The European Union is asserting its exorbitant privilege of appointing the managing director of the International Monetary Fund, even as the Americans just exerted theirs of appointing the president of the World Bank. Both pay lip-service to transparency and good governance, but it is hard to see how these archaic traditions serve the goals of the international financial system...
This comes as the IMF faces a bloody battle to reform country quotas (which determine voting power) to make them more representative of economic power. In all likelihood, quota reform will produce a mouse by the time of the Fund-Bank annual meetings, increasing the quota of emerging markets by just enough to be mathematically noticeable but not enough to make any real difference. At that same meeting, the appointment of the new managing director, the elephant in the room, may go unchallenged if the Europeans get the US to go along. So much for the greater legitimacy of international financial institutions!
Why do they need legitimacy? And why is it that the emerging giants, China and India, are strangely silent in the growing debate over the appointment of the managing director? The reasons are connected.
The problems an integrated world faces demand multilateral solutions. Take, for example, rising barriers to cross-border investment. Unlike in the past when only developed countries sought to invest in the developing world, the flow today is two-way. The world is better off if these barriers are kept low and confined to legitimate concerns about national security. One way is through negotiated rules. The IMF is the natural forum to set these rules, and this is where true legitimacy comes in. Unless non-industrial countries believe that the process will be fair, they will not participate. The process cannot be fair unless they believe management is impartial.
An impartial referee will be even more necessary in the task the IMF has now taken on: evaluating equilibrium exchange rates and deviations thereof. There will be a temptation for the Fund to follow the US lead and accept that the only truly undervalued exchange rates are those where the government intervenes explicitly in exchange markets, not those where the exchange rate is “market determined”. [Yet isn't this the sort of thing that annoys China?]
But this interpretation biases the rules against non-industrial countries, where the government substitutes more for the market. In a country with a closed capital account, there is no way for households to buy foreign financial securities directly. The build-up of central bank foreign exchange reserves, in part, may be a substitute for this missing market. In practice, therefore, there will be enormous scope for judgment in assessing the level of exchange rates and the validity of government intervention.
Moreover, an exchange rate can be undervalued in a medium-term equilibrium sense even if the central bank is not intervening directly. One example is if a country follows a highly accommodative monetary policy. Market participants may expect central bank intervention if abrupt exchange rate appreciation threatens overly to tighten monetary policy. These expectations could foster carry trades that depress the value of the currency below its medium-term equilibrium.
The point is, powerful industrial countries such as Japan should be equally liable to be put in the exchange rate dock by the IMF as large emerging markets like China. Anything else will be biased (put differently, it is OK to have an undervalued exchange rate to stabilise the business cycle – an industrial country concern – but not OK to have an undervalued exchange rate to enhance growth – a poor country concern), but the odds are that only China will be fingered in the months to come.
This brings us to why China and India are so silent. I would conjecture that they have little faith that the system can be changed or produce outcomes they can buy into. Why give the process more legitimacy by making noises about the selection of the managing director, noises that will only lead the EU to “consult” widely about the choice they have already made? Far better to keep quiet now, and allow the EU to dig a deeper grave for the multilateral financial system.
Chindia Don't Bother on IMF Chief
♠ Posted by Emmanuel in Bretton Woods Twins
at 7/13/2007 12:20:00 AM
Raghuram Rajan, formerly the chief economist of the IMF, has some pretty strong criticism of the process of selecting the IMF's next managing director. As you probably know, France's President Sarkozy handpicked the new candidate backed by the EU. The IMF is struggling to make itself relevant in a world where developing countries are not running into balance of payments crises on a regular basis. Rather, several of these countries have taken on gobs of reserves post-Asian financial crisis--probably to avoid seeking IMF help (yelp?) in the first place. As Nouriel Roubini suggests, countries may be drawing the wrong lessons from the crisis. Given how the IMF seems to tilt the playing field in favor of the G-7, it may be little mystery why China and India would rather not bother with the IMF and prefer to let it lapse into irrelevance (or so they hope). Here is Rajan's Financial Times commentary: