Select Committee on Treasury Written Evidence

Memorandum submitted by the Bank of England


  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 countries—Nigeria and Uganda—have 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 agency?

  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 financial system.

  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. [7]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.

June 2006

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

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