As most readers of this column know, Montek Singh Ahluwalia, the new deputy chairman of the Planning Commission, resigned as director of the Independent Evaluation Office (IEO) of the International Monetary Fund (IMF) to take the job. | |
| The IEO was set up by the member countries of the IMF following criticism of the IMF's performance in Russia and Asia in the late 1990s. Mr Ahluwalia was the first director appointed by the IMF's board, and has defined the method and functioning of the IEO over the last three years. |
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| The last major product of the IEO under Mr Ahluwalia's stewardship is the "Report on the Evaluation of the Role of the IMF in Argentina, 1991"�2001," dated June 30, 2004, but released at the end of July. |
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| The findings of the report are of interest to an Indian audience for three reasons. First, they illuminate thinking on exchange rate policy over the last decade. Second, they are relevant for the ongoing debate on the reform of the international monetary architecture. |
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| As Stanley Fischer (formerly number two at the IMF, and now a senior official of Citigroup) noted in Delhi in March, it is important that Indian economists involve themselves in this debate. Finally, the report provides insight into Mr Ahluwalia's own thinking, which will surely be influential in shaping the policies of the UPA government. I should perhaps disclose my own interest: I worked on Argentina for the World Bank between 1988 and 1992. |
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| The report concerns itself with the period from 1991"�2001, during which Argentina operated what was called the "convertibility plan". This was essentially a commitment to maintain a fixed exchange rate between the Argentine currency, the peso, and the US dollar. This arrangement, a modified currency board, was given credibility by being enshrined in law, designed to make it difficult to alter the exchange rate by whim or fiat. |
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| The convertibility plan was introduced following a decade of political and economic confusion in Argentina in the 1980s. Following Argentina's defeat in the Falklands war (by Mrs Thatcher), a venal and brutal military government was replaced by the civilian administration of Raúl Alfonsín. The Alfonsín administration struggled with an inheritance of stagflation throughout its term, with IMF support through four separate stand-by arrangements (SBAs). |
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| Performance was poor, particularly with regard to fiscal targets, leading to a breakdown in relations between Argentina and the Fund in 1988, not dissimilar to the situation that exists at present. The withdrawal of Fund support occurred shortly before the Presidential election in 1989, which was won by Carlos Menem, a Peronist, against the background of monthly inflation rates of 200 per cent and a decline in GDP of 7 per cent. |
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| The initial response by the Menem administration focused on tax reform and privatisation, but the twin scourges of inflation and debt proved intractable, leading to a restructuring of the domestic debt in 1990, and the convertibility plan in 1991. |
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| The economy responded extremely well to the combination of privatisation, a fixed exchange rate, and trade and investment liberalisation, with the result that Argentina became the darling of both the investment banks and the IMF itself. |
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| The currency board arrangement was extremely politically popular, and survived the test of the Mexican crisis in late 1994. Three years of strong growth followed during 1996"�98. With the Russian default of August 1998, the Brazilian devaluation of 1999, and the bursting of the US bubble, Argentine growth again turned negative. Once again this downturn coincided with a Presidential election; once again IMF support was mobilised to shore up domestic and international confidence, to little avail. |
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| The political crisis intensified, leading to the resignation of the President at the end of 2001, default on external debt, the abandonment of convertibility, and a sharp devaluation of the peso. GDP declined by almost 11 per cent in 2002, an outcome even worse than in 1989. While the economy has now returned to growth, the default to private markets is unresolved, and the threat to default to the multilateral organisations has also not fully receded. |
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| The main purpose of the IEO study is to glean lessons for the Fund itself. As such, a core concern is to understand whether the Fund staff, management, and Board were sufficiently alert to the risks entailed by the currency board (what it calls surveillance and programme design). A second concern, which I will not dwell on here, is to examine the Fund's effectiveness in crisis management. |
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| The report concedes that the credibility of the fixed exchange rate was decisive in eliminating the hyperinflation at the beginning of the 1990s. However, the lack of monetary flexibility entailed a degree of fiscal restraint during the boom years that was politically unwelcome and therefore ignored. |
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| The institutional arrangements designed to impart credibility to the convertibility plan, together with its initial success, its political popularity, and liberal access to foreign finance, meant that exit from the fixed rate was never really discussed between the Fund and the government. At the same time, the stress on fiscal adjustment (and to a lesser degree, labour market reform) was largely ignored, even as Fund prestige and resources were committed. |
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| Read from an Indian perspective, I draw the following broader lessons from the report: Fashions change in exchange rate advice, and consistency is not a characteristic of either economists or international organisations. |
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| Even as the lessons of Argentina are being drawn, much international professional opinion supports the continuation of a fixed exchange rate for the Chinese renminbi, despite the imbalance this is causing for both China and Asia as a whole. |
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| Many of the leading financial crises in the last decade were associated with a fixed exchange rate, leading one to conclude that floating rates are the way to go. Yet in a column in this newspaper recently, Martin Wolf argued that the costs of floating have been high and that a global market economy requires a global currency. |
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| Sound analysis is clearly essential for the design of policy but it is not sufficient. Argentina's economists fully understood the technicalities of managing a currency board, as much as any analysis prepared by outsiders. This still did not prevent domestic politics from being decisive. |
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| Each country needs to shape its monetary and exchange rate arrangements to reflect its idiosyncrasies. Like Argentina, and unlike many of its neighbours in Asia (other than the Philippines) India is characterised by fiscal imbalances and a high debt stock, neither of which is likely to disappear soon. |
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| While a floating exchange rate can play a useful role as a shock absorber, the combination of fiscal laxity and a floating exchange rate creates a bias towards tight money, which is bad for growth. Slow growth in turn exacerbates fiscal stress. |
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| Much of the growth in Argentine debt was on account of contingent liabilities and off-balance-sheet items, rather than the conventionally measured fiscal deficit. |
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| Murphy's law applies to vulnerability: if anything can go wrong, it will, despite a long period of seeming tranquillity. |
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| The capacity of resources from the International Monetary Fund to prevent capital flight and to induce private capital flows is limited. Consistent policies are the best defence; reserve accumulation an expensive second-best. |
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| (The author is Director-General, National Council of Applied Economic Research. The views expressed here are personal) |
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| sbery@ncaer.org |
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