from Follow the Money

The IMF hasn’t lost clout because private capital flows have ballooned.

June 7, 2006

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It has lost clout because emerging economies reserves have ballooned. 

Plus, the countries that count that matter now – whether big deficit countries like the US or big surplus countries like China or Saudi Arabia – are not exactly in the habit of taking policy advice from the IMF. 

Private flows have nothing to do with it, despite the standard conventional wisdom -- convention wisdom that David Piling and Holly Yeager of the FT echo at the end of their article on the need to adjust IMF voting shares to reflect Asia’s rising economic clout (something that I fully support).    Representatives of private financial firms repeat this argument at every international conference – the official sector is small, global finance is now a matter of private capital flows.

The IMF may be sort of small (though its financing can still be big relative to private flows to even a decent sized emerging economy like Turkey).  But private flows are not currently driving the global flow of capital.  Official reserve growth has exceeded the growth in private capital flows to emerging economies.  That means that the direction of the global flow of capital recently has been set by official actors, not by the private markets. 

Private markets – at least before May – were dumping money into emerging economies.  Private markets wanted to finance smallish current account deficits in the the emerging world and the US in 2005.   But central banks in emerging economies decided that they didn’t trust market flows to continue through thick and thin, and instead opted to build up their reserves, lend the funds back to the US and finance an enormous US deficit.

The decision to use private flows to build reserves -- not the resumption of private flows -- is why the IMF has lost a bit of clout in the emerging world.  Sorry about the rant.  This argument is one of my (many) pet peeves.

Nor is the basic premise that large private capital flows reduce demand for the IMF obvious to me.   Large, stable flows would reduce demand for the IMF.  But large and volatile flows increase the demand for reserves.  And that can include the demand for reserves borrowed from the IMF.   Large and volatile capital flows, after all, led to explosion of IMF lending from 1995 to 2002.

And it isn’t obvious to me that large and what now look to be still volatile capital flows won’t continue to lead to demand for IMF lending, at least in those countries that have not just used private capital flows to build up their reserves.

Think of Turkey.

It attracted big private capital flows in 2004 and 2005.   And even in the first quarter of 2006.   In the first four months of 2006, capital flows to Turkey totaled $21.6b – up from $11.8b in the first four months of 2005.    $7.5b of that was used to increase Turkey’s net reserves -- but it didn’t just use those capital flows to finance reserve accumulation.  It also had a big current account deficit.  And even though Turkey has a lot more reserves than it did in 2000 and foreign investors have taken on a lot more lira risk, it still isn’t in a position where it can easily walk away from the IMF.   Particularly if Erdogan wants to court his Islamist base in advance of the election …

p.s. the January-April data implies that net capital inflows were running at a roughly $65b annual pace in the first four months -- a very impressive sum.  Well aver 10% of Turkey's GDP, probably more like 15%.   Two times the amount needed to finance a $30b current account deficit.  Net inflows probably stopped in May.  Or inflows turned to outflows.  Talk about a sudden stop.  

Fortunately, there are real differences between Turkey today and Turkey in 2000/01 -- when the last "sudden stop" came along.    

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