IMF independence

First published in the UK edition of the Financial Times, 10 March.

What is the most valuable function of the International Monetary Fund? Its lending operations, some would answer. Its technical advice, others would suggest. None at all, its critics would insist. None of these is the right answer, least of all the last. The most important function of the IMF is its ability to signal the soundness of member countries' policies. Alas, high-profile failures have badly degraded that function. It can now be restored only with radical institutional reform.

This was the thesis of a thoughtful speech by Ed Balls, the UK Treasury's chief economic adviser, in Washington last week. In this, he argued that credible and transparent surveillance is even more important in today's world of more global capital markets. Such surveillance would perform three functions: it would lower the likelihood of big crises by precipitating pre-emptive policy change or earlier, and so smaller, crises; it would raise the perceived creditworthiness of well-run economies; and it would help keep the lending operations of the Fund honest.

How then is surveillance to be made more credible? To answer this, one has to recognise the danger of actual or perceived capture that now bedevils it. The Fund is captured when it is compelled to lend by powerful members or by borrowers who threaten default. Credible surveillance constrains capture by making what is happening more obvious. For this very reason, however, surveillance lacks credibility when those with an interest in subverting it are in charge. This is true even if they are completely honest. Perception of manipulation does the damage.

The solution is to recognise the parallel with central bank independence, argues Mr Balls. "The case for making the IMF as independent from political influence in its surveillance of economies as an independent central bank . . . is," he argues, "that credibility comes from demonstrating that surveillance is - as a matter of institutional design and procedural rules - impartial rather than influenced by political considerations."

The aim of independence would not be to fetter the lending discretion of the IMF's board. It would rather be to improve honesty by setting those decisions against an independent assessment of the risks. In practice, that means making the surveillance functions of the Fund independent of the board and managing director. The organisation must be split in two, with one part providing independent information, to allow the board and outsiders to assess the activities of the other.

As Mr Balls notes, the Fund has strongly supported independent central banks. The case for independent surveillance of countries and so, indirectly, of Fund programmes is quite similar, however uncomfortable the consequences. Without it, neither Fund programmes nor its surveillance can perform the signalling function effectively. Surveillance, like Caesar's wife, must be above suspicion. That, in turn, demands an institutional separation from operations. The argument is convincing. Action should follow.