Last week, Rodrigo Rato, the former Spanish Minister of Finance, assumed the helm as Managing Director at the IMF at what has to be one of the most critical moments in the Fund's sixty-year history. For the global economy is now characterized by unprecedented large external imbalances, as epitomized by a record U.S. external current account deficit that shows no sign of narrowing. At the same time, the apparent end of easy global liquidity conditions is now unmasking fundamental weaknesses in a number of large emerging market economies, like Brazil, while the IMF is yet to come to grips with Argentina's massive default on its private sector obligations at a great cost to the Fund's credibility.

Contrary to Mr. Rato's initial assertions, sticking to the course of Mr. Kohler, his predecessor, would appear to be a recipe for failure. For under Mr. Kohler, the Fund was largely uninvolved in addressing the accumulating global external imbalances or in actively promoting appropriate exchange rate policies for the larger industrial economies. Moreover, the Fund continued with its policy of large bailouts for emerging market countries like Argentina, Brazil, and Turkey, thereby perpetuating moral hazard in the system and seriously undermining its own balance sheet position. In the event that Mr. Rato were to fail to change the IMF's course soon to deal with the present global economic challenges, one must fear not simply for the future effectiveness and credibility of the Fund, but one must also be concerned about the orderliness of the global adjustment process.

Among the more serious omissions of the IMF in recent years has been its failure to discharge its original mandate of "promoting exchange rate stability, maintaining orderly exchange arrangements, and avoiding competitive exchange depreciations". Did the IMF as much as raise an eyebrow when, with the explicit objective of weakening the yen, Japan engaged in "awesome" foreign exchange intervention to the tune of U.S. $150 billion in the first quarter of 2004? Or did the IMF raise objections when Japan's Ministry of Finance authorized a further U.S. $560 billion in such intervention as needed in the remainder of the year? Or could the IMF have been more conspicuously silent about the fact that a host of Asian countries, led by China and India, have been maintaining currencies that are undervalued by any reasonable measure through heavy exchange market intervention? China's international reserves alone have now risen beyond U.S. $400 billion.

One must hope that Mr. Rato will soon provide the intellectual leadership so sorely needed to deal with today's difficult global exchange rate issues. At a minimum, one must hope that the IMF will soon revitalize its "special consultation procedures"--last used in the 1980s for Korea and Sweden--to put real pressure on those countries that consistently engage in currency manipulation to gain an unfair competitive advantage. For only then can one expect the IMF to get back into the game of promoting orderly exchange rates, so necessary for the early adjustment of today's external imbalances.

 One must also hope that Mr. Rato will soon restore order to the chaos in the IMF's emerging market lending policy. Since the 1995 Mexican peso crisis, the IMF has abandoned the normal access limits that used to apply to the amount of money that the Fund could lend to a country in distress. Instead, it has lent in a rather arbitrary manner tens of billions of dollars to emerging market countries in crisis on the grounds that "exceptional circumstances" prevailed.

The net result of this approach has been a further series of huge bailouts to those countries closely allied with the IMF's major shareholders. These bailouts have provided incentives for investors and governments alike to behave in an irresponsible fashion knowing that the IMF will be there to bail them out in case of need. It has also eliminated any semblance of transparency in the IMF's lending operations and it has seriously undermined the IMF's balance sheet. This latter point is epitomized by the fact that four countries alone--Argentina, Brazil, Indonesia, and Turkey--now account for three quarters of the IMF's outstanding loan portfolio.
 
Basic questions should be raised about the wisdom of the IMF's current lending policy by the fact that the IMF now feels compelled to lend Argentina very sizeable amounts of money, despite that country's egregious lack of good faith in negotiating with its private creditors, in order to ensure that Argentina does not default on its past IMF loans. In particular, one must question whether the IMF should not face up to its past mistakes in lending to Argentina by recognizing arrears on that lending and whether it should not revert to its pre-1995 type of access limit policy, whereby there were strict ceilings upon the amount that the IMF could lend to any individual country. Such a change in policy would effectively restrict the IMF to its original role of a catalytic lender for the emerging markets. It would also spare future countries Argentina's present fate of being saddled with excessive amounts of IMF "senior debt" that can never be rescheduled.

The time for considering basic reform at the IMF is now at a moment of still relative calm in the emerging markets. However, it is not clear how long this window for orderly decisions will last as would be suggested by the recent back up in U.S. long-term interest since May, when the Federal Reserve moved to a policy of "measured" interest rate increases.   The shabby way in which Mr. Rato was appointed to the job by the European club to which he belongs does not augur well for the support that he might need for radical change at the start of his mandate. This is a pity since crises do not have the habit of waiting to emerge until we are fully ready to deal with them.

Desmond Lachman is a resident fellow at AEI.