IMF puts the squeeze on developing countries

Fiscal austerity measures are being pushed through not only in Europe, but also by the International Monetary Fund (IMF) in many developing countries.  Bhumika Muchhala analyses the situation.

IN an effort to respond to the global financial crisis, the G20 grouping of major economies dramatically strengthened the role of the International Monetary Fund (IMF) in developing countries, including in low-income countries (LICs), by tripling the Fund's resource base from $250 billion to $750 billion.1 The IMF's concessional lending capacity to LICs will be 10 times higher in 2014 than before the crisis.

The IMF has announced that it has drawn lessons from the East Asian crisis of 1997-98, when its emergency lending was tied to procyclical policies, such as fiscal austerity measures and higher interest rates, which led borrowing countries into even deeper crisis, causing massive job losses and an economic recession that could have been avoided. The Fund's official position now is that it has reformed its programmes and provided greater flexibility for LICs to adopt expansionary policies.2

IMF still prescribing procyclical policies

Despite pledges to address the crisis in flexible and innovative ways, the IMF's key objective in crisis loans remains 'macroeconomic stability' through the 'tightening of monetary and fiscal policies'.

Since the onset of the financial crisis in 2008, IMF crisis loans have required policies such as:

   lowering fiscal deficits and inflation levels;

   buffering international reserves (as they fell to dismal levels from the impact of the trade shock in this financial crisis);

   reducing or restraining public spending (through public sector wage freezes and pension freezes, cutting minimum wages, eliminating subsidies to fuel, gas and power, and hiking utility tariffs and tax reforms);

   increasing official interest rates or restraining the growth of the money supply;

   preventing currency depreciation; and

   providing financial sector liquidity where needed.

Instead of increasing government expenditure and boosting domestic demand, local employment and economic activity to overcome the recession, the IMF is cutting spending and increasing tariffs and taxes in already contracting economies for the express purpose of maintaining low inflation and fiscal deficit rates, flexible exchange rates, and trade and financial liberalisation. The burdens of these questionable policies, intended to maintain investor confidence, access to external capital and sustainable debt situations, fall squarely on the shoulders of local taxpayers and consumers.

The impact of the recent financial crisis has threatened key elements of the progress made by LICs over the past several decades. For LICs as a whole, economic growth decelerated to 7.2% in 2008, in which industry and manufacturing took the brunt of the contraction in world demand. Exports and imports were hit by the trade shock, falling to 25% and 36% of GDP, respectively.  Workers' remittances decreased to 5.1% of GDP in 2008 from 5.7% in 2007.  Perhaps the largest decline was seen in LICs' foreign exchange reserves, which plummeted to 4.1 months of import payments in 2008, from a previous high of 6.2 months in 2002.

A study by academics at the School of Oriental and African Studies (SOAS) in London has found that in 13 LICs with IMF programmes, procyclical fiscal and monetary policies are still being imposed. During the brunt of the food and fuel price crisis of 2008, and the financial crisis of 2009, marginally higher deficits were permitted. However, the fiscal flexibility of the IMF proved to be short-lived, as the Fund has already begun advocating tighter fiscal policies starting this year (2010).

Ghana is a key example of a country that has had to shrink its fiscal deficits dramatically, with the IMF saying that the country's fiscal policies need to 'carry the brunt of the adjustment'.3 In countries such as Benin, Malawi and Zambia, the Fund has also prescribed wage and hiring freezes for public-sector workers. Latest IMF projections for the countries assessed show that the fiscal expansion projected for 2009 amounts to only 1.5% of GDP on average, and a fiscal tightening of 0.5% of GDP is projected for 2010. Eight of the 13 countries are facing tighter fiscal constraints in 2010 than in 2009. While this suggests greater flexibility compared to the Fund's pre-crisis targets for lowering fiscal deficits, it is not a significant revision of the IMF's framework, and cannot be equated to a genuine provision of fiscal policy space for LICs.

An alternative macroeconomic framework that would allow for policy space would incorporate the judgment that fiscal policy has to play a central role in driving the development process, and thus has to take the form of expansionary, public-investment-led fiscal policies. However, the IMF only assesses fiscal policy in terms of the costs of financing a fiscal deficit, while failing to factor in the costs of foregone growth and poverty reduction if the widening of the deficit were not allowed. The IMF also fails to assess dynamically the budgetary position of LICs, based on the potential for mobilising additional domestic revenue, or for creating greater fiscal space with additional debt relief initiatives or further grant assistance.

On monetary policy, the IMF has continued to push for tightening in countries such as Ethiopia, Ghana, Sierra Leone and Zambia, despite the fact that inflationary pressures are due to the external shocks caused by the food crisis, rather than to rising internal demand. Inflation targets for 2008 and 2009 remained firmly within the 'single-digit' range. And the Fund's inflation targets for 2010 have continued on a downward trend. In many countries, this only served to intensify recessionary trends.

A study by the United Nations Children's Fund (UNICEF) on 86 recent IMF country reports in low- and middle-income developing countries has also concluded that the Fund advises governments to withdraw fiscal stimulus or cut public spending. In two-thirds of the 86 countries reviewed, the IMF recommends cutting total public expenditures in 2010.  In all but a few countries, the Fund recommends further fiscal adjustment in 2011.  Furthermore, the IMF calls for curtailing wage bills, removing subsidies, especially those for fuel, and reforming and further targeting social programmes. UNICEF states that fiscal austerity measures, particularly in a context where economic recovery has yet to gain traction, entail serious human and economic costs that undermine efforts towards achieving the Millennium Development Goals (MDGs). (The MDGs are a series of time-bound development and poverty reduction targets agreed to by world leaders at the UN's Millennium Summit in 2000.)

The traditional biases of the IMF continue to support macroeconomic frameworks where private interests supersede public interests and the role of the state, where the financial sector takes priority over the productive sector, and where foreign investor and corporate interests override those of domestic actors.

The United Nations has also critiqued the Fund's contractionary policies in its flagship World Economic Situation and Prospects 2010 annual report. The report stated: 'Despite pronounced intentions, many recent IMF country programmes contain pro-cyclical conditions that can unnecessarily exacerbate an economic downturn in a number of developing countries. Indeed, amid sharply falling global demand, the Fund has been advocating belt-tightening for many developing programme countries. At the same time, it has been praising advanced economies for their unprecedented efforts in borrowing and spending their way out of recession. The IMF should expand the use of its resources to help support counter-cyclical measures in those developing countries that have sustainable public finances in the medium-term but are impeded in this effort by adverse market conditions.'4

Towards growth- and development-oriented fiscal and monetary policies

A more development-oriented macroeconomic policy stance is necessary in order to generate the quantum leap in resources that LICs need to finance large-scale new investments in economic and social infrastructure, which includes the specific MDG goals in the health and education sectors, and job creation. Progress on poverty reduction and basic human development has historically required, and continues to require, such a critical degree of spending and investment in the domestic economy. The experience of the 'Great Recession' of 2007-2009 has altered the terms of the debate on macroeconomic policies. However, the current debate has been mostly limited to advocacy for expansionary (i.e., countercyclical) policies without any real debate about the need to emphasise the role of deficit-financing.

Previously, the strategic framework of the MDGs helped redirect the international debate on macroeconomic policies. By calling for substantial scaling-up of external and domestic resources to meet the MDGs, it highlighted the need for more expansionary public-investment-led fiscal policies. The social outcomes represented by the MDGs need to be made explicit and taken into account as part of the macroeconomic policy-making process; otherwise, the MDG development agenda will continue to collide with the stability-focused macroeconomic policies that dominated policymaking in the period before the global financial crisis.

Furthermore, while the Fund has recommended and included social safety net spending in most of its loan programmes, the presence of social protection systems should not become an effort to merely compensate for the social dislocations generated by a procyclical and deflationary macroeconomic policy framework. Instead, social protection systems should be complementary and supplementary to an expansionary macroeconomic framework that prioritises social spending, even at the expense of higher inflation rates and deficit levels, until the domestic social infrastructure has built a healthy level of capacity and resources.

In order to support the achievement of the MDGs, IMF policies need to change:

   The IMF should not only permit, but also support, the active use of fiscal policy to support public investments and public spending to build essential economic and social infrastructures, on which private investment too inevitably relies. Future revenues expected from the investment should pay off the debt that the government initially incurred.

   The IMF should encourage more expansionary monetary options that better enable domestic firms and consumers to access affordable credit for expanding production, employment, and increased contributions to the domestic tax base. Monetary policy should thus maintain low real interest rates, rather than ineffectively trying to keep inflation low with high interest rates which dampen aggregate demand and growth prospects.

   The IMF should support exchange rate management in its developing-country member states in order to foster broad-based export competitiveness that can lead to greater structural diversification of the domestic economy.

   The IMF should permit the regulation of the capital account to confront the continuous inflow, as well as outflow, of private capital from national economies, i.e. 'capital flight'.                      

Bhumika Muchhala is a researcher with the Third World Network. The above is extracted from a paper presented at the United Nations General Assembly's civil society/private sector/academic hearings on the Millennium Development Goals held in New York on 14-15 June.

Endnotes

1    Group of 20 (G20), 'The Global Plan for Recovery and Reform,' London Summit Communiqu‚, April 2, 2010, http://www.g20.org/Documents/final-communique.pdf.

2    International Monetary Fund, 'IMF Overhauls Lending Framework,' Press Release No. 09/85, March 24, 2009, http://www.imf.org/external/np/sec/ pr/2009/pr0985.htm.

3    Eurodad and Third World Network, 'Standing in the way of development? A critical survey of the IMF's crisis response in low income countries,' written by Elisa Van Waeyenberge, Hannah Bargawi and Terry McKinley, School of Oriental and African Studies (SOAS), London, April 2010, http://www.eurodad.org/uploadedFiles/Whats_New/Reports/Standing%20in%20the%20

Way%20of%20development(1).pdf?n=3573.

4    United Nations, World Economic Situation and Prospects 2010, December 2009, http://www.un.org/esa/policy/wess/wesp2010files/wesp2010.pdf.

*Third World Resurgence No. 237, May 2010, pp 26-28