INT’L FINANCIAL SYSTEM JOINT CLASS FIVEIMF BASICS & LOIs

Prof. David K. Linnan UI-UGM-USC-UNDIPUniv. of South Carolina Joint Videoconferenced ClassSchool of Law September 10, 2002

ORIGINAL BRETTON WOODS SYSTEM

Late 1940s

Concept to avoid economic problems of 1930s & WW II again

Idea of three major institutions, International Monetary Fund (IMF), International Bank for Reconstruction

& Development (World Bank), plus International Trade Organization (ITO failed in adoption, but Havana

Charter and GATT, leading to WTO finally 1994)

Economic concepts of fixed currency parities but low or no tariffs in relatively open economy was attempt

to avoid 1930s policies andissues like Commonwealth Preference (economist claims that late New Order economy with monopolies, etc run like 1930s)

BRETTON WOODS IN TRANSITION

Original IMF Role

Originally, IMF was a special purpose lender for countries with balance of payment problems under older fixed rate currency exchange system

Monitoring function only for countries in trouble under original system

BRETTON WOODS IN TRANSITION

Once World Went to Floating Exchange Rates Matching General Economic & Currency Changes

Tensions with US conduct of economy (deficit spending) 1960s-1970s with Vietnam War & Social spending led to loss of U$ & gold reference

Exchange (floating) rates then subject to ups and downs following domestic policy even while concerns about costs of volatility (Prof Cathy Bonser-Neal lectures covered)

Parallel effect of change is that currency crises themselves may now drive balance of payments problems and IMF has constant monitoring function in anticipation

IMF BASICS-WASHINGTON CONSENSUS

Current “Washington Consensus” Created for Latin America in 1980s Structural Adjustment Approach under which Policy Reform Consists of 10 Elements (NB– Washington Consensus means IFIs, not US government)

1) Eliminating fiscal deficits for stability purposes (but problem of limiting idea of Keynesian growth enhancement in stimulative spending)

IMF BASICS-WASHINGTON CONSENSUS

Washington Consensus (cont’d)

2) Reviewing public expenditure priorities (increasing revenues versus decreasing

expenses)

a) Military spending sovereign prerogative, off table

b) Subsidies strongly disfavored as distorting economy & expensive

IMF BASICS-WASHINGTON CONSENSUS

Washington Consensus (cont’d)

2) Reviewing public expenditure priorities (increasing revenues versus decreasing

expenses)

c) Education & health spending viewed as proper, but issue of actual composition (investment versus

consumption and helping disadvantaged

d) Public infrastructure investment as productive

Concept of switching expenditures from subsidies to education & health or public infrastructure

IMF BASICS-WASHINGTON CONSENSUS

Washington Consensus (cont’d)

3) Tax Reform

Ultimately just reverse of cutting expenditures in raising revenues, but disfavored by politicians while favored by technocrats

This is the revenue side of public expenditure priorities

IMF BASICS-WASHINGTON CONSENSUS

Washington Consensus (cont’d)

4) Interest Rates

a) market determined to avoid misallocation of funds in bureaucratic credit rationing (efficiency hidden good)

b) positive real interest rates to discourage capital flight and perhaps encourage savings

East Asian disagreement on picking industrial champions

IMF BASICS-WASHINGTON CONSENSUS

Washington Consensus (cont’d)

5) Exchange Rates

a) Concept of “competitive” exchange rate versus technical question of how determined (export competitiveness)

b) Ambivalence on liberalization of foreign capital flows from developing country perspective (capital account)

IMF BASICS-WASHINGTON CONSENSUS

Washington Consensus (cont’d)

6) Trade Policy

a) Import liberalization & outward oriented economic policy

b) Disfavoring import substitution protection for developing domestic industry (costliness argument & who profits)

c) Import licensing & corruption problems, so if protection tariffs

d) free trade idea subject to (temporary) infant industry issues, plus phase out versus big bang approach bringing costs

IMF BASICS-WASHINGTON CONSENSUS

Washington Consensus (cont’d)

7) Foreign Direct Investment

a) Idea adding bricks & mortar capital good for real economy (current account-Prof Cathy Bonser-Neal lectures)

b) distinguish it from liberalizing financial flows (capital account-Prof Cathy Bonser-Neal lectures)

IMF BASICS-WASHINGTON CONSENSUS

Washington Consensus (cont’d)

8) Privatization

a) Efficiency (hidden view markets better allocator than governments through State Owned Enterprises (SOEs or BUMNs in Indonesia)

b) Market preference as change since 1950s, linked with competition ideals

IMF BASICS-WASHINGTON CONSENSUS

Washington Consensus (cont’d)

9) Deregulation

Idea ultimately is again competition through deregulation for cheaper prices and greater efficiencies

IMF BASICS-WASHINGTON CONSENSUS

Washington Consensus (cont’d)

10)Property rights

Concept of property rights ties into contracting & incentives, to make markets work

IMF BASICS

IMF BASICS

CURRENT IMF VIEW OF ITS ROLES

1) Surveillance

2) Technical Assistance

3) Financing

All roles are essentially to help countries in macroeconomic economic difficulties, with practical pressure on conditionality concerning which more later legally plus at heart of letters of intent (LOIs)-- But newer pattern of financial sector difficulties

as trigger for macroeconomic and exchange rate problems

IMF BASICS

Is IMF process with LOIs a “legal” or a “policy” process?

Compared to what, like WTO? Does it matter in economics versus financial sector areas?

Why is it either regularized in “rule” form (legal format) versus “policy” form (flexibility from economists’ standpoint)?

What about sovereignty arguments, are they more appropriate in legal versus policy format?

Does a private bank infringe on sovereignty in conditioning a loan on behavior?

IMF LOIs

Indonesia Memorandum of Economic and Financial Policies

January 15, 1998

Policy Framework

Fiscal Policy

Problems from currency depreciation

Subsidy decreases

Taxation system improvements & new excise taxes

Transparency in off-budget funds

Investment project cutbacks

IMF LOIs

LOI Policy Framework (cont’d)

Monetary & Exchange Rate Policy

Complications with banking system problems (runs & insolvencies)

High interest rates in face of uncertainties regarding rupiah exchange rate and liquidity generally (tight monetary policy)

Financial Sector Restructuring

Closing insolvent banks

State versus private bank issues

Strengthening legal and supervisory framework

IMF LOIs

LOI Policy Framework (cont’d)

Structural Reforms

Liberalization

Deregulation

Privatization

Foreign Trade & Investment

Move towards freer trade (removing export taxes, quotas & other NTBs)

Opening up investment list for foreigners

IMF LOIs

LOI Policy Framework (cont’d)

Deregulation and Privatization

(For Dr. Suad Husnan’s presentation next)

Social Safety Net

Targeted assistance to poor

Environment

Sustainability & pollution issues

IMF LOIs

Indonesia Supplementary Memorandum of Economic and Financial Policies

April 10, 1998

More details on Jan 15, 1998 LOI in face of further deterioration

IMF LOIs

Link Back LOIs to Washington Consensus Points

Big difference lies in prominence of financial sector problems

Blending of technical & system financial system issues with macroeconomic difficulties lender role of IMF

How accurate is IMF role description read against LOIs themselves

How have changes in the financial systems worldwide led to chnages in IMF roles & activities

IMF BASICS

WHAT IS LINK BETWEEN FINANCIAL SYSTEM EXPERTISE AND IMF’S ROLE IN BEING AN ADVISER/LENDER FOR COUNTRIES EXPERIENCING MACROECONOMIC DIFFICULTIES?