Unraveling IMF, the Financial ‘White Knight’

In 1962, an important country on the world stage was fearful about the stability of its currency in the wake of a deterioration in its balance of payments with key trading partners.

So the International Monetary Fund, the United Nations agency created after World War II to help rebuild the global financial system, agreed to create a special account that could be used to stabilize the worried nation’s currency, if needed.

That country was the United States of America.

For the IMF--now leading financial bailouts of Thailand and Indonesia, and soon likely to ride to South Korea’s rescue--the role of “white knight” has been a familiar one over the last 50 years.

Specifically created to provide a central authority “for consultation and collaboration on international monetary problems,” the Washington-based IMF also wields enormous financial resources.

As such, the agency has generated much controversy over the years. Critics call it an overbearing, meddling and ineffective bureaucracy, or say its monies have saved governments, banks and investors that should have been permitted to fail.

Supporters say the IMF has, especially in recent years, been true to a key element of the charter its original member nations signed in Bretton Woods, N.H., in 1947: to keep crisis-struck economies from worsening to the point where they might threaten the stability of the global financial system.

For the average American who lately has seen headlines trumpeting that tens of billions of dollars are being channeled by the IMF into the devastated economies of Asia, several questions may arise: Who supplies the IMF with its funds? Who in the troubled nations ultimately gets these dollars?

At first glance, the IMF’s funding pool seems gargantuan indeed.

That pool is the sum of “subscriptions” by the IMF’s 181 member nations, which essentially keep a share of their national currencies on deposit with the IMF. The bigger a country’s economy, the larger its required subscription.

The total value of all subscriptions is about $190 billion, with the United States, as the world’s biggest economy, accounting for 18% of the total. That also gives the U.S. 18% of the voting power in IMF decisions.

But the value of the IMF’s “usable” pool--that is, the dollars, German marks, Japanese yen and other major and readily exchangeable currencies--is about $50 billion, according to Shailendra Anjaria, the IMF’s director of external relations.

So that $50 billion is money the agency itself can readily commit for various uses within member countries, usually in the form of loans at specific interest rates and for specific terms. By tapping those funds, the IMF does not require an actual outlay from its member countries--and therefore does not create a budget item for those countries--because the money is already credited to the IMF.

The IMF has additional resources at its disposal as well.

Under the “general arrangement to borrow” set up in 1962, the agency can borrow up to $25 billion from the world’s 10 major industrial countries, plus Switzerland and Saudi Arabia. But that credit line can only be tapped to deal with “a threat to the international monetary system.”

Unquestionably, the IMF’s resources have been tapped at an extraordinary rate in the 1990s as the explosion of free trade and investment worldwide has also led to dramatic instability in the global financial system because money has been moving rapidly among economies.

In the wake of the 50% devaluation of the Mexican peso in late 1994 as investors fled that country’s markets, the IMF agreed to its biggest-ever outlay, a $17.8-billion, 10-year loan to Mexico.

The IMF has also loaned Russia many billions of dollars in the 1990s to grease that economy’s transition from communism to capitalism.

Economists say the most important role the IMF plays in extending such loans to troubled countries is in restoring investors’ confidence and thus stabilizing what might otherwise become hopeless situations. The agency then expects key member nations to step in with their own aid packages--as the United States did with Mexico in 1995, boosting the total sum extended to Mexico to $50 billion.

“The IMF’s role is as a catalyst to restore the private sector’s confidence in the system and then to attract money from other sources,” said Guillermo Estebanez, economist in BankAmerica’s foreign-exchange unit in San Francisco.

The IMF also takes the lead in trying to force the borrowing country to take steps necessary to fix whatever ails its economy. In other words, IMF money comes with many strings attached, which often makes the agency a villain in the eyes of the borrowing country’s population.

Thailand and Indonesia, for example, in qualifying for IMF bailout loans of $3.9 billion and $10.1 billion, respectively, since July, have had to agree to close, rather than save, many of the banks and other lending institutions that had issued loans aggressively in the countries’ overheated economies.

The IMF also usually requires strict fiscal discipline on the part of the borrowing countries, which translates into mandated social spending cuts naturally unpopular with the local population.

As a generally faceless foreign entity, the IMF has little problem taking the heat for austerity steps in borrowing nations.

“By having the IMF step up, the government may be able to put the blame on the IMF and do the unpopular things it should do anyway” to restore economic stability, said Alan Shapiro, professor of banking and finance at USC.

And who actually gets the IMF’s funds? The agency deals only with a recipient country’s central bank or financial authority, feeding money directly into that institution and thus bolstering the financial reserves ultimately backing the government.

Monies typically are disbursed not all at once, but over time--and only as the IMF decides that the country is in fact taking the agreed-upon fiscal and monetary steps to restore the economy to health.

Still, by trusting the central bank of the borrowing country to use its loan wisely, the IMF effectively loses control of the money once injected.

“We cannot say where a dollar that we give Indonesia goes,” conceded the IMF’s Anjaria. That leaves the agency open to criticism that its monies can be directed to save the investments of government cronies in a borrowing country.

In the case of Mexico, the IMF was criticized after the Mexican government repaid in full investors who had lent money to Mexico prior to 1995 in special dollar-denominated bonds.

But the IMF says the value of its aid to crisis-stricken economies in the 1990s should be measured by the progress those economies have made--in particular, Russia and Mexico.

Mexico has already repaid all but $9.5 billion of its IMF loan, which has a 10-year term. And the Mexican economy has rebounded sharply since 1995, powered by a new inflow of foreign investment after its currency and banking system were stabilized.

Nonetheless, the IMF has many critics worldwide.

Some argue that the agency has failed because it did not see certain crises coming--especially the current Asian debacle.

Others argue that IMF bailouts simply encourage smaller countries to engage in fiscal and monetary policies that are reckless--and encourage global investors to do the same--on the expectation that the IMF will fix whatever goes wrong, in the process repaying in full at least some investors.

The IMF counters that the idea that investors are saved en masse in bailed-out countries is nonsense.

Plenty of local and Western investors have already lost billions of dollars in Asia this year as the region’s currencies and stock markets have plummeted in value.

In addition, some analysts say the IMF and the U.S. Treasury, which works closely with the agency, have a legitimate case in arguing that allowing the free market to ravage certain countries truly would pose a grave threat to the world financial system and perhaps world peace.

For example, the specter of riots in South Korea if its banking system were allowed to collapse, destroying Koreans’ savings, raises the threat of an armed intervention by North Korea to take advantage of the South’s turmoil.

In any case, attacks on the IMF’s authority and its lending programs are likely to accelerate in political bodies worldwide soon--especially within the U.S. Congress.

While the IMF insists that it has not exhausted its current financial resources, it is seeking to raise its members’ subscription levels enough to boost the total IMF pool to $275 billion, and the usable pool of funds to about $73 billion.

The agency is also seeking to raise its general borrowing agreement with key industrialized nations from $25 billion to $50 billion.

Although the new sums have been agreed upon in principle by member nations, the IMF may face a long road--and a major fight--getting individual nations’ legislative bodies to ratify those increases.

* GLOBAL MARKET RALLY

South Korea’s decision to seek IMF aid sparked stock market rallies around the world. D1