WHEN IMF PROGRAMMES BRING PRIVATE CAPITAL BENEFITS

An International Monetary Fund (IMF) programme seeking to ‘catalyse’ private capital flows to a developing economy will not always succeed. According to new research by Drs Ashoka Mody and Diego Saravia, published in the July 2006 Economic Journal, such a programme will only be effective when foreign exchange reserves and debt levels make the country vulnerable but the reserves and debt have not deteriorated to the point where their early restoration to more normal levels has a low probability.

This conclusion is based on evidence from 3,300 bonds issued by emerging markets between 1990 and 1999, looking at the ‘spreads’ – or risk premia – on these bonds. The empirical analysis makes it possible to distinguish between bonds issued when a country had an IMF programme and when it did not, and also how the effect of the IMF programme was influenced by the state of the country’s reserves and external debt.

Recent theoretical analysis points to a ‘non-linearity’ in the IMF’s effectiveness in catalysing private capital flows:

• Countries that are not vulnerable to external crises have no reason to benefit from IMF programmes.
• Those that are vulnerable – but are not yet perceived as highly illiquid or insolvent – will achieve the greatest catalytic gain from IMF intervention.
• And those countries that have passed into a state of crisis or insolvency will once again derive limited or no benefit from IMF programmes.

Drs Mody and Saravia find strong evidence for this predicted non-linearity. Their contribution is to identify empirically the ‘intermediate’ vulnerability zone and, thus, to provide a more definitive empirical basis for the propositions and conjectures that have been made so far without solid supporting evidence.

The study infers that, in the medium-term, an IMF programme is catalytic when it allows a country to signal commitment credibly to a course of economic reform under IMF monitoring, alleviating the risk of expropriation under incomplete contracts. In mediating as a ‘delegated monitor’ between the country and international investors, an IMF programme can potentially substitute for missing contracts and act as a joint commitment device that improves access to international capital.

Enhancing its members’ access to international capital markets is widely regarded as an important IMF objective. Though the objective is not an explicitly stated purpose in the IMF’s Articles of Agreements, the flow of international capital is essential to such stated purposes as the stability of the international monetary system, efficient trade and productive resource use and the building of confidence when a member country experiences difficulties with its balance of payments.

The IMF’s interest in private international capital flows has, moreover, increased over the last decade. Reflecting this evolution, the IMF’s former Managing Director, Horst Kohler affirmed in 2001: ‘Because private flows are an indispensable source of financing for development, another crucial function of the IMF’s new Capital Markets Department will be to strengthen our ability to help countries gain access to international capital markets.’

Does the IMF succeed in its objective of catalysing capital flows to developing economies? In policy circles, it is often taken as axiomatic that an IMF-supported programme stimulates capital flows.

Graham Bird and Dane Rowlands say it is a ‘commonly held view’ that the IMF helps attract private capital to a country by endorsing the country’s economic reform plan. They cite, for example, a UK Treasury Committee report on the IMF that refers to ‘an all pervasive conventional wisdom’ that an IMF programme buys a ‘Good Housekeeping Seal of Approval’.

But when the question is put to the data, the statistical evidence goes the other way. In a recent literature review, Bird and Rowlands infer that IMF programmes not only fail to enhance countries’ access to capital markets, they may actually make things worse. This study indicates that a programme will only be effective in certain circumstances.

ENDS

Notes for editors: ‘Capitalising Private Capital Flows: Do IMF Programmes Work as Commitment Devices’ by Ashoka Mody and Diego Saravia is published in the July 2006 issue of the Economic Journal.

Ashoka Mody is at the International Monetary Fund. Diego Saravia is at the Pontificia Universidad Católica de Chile.

For further information: contact Ashoka Mody via email: AMody@imf.org; or Romesh Vaitilingam on 0117-983-9770 or 07768-661095 (email: romesh@compuserve.com).