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The IMF, Ukraine, and the Asian Financial Crisis Hangover

Could the Ukraine crisis help the IMF dispel lingering perceptions of credibility issues?

The IMF, Ukraine, and the Asian Financial Crisis Hangover

After failing to rally congressional support behind much-needed IMF reforms in January, the White House is now using the crisis in Ukraine to spur reluctant Republican lawmakers into passing legislation that would equip the Fund with more resources and a more balanced governance system. Taking to heart the old adage that every crisis is an opportunity, the U.S. Treasury Department attempted to include measures increasing the IMF quota in a bill pledging $1 billion in emergency loan guarantees to the nascent government in Kiev. While it was ultimately dropped from the final bill, Treasury officials supported the initial inclusion of wider Fund reform measures in the assistance package by emphasizing how the “IMF is critical for [U.S.] national security interests.” This consideration will no doubt continue to play a role in legislative actions regarding the international financial institution in the upcoming months.

This was a laudable effort from the Obama administration, which had been criticized earlier in the year for not wholeheartedly backing a budget that would have led to changes in the Fund. At the same time, establishing an explicit connection between U.S. foreign policy interests and the operations of the Fund was a very risky move that wagered the possibility of further damaging the international community’s trust in the IMF. At its core, Washington’s struggle over how to best salvage Kiev’s finances goes far beyond the crisis in Ukraine and touches on issues that have needed to be addressed since the Asian Financial Crisis – and which may determine the future of the global financial order.

Damaged Credit, the 21st Century Story

The eagerness of the United States to bolster Ukraine’s fragile financial position with both direct assistance and support within the IMF has already been met with some caution from other countries. Paulo Nogueira Batista, a IMF executive director representing Brazil, noted that “the institution will suffer a loss of credibility if it were to bend, or worse, break, its rules to meet the urgencies of a member country or the foreign policy agenda of some of its main shareholders.”

As the chief shareholder in the IMF, the United States has frequently been accused of advancing its own foreign policy interests, or those of Western nations, through the Fund. In particular, the botched assistance program coordinated by the IMF during the Asian Financial Crisis of 1997-98 resulted in Western investors being bailed out at the expense of East Asian taxpayers, leading to persistent claims that the Fund deliberately salvaged American and European interests while the capital markets of the economies in distress were left in shambles. Many South Koreans still refer to the 1997-98 financial crisis as the “IMF Affair,” revealing how the consequences of the Fund’s policies are at the forefront of the public’s collective memory, more so than the immediate causes of the crisis like the collapse of the Thai baht and imbalances in South Korea’s banking sector.

Further exacerbating the international community’s wariness towards the Fund, recent studies have highlighted a correlation between countries receiving U.S. aid and their ability to draw assistance from the IMF. Such studies and the legacy of mistrust that emerged from the Asian Financial Crisis mar both the Fund’s credibility and its operational capacity in Ukraine as Moscow-oriented media outlets accuse the IMF of forwarding the West’s foreign policy agenda in the former Soviet space.

Of course, as an international financial institution, the consequences of the Fund’s lost credibility do not stop with the specter of Ukraine’s default. First, the perception that the IMF provides preferential treatment to governments with foreign policies closely aligned with those of the United States weakens the incentive for those governments to take the IMF-recommended reforms seriously. Since scaling back the application of punitive conditions in the late 1990s, the IMF has relied more heavily on governments receiving financial assistance to take ownership of the reforms and make the necessary changes in their fiscal policy to ensure long-term solvency. However, implicit signals from Washington to governments with high geostrategic importance that financial assistance will continue regardless of their commitment to the prescribed reforms undermines this delicate process.

Second, the belief that the IMF’s policies are biased towards Western interests encourages governments to engage in unilateral actions that limit intermediation by international financial institutions. While this has led to the establishment of new stabilizing arrangements like the Chiang Mai Initiative, it has also induced policies that destabilize the global financial order. In East Asia, central banks have sought to ensure their respective financial security since the crisis in 1997 by amassing enormous dollar reserves. The increased demand for dollars then allowed the U.S. Treasury to issue securities in quantities that bordered on irresponsible. This in turn created externalities that exacerbated the fragility of the global capital market. It is this mutually damaging relationship that inspired accusations from China’s state-owned newspaper Xinhua in October 2013 that the impasse in U.S. Congress was stoking international financial insecurity.

Given the serious consequences of the IMF losing its credibility as an institution that operates independently from U.S. foreign policy aims, restoring confidence in the Fund and its multilateral process of crisis resolution is clearly vital to global financial stability.

Putting on the Velvet Gloves

Then why did the U.S. Treasury Department explicitly mention the Fund as being vital to U.S. national security when that association would hinder the IMF’s ability to restore its credibility? In part because government trust in the IMF will only extend to the extent that the institution is actually able to deliver effective financial assistance. While weakening the IMF’s credibility, the Asian Financial Crisis also revealed to Washington that the Fund was not equipped to deal with a modern financial crisis. Established alongside the Bretton Woods system to provide liquidity for small balance of payments deficits, the IMF proved ill-equipped to stem the massive capital outflows leaving East Asia in 1997.

In an attempt to rectify this serious impairment, a solution was proposed in 2010 to double the Fund’s quota to $720 billion. In addition to bolstering much-needed equity capital, the tabled reforms also gave developing economies a greater share of the quota and moved two of the twenty-four directorships from Europe to emerging market economies, increasing their voice in the Fund and bolstering perceptions of the institution’s fairness. While not resolving all the imbalances and inadequacies of the IMF, these reform measures were definitely steps in the right direction.

However, Republicans in the U.S. Congress, under the guise of their consistent yet convenient budget concerns, refused to fund measures for the IMF’s governance reforms in January of 2014. Now, as is often the case, the Obama administration is trapped between two unpalatable choices: uphold the IMF as an independent institution but one incapable of responding to major financial crises; or use Ukraine’s geopolitical importance to galvanize domestic support for vital changes in the IMF at the risk of further alienating certain governments from the international financial institution. The White House and the U.S. Treasury have chosen the latter route.

Because there is immense political will in both the European Union and the United States to see the new Ukrainian regime survive this financial crisis, adequate resources will no doubt be forwarded to Kiev regardless of Washington’s final decision on the IMF reforms. In addition, while the $15 billion requested by Ukraine is a significant sum, the government reportedly still retains enough reserves to cover its obligations for the next two months and the IMF’s fact-finding mission has so far been impressed with the new government’s commitment to reform, paving the way for IMF assistance.

But the issue is no longer the financial survival of Ukraine alone. The tapering of the U.S. Federal Reserve’s bond purchasing program and the political instability stretching from Thailand to Turkey have sent emerging markets into a financial tailspin. It is imperative that an able institution oversee the ongoing volatility and respond to potential crises. The Obama administration has decided that the consequences of associating the Fund’s reforms to larger U.S. foreign policy interests is an acceptable risk to take for the long-term stability of the world’s capital markets. This approach has not yet yielded the desired political outcome, but Washington will no doubt continue to wrestle with the issue, leveraging the country’s foreign policy interests as long as Kiev remains an important geopolitical concern. If Washington manages to handle this issue with enough caution and succeeds in passing the reform measures, the IMF might yet remain a cornerstone of the global financial order and finally begin to rectify some of the shortcomings that were revealed by the Asian Financial Crisis.

Yong Kwon writes on Asia-Pacific history, economics, and geopolitics. He is the chief editor of the DPRK Food Policy Blog, focusing his research on the nexus between North Korean monetary policy, industry and agriculture. Follow Yong on Twitter @ykwon88.