IMF POGRAMS:WHO IS CHOSEN & WHAT ARE THE EFFFECTS?

PAPER REVIEW (2)

MADIHA KHAN MBA2K12 (B)

IMF Programs: Who Is Chosen and what are the Effects?

Robert J. Barro, Harvard University and Jong-Wha Lee, Korea University The paper entitled IMF Programs: Who Is Chosen and What are the Effects? written by Robert J. Barro and Jong-Wha Lee provides an insight about IMF lending practices and the different factors that influence it. Writers are of the view that IMF lending practices respond to economic conditions but are also sensitive to political-economy variables. The International Monetary Fund (IMF) is an international organization that was created on July 22, 1944 at the Bretton Woods Conference and came into existence on December 27, 1945 when 29 countries signed the Articles of Agreement. It originally had 44 members. The IMF's stated goal was to stabilize exchange rates and assist the reconstruction of the worlds international payment system post-World War II. Countries contribute money to a pool through a quota system from which countries with payment imbalances can borrow funds temporarily. The IMF describes itself as an organization of 183 countries, working to foster global monetary cooperation, secure financial stability, facilitate international trade, promote high employment and sustainable economic growth, and reduce poverty. The organization's stated objectives are to promote international economic cooperation, international trade, employment, and exchange rate stability, including by making financial resources available to member countries to meet balance of payments needs. The research paper investigates the role of IMF financial arrangements and its effects on economic growth of the countries. The main objective of this paper is to find out what are those circumstances under which a country come to the IMF for assistance and the benefits a country can get from participation in an IMF financial arrangement. For this purpose, cross-country panel data set is taken, which comprises information on 130 countries over the last three decades. In cross-country econometric framework, instrumental variables IMF quotas, IMF staff size, and political proximity to the United States are used. Holding fixed a set of standard economic variables, IMF lending was influenced by a countrys presence at the Fund, as measured by the countrys share of quotas and professional staff. IMF lending was also sensitive to a countrys political and economic proximity to some major shareholding countries of the Fund specially the United States. The set of political-economy variables was statistically significant overall for explaining the size of IMF loans, the frequency of participation in IMF lending programs, and the probability of IMF loan approval. The IMF has become an almost universal financial institution with the membership of 183 countries at present. Each member country of the IMF contributes a quota subscription, as a sort of credit-union deposit to the IMF. The quota is the basis for determining the voting power of the member. Each member has 250 basic votes plus one additional vote for each SDR 100,000 of quota. The IMF performs general quota reviews at intervals of about five years. These reviews

allow for adjustments of quotas to reflect changes in economic power of the countries. The United States holds the largest portion of the quotas (currently amounting to 37,149 million SDRs or 17.5% percent of the total) and it has the strongest influence in the IMFs main decisions. Other members quotas are Japan (6.3% of total IMF quotas), Germany (6.1%), France (5.1%), the United Kingdom (5.1%), Saudi Arabia (3.3%), China (3.0%), and Russia (2.8%). Pakistan has quota of 0.43% in IMF. SDR (special drawing rights) is a specific currency issued by IMF for its member countries. The IMFs Board of Governors delegates most decisionmaking power to the Executive Board, which has 24 directors. Eight directors are appointed by the largest eight shareholders and the others are elected by sixteen groupings of the remaining countries. The highest decision-making body of the IMF is the Board of Governors, which consists of one governor and one alternate for each member country. On December 31, 2001, the IMF had a staff of 2633787 assistant staff and 1846 professionals. Upon initial IMF formation, its two primary functions were: to oversee the fixed exchange rate arrangements between countries, and to provide short-term capital to aid balance-of-payments. After the developing countries recovered from the debt crisis of the 1980s, other problems arose. Eventually, the IMF evolved as: Crisis Manager Development financier As both of these roles suggest, IMF provide aids and short term or long term loans to its member countries facing balance of payment difficulties and economic crisis. Loan is provided by observance of policy bench marks and performance criteria which is referred as conditionality. For short-term balance-of-payments assistance, Stand-by Arrangements (SBA) and the Extended Fund Facility (EFF) are the main IMF programs. Stand-By Arrangement covers a period of 1 to 2 years, with repayments scheduled between 3 1/4 and 5 years from the date of the borrowing. The EFF arrangement typically lasts up to 3 years, with repayments scheduled over a period of 4 1/2 to 10 years. For very poor countries, IMF has established long term financing facility which includes Structural Adjustment Facility (SAF) in 1986 and the Enhanced Structural Adjustment Facility (ESAF) in 1987. The interest rate charged is 0.5% and repayments are scheduled over 510 years after a 5-year grace period. In 1999, the ESAF was replaced by the Poverty Reduction and Growth Facility (PRGF). Over the last three decades, a total of 725 programs were approved. To find out the economic determinants of IMF lending, many standard variables are used in this study. The variables that are included for each country are the presence of a currency crisis, the presence of a banking crisis, international reserves, per capita GDP, the lagged growth rate of GDP and a variable for whether a country is included in the set of rich OECD countries. The countrys political connection to the IMF is determined by two institutional variables i.e. size of quota and size of professional staff, and by a geopolitical variable based on U.N. voting.

The quota measures a countrys voting power at the IMF and also matters directly for a portion of the lending available to a member. For given economic conditions, a higher country quota raises the probability and size of an IMF loan. The effect of the share of a countrys nationals among the IMF professional staff of economists is also significant. the presence of own nationals on the staff can help a country to get more access to inside information and, thereby, make it easier to negotiate with the IMF on the terms of a program. As with quotas, the number of nationals working at the IMF tends to reflect the economic sizes of countries. A countrys involvement with IMF loan programs is measured by: approval and participation. Approval is a variable indicating that there was at least one new agreement on lending between the IMF and a member country during the five-year period. Loan participation rate is the fraction of months during each five-year period that a country operated under an IMF loan program. The pobit and tobit models are applied by using these variables and the estimation results are obtained. The results show the effect of different variables on IMF lending. Results can be summarized as: The incidence of a currency crisis (the crises with large nominal depreciations of a country's currency over a short period.) raises the probability of approval of an IMF arrangement by 15 percentage points. The probability of an IMF program approval increases with a banking crisis (characterized by loan losses, the erosion of bank capital, and the extension of large-scale government assistance) by 11 percentage points. The lagged growth rate of per capita GDP is significantly negative in all of the specifications. A decline in GDP growth by 1 percentage point raises the probability of IMF program approval by 1.3 percentage points. For international reserves, a decrease in reserves by one month of imports would raise the ratio of IMF lending to 3.3 percentage points. The ratio of IMF has a non-linear relationship with per capita GDP. The level is significantly positive and the square is significantly negative. Hence, the probability of having an IMF program initially increases with per capita GDP but later decreases. the overall marginal effect of log GDP on the probability of IMF program approval is positive For a group of rich OECD countries has a significantly negative effect on the probability of IMF program approval. The shares of IMF quotas and staff are each significantly positive at the 5% level.

The results also show that a higher political proximity to the United States, as gauged by the U.N. voting pattern, helps a country to receive IMF program approval. The indication is that political connections with the United States are the ones that raise the probability of IMF

lending. The apparent importance of political proximity to France, Germany, and the U.K. in seems to reflect only the correlation of these U.N. voting patterns with that for the United States. According to these results, we can conclude that a country that has more IMF staff, more IMF quota, and voted more often with the United States is expected to have a higher probability of IMF loan approval and participation. An assessment of the impact of an IMF adjustment program requires an evaluation of the performance of program countries in comparison with the performance that would have prevailed in the absence of the IMF assistance. Two approaches, before-after approach or the with-without approach to assess the impact of an IMF adjustment program is used. The beforeafter approach compares performance during a program with that prior to the program. While with-without methodology compares the behavior of key variables in the program countries to their behavior in non-program countries, which constitute a control group. Another useful approach is Generalized Evaluation Estimator (GEE). It is the estimator of choice in evaluating the effects of Fund-supported adjustment programs. The effect of IMF lending on economic growth of the country is controversial. Previous studies give conflicting results. However, in this paper, author assessed the economic growth by number of determinants like, initial per capita GDP, human resources (educational attainment, life expectancy, and fertility), ratio of investment to GDP, changes in the terms of trade, institutional and policy variables (government consumption, rule of law, international openness, and inflation). After assessing these factors, the final results show that participation in an IMF program is associated with lower per capita growth by about 0.9% per year but the retardation of growth due to an IMF program does not persist into the next five-year period. In Pakistan, IMF loans have been an important source to manage the financial problems such as balance of payment deficits, stabilization of currency, rebuilding international reserves, managing liquidity problems along with enabling the country to meet their short term needs by providing various types of loans. In spite of effective policy actions taken by State Bank of Pakistan, issues such as sharp depreciation of exchange rate, depletion of foreign exchange reserves of $5 billion till November 2008, inflation rate of more than 25%, and increase in import bill by 35.2% created immense challenges for the government and State Bank of Pakistan. Finally, the IMF loan of $7.6 billion was approved to help Pakistan come out of the liquidity and financial crisis albeit with certain IMF conditions. Since 1988 when Pakistan became member of IMF, almost eleven loan arrangements (including the recent IMF loan of $7.6 billion in 2008) have taken place under various IMF facilities/programs. It is important to note that in the tenure of last two decades, on average almost 44% of the total lending amount has been drawn from the original 100% agreed upon

lending amount because of the failure of the government to act upon the strict measures determined by IMF. For the first time in the year 2000, this tradition was broken in Musharraf regime when Musharrafs government successfully implemented the conditions proposed by IMF and successfully drew the whole lending amount of $1.3 billion. Pakistan saw a decline in GDP growth rate and other economic indicators right after infusion of IMF funds in the economy except in the second last lending arrangement in Musharrafs regime when full amount of loan was drawn from IMF. Although Pakistan has not experienced smooth relations with the IMF, it remains the top client of the IMF among developing countries. During the period of 1988-2000, out of a total agreed amount of IMF loans of US $ 4.07 billion, only US $ 2.10 billion (51.5%) was actually disbursed to Pakistan. This was due to Pakistans poor track record of policy implementation. There has been a huge controversy about the biasness of IMF lending. Although IMF portrays itself as an independent organization working for the welfare of people but the analysis shows that IMF may favors geopolitically important countries in the distribution of IMF loans. Proximity to US is an important factor to decide about loan approval. US are the most powerful member in the IMF as it has 37,149 million SDRs or 17.5% percent of the total IMF quotas. Therefore, US influence the major decisions by having de facto veto power at the IMF. If a country votes more often with the United States in the United Nation, then the IMF loan-to-GDP ratio rises by 0.4 percentage points. The results also indicate that IMF lending tends to increase when a country has high political and economic proximity to the United States. An evident criticism is that the effects of Fund policies are anti-developmental. The deflationary effects of IMF programmes quickly led to losses of output and employment in economies where incomes were low and unemployment was high. Moreover, it was sometimes claimed that the burden of the deflationary effects was borne disproportionately by the poor. At the end, it can be concluded that although IMF stated objective are to promote international economic cooperation, international trade, employment, and exchange rate stability, making financial resources available to member countries to meet balance of payments needs but it is unable to meet these objective efficiently. It should work in real time to improve the financial position of a particular country so that world economy can be made stable.