This essay is part of a strategic dialogue on the IMF. The response by Soren Ambrose is here; Ambrose’s essay is here, followed by Edwards’ response.

The onset of the global economic crisis has reinvigorated the International Monetary Fund (IMF). The G-20 London summit drastically increased the Fund’s resources and asserted its importance as a global economic repairman.

The Fund has responded to this vote of confidence by adding new lending facilities to its toolkit. New Fund programs focusing on crisis prevention presage a new collaborative relationship between the Fund and its member countries. Forging this new partnership, however, will require the IMF to heed its own advice.

Flexible and Rapid

In March, the IMF created the Flexible Credit Line, which is a fast-disbursing loan facility with low conditionality aimed at reassuring investors by injecting liquidity. The revolution in the Flexible Credit Line, (FCL) which was intended for middle-income countries, lies in how it is negotiated. Traditionally, IMF loan programs require the imposition of austerity measures such as raising interest rates that can reduce foreign investment. Moreover, traditional loans are disbursed following a quarterly review of the country’s commitment to austerity. Both austerity and the time lag render these programs ill-suited for crisis prevention. Countries in danger of capital outflows need to signal to the rest of the world that they are taking corrective measures. Waiting an additional 90 days for the Fund’s verdict does not boost investor confidence. A loan program, then, that is front-loaded and avoids harsh conditions is a superior tool for reassuring jittery markets.

Conditionality is intended to stabilize a country’s balance of payments. In many cases, increasing foreign reserves can require governments to cut spending or slow the growth of inflation. These are choices that can be politically costly. As a result, cooperation between the IMF and borrower countries can break down because the borrower develops a distaste for corrective policies. In the case of the FCL, countries qualify for it not on the basis of their promises, but on the basis of their past history. Just as individual borrowers with good credit histories are eligible for loans at lower interest rates than their risky counterparts, similarly, countries with sound macroeconomic fundamentals are eligible for drawings under the FCL.

A similar program has been proposed for low income countries. Known as the Rapid Credit Facility, it is also front-loaded (allowing for a single, up-front payout as with the FCL) and is also intended to have low conditionality. Again, this program is aimed at low-income countries with strong fundamentals and short-term balance of payments needs.

From Adversary to Cheerleader

The Fund is positioning itself to be less of an adversary and more of a cheerleader to member countries. For some countries that need loans more for reassurance than reform, these changes to the Fund toolkit are welcome. Instead of providing the same medicine to all countries regardless of their particular problems, these new loan facilities are intended to aid reform-minded governments by provide short-term resources to reassure investors. In this manner, they help politicians in developing countries manage the downside costs of integration. The conventional toolkit of IMF lending for crisis resolution remains accessible for those countries needing reform. To help these new programs reach their full potential, the Fund will need to address two key challenges — both of which are normally part of the IMF’s own advice.

The Fund is often criticized for asking politicians in developing countries to do things that they would rather not do. Elected officials are loath to raise taxes, cut government spending, or raise interest rates — three things that might jeopardize their political survival. Temptations to renege can be difficult to pass up. In this case, the Fund will be tested to hold the line on the Flexible Credit Line and the Rapid Credit Facility and establish stringent eligibility criteria. Programs that are meant to reward governments on the basis of their strong economic performance will soon lose their luster with international investors if every country is eligible for them. These programs should remain earmarked for countries with substantial access to international markets and not become a means for countries to establish these connections. Otherwise, the informational value of the IMF’s endorsement will be meaningless.

Similarly, the Fund encourages countries to be more transparent. This is another area where it can benefit from adopting its own advice. Open and transparent eligibility requirements will benefit the Fund in the long run by posing a barrier to geopolitical influence. The history of the Fund is rife with member countries gaining added benefits because of their special relationships with G-7 governments. Formal eligibility requirements for both these programs will not only allow it to assert autonomy by saying no, but also preserve the “seal of approval” with international markets.

Managing the world economy is not an easy job, and it is difficult to balance the needs of members with a need to solve problems. Nothing above is meant to suggest that conventional IMF lending programs with austerity measures are going to vanish overnight. Creating programs intended for select borrowers means that the Fund is going to be pressed to hold the line on who is eligible and who is not. However, the development of these new programs, by transforming the Fund’s role, might help it better reconcile the tensions of an increasingly integrated world.

, Martin S. Edwards is assistant professor at the John C. Whitehead School of Diplomacy and International Relations at Seton Hall University and a contributor to Foreign Policy In Focus.