What a difference 10 years make to the global economic landscape. Almost a decade ago, Asia was overwhelmed by a major economic and financial crisis that forced many Asian countries to go as supplicants to the International Monetary Fund.

Resident Fellow Desmond Lachman

Today, as China’s international reserves surpass $US1000 billion ($1300 billion) and as Asia moves down the Chiang Mai road to closer Asian monetary co-operation, the tables are turned. It is the IMF that is now desperately seeking to restore its legitimacy with a radically recharged Asia. And it is the IMF that now has to persuade Asia on the merits of co-operating to address the large global payment imbalances.

The IMF’s present lack of legitimacy in Asia is to a large degree the fallout of the highhanded and misguided manner in which it treated many Asian countries during the 1998 financial crisis. Indeed, with the benefit of hindsight, most Asian policymakers remain more convinced than ever that the IMF exacerbated the Asian economic crisis by its poor policy prescriptions. The IMF did so by dogmatically insisting on its cookiecutter recipe of restrictive demand management policy and painful structural adjustment reforms at a time when an alternate policy approach was required.

At a more fundamental level, the IMF’s lack of legitimacy in Asia mirrors Asia’s chronic underrepresentation at that institution.

As recently noted by the Brussels Bruegel Institute, whereas the United States, the European Union, Japan, and China each account for about 20 per cent of world gross domestic product at purchasing power parity, their respective representation at the IMF could not be more unequal.

Indeed, the 25 countries of the EU occupy no fewer than 7 of the 24 seats on the IMF’s executive board, exercise more than 30 per cent of the IMF’s votes, and effectively select the IMF’s managing director.

By contrast, China and India combined, despite having a GDP larger than that of Europe, exercise only 9 per cent of the IMF votes, have but two seats on its executive board, and have virtually no say in the appointment of the managing director. As if to add insult to injury, tiny Belgium has more votes at the IMF than does India and not very much less than does China.

The IMF now recognises the urgency of needing to deal with its basic governance issue with Asia. It does so since it realises that the governance issue is very much linked to the IMF’s present ‘‘enhanced multilateral surveillance’’ exercise, aimed at addressing the pressing issue of global payment imbalances. Those imbalances are epitomised by an unprecedented US external current account deficit of about 7 per cent of GDP.

The IMF is painfully aware that Asian co-operation, especially in the area of allowing greater exchange rate flexibility, is vital to any effort to redress those payment imbalances in an orderly manner. For the main counterpart to today’s outsized US external current account deficit is a corresponding record Asian current account surplus. China alone is recording an annual current account surplus of more than $US150 billion, which is expected to widen to $US250 billion in 2007.

The basic challenge the IMF faces in rebalancing its members’ quota shares is that it is dealing with a zerosum game. If China and the other underrepresented emerging market economies are to gain in quota shares, some other group of countries has to lose. As the IMF is again finding out, this is a difficult circle to square.

At its recent annual meeting in Singapore, the IMF was able to reach agreement on an ad hoc quota increase for four of its most underrepresented members--China, South Korea, Mexico and Turkey. It also agreed to actively discuss a more basic overhaul of quota shares over the next two years with a view to reaching agreement by 2008. However, the IMF fell woefully short of setting out any clear road map as to how this overhaul is to be achieved.

Past IMF experience with efforts to realign quota shares would suggest that these adjustments will be the subject of heated and protracted political debate. In that debate, it is far from clear that the European countries will yield much ground.

IMF managing director Rodrigo de Rato has further reduced prospects for getting a satisfactory arrangement for the Asian countries by insisting that the least developed countries in Africa should also gain a voice in the IMF. He has done so despite those countries’ relative economic insignificance.

At a time of major global payment imbalances, it is a rather depressing prospect that the IMF will now be bogged down in protracted and acrimonious wrangling over adjusting relative quota shares. For experience suggests that dollar crises do not have the habit of waiting for the multilateral agencies to get all their ducks in a row. With the very real prospect of aUS economic slowdown in 2007 that might trigger such a dollar crisis, the need for prompt action on the IMF’s governance issue could not be more urgent.

Desmond Lachman is a resident fellow at AEI.