Capital Account Crises and IMF Resource Insufficiency
The IMF was designed by its founders to address misalignments in member countries’ current accounts that tended to develop slowly. It was not designed to manage fast developing capital account crises. In this new era, effective crisis management required swift action from an ILLR. Although speed has never been the IMF’s strong suit, the problem of unresponsiveness that had dogged the IMF in the 1980s faded somewhat the following decade. The Fund’s newfound speed was a result of two key developments. First, the move away from concerted lending in the late-1980s meant that IMF loan approvals were no longer contingent on up-front bank financing. Thus, the Board could approve requests without having to wait on the conclusion of negotiations with banking syndicates. Second, as I will discuss more below, the Fund implemented reforms after the Mexican peso crisis in 1995 that enabled the institution to accelerate loan approval in a matter of days when faced with exceptional circumstances. Yet, even though the Fund proved to be a speedier emergency responder during the 1990s, the problem of resource insufficiency reemerged to challenge the institution’s ILLR credentials.
The number of actors active in global financial markets had grown exponentially from the early 1980s to the mid-1990s. In the midst of a panic, reversing capital outflows became more difficult as the number of creditors grew. No longer could Fund management simply haul a handful of banks to New York, press them to roll over existing debts, and fill in the financing gap as they had during the 1980s debt crisis. To complicate matters, the 1990s also witnessed a rapid increase in the accumulation of short-term debt in emerging market economies. This trend has been linked to the occurrence of more severe financial crises and capital flight. Concerted lending was no longer an effective way to catalyze private capital flows on behalf of borrowers in trouble. Financial crisis management had to adapt to these new realities.
The approach that emerged has been compared to the so-called Powell Doctrine in military affairs: Once policymakers decide to intervene in a financial panic, it must be implemented with overwhelming force in terms of the size and speed of the rescue package. The best way to prevent a disparate, disorganized herd of foreign investors from stampeding out and crashing an economy is to act quickly and shock markets with a massive bailout package. For instance, Manuel Guitian noted that "capital account problems typically require a rapidly agreed and relatively large financial support package.” If creditors do not believe a rescue package is sufficient to backstop the entire market, it will have no impact on their behavior. As Bagehot argued, partial insurance during a panic is essentially no insurance at all. Thus, during the 1990s, the Fund sought to provide much larger loans that sent stronger signals to financial markets in the face of developing capital account crises. This was necessary "in order to generate 'catalytic financing’ from a disaggregated, heterogeneous group of private international lenders.”
The Fund’s new crisis-management strategy was embodied in reforms borne out of the G7 Halifax Summit in mid-June 1995. There, the IMF examined the "adequacy of the Fund’s current mechanisms” and proposed "the establishment within the IMF of a new standing procedure—'Emergency Financing Mechanism’ [EFM]—involving a fund arrangement with strong conditionality but with high up-front access and faster procedures to access Fund resources in crisis situations under the 'exceptional circumstances’ clause.” In effect, the Fund was pledging that, when necessary, it could move itself closer to an ideal-type ILLR that could provide sizable loans much more swiftly than it had in the past.
Despite these reforms, the new model of crisis management posed a challenge for the IMF. In theory, providing much larger credits to borrowers facing capital account crises was the right strategy. However, making good on this promise would prove difficult because of the Fund’s inability to create liquidity like a central bank. As discussed in chapter 2, the institution’s lending capacity was limited in two key ways. Together, these limitations brought the institution’s problem of resource insufficiency to the fore once again. First, vis-a-vis individual borrowers, member quotas effectively cap the amount of resources a government can borrow from the Fund. Specifically, IMF "access limits” constrained member country borrowing. In 1994, annual access limits were set at 68 percent of a member country’s quota, although this was temporarily increased to 100 percent at the end of that year. Cumulative access limits were left at 300 percent. Of course, the IMF did have some flexibility since it could exceed these limits under the "exceptional circumstances” clause as determined by the executive board. However, the board directors could push back on a decision to lend an amount significantly above a borrower’s access limits if they felt a package was too generous. Thus, even under such cases, the proposed size of any given loan may be constrained by the potential threat of opposition by some on the board.
One reason for such opposition relates to the second way in which Fund resources are constrained: the possibility that IMF’s total resources become strained as too many loans significantly exceed member countries’ access limits. Because the Fund’s lendable resources are finite, its ability to fight several significant financial fires at once can quickly run up against its financing capacity. The institution ran into this problem in the late 1990s after it provided large loans to several members during the Asian financial crisis. The IMF’s 1998 annual report noted that because of "very high demand for the use of IMF resources ... its liquidity position weakened considerably” and the board "considered the IMF’s liquidity position vulnerable and expected it to remain under considerable strain in the period immediately ahead.” Ultimately, the IMF raised new funds by increasing quotas. However, as I discussed in chapter 2, such reviews generally take many months to be fully realized—time that often cannot be spared if a crisis is to be adequately addressed.