IMF AND THE WORLD BANK: TIME FOR REFORM?

Oleh : J. Soedradjad Djiwandono
Gurubesar tetap Ilmu Ekonomi, Universitas Indonesia


Pointers of a presentation in a panel ‘IMF and the World Bank: Time for Reform? On the occasion of the 15th annual international symposium, “Global Crime, Corruption and Accountability”, organized by Education for Public Inquiry and International Citizenship (EPIIC), February 7- March 8, 1999, Tuft University, Medford, MA.

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INTRODUCTION

  • The topic of our discussion is on whether it is the right time to reform IMF and the WB in light of the still going on Asian crisis and the role that these two institutions may have played, either in causing the crisis or resolving it. Since corruption and its implications seem to be part of the common elements in the crisis countries, issues related to the two institutions’ role in either the origin or the cure of corruption should be addressed.
  • I will address the topic by making a general comment about the role of the World Bank and the IMF in the Indonesian economy in dealing with the pressing problem, how to address problems related to the crisis. By looking at how the two institutions get involved in the process, both prior to and in the crisis, we should be able to make some conjecture on whether they pass the test of accountability. This would lead us to the direction of the reform that is needed.

PROPER ROLE OF IMF AND THE WB

  • What is the proper role of the WB and IMF in the world economy? At times there is confusion about the role that the WB or the IMF plays in member countries’ program. Beside, to make assessment about their accountability, it is important to be clear about their respective role. As late as last month, President Wolfensohn was still making some point to clarify about the role of the WB and IMF. He said, “So we have move to a situation where we now have a position where we believe we are getting close to clarity, that the Fund’s responsibility is macroeconomic and surveillance, and ours (WB) is social, structural and human.” (Remarks of the World Bank President at the Reinventing Government Conference, Washington DC, January 19, 1999)
  • When we look at what the respective institution did during the Asian crisis, we may understand why there seems to be some tension between the two sister institutions. What Dr. Stitglitz said in different occasions and what was written in the recent World Economic Prospect that implies to say that IMF has been mishandling the Asian crisis, showed that there is different perception about the respective role of the two institutions, or about how to play their role in supporting member countries.
  • I could cite the Indonesian case as a possible source of the disagreement. The Indonesian IMF supported program, which was launched in November 1997, basically was a comprehensive program of economic reform and financial sector restructurization, supported with standard macroeconomic policy of prudent monetary and fiscal policy. Questions were raised, like was it the Fund jurisdiction to deal with real sector economic reform, like abolishing crony capitalism? Was it the jurisdiction of the Fund to deal with microeconomic problems, like banking sector restructuring? Do they have the expertise in dealing with these issues? Well, the reality was that there was supposed to be a division of role to play between the WB and IMF as well as AsDB. However, since the program is an IMF supported program with an IMF stand by loan, the IMF was in the forefront (in the negotiation with the Government of Indonesia), while the other institutions were in the background. The problem might either come from the misinterpretation of the respective role or just a simple institutional bickering about which should be in charge of what, or a coordination problem. The latter, of course, has been historical.
  • Analyzing how Asian crisis was unfolding would lead us to finding some answers to what we are questioning to day, whether it is time for reform of IMF and the WB. From the many IMF critics on the handling of the crisis, as well as from internal evaluation made by the respective institution, we could clearly read the burning issue, namely, not whether to reform the two institutions, but when and how to do it.
  • IMF produced a report ‘IMF-Supported Programs in Indonesia, Korea, and Thailand: A Preliminary Assessment’ which reviewed the program implementation in the three most affected crisis countries. While the WB produced a critical evaluation on its involvement in Indonesia in a document entitled ‘Indonesia- Country Assistance Note’. The IMF report is specifically on the IMF-supported programs, so it makes evaluation on the implementation of the programs coping with the crisis. It is basically defending the steps that IMF took in response to the respective government proposals to ask for stand by arrangements. It defends the policy for high interest rates for stabilizing exchange rates, citing the experiences of Korea and Thailand. In short the report shows as Jack Boorman, Director of the Policy Development and Review Department of the IMF said ‘Let me say that the paper says, in essence, that the policies the Fund recommended and which to varying degree the three countries-Indonesia, Korea, and Thailand-followed were broadly appropriate to the circumstances given what was known as these programs unfolded’
  • The WB paper, Indonesia-Country Assistance Note is a critical report on WB involvement in Indonesia, not specifically during the crisis, but its involvement prior to the crisis. It said, for instance, that ‘the Bank (WB) should have been better prepared for the crisis, but it could not have prevented it’ And in the conclusion section it said ‘On balance over the past decade, the outcome of the Bank’s (WB) strategy, the Bank’s performance as well as the Government’s (GOI) performance is rated marginally satisfactory’
  • Aside from those internal evaluations, there are a host of criticisms, in particular, on IMF handling of the crisis. It is now very familiar to us; criticisms targeted at the IMF in this matter as voiced by Jeff Sachs, Martin Fieldstein, Paul Krugman, Joe Stitglitz, and many others. Proposals on the new international financial architecture, the international lender of last resort, and the many statements from the WB President, the IMF Managing Director and his Deputies on what to learn from the crisis are also leading toward reforming the World Bank and the IMF.

NOTES ON CORRUPTION AND ACCOUNTABILITY

  • The Asian crisis, which after some times hit Russia and then, Brazil, basically became a global crisis. These crises finally become a wake-up call for the world to seriously get their acts together. This, at least partly, means that some reform is called for in the institutions dealing with the crises. I guess generally people would agree with some of the proposals in this matter, as that had been argued by Stanley Fischer, the second in command in the IMF, that changes would require action by three key sets of players in the international system: first, governments and the private sector in emerging market countries; second, governments and private sector in the leading industrialized countries where the capital flows originate; and third, international institutions. Thus, reform of the World Bank and the IMF is, for sure, in order. We have seen many proposals floating around showing the need to reform different aspects of these institutions. But, the reforms in the two institutions should be a part of a wider reform by other players in the global system.
  • The need to reform the two institutions is not just in its relation to crisis management. But, it is related to the more basic ingredients of a new era of development in a global economy that requires good governance of all the sets of players in the international system. Good governance implies open, transparent and accountable public institutions, private sectors as well as international institutions. This is where I would like to enter my discussion on this topic in relation to the main theme of the symposium, in particular on corruption and accountability.
  • Referring back to the evaluation reports on the performance of the two institutions, the IMF paper did not make any attempt to look at the issue. The only thing that was mentioned was the Summing up by the MD in the Board Meeting which said ‘Directors also stressed the importance if reforms in the governance, together with the host of issues touching on the establishment of appropriate incentives for private market behavior and the need to ensure that the costs of failure are borne by private investors……They thus saw improvements in governance as fundamental to fostering reforms in other areas, including financial and corporate restructuring, competition policy, trade liberalization, and privatization’
  • In contrast, the World Bank paper, since attempting to make evaluation of WB involvement in Indonesia prior to the crisis, very specifically mentioned about its concern on widely practiced of corruption in WB projects. The WB had sent two missions visited Indonesia to review the macroeconomic and governance implications of corruption, allegations about corruption in WB operations, the financial management system, etc. The WB used the findings to outline a new long-term strategy in its operation.
  • Rather than discussing these reports, I will address today’s topic by sharing with you some of my experience in dealing with the Indonesian crisis which has some bearing on problems of corruption and accountability. I would pose to you how an unhealthy surrounding become a major constraint for policy implementation. Corruption practices in a crony capitalistic economy cause professionals to become ineffective. What could international institutions like IMF and the WB do to help?

MANAGING CRISIS IN A MUDDY ENVIRONMENT

  1. Indonesian crisis is the worst in Asia because it is resulting from the work of external shock arising from a contagious process of a financial panic which hit an economy embedded with several structural weaknesses. The weaknesses engulf the economic structure, the real sectors and the financial sectors, the social as well as political structures. Weak governance is prevalent in both public as well as private sectors. Transparency has not been part of the government and private characteristics. Legal tradition is weak. As corruption is both economic, social as well as political phenomena, it is easy to conjecture that it must had been widely practiced in such a muddy environment pertaining in Indonesia, when the economy was experiencing high growth for a long period.
  2. One could trace corruption in different stages of budgetary process, from the initial preparation of a proposal for a project to the actual disbursement of the fund, to find where have irregularities been occurring. One could do a similar process to bank loan, awarding contract, tender, procurement, licensing, and other activities to find out about leakage. It is hard to prove but easy to conjecture. Irregularities will later on be shown in the unusually high unit prices of these projects, in electricity or energy, telephone lines, toll roads, etc.. People used to interpret the much higher ICOR figures for Indonesia in comparison to the neighboring countries as indicator for leakage, which was arising from practices of corruption, aside from inefficiencies. It is curious though, that even though in some publication, like corruption watch, Indonesia is usually placed close to the bottom, meaning one of the most corrupt economies, studies on corruption in Indonesia have not been much.
  3. Suharto governments have been accused of ruining the Indonesian economy using his style of governing, in his more than thirty years of rule, which was full with practices of corruption, collusion and nepotism. President Habibie who got his power from Suharto when he left the government in May of last year has been promising to reform the government, and to get rid of the negative practices of the past administration. Some progress has been made. However, efforts by the present government to clean up practices of corruption, collusion and nepotism as demanded by the people, have not been promising. It has even been widely rumored through the media that corruption practices are still rampant. Even in the implementation of social safety net projects, corruption practices are reported in many cases. I am afraid, like many cases in the past, the issue of corruption, collusion and nepotism is in danger of becoming a mere slogan without meaningful operational significant. It is widely publicized for a short period, but then it is fading over time. We still have to wait until after the general election in June and the presidential election in November, to see whether a decent government that seriously committed and have the integrity to implement a program to form a clean administration could really come out in Indonesia.
  4. Let me go back to our main topic by giving you some illustrations to show how implementation of government policy could become ineffective, due to the weak governance in public as well private sector as experienced by Indonesia:

    • The failure of bank closure as a part of banking restructuring. As an n important part of banking sector restructuring, Indonesia revoked licenses of 16 insolvent banks in November 1997. Closing insolvent banks is a must for a credible restructuring financial sector policy. It was aimed at bringing back public confidence to the banking system so that the banking sector could resume its task for financial inter mediation and facilitating the payment system to service transaction in the national economy. But, the Indonesian experience in November 1997 showed that the decision resulting in a total loss of confidence in the banking system instead. The banking sectors lost the public trusts in its role as financial inter mediator (the flight to safety by depositors), as well as a means in payment system (the increase in the use of cash). The confidence was even lost in inter bank market (the compartmentalization of inter bank market). How did that happen? What had gone wrong? What we could say is, that lack of transparency, weak governance in banking supervision as well as in banking practices breed fragile financial structure.
    • As a follow up step for banking restructuring, the current banking recapitalization program also suffers from similar problems. With full government guarantee of both banks’ assets and liabilities, there is no problem with bank runs. However, with confusing explanation on the postponement of bank closure, the problem of confidence seems more in the government itself. Suspicion arises on the possibility of some behind the scene deals between bank owners and the government.
    • On the central bank policy as lender of the last resort. Bank Indonesia provides some facilities to assist banks in facing mismatch in liquidity problems. During a crisis in a system that suffers from weak governance in both public as well as private sector and lack of transparency, it is very difficult for the central bank to play effectively its role as lender of the last resort. The dynamic of the crisis is such that a bank can move its status from having a liquidity problem to solvency problem within a very short period. The truth, with weak governance in banking sector, could only be revealed with a due diligence, ex post. This, together with a weak compliance on prudential measures result in a very ineffective central bank policy implementation of safe guarding the banking system
    • Lack of transparency of the central bank operation, weak governance with weak compliance on prudential measures as well as weak adherence to good business practice in the private sector, in addition to pure criminal acts, are constraining the effectiveness of any program aimed at addressing banking problems. In addition, lack of understanding about banking operation as well as too much leaning toward resorting to social and political considerations in addressing banking problems would certainly further constraining the effectiveness of program to make Indonesian banking system robust and sustainable.

  5. Implementation of exchange rate policy, strengthening the currency by resorting to high rates of interest is a dilemma that very often Bank Indonesia has to face. This is putting aside some conflicting advises that BI used to receive from the WB which gives advise to depreciate the rupiah for export purpose, and the IMF which advises the reverse to fight inflation. In the implementation of monetary policy and its role as lender of the last resort, the central bank, which is also functioning as bank supervisor, is facing another dilemma, especially in time of distress in the banking sector. In the example above, aside from the trade off between the monetary and real sector objectives, there is another trade off here, namely that the policy for high rates of interest is constraining the policy to nurse weak banks which is the responsibility of bank supervision authority. The moral of the story, as a good economist would say, is that we cannot have too many objectives, there should be a one to one correspondence between the objectives and the policy instruments. But, this doesn’t help the central bank problem.
  6. The issue here is what could IMF and the WB do to assist these efforts to make effective banking policies or effective economic policies in general? The issue is how to make these two institutions effective in providing assistance to Indonesia for effectively addressing the problems that Indonesia are facing presently and in the future. This is what reform of the WB and IMF operation in their dealing with member countries should be aimed at.

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