What happened after July 1997 is history.

The most recent instance is the Turkish collapse. The Fund had put through a package in December 2000 and was hoping for the tide to turn. By the end of February 2001, there was gloom with the lira and the stock market plummeting.

No lessons learnt

In all these episodes, one thread that runs through is the destabilising role of capital. In accepted economic theories there is a better understanding of the risks attached to large volume volatile capital flows. While the linkages between financial flows, exchange/interest rates, stock exchanges, trade flows, and other parameters have been explored, there is no clue as yet to the transmission mechanisms and the factor or factors causing crisis. The capital market has become so risky and unpredictable that even Mr. Soros and Mr. Robertson had to close their hedge funds. The Fund was not alone in its failure to foresee crises.

Why is the Fund committed to capital convertibility and has not apparently learnt from past experience? This is because there is a policy divide or schism between developing and developed countries. The developed countries which control the Fund with their voting strength set the policy approaches. Though the thinking on capital freedom has been chastened to some degree by the Asian experience, the attachment to it continues unabated.

With the crises receding in Asia, complacency also set in. Contrary to earlier expectations there was then a noticeable shift in the stand of the G7. They began to allege that the root causes of the financial crises in developing countries were the weakness of the banking system and lack of prudential regulation and corporate governance. The thrust changed to evolving international codes and standards covering fiscal transparency, accounting standards, monetary and financial policies, banking supervision and data dissemination.

New Forum

In the wake of the Asian crises there was resentment over the functioning of the Fund. Germany pressed for replacing it with a new agency for crisis prevention and stability. These came up in the G7 meetings of 1999. Though much was expected, the end proved to be rather tame. The Financial Stability Forum (FSF) was created in April 1999 to promote financial stability through information exchange and cooperation in financial supervision and surveillance.

The FSF is a club of the rich since it has minimal representation of the developing countries confined to financial centres such as Singapore and Hong Kong. So far, the FSF has set 12 standards as essential for creating a sound financial system in developing countries. It is working on 60 more! We may expect more codes and standards if there are newer crises as in Turkey or elsewhere.

The capital adequacy guidelines were evolved under the auspices of the BIS in 1989 and their revision is slated for completion by 2004. There are continuing differences among the OECD partners on the revision and no one knows what the final version would be. However, there is an attempt in the draft to grant freedom to banks to set their own internal standards based on their risk perceptions and the regulatory authorities are not expected to impose other standards to judge them. If there is to be financial stability in the world market, it seems that the big banks should have autonomy and sovereign states should abide codes and standards set by others.

Somewhere along the line the Fund got into these exercises and assumed a central role. In the Prague meeting, the MD outlined his "vision of the future role of the Fund" with the idea that it should become a centre of excellence for stability of the financial system. This was approved and the exercise is now captioned as "Reforming the IMF and Strengthening the Architecture of the International Financial System."

Truly, the Fund may have succeeded in bringing the work of the BIS, FSF and all related groups under its umbrella. How effective will these exercises be in ensuring stability?

It is a misnomer to characterise the work as "new architecture" when each area is fuzzy and there is lack of coherence and integration between the areas. A summary report given by the Acting MD to the board in April 2000 runs to 41 pages excluding appendices. It looks more like a jellyfish than a defined structure or monument. And yet, the Fund pins its hope on this to enhance its capacity for surveillance and crises prevention and position it as a centre of excellence for the stability of the international financial system.

Inadequate database

While the Fund is unwilling to give up its attachment to capital convertibility, it is perhaps nagged by worries that it is deficient in its understanding of the capital market, the private sector in particular. It feels the inadequacy of its database and its capability to deal with the private sector. Mr. Fischer admitted in the press briefing that "the interactions between the Fund's operations and intelligence gathering aspects of what the Fund has done have been inadequate in many respects." Earlier, the Fund had set up a Capital Market Consultative Group to fill some gaps. It is now upgraded to a new department to have "dialogue with the private investor and communication with the investors" since they "are sitting in a common boat."

Care was taken to explain that the Fund will not be a prolonged arm of the risk management capacity of the private institutions. Yet, there is no clarity on the nature of relationship between the new department and the private sector. How can there be any dialogue without the Fund and private sector sharing sensitive information? Will not the Fund be embarrassed in its role to safeguard the interests of members since the endeavour of the private sector may often be to gather sensitive information for arbitrage purposes? How free can the dialogues be from charges of 'insider trading' or 'collusion'?

The dialogue idea is as fuzzy as the new architecture. The proposal may better be seen in the light of the so-called "private sector" involvement in bailouts. The present writer dealt with this in a separate article. (The Grin and the Cat, The Hindu, December 14, 2000.) There is pressure from the U.S. Congress and Treasury to involve the private sector in bailouts and the Fund is denied additional resources. It cannot also be a lender of last resort, as reiterated by Mr. Kohler in the briefing.

Against this background, the creation of the new department is to step up efforts to promote private sector involvement since country or area departments cannot fill the bill. The new department may have respectability since it is positioned as the apex of the new architecture.

K. Subramanian

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