By Kandaswamy Subramanian
There was no high drama or excitement attached to the selection of Christine Lagarde as the successor to Dominique Strauss Kahn who had to demit office after an infamous scandal. Her selection was a conclusion foregone but had been held back farcially. The Executive Board of the International Fund (IMF) met on Tuesday (28th June 2011) and opted for her. As Financial Times reported, “As is traditional, she was appointed by consensus by the fund’s 24-member board.”[i] Rituals die-hard.
Poor Carstens, the Mexican Governor, had to bow out. Indeed, as demanded by protocol, there was high praise for him from the IMF Board and Tim Geithner, US Treasury Secretary, for his qualifications and experience. As an experienced politician, he would have known well before he started the campaign that he stood no chance of winning. He could not even muster the votes of all the Latin American countries and some like Brazil and Argentina were openly against him. The puzzle was why he was in the battle until the last hour? Why did he travel all the way to India and China to canvass his candidature? True to style, he had made very valid and critical comments against the infirmities of IMF functioning and also his rival. These were not heard or, if heard, ignored. Was he a dummy candidate as in local elections in India to lend respectability to the selection process? As a former IMF hand and a buddy of the U.S. Treasury did he help maintain the charade that the selection process for the post was open and transparent? From all reports, it was clear that his candidature was a long shot.
What was dramatic about the whole process was the stance of China. Though there were occasional leaks through the French press about China supporting Lagarde, which were immediately denied. To show loyalty to the group, China had joined the Executive Directors of the BRICS in the IMF in issuing a loud statement on 24th May 2011 attacking the Europeans for their domination of the IMF and seeking openness, transparency and merit in selection. Inscrutably, China had kept the decision close to its chest until the last minute. It was on 27th June, a day before the IMF Board Meeting that Zhou Xiachuaan, the Governor of the PBOC, came out with his support to the candidature of Lagarde. Even then. He remained somewhat vague and ambivalent. However, the message was clear: China was indeed supporting her candidature. That move clinched the issue and all the other pieces fell into place. In its wake, the U.S. Treasury revealed its own hand to support Lagarde. Indeed, the US support was no surprise; the real surprise was that it hedged its bets for such a long time. It is China’s decision that is worthy of study and we will go into it in a later part.
The U.S. was acting like a coy virgin in a Victorian novel who adored the suitor but could not, as yet, give out her hand in public. Hillary Clinton had personally praised her qualities and was ready to accept her as the most suited for the job but added that the Treasury would have to take the final decision. There were rumours that Carstens was an old IMF hand and a Chicago University crony who would find favour with the U.S. Indeed, the odds seemed to work heavily against the weighty (300 pounder!) Mexican. Significantly, even on 27th June when Geithner appeared with Pranab Mukherjee, the Indian Finance Minister, in a press meet after the India Forum meetings, Geithner did not give any hint about the U.S. Treasury’s choice. Nor did Pranab Mukherjee, though India’s decision was of no consequence.
To cut the long story short, “Ms Lagarde, who had been clear favourite for the job, maintained Europe’s dominance at the top of the international financial institution.”[ii] In the final tally, it was observed that Brazil, China and Russia had voted for Lagarde. In short, the BRICS long publicized as a fortress had fallen apart with the desertion of three s major members. That left India and South Africa in a hapless corner.
South Africa had its own ambitions of sponsoring Stanley Manuel as a candidate but did not persist. After initial probing, the candidate himself decided to withdraw for personal reasons, perhaps fear of scandals in his cupboard. India harboured no such ambition from the beginning; unfortunately, the only horse it could have fielded in the race was over aged! These are interesting snippets to the story. But the IMF succession story is more devious and complex than suggested by press reports. We attempt to highlight some parts of it.
There is an assumption among policymakers in the G-20, especially those who belong to the emerging market economies (EMEs) that the G-20 and BRICS within it have emerged as powerful groups, which can play a crucial role in reshaping the global financial architecture, and evolve regulatory measures in a coordinated way. The reasoning that the new groups reflect the shift –the so-called Southern Shift – in global economic power from the West to East further bolsters it. Though somewhat dubious such ideas serve to boost the self-image of some politicians in the EMEs who are eager to play a role in international gatherings. Investment bankers who undertake research on EMEs have their inner agenda and covertly encouraged these visions. It was Goldman Sachs, which promoted the idea of BRICS to serve its own corporate strategies, i.e. to lure funds for investment in emerging markets at a time when the U.S. and European markets were in secular decline.
Sadly, the idea of BRICS as an economic formation or an entity has acted as an anodyne on some leaders in those countries. Their rhetoric levels rose and became more strident. Unfortunately, leaders in those countries did not realize the trap into which they had been drawn. Since then, the financial crisis and successive waves of capital flows in various forms from and to EMEs have altered that picture beyond recognition. Stock markets in EMEs are indeed appendages volatile flows fed by QE1 and QE2 cash bailouts by the Federal Reserve. These have given rise to ‘currency wars’ among those countries. And yet, leaders from the BRICS countries imagine their group to be a sturdy mosaic or an independently acting force. Truth to tell: developed countries comprising the G-7 have not formally recognized BRICS as a group. Indeed, the G-20 itself was their creation. What is the background?.
The G-20 emerged in 1999 in the wake of the financial crisis in Asia. On 25 September 1999, the G7 Finance Ministers and Central Bank Governors announced their decision to “broaden the dialogue on key economic and financial policy issues.”[iii] The G7 countries invited their “counterparts from a number of systemically important countries from regions around the world” for the first G20 meeting held in Berlin a few months later. The Berlin communiqué explained the intention stated by the G7 in its September meeting: “The G20 was established to provide a new mechanism for informal dialogue in the framework of the Bretton Woods system, to broaden the discussions on key economic and financial policy issues among systemically significant economies and promote co-operation to achieve stable and sustainable world economic growth that benefits all.” [iv]
The G20 as established in 1999 was a public relations exercise. The Asian financial crisis of 1997 and the policies adopted by developed countries to combat the crisis through the loan windows of the IMF had bred considerable anger and frustration among developing countries. It became tactically necessary to soften their angst and create a conciliatory mechanism or atmosphere.
Significantly, the G20 meetings of Finance Ministers and Central Bank Governors in the first decade (1999 to 2008) did not attract any public attention. The G20 had become the fifth wheel to the G7 coach. Many researches, even conservative think tanks like the Brookings of Washington D.C. observed that the G20 was more to rubber stamp the decisions already taken by the G7 than to act as an independent institution to involve developing countries in decision making. No wonder it was in limbo for a decade and remained a side show to the Annual the Fund/Bank meetings. Finance Ministers from some countries like India would get back home and, even as they land from aircrafts, address the press about their ‘achievements’ at the those meetings. .
Meanwhile, developing countries, which were frustrated with the structural adjustment policies (SAPs) of the Twin Sisters decided to move away from them. They began to build foreign exchange reserves as a safeguard (or insurance) against future financial crises. Economists from developed countries like Lawrence Summers voiced concern over excessive build up of foreign exchange reserves and wasting them by investing in low yielding assets like the U.S. Treasuries. Furthermore, policymakers in the west began to worry about the rise of a new gorilla called Sovereign Wealth Funds (SWFs). These were investment vehicles set by reserve-rich countries like China to make global investments.
In the early years, there was love-hate relation with the SWFs. The SWFs were frowned upon as political creatures, which would not abide by the market discipline or competition rules. However, policymakers including those from the U.S. Treasury who had foreseen longer-term liquidity crunch staring at the face of their banking system were turning pragmatic in their response. They began to plead that conciliation with the SWFs was better than confrontation. The present writer analysed these policy trends in an article in 2008.[v]
Their reshaped strategy was to tame SWFs. Robert Zoëllick had given them the wise the message: conciliation with the SWFs is better than confrontation, both for the world and the U.S. economy. President George Bush himself made friendly overtures to them signaling change in policy towards SWFs. It was not surprising that around the same time major banks like Citi, etc. that faced capital adequacy issues even to comply with the basic Basel-I or II norms began to engage in secret negotiations with SWFs soliciting equity. Not surprisingly the pink papers described them as great strategic achievements. Strangely, no credit was given to China or to Gulf countries, which were counter parties!
At another plane another drama was unfolding. By 2007 the IMF found itself in budgetary straits. The physician who was prescribing medicine to poor countries could not heal himself. It faced a situation where it could not meet its own administrative expenditures out of its lending operations. The formula on which it was functioning for decades had lost its rationale. The IMF was surviving on interest differentials between its high lending rates and low borrowing rates. There was cushion as along as lending volumes were high and rising. If there were no lending, the IMF would end up in bankruptcy! This was the fate, which befell the IMF around 2007. The present writer analysed the issues in an article around that time.[vi] Several cost cutting options were adopted and, among others, the IMF was forced to sell its gold stocks to meet its administrative costs. These were the years when Augustine Carstens was the Senior Deputy Managing Director! (It was on this experience that some among the Fund staff and the U.S. Treasury lent support for his candidature!) These years also witnessed a growing antipathy or confrontation between the Bretton Woods institutions and many developing countries. Surprisingly, India was not one of them!
By 2008 the high tide of finance capitalism had run aground and created one of the worst and deepest economic recessions recorded in modern times. It was convenient to blame it on the subprime loans though its roots went deeper. It started in the U.S. and spread globally to other countries. Notwithstanding all the cheery statements of capitalist apologists, there is no end to the crisis. What started as a banking cum financial crisis morphed into grave crisis afflicting the real economy. It spread globally to many other countries in varying degrees. At the darkest hour of the crisis, the developed countries represented by G7 roped in the developing countries. They felt the need to give the G20 a new avatar.
Now we have to knit the strings together. It may not be simplistic or even a conspiracy theory to suggest that the G-20 was revived by the western powers, the U.S. in particular, to meet their strategic needs. Truly, it was a diplomatic tour de force. The developing economies, which had no role in creating or contributing to the crisis, were called upon to douse the fires. The G20, which had no relevance or life in the past decade was dug up from the caverns.
Revelations made in Wikileak cables[vii] throw some light on the genesis of the new strategy. By March 2008, Dr. Mervyn King, the Governor of the Bank of England, was so worried about the health of the world’s banks that he plotted a secret bailout of the system using funds from cash rich nations. The cables suggest that Dirking discussed the issues with the U.S. Ambassador Robert Tuttle and the visiting Treasury Deputy Secretary Robert Kimitt and urged that there needed a “coordinated effort to possibly recapitalise the global banking system.” King argued that the G7 was “almost dysfunctional on an economic level” as key economies were not included. He wanted to set up a new, temporary group and suggested that perhaps the central banks and finance ministers of the U.S., UK and Switzerland could coordinate discussions with other countries that have pools of capital, including sovereign wealth about recycling dollars to recapitalise banks. (Emphasis added.) Is it possible to suggest that the newly revived G20 was the offspring of this debate? There are strong grounds to believe so. As it turned out, the newly formed G-20 did provide a bridge in the early days of euphoria.
President George Bush who had already lost the election convened the first summit of the G20 in November 2008 in Washington D.C. Barrack Obama took over the reins in later years after he took over as U.S. President. Many critics contend that the G20, as constituted, was by no means representative or legitimate. It was in part historical baggage and, in greater part, G7 selection. As analysed by Jakob Vestergaard[viii], if countries had been selected in 2008 on the basis of the then prevailing geopolitical world order, there was no doubt that a different set of countries would have been chosen. As he clarified in another Note[ix] along with Prof. Robert Wade of the London School of Economics, the G20 does not meet the widely accepted criteria of “input” legitimacy. It was “constituted as a reflex of G7 power. Its 19 states plus the European Union were selected back in 1999 by the US Treasury and German finance ministry, using no explicit criteria…” Moreover, countries like Argentina, Australia and Saudi Arabia were included more for their being good allies of the U.S.
One of the strategic compulsions stemmed from the so-called lessons of the Great Depression of the pre-war years. It is the accepted wisdom that the Depression was aggravated by panic reactions of nations adopting highly protectionist or “beggar’-thy-neighbour” policies. As the EMEs were relatively less affected by the crisis and some of them were growing at relatively a faster rate, the developed countries were keen to safeguard their access to those markets. Hence one of the earliest calls made to G20 was that they should keep their markets open. Unfortunately, as several studies then established, these homilies did not put a stop to G7 countries adopting protectionist policies; and the U.S. was one of the worst offenders with its emphasis on ‘made in America’ policies.
Another area related to stimulus programs. The financial crisis had questioned the relevance and effectiveness of monetarist policies to revive the economies and there was a sudden, though short-lived, revival of Keynesian policies. Sadly, there was no genuine revival as such, nor any common ground among members on the so-called ‘stimulus’ programs. The IMF churned out theological sounding documents to suit every occasion or meeting both on the need for stimulus and on exits! By and large, the western countries pumped in trillions of dollars of taxpayer’s money to revive banks through provision of liquidity. Only China pursued a development oriented stimulus program to fund massive projects through bank loans. In fact, it was China’s rapid growth under its stimulus program that held the global economy in the dark days of the crisis. In spite of all the grandiose statements made from time to time, the G20 could never reach any agreement or even coordinate the stimulus policies. Each country had to fend for itself and do what it wanted within its own resources and national objectives. The gain to the G7 was that it could keep the poorer members morally in check. On their part, they could eat the cake and have it too.
With the emergence of the global crisis, there was global antipathy to capitalist models and demands for global regulation to ensure economic growth and stability. Many reputed economists including Nobel Laureates like Joseph Stiglitz voiced these. The United Nations took special efforts to convene a global conference to study the roots of the crisis and suggest measures to handle them in the future. The Commission had delved deep into the issues and made radical suggestions for global cooperation and coordination. Unfortunately, the U.S. was apprehensive about these radical efforts and cold-shouldered them. It distanced itself from the deliberations of the U.N. Commission. Rather, the U.S. propped up the G20 as a counter to other Commissions or agencies. In the early years of the crisis it provided a propagandist buffer and helped the U.S. to shield itself against attacks on its market model. The G20 borrowed much of the rhetoric from its former critics.
Yet another area where the U.S. hoped to fall aback on the G20 was in “currency wars.” The U.S. had commenced its currency wars against China way back in 2002. It has continued unabated till date. Though the wars are muted now and the fires have turned into ashes, the war against Yuan was one of the most strategic for the U.S. It remained a bilateral war in the initial years. Several economists like Arvind Siubramanian advocated that other countries like Brazil and India were also adversely affected by it and that the U.S. could battle the issue along with them. It is interesting that before the commencement of every G20 Summit the U.S. would raise the bogey of China’s Yuan rate policy and threaten to raise it. The record on date is that the U.S. could not succeed in its efforts to multilateralise the issue or even raise in any of the G20 meetings. Shockingly, the U.S. had no allies and its own friends who were hurt by the Fed’s QE-2 programs. Brazil has been the most vocal.
It may be hazarded the U.S. and the G7 concealed their strategic agenda and made overtures to befriend developing economies in their efforts to revive G20. There was a sense of high drama and an appeal come together at the hour of global crisis. What attracted the developing countries was that G20 acknowledged ‘a lack of legitimacy and membership of international financial institutions including the IMF.” The London communiqué stated: “We will reform their [international financial institutions} .. governance to reflect changes in the world economy and the new challenges of globalization, and that emerging and developing economies including the poorest, must have greater voice and representation.” These were included in most of the statements issues after the Summits held in 2008 and 2009. Washington summit (2008) was followed by London (April 2009) and Pittsburgh (September 2009). The last was in Korea in October 2010. There is a long list of summit declarations and statements running to several pages, which repeat these themes ad naseum.
In summary, after all the early Summits, the G20 agreed on four measures towards IMF governance reform: shifting of at least 5% of votes from over- to under-represented (emerging market and developing) countries; accelerating the next general quota review; delinking the election of the IMF Managing Director from regional origin; and moving forward the Singapore quota and voice reform. All these were framed in such grandiloquence that it warmed the hearts of the developing country members of the G20. They felt they were nearer the achievements of goals which they have long been fighting and hoping for decades. Heaven seemed so close to them now.
Unfortunately, it was an illusion and the victory was not worth the battle. The G7 remained a solid block and was unyielding. The softer option like shedding 5% of votes and redistributing them to countries like China and India was done hurriedly. In fact these were decisions already taken in 2006 in the IMF Meetings. It was done by taking away a part of the voting share of poor African countries and giving them to China and India. It was no surprising that when Lagarde met the African leaders in Lisbon to canvass her candidature, ten African states agreed to support her. They were showing their anger against G20 from which all African countries other than South Africa have been excluded.
European countries giving away 2 seats from the IMF Executive Board was a deft diplomatic act of the U.S. using its veto powers to appease the developing countries. Further reforms to restructure the Board are not in sight. I have narrated these developments in a paper.[x] Major restructuring of the IMF Executive Board has not been undertaken. It is unlikely to be done in our times.
Though there was a commitment in the G20 that in selecting and appointing the Managing Director of the IMF there would be delinking of regional origin, all of Europe has reneged on the commitment and the U.S. has also gone along with them. This has come about since the G20 has no formal institutional structure and there is no mechanism for enforcing its decisions. It remains an informal gathering, which can be opportunistically used by the G7. The G7 continues to set the tunes.
Though acceleration of quota review has been agreed to it is linked with what are called Singapore issues of quota and voice. The Fund has inherited over the years, especially under the domination of European countries, arcane formulae in determining vote strength of the members. Successive group have failed to come out with realist formulations, which will capture current economic realities. Vested interest resists pressures for reform.
Though Dominique Strauss Kahn touted “as the biggest reform ever in the governance of the institution” after the Summit in Gyeongu, Korea, the changes were incremental. As Alan Beattie put it[xi], the IMF reform change in voting may be more symbol than substance. As he elaborated, “Although the precise details have been deferred for two years, the concessions were enough for the US and the big emerging market countries to claim that a serious effort sat governance had been made.”
The so-called Summit Declarations and statements were put to test when the vacancy occurred with the exit of Dominique Strauss Kahn. The developing countries within the G20, especially the BRICS, could not put forward a common candidate. They continued to make loud declarations on first principles and could not come together with a common candidate.
The Executive Directors of the developing countries, especially BRICS, were unaware that the Strauss Kahn had changed the total emphasis of the Fund to tackle the banking crisis in Europe. There were reports that the IMF had prepared a secret paper about the banking crisis in Europe and the funding of nearly $2 trillion sought for by Kahn was to bailout the banks in Europe, especially the periphery. Lending to developing countries had taken the back seat and Strauss Kahn softened the conditionalities for European lending which the IMF was unwilling to do in its dealing with developing countries. With the emergence of the crisis in Greece and its spread to other countries like Portugal, Ireland and Spain (PIIGS!), there was a paradigm changes in the postures of the IMF. Many analysts were convinced that the IMF required a chief who was politically savvier than in finance or economics. Dominique Kahn was credited with such a role. There are many who question this. But myths die hard, especially when there is a crisis atmosphere. It was no surprise that Lagarde could step into the post without much effort. She could have won the post sitting in Paris or Brussels. There was no need for her to undertake visits to India, China, etc. to canvass her candidature. That he undertook the trips was to create a make believe about the process being open, transparent and on merit. As many papers reported, she had won the race before she commenced her running. In effect, it was also a one horse race. As explained earlier, Carstens had lost even before he commenced his race.
For some analysts, China’s role may be surprising. It is not really so. China had joined the G20 having in view its own strategic objectives. China was hoping to gain much by joining it. However, it was not dreamy eyed and new the limitations. At one level it wished to keep its good relations with developing countries. With all its high growth and its rise in the international market, China considers herself to be developing country. It has always acted with responsibility as a member of an international organization and has stood by its commitments. Many researchers assess that China had hoped to gain from its association with the G20 on its currency policies.
Firstly, it would not allow the U.S. to exploit the Summits of G20 to settle its Yuan rate issues. In fact, it was able to turn the tables against the U.S. Secondly; China has longer-term ambitions of making Yuan a global reserve currency. In the shorter term, it looks to an opportunity to include Yuan in the basket of currencies or special drawing rights (SDRs). China has received the support of developing countries in the G20. The World Bank has also supported the idea.
In one of his early and seminal speeches, Xhou Xiachuaan outlined a plan for internationationlisation of Yuan. It has introduced swaps with several countries and encouraging issue of bonds in Yuan. These are catching up in volume and also diversity. Dim Sum bonds are the flavour of the Hong Kong market. Along side its enlargement of Free Trade Arrangements with other countries including ASEAN China hopes to enlarge its currency role. The support of G20 has been valuable.
More than its Yuan, the major goal concerns the value and safety of its foreign exchange reserves, which currently exceed $3 trillion. It is estimated that 60 to 70 per cent of this is held in dollar assets witch are troublesome. China has been making efforts to diversify them into other assets and investments. Given the size of the reserves, it is not an easy task. However, China has been following a very shrewd policy and has been shifting to euro. At a time when western banks are fleeing from Europe, China has mad bold offers to invest in stocks or offer loan s to countries like Greece, Spain, etc. The recent visit of Premier Wen Jiabao to Europe created waves in euro markets. Chinese authorities have declared at the highest level that they would stand by the euro. China has agreed to support them with its huge reserves. Rather, by doing so, China will serve itself than help the Europeans or the euro. It is in their mutual interest. Not least, it will help China in its long efforts to globalise its currency. If euro falls it has to contend against the dollar and its hands will be tied. There is no need to read tealeaves. China will look forward to a proactive role for the IMF in saving and boosting the euro and, thereby, the European economies.
Now we come to the end of our story. The BRICS lost the crown. They did not have firm guarantees that the G20 would stand by its assurances. BRICS did not have unity to coordinate and promote one candidate. Even if they had chosen a common candidate, they did not have the voting share and strength on their side. Sadly, their ranks were divided. The incremental changes made to the IMF rules were of no help. The Europeans were united and had created an atmosphere of siege and could rush through the track. The American were there to crown them at the final hour.
(The writer is a Former Joint Secretary, Ministry of Finance, Government of India)
[i] Financial Times, June 29, 2011, “Athens tops agenda for Lagarde”, Alan Beattle in Washington.
[iii] G20 Research Group, “The Group of Twenty: A History”, November 2008, p.8, available at Www.g20.utoronto.ca/docs/g20history.pdf
[iv] Ibid. p.63
[v] Subramanian, K, Conciliation better than confrontation, Business Line, April 11, 2008, at http://www.thehindubusinessline.in/2008/04/11/stories/2008041151040800.htm
[vi] Subramanian, K:IMF grappling with fiscal woes, Business Line, March 22, 2008.
[vii] Treanor, Jill, Wikileaks cables: Mervyn King plotted banks bailout by four cash-rich nations, The Guardian, 13 December 2010, at http://www.theguardian.co.uk/business/2010/de/13/wikileaks– mervyn-king-bank-bailour/print
[viii] Jakob Westergarrd, The Future of Global Economic Governance from the G20 to a Global Economic Council, Foreign Policy, at http://www.notre europe.eu/fileadmin/MG/pdf/TGAE 2011_6g_vestergarrd_1_
[ix] Robert Wade and Jakob Vestergarrd, Judging G20 by output ignores input problem, Financial Times, April 5, 2011.
[x] Subramanian, K: Assault on the IMF, South Asia Strategic Analysis Group, Paper No.45122, 28th Marcy 2011.
[xi] Beattie, Alan: IMF reform change in voting may be more symbol than substance, Financial Times, November 10, 2010.