What IMF wants China to do

10:14, July 08, 2011      

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To many people in the street, the International Monetary Fund (IMF) is perhaps known as a bank that lends money to countries in some sort of crisis. This is not entirely correct.

The IMF is more like a rural cooperative or a credit union on a global scale where members have established rules on how much each would contribute to the fund (that is, the quota system) and when and how to use the fund (that is, lending facilities). Indeed, the fund is not meant for "investment" or "development" but for temporary relief of shorter-term external funding pressures.

Moreover, each member has a say proportional to what it contributes to the fund, which in turn is a reflection of its relative economic size, on how these rules should be changed (that is, representation).

Perhaps most importantly, members want to watch over each other's shoulders (or more accurately hire technocrats, the IMF staff, to do this job) to make sure that no one needs to borrow in the first place (that is, the surveillance function) for the sake of each member, as well as to contain spillover on other members. It is also a "monetary" fund because the stability of an economy hinges on how financial flows are managed, including the relative value of currencies. The end objective, as enshrined in its mandate, is to promote free trade and full employment in each of its member countries.

Such a mandate requires the IMF to evolve with the global economy. Christine Lagarde committed to continue the ongoing reform effort of the IMF to reflect the changing global landscape when she was selected to serve as IMF managing director by its 24-member executive board. She emphasized evenhanded service to its entire membership, under a motto summarized as relevance, responsiveness, effectiveness and legitimacy of the IMF.

Now that Lagarde has assumed duty as IMF's new head, attention is returning to the challenges that it is expected to address. These challenges are, by region, weaknesses in the US and Japanese economies, problems in the eurozone and potential risks of overheating in some emerging economies, and by issues, unbalanced global growth, rising risks from the financial sector and the need to rein in public debt. This list attests to the fact that the global economy has still not fully recovered from the financial crisis.

According to the latest update to the World Economic Outlook, global growth has been temporarily weighed down by Japan and the United States, but it is expected to re-accelerate in the second half to reach 4.3 percent this year, and rise to 4.5 percent in 2012.

While the eurozone was buoyed by upbeat investment in Germany and France, uncertainties related to sovereign debt still cloud the outlook, with the most acute problem being Greece. Besides, world growth will remain uneven, with emerging and developing economies expected to continue to be strong, and rebalancing remains elusive.

The updates to the Global Financial Stability Report, which assesses trends in capital markets and the global financial system, and the IMF Fiscal Monitor, which tracks changes in public finance and debt, highlight the depth of fiscal challenges in some European Union member states, which have triggered renewed financial volatility. These were recently described by Olivier Blanchard, the IMF economic counselor, as "a bump in the road rather than something more worrisome".

Increased financial risks in recent months reflect doubts about the strength of the global economic recovery, lack of political support for adjustment in the EU's periphery and fiscal adjustment in some advanced economies, and search for yield by a growing number of investors that may build up future financial imbalances, especially in emerging market countries, spurred by a sustained period of low interest rates in advanced economies.

The last point has been particularly noted as a concern by Chinese authorities. While progress has been made in repairing bank balance sheets, it has been slow and asset quality and funding challenges still remain. Jose Vinals, the IMF financial counselor, has noted that the "results from the new round of European stress tests will mark an important watershed" summing up well the urgency for banks to pick up the pace to rebuild their capital.

On public debt, the US and Japan both have yet to institute specific reduction plans. Carlo Cottarelli, head of the IMF's fiscal affairs department, draws attention to the lack of a political consensus in the US on a "comprehensive and balanced set of specific measures to underpin a credible medium-term adjustment plan with objectives endorsed by Congress". This, he warned, will start to be reflected in the yield of US government bonds.

In a few European countries, financial markets are already charging high rates. On the positive side, government debt and deficit reduction is proceeding in many advanced economies - notably in most of Europe and in Canada - helped by bright spots of economic activity and growing government revenues.

China is a member of this global credit union - actually, one of the most important ones. During the 14th quota review last December, the IMF's board of governors agreed to make China the third largest member. In addition, China has committed resources beyond the quota contributions to the IMF in case there is liquidity shortage. Reflective of these changes, China is becoming an important voice in the IMF decision-making process, as well as on surveillance discussions of its member countries' economies. Now since China is the third-largest member, IMF challenges are China's challenges.

China has contributed directly to the global economy, too, through its stimulus package in 2009. The positive spillover from strong domestic demand was not only essential for the Chinese economy to maintain robust growth, but also helped dampen the global economic slowdown.

Similarly, looking ahead, China can continue to contribute to the prosperity of the global economy precisely by doing what benefits its own economy most, and as eloquently captured in its 12th Five-Year Plan (2011-2015), that is, rebalancing its growth model away from investment and exports toward Chinese consumers and households. At the core of the rebalancing effort, according to the 2011 IMF surveillance mission, is the financial sector's reform.

(The author is senior resident representative of the IMF in China.)

Source:China Daily
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