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How the IMF Could Become a Real S&P for International Debt
How the IMF Could Become a Real S&P for International Debt
July 26, 1983
Originally published in The Wall Street Journal
Should the U.S, donate an added $8.4 billion- to the International Monetary Fund? IMF opponents, of course, answer "No," They claim that increased- IMF funding only. would bail out-the big banks. Generally, however, IMF supporters favor the increase. They view the IMF' as a vftal. credit-rating agency, a political Standard-" & Poor's that also lends. And, certainly, accurate credit-assessment 1$ necessary if private institutions the developing nations' primary Source of funds-are to continue foreign lending.
But the IMF's proponents fail to consider the S&P example fully. Why do we need an imitation S&P? Why not S&P itself, or some other private-sector concern? A close examination of the S&P model suggests that the IMF functions are better handled privately, and that the IMF's lending role be eliminated-not expanded.
To see this, let us briefly review how the IMF functions. A debtor nation calls upon the IMF when it discovers a foreign-exchange shortage. The IMF then sends a -"mission" to determine what steps the nation should take to regain economic wellbeing, and those steps are defined in a "conditionality" agreement. If the debtor nation accepts these conditions, it gets a direct IMF loan and far more important access to the world's private credit markets. The IMF then monitors the debtor nation's adherence to these agreed-upon conditions. If problems develop-as they have in recent years with distressing frequency-the IMF threatens to suspend loan payments, the private sector follows suit and negotiations begin again.
The main reason that countries accept such restrictions or conditions is their desire for private-sector loans that are predicated on the. IMF's credit approval. The IMF'S direct lendingrole plays at most a minor part, because private sources historically provide almost 80% of the funds made available through IMF operations. Private lenders accept the IMF's ratings largely because they trust its accuracy and honesty.
But this trust is compromised by both the IMF's political nature and its direct lending role. The political problems are obvious. Suppose the U.S. government rated municipal bonds. Democratic administrations would be accused of favoritism by Republican mayors and vice versa. In contrast, while Moody's and S&P receive occasional criticism-no borrower likes his credit rating lowered - their overall reputations remain- intact. The reasons for is are clear. Like any private concern, S&P must sell its product-in this case, its credit assessments - to survive. In contrast, the IMF needn't meet any such market test, and thus is free to play politics. Not surprisingly, the IMF has been accused bf political bias in its decisions on loans to such nations as South Africa and Nicaragua.
The IMF's lending role creates an equally obvious problem. Suppose S&P had to rate New York City's bonds while It simultaneously held them. S&P would have a strong incentive to avoid any downgrading that would reduce the value of its own holdings. Instead, it would be tempted to "work with" city officials to arrive at a "sound economic program for gradual recovery." Naturally, city officials would take advantage of S&P's conflict of interest to argue against any readjustments. They would argue for increased city salaries and continued public spending. S&P thus would be exposed to the type of political blackmail that the IMF undergoes.
The private market outperforms the_ IMF in yet another way. Both Moody's and S&P provide far more credit information than the IMF. S&P. for example, uses a 20-tier rating system (triple-A to single-D) with credit availability and interest rates varying accordingly. In contrast, the IMF uses only two classifications-a nation either is or isn't meeting its agreement. This makes the IMF's enforcement role difficult. Suspending loan payments seems too severe for minor infractions, yet a series of minor infractions becomes significant -over time. The results are bizarre. Unwise policies by U.S. mayors-but not Third World leaders-are immediately reflected In bond ratings and thus higher borrowing costs. Cities are given an immediate chance to rethink their policies, while debtor nations don't receive warning until their economies are in crisis.
The private sector tries to avoid conflicts of interest and diffusion of effort. S&P leaves the business of lending to others, which leaves it free to let the rating chips fall where they may. Also, S&P elects not to play the paternalistic role assumed by the IMF and does not dictate any "recovery" plan. S&P doesn't consider itself competent to run a sovereign government, and is well aware that if mayors want management advice, they can hire professional consultants. The IMF would benefit from a similar concentration of function. And the S&P approach works- Cities are aware of the basis of S&P ratings and determine their policies accordingly. Of course, S&P stands ready to-discuss its decisions and may elect to revise them if the city modifies its policies. But S&P does ta dicker with the city or offer to relax its usual grading terms in hopes of advancing the "bargaining process." Only the city's officials decide whether the policy is worth the higher borrowing costs.
Further, S&P, unlike the IMF, judges results, not merely intent. Thus. S&P avoids the dilemma confronting IMF when it finds that a debtor's economic prospects have been reduced by uncontrollable events or actions not circumscribed by the conditionality agreement. The changed economic prospects suggest further belt-tightening: but as the nation has lived up to its agreement, it wouldn't be "fair" to penalize it. The S&P approach is superior. S&P provides information about the prospects for debt repayment-not moral judgments about the debtor's intent.
Finally, the S&P model has the attraction of being self-financing. The costs of rating and monitoring a bond issue over its lifetime are paid by the concerns or governments issuing the debt.
In brief, the market has much to teach the IMF's supporters. In particular, the market's separation of lending and credit-assessment tasks argues against any expansion of the IMF's lending role: Such an expansion merely would exacerbate an already serious conflict of interest. More generally. S&P and its private-sector competitors demonstrate the superior approach that the IMF should seek to imitate. Congress should avoid any act that moves us further from this ideal.