Understanding Pathways through Financial Crises and the Impact of the IMF: An Introduction

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The International Monetary Fund is often perceived as imposing harsh policies on countries facing financial crisis. A comparison of six countries affected by the pressures of the 1990s suggests more subtle effects. In Malaysia, India, and South Africa, policymakers kept the IMF at arms length to permit a more gradual and heterodox adjustment, including capital controls in India and Malaysia. By contrast, Argentina, Turkey, and Indonesia were bound tightly into the embrace of the IMF. However, this did not push policymakers to take tough decisions. Rather, IMF loans to Argentina and Turkey permitted policymakers to postpone difficult choices as both they and the IMF sought to protect previous policies and loans. In Indonesia, by contrast, borrowing from the IMF opened up a conduit for larger political pressures that brought down the Suharto regime. KEYWORDS: International Monetary Fund, financial crisis, conditionality, capital markets, policy space, emerging economies.

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In 1997, a crash in the Thai baht triggered a financial crisis that rapidly spread across East Asia and beyond. Many countries were affected by the crisis--some immediately, others less directly--as the reversal in confidence in emerging markets spread across to other corners of the globe. It soon became apparent that the East Asian crisis had recalibrated the willingness of capital markets to invest in emerging markets. Following on from Mexico's December 1994 peso crisis, it was also clear that a new kind of financial crisis had been born.

The International Monetary Fund (IMF) was the first agency of international recourse in dealing with the new financial crises. Its officials found themselves working amid a sharp debate about the causes of financial crises and how best to manage them. (1) While some economists focused on international factors--including contagion, recession in major export markets, and capital account liberalization--others focused on domestic causes of each crisis, such as uneven deregulation of the financial sector, poor fiscal and/or monetary policy, artificially high interest rates, corruption, and misallocation of capital at the domestic level. Unsurprisingly (given the difference of views among officials, economists, and political scientists), the IMF soon found itself criticized on several counts. Critics argued that the Fund helped cause the crisis by having pushed countries to liberalize their capital accounts too fast. Equally, they accused the Fund of paying insufficient attention to the poverty effects of the stabilization measures it advised and of overstepping its jurisdiction in applying deep structural conditionality.

In the aftermath of the 1990s crises, much rethinking and analysis has taken place. Various international commissions were immediately formed to consider how to reform the Fund. (2) IMF staff have actively researched and debated the advantages and disadvantages of capital account liberalization and the possible uses of capital controls, as well as the possibilities for a more formal mechanism for restructuring sovereign debt. (3) Others have debated the appropriate and most effective role the institution might play in resolving financial crises. (4)

This special issue does not revisit the economics of the financial crises of the late 1990s. Nor does it look at the long-run political impact of the crises. Rather, it is concerned with how the IMF's engagement with a country affects the agenda of policymakers managing a particular crisis as well as the process by which decisions are made.

The impact of the IMF can be viewed in several ways. An informed outsider arriving in a moment of crisis may perceive the Fund as injecting new ideas, new solutions, and better information into the policy process. Politically, this contribution favors "technocrats" within government and can marginalize local coalitions supporting alternative government policies. The IMF typically sees itself as stiffening the spine of policymakers, enabling them to seize the opportunity presented by a crisis so as to boldly reform. Critics interpret the same intervention as opportunistic--with the IMF seizing a country's moment of weakness to press a government to adopt an agenda formulated in Washington, D.C.

The case studies presented in this special issue examine these competing presumptions, tracing out the role the IMF played in widening or narrowing the policy debate; the choices policymakers made; and the ranking of priorities. The answers are different in each case. We seek to probe why.

At the country level, the financial crises of the late 1990s (obviously) did not affect all countries in the same way. In some countries, the financial crisis left a legacy of enduring social and political disruption, while in others the economy soon bounced back. In part, this was because government responses were different. Facing a crisis, some engaged immediately with the IMF. Others did not. Some countries endured a political crisis at the same time as a financial one. Others had relatively robust and capable institutions of government with which to manage the crisis. Some had longstanding relationships with the IMF. Others had integrated into global financial and capital markets at their own speed and in their own way.

In each case examined in this special issue, researchers have attempted to get as close as possible to the decisionmaking process. They were greatly assisted by the cooperation of senior officials within each country and from a workshop held in Oxford in 2004 attended by Kemal Dervis (former finance minister of Turkey), Shankar Acharya (former chief economic adviser to India), Mario Blejer (former central bank governor of Argentina), Sergei Dubinin (former central bank governor of Russia), Gill Marcus (former deputy finance minister and deputy central bank governor of South Africa), and Rizal Ramli (former coordinating minister for finance and economy of Indonesia).

This framework paper sets out the initial hypotheses about the impact of the IMF on the policy choices made by governments, highlighting the potential sources of bargaining power and leverage enjoyed by the IMF, as well as the limitations on the institution's influence. It then outlines the six cases, noting their similarities and differences, and reports back some of the comments made on the studies by senior finance officials involved in each case, before offering some conclusions.

The Role of the IMF in Financial Crises

Countries facing a financial crisis soon find that commercial creditors desert them. Typically they approach the IMF as a last resort when they have little access to alternative sources of finance. (5) IMF assistance comes with many strings attached, including both formal conditionality and informal pressures and influences over the design, implementation, and procurement within programs and projects. The approval and support of the IMF tends to be a necessary prerequisite for most other forms of official assistance.

For the IMF and its powerful government members, engagement with a debtor opens up several channels of influence. The IMF can refuse to lend to the country, thereby depriving a government of the emergency resources it seeks. Furthermore, when the Fund turns down a request for assistance, the action may carry a second kind of penalty. In the absence of IMF willingness to intervene, other lenders and private creditors may refuse. More broadly, a refusal to lend may be interpreted by investors as a statement that a government's economic policies and prospects are not sound, although, as the discussion will show, the view that IMF's approval catalyzes private flows is much debated. The conditionality accompanying any loan involves some formal and some less formal requirements across a spectrum from "hard" to "soft." Hard conditionality describes measures a country must meet in order to access any money. Typically this involves "prior actions" and "performance criteria," which are specified in the formal agreement. These can be waived where minor deviations from agreed targets are considered to be of a temporary or reversible nature. Soft conditionality refers to a wide range of other elements that the Fund will take into account in deciding whether or not to "complete" the reviews that are necessary to permit the disbursement of each portion of the loan. Such soft conditionality includes such things as structural benchmarks, indicative triggers, and general undertakings in the government's Letter of Intent.

Once an agreement is reached, the IMF has formal powers to monitor its lending and to apply sanctions if necessary on borrowers. If a government falls behind in implementing its agreed-on program, the institution can suspend or cancel its disbursements. More serious sanctions can be imposed on a government if it falls behind in its repayments, as governed by the IMF's arrears policy. Further to this, until the early 1990s, the IMF would withhold funding if a …