WELLESLEY, Mass., Jan. 21 (AScribe Newswire) -- The Congressional Joint Economic Committee has published a study on the International Monetary Fund's lending rates, "The Subsidy in IMF Lending," which proposes that the Fund charge risk-adjusted interest rates on its loans to member countries. The IMF currently charges a base lending rate tied to the short-term rate paid by the industrial countries and imposes a surcharge on its larger loans. The study's authors intend the Fund to charge higher rates on virtually all its loans. However, the study skirts the issue of why the IMF makes such loans and how raising the cost of borrowing would affect the international financial system.

Under normal circumstances, a country can borrow in the private capital markets to finance a balance of payments deficit while implementing policies to reverse it. However, during a currency crisis private lending dries up and is unavailable at virtually any interest rate. The IMF provides an international public good when it lends to a country in crisis and acts to stabilize the situation. The international community benefits when the country does not default on its obligations, and economic activity is not disrupted.

The East Asian crisis of 1997 demonstrated how such a crisis can spread across an entire region, imposing costs on millions of people and threatening global financial markets. While the conditions attached to the IMF's loans to Thailand, Indonesia and South Korea were subsequently criticized, few questioned the need for an international lender to provide assistance while local governments sought to slow the effects of the massive capital outflows. The IMF's financial assistance provides the necessary breathing space that allows a government to negotiate with its creditors a resolution of its financial commitments.

The authors of this study advance two rationales for raising rates on the IMF's loans. First, they claim that the current system imposes an "opportunity cost" on U.S. taxpayers, which they define as the difference between the amount paid by the IMF to the U.S. as a net lender to the Fund and the rate that the U.S. could charge if it lent directly to a borrowing country. It strains credulity, however, to envision a situation where the U.S. took over the role of the IMF as a crisis lender. International organizations such as the IMF exist precisely to serve these roles on behalf of their member governments. The U.S. and other governments provide financial backing because of the benefits that their taxpayers receive from an orderly resolution of crises.

The second reason given for higher lending rates is their supposed deterrence effect on bad economic policies. However, not all borrowers are guilty of reckless actions. Uruguay, for example, is paying the cost of living in proximity to Argentina. The report does admit that IMF loans come with policy conditions that should be sufficient to prevent unwarranted borrowing. The Argentine situation, moreover, is evidence that the IMF is capable of withholding credit when it does not believe that a government is executing credible policies.

Are there ever any circumstances that justify higher borrowing costs? The report points out that the IMF is currently both an aid agency and a quasi lender of last resort. The IMF in the former role lends to the poorer countries that have little access to financial markets under any circumstances. However, the IMF has become a source of perpetual credit to some of these countries, lending year after year. The IMF's own recently instituted Internal Evaluation Office has addressed this issue in its first report. Among its recommendations is a proposal that the IMF consider a differentiated rate of charge for frequent borrowers to deter long-term dependence on the IMF. However, the IMF's Executive Board has not followed up on this proposal.

Raising the cost of borrowing in crisis conditions, however, may deter a government from approaching the IMF during the first stages of a crisis, when the situation may be relatively easy to work out. It also imposes a financial burden on countries that may already face the costs of resuscitating their financial sectors. The IMF has sought in recent years to emphasize a country's "ownership" of a program to heighten the borrowing government's responsibility for implementing it. Raising interest rates would make borrowing less palatable, delay a government's acceptance of the need to approach the Fund for assistance and only boost the final costs of resolving the crisis.

- Joseph P. Joyce is a professor of economics at Wellesley College.

Web address: www.wellesley.edu

For more information, contact Wellesley College Public Information, 781-283-3321.