HOW LAGARDE CAN RESCUE THE IMF / THE FINANCIAL TIMES COMMENTARY & ANALYSIS ( VERY HIGHLY RECOMMENDED READING )

How Lagarde can rescue the IMF

Mohamed El-Erian

June 28, 2011

I remember sitting in a meeting at the International Monetary Fund back in the 1980s, debating the meaning of a small annotation in the margin of a memorandum that had just returned from the office of the managing director. It was just a squiggle; yet we debated possible interpretations for a full half an hour!


This is a small example of what is well known to IMF insiders – the post of managing director is not to be taken lightly in an institution that operates like a well-disciplined army, with staff looking up to the unquestioned general for decisive leadership.


This is why the resignation of Dominique Strauss-Kahn has been so disruptive to the functioning of the IMF. It is also why Christine Lagarde – who following Tuesday’s public backing from Tim Geithner, US treasury secretary, will assume the post shortly barring any legal complications – must move on five key issues in her first few months at the helm.


First, she must restore proper separation between the post and the political ambitions of the holder. This separation has been eroded in recent years by Europe’s decision to appoint politicians (Mr Strauss-Kahn and Rodrigo de Rato before him) and, was essentially eliminated by the widely-held view that Mr Strauss-Kahn was using his position as a springboard to the presidency of France.

To this end, Ms Lagarde must realise that Europe’s perceived entitlement to the top post has left a bitter taste in the mouths of the institution’s membership and anyone who believes in the importance of a legitimate IMF at the center of the global monetary system. The manner in which the entitlement was imposed once again with her appointment has alienated some steadfast supporters of the institution.

With this in mind, she should waste no time in establishing a legitimate selection process for the next managing director that is truly based on merit, not nationality. Rather than repeat the empty European promises that were also made after the appointment of her last three predecessors, Ms Lagarde should improve the institution’s governance by hardwiring a process that emphasises qualifications, meaningful due diligence and true openness to candidates irrespective of nationality.


Second, Ms Lagarde should reinforce her commitment to a meritocracy by eliminating other nationality-based appointments. She should start with the replacement for John Lipsky, the Fund’s first deputy managing director, and an American, who announced his intention to step down just a few days before Mr Strauss-Kahn was arrested. She should let this choice be based on merit, rather than another nationality-based directive – this time from the US Treasury Department.


Third, Ms Lagarde must strengthen the analytical robustness of the IMF’s response to debt crises. This should start with addressing the legitimate criticism that the institution’s role in the peripheral European bailouts was excessively influenced by political considerations, thus undermining its reputation of rigor and evenhandedness. In doing so, she would also enhance its ability to help address other systemic challenges, such as persistent global payments imbalances and deep-rooted structural rigidities that stifle employment creation.

Fourth, Ms Lagarde must prepare the Fund’s balance sheet for the risk of some future financial impairment on account of the massive loans made in the past year, particularly to Greece. The sooner she does this, the less likely that the IMF will fall victim to behavior patterns the ECB seems to be stuck in – that of denying a solvency problem in a member country because too much of the sovereign debt now resides on the bank’s balance sheet. This trap converts institutions from being part of the solution to being part of the problem.


Finally, Ms Lagarde must help restore the public standing of the IMF’s staff. The stunning arrest of Mr Strauss-Kahn has fueled a series of attacks that are inconsistent with the dedication shown by the institution’s talented staff.


In just a few weeks, previously inconceivable circumstances have catapulted Ms Lagarde into the role of presumed leader of the world’s most influential and fastest-responding multilateral institution. With Europe again imposing its will on the rest of the IMF membership, she will need to hit the ground running if her tenure is to be an inspiring story of institutional transformation, rather than one of maintaining a myopic approach to a critical international post.
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The writer is the chief executive and co-CIO of Pimco, the world’s largest bond investor.


Response by Eswar Shanker Prasad

The old order has triumphed yet again

Christine Lagarde owes Agustin Carstens a debt for having made this an ostensible contest rather than a choice by acclamation. This may actually strengthen her legitimacy if she can turn the narrative around to having won the top job at the IMF in a fair and open contest. Still, for emerging markets, the selection process that culminates in Lagarde’s victory leaves a bad aftertaste.


Although emerging markets lost this round, Ms Lagarde’s victory may well turn out to be a good outcome for them in the long run. She brings to the position an excellent set of strategic and political skills that could make her an effective advocate for emerging markets at the IMF. Ms Lagarde can twist the arms of European countries that have blocked progress on governance issues by arguing that such reforms would be for the greater good of the IMF.


As a well-respected insider in European economic and political circles, Ms Lagarde has the clout and credibility to corral Europe into supporting further reforms at the IMF. Indeed, Mr Carstens may have been less likely to deliver on governance reforms (such as voting rights and representation on the executive board), despite his heart being in the right place, as he would have found it more difficult to overcome European resistance.


The immediate priority for Ms Lagarde, as Mohamed El-Erian notes, is to reset the IMF’s engagement with the debt crisis in Greece in a manner that avoids a blow-up but doesn’t smack of favoritism. Having been embroiled in dealing with the European debt crisis already, it remains an open question whether she can shed that baggage when she comes into the IMF job and can take a fresh and more objective perspective.


Ms Lagarde’s longer-term challenge is to rebuild the emerging markets’ trust in the IMF and make them feel they have a strong stake in the institution. Two factors have heightened the emerging markets’ perception that the IMF subjects them to a different set of rules than it does the advanced economies. One is the selection process for the next managing director. The second is the treatment of European countries in crisis, with the sense among emerging markets that they would not have been given as much rope as Greece seems to be getting if they did not meet policy commitments and targets.


Ms Lagarde will have to work hard to convince emerging markets that she will not let the IMF once again be dominated by European and American views and interests. Otherwise, her legitimacy and that of the institution could be sullied.


How can she do this? First, Ms Lagarde needs to ensure that the shifts in voting shares and executive board representation in favor of emerging markets that were agreed during her predecessor’s regime are carried through fully and quickly. Second, she needs to push for more aggressive reforms that bring representation at the institution more in line with existing economic realities on the ground.


Ms Lagarde takes over an institution that has become central to the global financial system. The way she manages the political, technical and strategic aspects of the job will help determine the IMF’s future legitimacy and effectiveness.


The writer is the Tolani Senior Professor of Trade Policy at Cornell University and former chief of the financial studies division in the research department of the IMF.