Beefing up IMF: Beware of the flight of capital

The US is arguing for a coordinated global stimulus. It also wants to beef up the International Monetary Fund. Washington wants to add a whopping $500bn to the IMF’s capital, twice what the fund itself has asked for. The idea makes sense.

True, ambitious stimulus packages in advanced economies could help the rest of the world. Emerging and developing markets have been hit hard by the drop in commodity prices. Lower remittances, which make up to 40% of some nations’ GDP, have put a dent in many emerging market economies. A giant stimulus is supposed to revive a market for their goods and jobs.

But those positives would be outweighed by effect of government borrowing on international capital flows. The risk-free paper is likely to suck up a high proportion of the funds of rich-countries investors. So a glut of public spending in Japan and the US will mean less funding for nearly broke countries such as Hungary. As economists say, the poor will be crowded out by the rich.

Developing nations are already suffering from a sharp slowdown of capital flows. Net private capital flows to emerging markets is expected to decline in 2009 to less than a quarter of their 2007 value. The World Bank estimates emerging markets will face a financing $270-$700bn funding gap. The greater the stimulus, the higher the funding gap is likely to be.

A beefed up IMF would be able to plug the hole. That would take significant pressure off poor countries which cannot afford borrow to undertake their own countercyclical spending.

But a stronger IMF would help the rich as well. Western banks are on the line for most of the $1.3 trillion in emerging market debt maturing in 2009. If capital continues to fly away from these counties, the banks, and their home-country taxpayers, would have yet another gigantic problem to deal with.

If the US gets its way, the IMF would have enough resources to plug the capital gap caused by fiscal fervour in developed countries. Whether or not this borrowing is considered reckless, the whole world needs a strong IMF safety net. It should be part of any G20 effort.