x Abu Dhabi, UAE Friday 21 July 2017

Big challenges ahead for IMF's new leader

As Christine Lagarde settles in, she needs to immediately address several pressing issues, from the fund's tarnished image to growing euro-zone debt woes, Raghuram Rajan writes.

Christine Lagarde, the IMF chief, will have her hands full with major challenges. Above, at the IMF headquarters in Washington, DC. Andrew Harrer / Bloomberg News
Christine Lagarde, the IMF chief, will have her hands full with major challenges. Above, at the IMF headquarters in Washington, DC. Andrew Harrer / Bloomberg News

Now that the dust has settled over the selection of the IMF's managing director, it can return to its core business of managing crises. Christine Lagarde, a competent and well-regarded technocrat, will have her hands full with three important challenges.

The first, and probably easiest, challenge is to restore the IMF's public image. While the criminal case against Dominique Strauss-Kahn on sexual assault charges now seems highly uncertain, the ensuing focus on the IMF suggests an uncontrolled international bureaucracy with unlimited expense accounts, dominated by men with little sense of restraint.

Fortunately, the truth is more prosaic. Top IMF staff face strict limits on their allowable business expenses - no US$3,000 (Dh11,000) per night hotel rooms, despite reports - and are generally underpaid relative to private-sector executives with similar skills and experience.

The IMF, like many organisations in which workers spend long trips together, has its share of intra-office romances. But the environment is professional, and not hostile to women. A previous incident in which Mr Strauss-Kahn was let off lightly for an improper relationship with a subordinate clearly suggests the fund needs brighter lines for acceptable behaviour and tougher punishment for transgressions.

The second, and perhaps most difficult, challenge facing Ms Lagarde is the mess in Europe, where the IMF has become overly entangled in euro-zone politics. Typically, the IMF assesses whether a country, after undertaking reasonable belt-tightening measures, can service its debt - and lends only when it is satisfied that it can. The entire objective of IMF lending is to help finance the country while it makes adjustments and regains access to private borrowing. This also means that a country with too much debt should renegotiate it down before getting help from the IMF.

Perhaps swayed by promises of euro-zone financial support, the IMF took a rosier view of debt sustainability in countries such as Greece than it has in emerging markets. But this has not "helped" such countries, for the availability of soft credit from the euro zone or the fund enables only a greater accumulation of debt.

Ultimately, debt can be repaid only if a country produces more than it spends. And the higher the debt, the less likely it is that the country will be able to achieve the mix of belt-tightening and growth that would enable it to generate the necessary surpluses. Delayed restructuring eventually means more painful restructuring.

If troubled euro-zone countries, especially Spain, start growing rapidly again, there is still a "muddle-through" outcome that might work. The debt of highly indebted peripheral countries such as Greece could be written down through interest waivers, maturity extensions and debt exchanges. The euro zone - and the EU - could survive its fiscal crisis intact.

But having failed to insist on an upfront restructuring, the IMF will face problems. With private investors reluctant to lend more or even to roll over existing debt, the bulk of Greek debt at the time of any restructuring will be from the official sector. How the resulting losses imposed on debt holders will be divided between the euro-zone institutions and the IMF is anyone's guess. For the first time in its history, the fund might have to take a significant "haircut" on its loans, and it will have to prepare its non-European shareholders for it.

A greater dilemma will emerge if the muddle-through strategy does not seem to be working. Ms Lagarde's challenge will be to chart a strategy for the IMF that is independent of the euro zone's strategy, even though she has been intimately involved in formulating the latter.

The third challenge for Ms Lagarde concerns the circumstances of her election. It is not inconceivable that a number of emerging market countries will get into trouble in the next few years. Will the fund require the tough policy changes it has demanded of countries in the past, or will Ms Lagarde's need to show that she is not biased towards Europe mean that future IMF interventions will become more expansive and less demanding? A kinder, gentler fund is in no one's interest.

In her campaign for the position, Ms Lagarde emphasised the need for diversity among the IMF's top management. But what is really needed is the selection and promotion of the best people, regardless of national origin, sex or race.

Clearly, the IMF's existing culture and history will bias its selection and promotion of staff towards a certain type of person. In the long run, more diversity is needed. But if it is attempted too quickly to paper over the fact that a European is in charge again, the fund risks jeopardising its key strength.

The IMF is perhaps the central global multilateral economic institution at a time when such institutions are needed more than ever. Ms Lagarde arrives to lead it at a difficult time. We all have a stake in her success.

Raghuram Rajan, a former IMF chief economist, is a professor at the University of Chicago's Booth School of Business

* Project Syndicate