Raghuram Rajan on selecting a leader for the IMF

Appointing the World Bank president is the prerogative of the US; in return for this favour, the US allows the EU to select the MD of the IMF. Many such as Joseph Stiglitz have been critical of the manner in which the top jobs at the two multilaterals are filled. They would like selections to be made on merit.

In an article in FT, Raghuram Rajan, who quit recently as IMF Chief Economist to return to Chicago GSB, says that if the IMF is to be effective, it needs legitimacy. It can have legitimacy only if large developing countries have a voice. Yet, the odds are that current discussion on IMF reform will yield anything more than token increases in quotas (that determine voting power) for developing countries.

Rajan thinks this will cast a shadow on the IMF's functioning in two areas: removal of barriers to cross-border investment and the determination of the "right" exchange rates (a task that the IMF has recently assigned to itself). The latter especially has the potential to stir a hornet's nest.

An impartial referee will be even more necessary in the task the IMF has now taken on: evaluating equilibrium exchange rates and deviations thereof. There will be a temptation for the Fund to follow the US lead and accept that the only truly undervalued exchange rates are those where the government intervenes explicitly in exchange markets, not those where the exchange rate is “market determined”.

But this interpretation biases the rules against non-industrial countries, where the government substitutes more for the market. In a country with a closed capital account, there is no way for households to buy foreign financial securities directly. The build-up of central bank foreign exchange reserves, in part, may be a substitute for this missing market. In practice, therefore, there will be enormous scope for judgment in assessing the level of exchange rates and the validity of government intervention.

To resolve matters such as these, getting the right leader is important. Rajan wonders why India and China are silent on this subject. He goes on to provide the answer:

I would conjecture that they have little faith that the system can be changed or produce outcomes they can buy into. Why give the process more legitimacy by making noises about the selection of the managing director, noises that will only lead the EU to “consult” widely about the choice they have already made? Far better to keep quiet now, and allow the EU to dig a deeper grave for the multilateral financial system.