Global Policy Forum

IMF, World Bank Principles Face a New Policy Threat

By Paul Blustein

The International Monetary Fund and the World Bank are out of the frying pan. The massive protests planned against them for this weekend in Washington, along with their annual meetings, have been canceled because of the Sept. 11 terrorist attacks, and their critics are refocusing their energies on teach-ins and antiwar rallies.

But into the fire they go. For the IMF and the World Bank, the events of Sept. 11 present a far more serious threat to their principles of sound economic policy than any throng of anti-globalization demonstrators.

The war against terrorism being mobilized by the Bush administration will surely involve using the IMF and World Bank as financial tools of the U.S.-led coalition, according to experts both inside and outside the two institutions. That means the United States and its allies in the Group of Seven major industrial nations, the dominant shareholders of both organizations, will use their influence to funnel billions of dollars in loans on easy terms to strategically important governments such as Pakistan. Those kinds of loans, though financially beneficial in the short run to the governments receiving them, have a dismal record of boosting growth and living standards in the long run.

The official position of the IMF and the World Bank is that they will respond to the attacks by sensibly providing aid to countries hit by the shock waves that are rippling through the global economy. But while the need for some additional loans isn't in dispute, many on the IMF and World Bank staffs are convinced that Washington's foreign policy goals will override economic concerns more than ever in determining how and where the dollars are doled out.

"It's obvious that there is political pressure now to expand lending to countries that are going to be allies in the war against terrorism," said William Easterly, a veteran World Bank economist who was willing to state publicly what a number of his colleagues would say only privately -- that the long-term economic implications present "huge grounds for concern."

Cold War Constraints

Since the fall of the Berlin Wall in 1989, the IMF and the World Bank have prided themselves on breaking free from many of the geopolitical constraints that had heavily influenced their operations during the Cold War, when the United States steered some of their loans to wretchedly managed economies whose leaders happened to be anti-Soviet. During the 1990s, the fund and the bank, though still under the thumb of the G-7, were able to give much higher priority to economic considerations as they performed their duties. (The IMF specializes in short-term loans to help countries overcome financial setbacks; the World Bank makes long-term loans for economic development projects such as roads, schools and health systems.)

But as the attacks on the World Trade Center and Pentagon prompt President Bush to divide the world anew into those aligned with America and those against, the anti-terrorist campaign -- however noble its goals may be -- will revive some of the bad old ways at the fund and the bank, Easterly and others warn.

"In a way, this is really redoing some of the big mistakes of the Cold War," Easterly said. "We did the same thing then -- we picked out countries that were far-from-desirable recipients of foreign aid, but just because they were on our side, we gave them aid, and World Bank and IMF loans too." Citing Mobutu Sese Seko, the late despot who ruled Zaire, Easterly added: "Mobutu got nine IMF and World Bank adjustment loans, which is amazing considering what was known about his being corrupt and doing everything possible to destroy his country's economy. Now it looks like the same mistakes could be made again."

It all adds up to a wrenching twist of irony for the IMF and the World Bank. Just as they were girding to defend themselves against an attack from anti-globalizers whom they viewed as ill-informed, they find themselves in circumstances that are propelling them toward doing precisely what their critics accuse them of -- propping up inefficient, corrupt regimes; providing quick dollops of cash that stave off crises only temporarily; and piling loans on countries that may well waste the money and fall deeper into debt.

Since the attacks occurred just 19 days ago, hard evidence is still scant that foreign policy pressures are being brought to bear on the two organization's policies. But it is not entirely absent.

Last Wednesday, for example, the IMF's executive board approved -- as previously scheduled -- a $135 million loan for Pakistan, the final installment of a $600 million one-year package. Confronted with questions about whether the Pakistani government was being rewarded for its support of Washington, IMF officials issued assurances that their decision was thoroughly justifiable on economic grounds, because Islamabad had met most of the conditions attached to the loan, including keeping the budget deficit within the agreed target.

"Pakistan was already in shape [to get the loan] because they'd been performing well," Anne Krueger, the IMF's first deputy managing director, told reporters last week. "It so happens that they were already fortuitously there, or fortuitously at least from this viewpoint of timing."

But according to a senior IMF staffer, the expectation among some of the people dealing with Pakistan before Sept. 11 was that the chances for board approval were 50-50, because although the Pakistani government had kept many of its pledges, it had failed to deliver on others, including tax collection.

After Sept. 11, the political atmosphere was transformed -- so at Wednesday's meeting, board members representing the IMF's member countries heaped praise on Islamabad's economic performance. Furthermore, Pakistan firmed up its prospects for receiving a larger, three-year loan it has been seeking. Board members representing G-7 governments had previously insisted that Islamabad must cut defense spending to qualify for such a loan; they refrained from making such demands on Wednesday, according to the senior IMF staffer.

"Countries are going to be judged by whether they're on our side or the terrorists' side," the staffer said, adding that whereas American muscling of the IMF during the 1990s was handled by the U.S. Treasury, where economists held sway, "we're coming into a world now where the State Department will call the shots much more than Treasury."

The Pakistan Problem

In a recently published book, "The Elusive Quest for Growth," the World Bank's Easterly cites Pakistan as an egregious example of a country that has failed to get its economic act together despite having been the world's third-largest recipient of foreign aid over the past 40 years. That aid, much of which was bestowed for Cold War reasons, includes 22 loan programs from the IMF and World Bank.

An eight-year donor-backed "social action program" has made little headway in remedying the nation's most glaring deficiencies in areas such as health and education; barely a quarter of Pakistani women can read, and this year the government is spending only about $2 per person on health. Easterly and other critics blame corruption -- in international surveys, the country regularly rates among the world's worst on that score -- and government spending on projects that primarily benefit the elite, such as an expressway linking Islamabad and Lahore.

Accordingly, even though the current military government has done better than its civilian predecessors at cutting outlays and going after tax cheats, World Bank staffers are dreading the prospect that they will have to gin up new loans for the country.

"Their public procurement regulations are terrible and corrupt," said one World Bank economist, "and there is some fear in the South Asia region [which oversees Pakistan] that we might be prepared to be less stringent than we have been in the past" in enforcing lending conditions.

"What are you going to do? If that's what the board decides, they represent the 183 countries that own the bank, and that's what will happen," added one of his colleagues, who said similar predictions are making the rounds about increased lending for Uzbekistan, Tajikistan and other countries that are being asked to support military action against Afghanistan. "We haven't faced anything yet, but you can feel it in the air."

Top IMF and World Bank officials emphasize that nonpolitical reasons abound for them to come to the aid of countries in south and central Asia, as well as elsewhere, that are suffering economically in the aftermath of the attacks. Mutual funds, international banks, and other investors and lenders in rich countries were already pulling money out of emerging economies as global growth slowed earlier this year, and that withdrawal of funds has accelerated since Sept. 11. Tourism, a mainstay of many developing countries' economies, has fallen off sharply.

"You expect to be needed more when times are difficult," said Nicholas Stern, the World Bank's chief economist, adding that this hardly means the bank will lend indiscriminately or without regard to issues such as budget discipline and corruption. "We have learned from all our work on aid effectiveness that we're much more effective in combating poverty, and helping counter sharp shocks, in the context of good policies and movements in the direction of sound reform. And we would, I'm sure, continue to be guided by that."

Likewise, the IMF's Krueger and her boss, Managing Director Horst Koehler, said last week that the fund stands ready to provide financial support to countries if needed. But "as all of us have discovered, a large part of what happens to individual countries is a function of their own economic policy," Krueger admonished.

Market Support

In financial markets, however, big-money players are already starting to bet that geopolitical issues will force the IMF and the World Bank to adopt looser lending standards than their PhD economists would like. Trading data in recent days show that some investors are speculating that the IMF will now go to extraordinary lengths to prevent a nation from going into default, especially when it comes to key U.S. allies such as Turkey.

While stocks, bonds and currencies of nearly all emerging economies have tumbled since Sept. 11, the government bonds of Turkey and Argentina have fallen substantially less than similar bonds of other countries, noted Mohamed El-Arian, an emerging-markets specialist at Pimco, a California-based investment firm. Turkey and Argentina are in rocky shape economically, having undergone financial crises earlier this year, so El-Arian concludes their bonds are benefiting from "moral hazard trades" -- that is, trades based on the expectation of an IMF bailout.

Pakistan's markets are drawing investors making similar bets. Raphael Kassin, a London-based emerging-markets fund manager, told Bloomberg News last week that he had increased his holdings of Pakistani bonds, saying "Pakistan should at least get support after this" from the IMF.

Treasury Secretary Paul H. O'Neill has long vowed to find a way to restrict bailouts and the moral hazard trades they encourage. In Senate testimony 10 days ago, he suggested that the events of Sept. 11 might give new impetus to his efforts.

"Maybe one of the consequences of this tragedy is we'll finally take action on some of these things we know we need to do," he said, disclosing that he had just spoken with the IMF's Koehler about the need for an international bankruptcy court that could force bondholders to take their lumps if countries fell into default.

But such a court would take years to establish, and for now even economists who share O'Neill's concern about big bailouts and moral hazard believe he will have to yield to other imperatives.

"Any country in the front lines is going to find it easier to get money," said Morris Goldstein, a scholar at the Institute for International Economics. "If you worried about that kind of issue before, it's going to be much harder to control it now. That's not to say that the anti-terrorism effort isn't more important. I think it is. But this is an unfortunate byproduct."

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