By Andrzej Zwaniecki
Washington File Staff Writer

(This article is part of a series on IMF reform.)

Washington - International Monetary Fund (IMF) governance reforms that aim to increase the decision-making power of rapidly growing developing countries are essential to making the 60-year-old institution more representative of the global economy, a leading expert on the fund says.

"You need to recognize a reality of today's global economy in which there are more important ‘players’ than there were 30 years ago," Edwin Truman, a senior researcher at the Institute for International Economics (IIE) in Washington, said in a September 6 interview.

He said smaller industrialized nations such as Belgium, the Netherlands and Italy continue to have a greater say in the IMF than emerging-market countries such as China, South Korea, Mexico, Turkey, South Africa and India, which have grown rapidly in recent decades.

The IMF's executive board, which oversees the fund's day-to-day operations, recommended September 1 a two-year governance reform package as the first step toward restoring the institution's relevance for all its members.

The proposal initially would increase voting shares of the "most underrepresented countries comprising China, South Korea, Mexico and Turkey" as part of a broader effort to make the governance structure better reflect the increased economic weight of major emerging markets, according to an IMF news release. The IMF's board of governors will consider the proposal at its September 19-20 meeting in Singapore.

DEVELOPING COUNTRIES EXPECT MORE

The United States has welcomed the proposed reform. But some large developing countries, such as Argentina and Brazil, expressed disappointment they were not included in the ad hoc readjustment. 

The IMF governance is based on a complicated quota system in which the distribution of quotas largely determines countries' financial commitment to the fund and their number of votes.  The size of the quota also influences the amount a country can borrow from the fund. Quotas are calculated according to a formula that includes various economic factors, such as gross domestic product (GDP), current account transactions and official international currency reserves.

What matters most, however, is the relative size of the quotas because an 85 percent vote is required for many IMF matters.

The fund said that at a later stage it wants to revise the formula according to which quotas are calculated to allow for a broader realignment of decision-making powers involving more countries.

Although the proposed changes would not reduce the quota of any country, they are likely to be opposed by those nations that stand to lose their relative voting power, Truman said.

Among them are Belgium, the Netherlands and Scandinavian nations as well as the poorest developing countries, mostly in Africa. (The proposal tries to preserve the voting power of the latter by doubling their basic votes. Those votes originally were distributed in equal number to all members.)

The United States and some other countries also have called for reform of the executive board to allow for greater representation of major emerging-market countries, mostly through consolidation of European Union seats.

Officials in India reportedly have expressed doubts as to whether European countries will be willing to relinquish some of their decision-making powers.

Former U.S. Treasury Secretary John Snow said in April that for the reform effort to succeed, “members need to look beyond their immediate narrow interests.”

CREDITORS VS. BORROWERS?

Not all experts agree to a principle of shifting power from industrialized to developing nations.

Adam Lerrick, an economist at Carnegie Mellon University and the American Enterprise Institute, said that giving emerging market countries, which are primarily borrowers, much more say in managing the institution runs counter to the accepted practice in the private sector, where creditors, not borrowers, determine policy.

"Borrowers always want more money, lower interest rates, longer maturities and fewer conditions,” Lerrick said in a September 6 interview.  “This will not protect the financial solvency of the institution."

To mitigate this risk of insolvency, he said, a country's relative voting power should also reflect in some way whether it is primarily a creditor or a debtor.

Moreover, Lerrick said, reforming the IMF's governing structure before redefining its mission and objectives is the wrong approach. He said that the criticism of the fund has little to do with its governance structure and much with its role.

The institution was created in 1944 with objectives, he said, that were appropriate for postwar economic conditions - fixed exchange rates and an absence of international capital markets.

"So the question governments should ask first is: What should be the role of the IMF in the 21st century?" Lerrick said.

Truman said the view that the IMF’s new mission should be defined first and realignment of voting powers done later strikes him as "absolutely illegitimate.” He said it would leave to the countries that now have the greatest decision-making powers in the fund to define its role for the future and would give emerging-market countries more power only after that new role is defined.

Truman agrees with the prevailing view that the governance reform should be the first priority for the fund. Otherwise, he said in an IIE 2006 report,  “the Fund’s effectiveness will be permanently undermined.”