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Friday, April 16, 1999 Published at 16:47 GMT 17:47 UK

Business: The Economy

Struggle for IMF reform

The World Bank and IMF are struggling to get a grip on global markets

As bankers and finance ministers begin to gather in Washington for the spring meeting of the World Bank and the International Monetary Fund (IMF), reform will be in the air.

The performance of the world's leading financial institutions will be under scrutiny, with many dissatisfied at their ability to cope with the global economic crisis that unfolded last summer.

[ image: Severe social unrest was one result of financial meltdown]
Severe social unrest was one result of financial meltdown
Six months ago the IMF and World Bank were meeting amid frantic efforts to stabilise the global turmoil.

Now, with that crisis contained, agreement on global reform has proved harder to reach.

The crisis nevertheless revealed a new set of "fault lines in global capitalism," in the words of international speculator George Soros.

These include

  • destabilising private sector flows of money to and from developing countries,

  • varying standards in the regulation for the international financial system,

  • lack of early intervention by the IMF to prevent crises developing,

  • huge liabilities undertaken by hedge funds that are hidden from the authorities.

The IMF and World Bank will also come under pressure to provide more to the poor, who were the main victims of the crisis in the developing world.

Gordon Brown, the UK Chancellor, is urging the IMF to sell $1bn of its gold reserves to fund debt relief for some of the world's poorest nations, a suggestion that until recently was opposed by some countries.

Private sector 'bail-ins'

[ image: The economic crisis spread around the world]
The economic crisis spread around the world
Although the IMF is generally considered the lead institution in dealing with international financial crises, many critics believe it was ill prepared to deal with the chain of events that was triggered in Asia in July 1997.

The crisis was caused by private sector capital flight, with the IMF estimating that some $350bn in short-term money went missing.

Now the fund is discussing proposals to force private sector lenders to 'bail-in' to countries that are undergoing financial crises - to voluntarily limit their ability to move capital, especially bonds, out of a country.

Private banks responded with a proposal of their own. They would provide extra support for struggling countries, but only if the IMF would guarantee the private loans. The fund has rejected this suggestion of risk-free 'bail-ins'.

The IMF would also like to find a way of ensuring that the private sector is forced to participate in funding any bail-out that becomes necessary. This would provide a necessary boost to its own limited resources.

The fund's loan to Brazil, for example, was accompanied by some pledges of private money. However, it failed to prevent the devaluation of Brazil's currency.

Private sector lenders therefore remain cautious.

"In the interests of generating more private sector investment in the short term it could lead to less involvement in the long run," said Charles Dallara, head of the Institute of International Finance, which speaks for the large banks.

The lenders are also fiercely resisting any proposals that would limit their freedom to get their money out in a crisis - although they may accept that more co-ordination among bondholders is necessary.

Monitoring hedge funds

The world's financial institutions have also decided to monitor hedge funds and offshore financial centres in their bid to stave off future financial crises.

The International Financial Stability Forum - a body bringing together central bankers, regulators, and finance ministers - met for the first time in Washington on 14 April and made that task its first priority.

One US hedge fund specialising in bonds, LTCM, had used its investors' money to borrow billions of dollars that it bet on bond prices. It had to be bailed out by a consortium of private financial institutions to avoid unhinging the entire market.

Andrew Crockett, head of the new Stability Forum and general manager of the Bank for International Settlements, said:

"There is concern that we should make sure the activities of highly leveraged institutions and the activities of the counterparties that provide them with funds are conducted on a prudent basis."

The new body would also suggest means of strengthening regulation of financial markets in developing countries, trying to move towards tighter global standards that apply to equity investment, banking and international capital markets.

Saving the world's poor

The global financial crisis had its biggest impact on the world's poor.

In countries like Indonesia, the collapse of the economy tripled the poverty rate.

The world's poorest countries, which lacked access to private capital, found they had to pay more to service their debt to Western institutions. Few have qualified so far for the main aid programme to help them, the IMF-managed Highly Indebted Poor Countries initiative (HIPC).

Now momentum is growing for a major new initiative from the IMF to relieve the debt burden on poor countries by selling some of its 100 million ounces of gold.

Crucially, Germany, which had previously opposed gold sales, has changed its stance under the new social democratic government. Its new finance minister, Hans Eichel, said on 16 April that the German position had "relaxed slightly", but that the government still had "to conduct some internal discussions on this".

Gordon Brown, the UK Chancellor, told the House of Commons: "I confidently expect that all G7 members will now support the sale of gold and I believe therefore that the IMF will go ahead with this proposal later this year."

But there could still be a difficulty in getting the proposal through the US Congress, which would have to approve any capital increase and is increasingly hostile to the IMF.

Crossroads for reform

If the impetus for "restructuring the global financial architecture" has slowed since the crisis began to abate, nevertheless many of the initiatives suggested six months ago are now underway.

The difficulty is that, as Alan Greenspan, head of the US Federal Reserve, has said, no one fully understands the causes of the crisis.

It will only be during the next crisis that we will know whether the IMF and other institutions have learned their lessons fast enough.

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