Memorandum submitted by the Bank of England
FOLLOW-UP TO TREASURY SELECT COMMITTEE HEARING
During the TSC evidence session on 27 April,
the Chairman raised the question of whether the IMF is developing
into a ratings agency for private lenders, especially following
the creation of the Policy Support Instrument (PSI). This short
note complements our verbal evidence, setting out: (i) the key
features of the PSI; and (ii) why the Fund should not adopt the
role of a ratings agency.
(i) The Policy Support Instrument
The Policy Support Instrument (PSI) provides
a mechanism through which low-income countries that neither need
nor want to borrow from the IMF can enter into a programme relationship
with the Fund. Since its introduction in October 2005, two countriesNigeria
and Ugandahave sought and obtained a PSI arrangement.
For eligible countries, there are three potential
benefits from securing a non-borrowing IMF programme under the
PSI. First, it allows national authorities to draw on the expertise
of Fund Staff in developing a macroeconomic policy framework designed
to achieve sustainable growth and reduce poverty. Second, and
most important, a programme relationship with the IMF should strengthen
the credibility of the policy framework and provide a signal (of
policy strength) to donors and creditors. Finally, a PSI arrangement
can facilitate rapid access to IMF resources in the event that
an unanticipated shock creates a financing need.
Access to the PSI is currently restricted to
low-income countries eligible to borrow from the IMF under the
Poverty Reduction and Growth Facility (PRGF) and which have a
suitable Poverty Reduction Strategy (PRS) in place.
The approval of a PSI arrangement and the outcome
of subsequent programme reviews can have a significant impact
on the actions of donors and creditors (actual and potential).
In principle, this could include exerting influence over the lending
decisions of private creditors. But very few low-income countries
have the ability to access international capital markets on affordable
terms. Rather, a large majority of these countries' financing
needs are met by grants and low-cost loans from official donors,
the multilateral development banks and bilateral (Paris Club)
creditors. Accordingly, it is not realistic to argue that the
creation of the PSI has moved the IMF in the direction of becoming
a ratings agency for private lenders.
Importantly, the creation of the PSI does not
change the well-established role of the Fund in acting as a "gatekeeper"
for aid flows from donor countries and other multilateral institutions
(including the World Bank). These flows are typically contingent
upon IMF endorsement of a recipient country's macroeconomic policies.
One of the benefits of the PSI is that the Fund will now be able
to provide such endorsement without extending new loans to low-income
countries that are already heavily indebted.
(ii) Should the Fund become a ratings
The IMF routinely assesses the economic prospects
of all 184 member countries as part of its bilateral surveillance
activities. It is reasonable to claim that the private rating
agencies conduct a similar exercise, albeit for a more restricted
set of countries. A key difference, however, is in the focus of
the analysis. For the Fund, the intention is to develop largely
qualitative policy recommendations that can be conveyed to the
relevant authorities in the country concerned. The rating agencies,
by contrast, aim to construct a quantitative measure of the likelihood
of sovereign default (encapsulated in a rating), primarily for
the benefit of private creditors.
Furthermore, the premise that the IMF should
act as a rating agency is inconsistent with the role of the Fund
as a provider of temporary financial support to member countries
that encounter balance-of-payments problems. Analysis produced
by the ratings agencies exerts significant influence over the
lending decisions of private investors in emerging market economies
in particular. But it is inevitable that there will be occasions
on which sovereign credit ratings fail to predict a financial
crisis. In a situation where an over-optimistic rating was produced
by the IMF itself, the institution would be placed under considerable
pressure to remedy the situation by providing a large "bail-out"
package. There is a clear risk that this dynamic would prevent
the Fund from focussing on its core surveillance mandate, undermine
the credibility of IMF access policies, and distort the international
These concerns notwithstanding, several commentators
have suggested that IMF surveillance should move in the direction
of providing a more precise assessment of member countries' policy
performance. For example, a recent IMF Working Paper by Jonathan
Ostry and Jeromin Zettelmeyer proposes that the Fund should assign
to each member country a "summary rating" that would
map directly to access levels. Under
this model, a strong record of prudent policy choices would translate
into greater availability of financial support, should the need
arise. In this way, the incentive to implement IMF policy recommendations
would be strengthened.
Although a significant contribution to the debate,
it is important to emphasise the Ostry-Zettelmeyer proposal stops
far short of turning the IMF into a ratings agency. The authors
envisage just three alternative summary ratings. By contrast,
S&P employs more than 20 different ratings, ranging from AAA
to D (default). More importantly, there is no suggestion that
IMF-produced ratings should attempt to measure of the likelihood
of sovereign default. Rather, the intention should be to ensure
that the level of access available to member countries is consistent
with the quality of their national policy frameworks.
7 "Strengthening IMF Crisis Prevention",
IMF Working Paper WP/05/206, November 2005. As with all IMF Working
Papers, a disclaimer is included to emphasise that the views expressed
are personal those to the authors and do not reflect an official
IMF position. Back