New FX system, lending window proposed for IMF

Failure to reform the International Monetary Fund will leave it ill-equipped to handle future financial crises, according to working papers and a report prepared for the World Economic Forum.

Two major reform proposals have been outlined in a broader review of the IMF's role by academics and market participants for the WEF.

**The IMF should adopt a foreign exchange reference rate system to measure countries' progress in redressing macro-economic policies that threaten the global economy

**The IMF should open a liquidity window so that it can act unconditionally as lender of last resort to countries.

The IMF's voting structure also needs overhauling to reduce Europe's weight and give Asia a bigger say, and the quality of the IMF's capital market surveillance needs improving, the papers and interim report said.

The review of the IMF is aimed at informing a panel discussion on global monetary institutions scheduled for Saturday at the WEF's annual meeting of business and political leaders in Davos, Switzerland.

IMF Managing Director Rodrigo Rato, New York Federal Reserve President Timothy Geithner and European Central Bank President Jean-Claude Trichet are due to participate.

John Williamson, a senior fellow at the Institute for International Economics in Washington, said in his working paper that the IMF needs a new role in monitoring exchange rates to improve its ability to act as policeman for the global economy.

The IMF's most important job is to head off economic and financial disasters. Yet the biggest risk to the global economy has gone un-addressed -- the global imbalances caused by the huge US current account deficit, China's managed currency system and Europe's rigid labour and product markets, Williamson said.

The IMF has warned of the dangers to no effect, which shows that new rules and practices are needed to induce countries to adopt policies contributing to a safer global economy, rather than pursuing their national interests, he said.

Williamson proposed that the IMF develops a system of reference exchange rates for currencies, based on purchasing power parity models. Countries should also agree not to intervene to manage their foreign exchange rates.

The reference rates would act as the IMF's measure of how well a country's economic management is contributing to a stable global economy, the paper said. If a country has agreed that a sustainable global economy was in its interest, then it would pursue economic policies that would result in a favourable IMF reference rate, Williamson said in the paper.

The proposal is an attempt to link national interests to global outcomes, he said. Otherwise changes in IMF procedures are unlikely to have much impact on major countries such as the U.S. and China, which are pursuing policies that suit their domestic needs, the results of which could be disastrous.

"If such measures are not implemented, and if the judgement that the present situation (of global imbalances) is unsustainable proves correct, the result is bound to be a crisis," Williamson said.

LENDER OF LAST RESORT

In his paper Angel Ubide from the US hedge fund Tudor Investment Corp proposed that the IMF operate a liquidity window for countries facing short-term liquidity crises.

Like a central bank, the IMF would lend at a pre-set rate to any of its member countries. The credit would cover the rollover costs of a country's debt. If a country needed longer term assistance, it could negotiate an IMF programme with conditions.

Since the emergency lending would be available to any country, there would be no stigma attached to eligibility, a problem that derailed the IMF's contingency line of credit.

Ubide said there is strong proof that countries want such a liquidity insurance facility because they have been adopting "self-insurance" solutions as buffers against crises. While these national and regional solutions have succeeded in warding off smaller crises, they contribute to global imbalances that are likely to result in even bigger crises later, he said.

Asia has accumulated a huge war chest of foreign exchange reserves after the 1997-98 Asia currency crisis, for example, to cushion itself against capital withdrawal. But this has contributed to financing at low rates the US current account deficit, one of the biggest threats to the global economy.

Eastern European countries, meanwhile, have turned to the European Union and its monetary system to gain a financial security umbrella. But this has made the EU and the European Central Bank potentially vulnerable if they are asked to be lenders of last resort, which is an untested insurance system.

An IMF liquidity window, financed by raising the IMF's capital contributions, could address these weaknesses, he said.

"An inclusive and automatic insurance mechanism would bridge the existing gap in the international financial architecture and significantly reduce the potential extent and impact of financial crises," Ubide said in the working paper.