The IMF will monitor the policies of 25 countries to assess their impact on global financial stability. It will focus more on countries where the financial crisis broke out, and ensure they take the IMF's advice seriously.
The International Monetary Fund (IMF) has come out a winner after the recent global financial crisis. It has provided intellectual and technical inputs to the G-20, which has emerged as the new global leadership to evolve policies to minimise the impact of the crisis. G-20 became the focal point for the revival of confidence in the global financial system.
The IMF has acquired the membership of the Financial Stability Board, which oversees the follow-up of G-20 decisions. It strengthened its position last week by integrating financial stability assessment with bilateral mandatory surveillance for 25 select countries.
These countries have been identified as important from the perspective of global financial stability, taking into account the size of their respective financial sectors and their interconnectedness with the rest of the world (see Table).
India has been caught in the net of these 25 countries. As a result, it will have to allow the IMF to undertake a stability assessment at least once in five years. Hitherto, such an assessment remained purely voluntary. But India, besides subjecting itself to IMF assessments since 1999, had undertaken a comprehensive self-assessment by the Rakesh Mohan Committee on Financial Sector Assessment in 2009.
While for India this policy change does not make any technical or policy departure, for many other jurisdictions identified as systemically important it will make a difference. Some of the advanced countries like the US, which were not keen to undertake stability assessments, will be compelled to comply with the new discipline.
Will the new paradigm make a difference in minimising the potential risks to global financial stability? While it resolves some weaknesses of the previous voluntary regime, it has thrown overboard some earlier strengths.
The new regime also lacks focus and a right sense of priorities.
The focus now has shifted in favour of stability issues, whereas the earlier regime laid equal emphasis on stability and development.
Financial sector development, in terms of orderly evolution and functioning of institutions and markets, is a prerequisite for ensuring stability. In fact, the recent crisis stemmed from the lack of robust financial markets and imprudence on the part of financial institutions.
The first priority, therefore, should have been to plug such loopholes and bring about orderly financial development in these countries.
This focus is dissipated to the extent that the newly identified systemically important countries include India and China, which were more the victims of the crisis rather than contributors to it. Dr Y V Reddy had often mentioned that India was not a contributor to the crisis, but was vulnerable to the crisis.
The mandate for making the Financial Sector Assessment Programme mandatory is derived from the provisions of Article IV. The success of the new regime will depend on whether the IMF policy advice under bilateral surveillance is effective, particularly in the case of advanced countries like the US.
The evidence so far has not been encouraging. IMF policy advice was effective in cases where the countries were implementing its programmes, since the release of IMF assistance depended upon the country's compliance with policy advice.
In advanced creditor countries, bilateral surveillance was more of a routine to be complied with periodically.
Article IV in particular emphasises policy advice on exchange rate management. In accordance with the framework set out in Article IV, the 2007 Surveillance Decision provides that systemic stability is best achieved by each member adopting policies that promote its own “external stability”— that is, by working towards a balance of payments position that does not give rise to disruptive exchange rate movements.
The new paradigm assumes that in the conduct of their domestic economic and financial policies, members are considered to be promoting external stability while promoting domestic stability.
How far has the IMF been successful in providing policy advice to its members on exchange rate management?
An evaluation carried out by the Independent Evaluation Office of the IMF in this regard concluded that in the period reviewed (1999–2005), the IMF was simply not as effective as it needed to be to fulfil its responsibilities for exchange rate surveillance.
All this is not to decry the IMF's new initiative. It is a welcome step and the new paradigm provides some teeth to IMF.
However, the following approach could provide better results: (i) within the group of 25, IMF should prioritise surveillance in the crisis-originating countries; (ii) in these jurisdictions, give equal emphasis to stability and development, so that orderly development of markets and institutions is ensured with a sense of urgency; and (iii) providing analysis of stability and advice are not enough by themselves and effective compliance mechanisms may need to be developed with appropriate incentive structures.