Is the IMF a necessary evil?

The International Monetary Fund (IMF) has always been a source of controversy. But that is what happens when taking care of the sick and the medicine is more bitter than the pain. The IMF is used to this because it is convinced that when the bitter medicine is taken, the pain will be over, and that is what counts. Yet, it really does not always work out that way, and the IMF is left with the blame, sometimes deservingly so.

Take Jamaica as a very good example. In the 1970s, the Jamaica economy was, as I termed it then, on a “collision course”. This occurred because the government of the day tried to radicalise, or perhaps more so, bastardise, the market economy that had been internationally recognised for its record of economic growth in Jamaica. The PNP government of Michael Manley, which took over from the JLP in 1972, tried to mould the economy into a socialist-type model. The government had such a powerful political working majority that it believed that it could do whatever it wished without reaping public disapproval, even trying to mix water with oil. It did not work and cannot work without being prepared to use a military solution to control rejection by the people.

The path to collision is well known: first, excessive government expenditure which outstrips revenue, resulting in increased state indebtedness; then the Bank of Jamaica printing money, creating hyperinflation and, eventually, high unemployment. The Bank of Jamaica by 1975 ran out of net international reserves. By 1977, the IMF was called in to restore economic stability. It failed to do so because government resisted the harsh policy measures necessary for recovery. The finale came when it was apparent that10,000 public-sector jobs had to be cut to substantially reduce expenditure, making way for growth. For this, the IMF was blamed politically as part of the international imperialist machinery which socialist governments were fighting politically. As a consequence, the IMF was told that government would not continue the programme. This brought the discussions for borrowing arrangements to an end in April 1980.

The JLP became the new government in November 1980, inheriting the old problems. The IMF was asked to return for new discussions because the economic situation had deteriorated considerably since the impasse of the 1970s: the fiscal deficit was now the second worst in the world; much larger cuts in expenditure would now be needed. Instead of the 10,000 public-sector job cuts, 30,000 would have to be severed to balance the Budget, nearly one-third of the central government labour force.

If ever there was a time to reject the IMF, it was then. But it was also obvious to the new JLP government that the economy was on the verge of collapse and there was no alternative. With deep sorrow, the cuts were made over two years, 1984 and 1985, and the recovery began in 1986. There was no political recrimination between the government and the IMF in this painful rebalancing of the fiscal account. The IMF had a job to do. It was in our interest to do it, and we did, with deep regret for the unfortunate individuals whose jobs were severed.

By 1986, the economy was in fiscal balance; the deficit had been wiped out. Under the recovery programme, the Jamaican dollar had become virtually competitive. But the IMF still wanted a small devaluation to cover the remaining 2.5% gap to achieve full competitiveness. As prime minister, I disagreed because of the negative impact it would have on the psyche for the rebuilding of the Jamaican economy. The foreign exchange rate for Jamaica should now be pegged, the IMF was told. The Fund disagreed at first, but some eight months later, by January 1987, the IMF agreed that, after much pressure was brought to bear on them, that the dollar could be pegged at $5.50. The robust economic growth rates and the economic recovery that followed from 1987 to 1990 were tributes largely to that decision.

By 1989, when another general election was held, the Manley-led government was returned to office. Within a matter of months, it allowed the IMF to convince it to remove the exchange-control regulations on the movement of foreign exchange in and out of the country. This left the economy wide open for capital flight, since there were no back-up reserves in the BOJ to compensate for the outflow. That was the most disastrous mistake ever made in the financial history of the country: the exchange rate flew through the roof, inflation through the window and growth was buried under the floor. The economy was in a meltdown, wiping out all that had been done for recovery in the 1980s. Soon after the damage peaked in 1996, government once again discontinued discussions for borrowing arrangements with the IMF.

It was a case of travelling forward, then backward, forward again and backward again until today the IMF is back with us. This time it was called in for a special assignment to dig Jamaica out of the hole into which the country has sunk over the past more than 20 years. This new arrangement with government started during the recent Great Recession of 2008. It is about more than pulling the country out of a hole and stopping it from spinning out of control; it is more about covering the hole so that the country may never fall into it again.

As a consequence, the IMF agreed to provide for Jamaica a very substantial US$2.2 billion through an extended fund facility over the next four years ending 2017. This was to help:

n Close the fiscal gap between expenditure and revenue in order to create a surplus to pay down the national debt and create a surplus which would facilitate growth;

n Reduce the import-payments gap in goods and services to a manageable level, which would sustain net earnings in foreign exchange to help pay down the debt and encourage growth.

The ultimate objective now is to create an economy in which sufficient surplus is earned annually to cover expenses and provide funds for economic growth and jobs. Fortunately, the Fund and the government are, up to now, on the same side.

Whether the struggle to achieve this will be successful depends on the strategy of implementation. Not surprisingly, the lead strategy is the IMF mantra, used regularly, changing the currency value to achieve competitiveness in foreign exchange transactions. The devaluation of the Jamaican dollar being carried out by the BOJ continues to shift the cost of Jamaican exports downward without encouraging more export earnings, while pushing upwards the cost of imports and borrowings, which increase expenditure. This is traditional for devaluation of the currency, and it makes sense for almost all economies where there is an imbalance of foreign-exchange trading in an active export environment and small changes of the rate of exchange can shift trading from loss to recovery.

Unfortunately, Jamaica, while having a substantial imbalance in foreign exchange, cannot make use of this devaluation strategy because its main foreign-exchange earnings are in tourism and mining, and remittances from the Jamaican diaspora overseas. But these sectors are already denominated and operated in external currencies, such as the US dollar, and are valued separately by the markets in which they trade. Hence, hotel rooms are valued, for instance, in US dollars and trade in a market which determines its own market competitiveness. Likewise, alumina is traded according to prices set on the London Metal Exchange. The amount of remittances is determined by the market of the currency of origin of the remittance. Devaluation has limited impact on these major export sectors.

The graphs below illustrate these points. Figure 1 shows imports cost, in large part, increasing with the movement of the exchange rate, and sometimes, with momentum, moving ahead of the rate. Export earnings, on the other hand, were failing to increase significantly. Imports were expected to decline, and exports to increase, according to the devaluation strategy based on the continuous surge of the exchange rate. The graphs indicate that the performance in imports and exports is moving contrary to expectation, non-productively with devaluation.

Figure 1The graph below sets out the data on the movement of these sectors

Debt service, as set out in Figure 2, shows the strong impact of devaluation on costs, literally being pulled up by the surge in the rate of exchange, thereby increasing debt contrary to plan.

Figure 2

There cannot be much doubt that devaluation of the currency has a negative impact on the growth of exports while pushing up the cost of imports and debt. In both cases, there is no appreciable stimulus for earning or saving vital foreign exchange. Indeed, it is the opposite: spend more, save less. Accordingly, the use of devaluation as a strategy to provide vital foreign exchange will not work in these circumstances and the results expected to support the economy will be compromised.

The negative performance of devaluation does not stop here. The extra costs for imports, services and debt are additional charges that must be paid out of the gross production of the country, thereby reducing growth (GDP) of the economy. The long series of blips of economic growth, year after year, tell the story of real growth being used to pay more for goods and debt rather than necessary growth. Accounting for the lack of economic growth must recognise the loss of earnings and savings that are being used to satisfy the higher prices and higher debt, particularly in the absence of any strategy to successfully keep these earnings and savings at home in the GDP to improve the economy. The big question arises as to how much greater growth would have been if devaluations had not been the strategy of choice. A study needs to be done to calculate this massive waste that is destroying gain.

An explanation is due from the IMF as to why it is pressing a strategy that chokes the economy and stifles the poor, by increasing costs and debt, producing mere blips of growth.

Further, it discourages investment because costs continue to increase with devaluation, depriving the country of vital profitable inflows of foreign exchange to close budget gaps and provide surplus funding for growth.

The strategy of devaluation may be good for many countries, but not for economies like Jamaica. It is a failure forced on helpless governments which have no choice but to yield to the distress, accepting it as a necessary evil.

This is not to say the IMF is evil. It is at the epicentre of the financial world and carries awesome authority. If it did not exist we would have had to invent it. The Fund was created at the end of World War II to regulate and monitor the financial systems of member organisations and to extend financial assistance to those countries in justifiable need which would be willing to accept conditionalities for performance. It operates both in the fiscal and monetary areas, principally to ensure that adequate foreign exchange is available to them, subject to appropriate conditionalities required by fiscal and monetary policy.

It is the selection of which policies are appropriate that allows the IMF to treat virtually all countries within the framework of one policy regime, applying devaluation as a mantra.

In the Caribbean, there are a small number of countries that peg the exchange rate to avoid devaluations, notably, Barbados and the six Organisation of Eastern Caribbean States, which, though well behind Jamaica in development 50 years ago, moved to the front when pegging the rate in the mid-1980s and have shown much progress since then. The IMF needs to recognise that one shoe cannot fit all feet and make variations to allow countries with particular export systems to be able to participate with the Fund on a specialised basis.

n Edward Seaga is a former prime minister. He is now chancellor of UTech and a distinguished fellow at the UWI. Email feedback to columns@gleanerjm.com and odf@uwimona.edu.jm