INT’L FINANCIAL SYSTEM JOINT CLASS FIVE IMF BASICS & LOIs

1. 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

2. 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)

3. 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

4. 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

5. 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)

6. IMF BASICS-WASHINGTON CONSENSUS Washington Consensus (cont’d) Reviewing public expenditure priorities (increasing revenues versus decreasing expenses) a) Military spending sovereign prerogative, off table b) Subsidies strongly disfavored as distorting economy & expensive

7. IMF BASICS-WASHINGTON CONSENSUS Washington Consensus (cont’d) 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

8. 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

9. IMF BASICS-WASHINGTON CONSENSUS Washington Consensus (cont’d) 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

10. IMF BASICS-WASHINGTON CONSENSUS Washington Consensus (cont’d) 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)

11. 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

12. IMF BASICS-WASHINGTON CONSENSUS Washington Consensus (cont’d) 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)

13. IMF BASICS-WASHINGTON CONSENSUS Washington Consensus (cont’d) 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

14. IMF BASICS-WASHINGTON CONSENSUS Washington Consensus (cont’d) Deregulation Idea ultimately is again competition through deregulation for cheaper prices and greater efficiencies

15. IMF BASICS-WASHINGTON CONSENSUS Washington Consensus (cont’d) Property rights Concept of property rights ties into contracting & incentives, to make markets work

16. IMF BASICS

17. 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

18. 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?

19. 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

20. 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

21. 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

22. 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

23. 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

24. 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

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