Sovereign risk was a principal theme in 2011 – most visibly in Europe and, to a lesser extent, in America's loss of its triple A rating. Along with poor growth and rising inequality, it will continue to raise serious questions next year about the functioning of the global economy. As this occurs, one institution – the International Monetary Fund – will attract special attention. The key question is whether it can finally step up to the role of global conductor, rather than suffering yet more erosion of its credibility.
The sovereign risk crisis has not been kind to the IMF, especially when it comes to Europe. There is no denying that too many of the adjustment programs it has overseen have fallen short of their objectives. Whether it jumped or was pushed, the institution sacrificed some of its own rules, including those previously deemed sacrosanct.
For two years, the IMF agreed to a series of programs that were partially designed, inadequately funded and, in some cases, even threatened its preferred creditor status. In each case, the IMF ended up supporting a weak attempt to muddle through, rather than a plan sustainable in the medium term.
This shortfall has accentuated prior concerns about the IMF’s governance, representation and legitimacy. The damage has been material, though fortunately not irreversible.
Don’t get me wrong. This is not about the IMF’s ability to be an agent of good for the global economy. After all, it is endowed with considerable influence, global standing and talented staff. Rather, it is due to political pressures from Europe.
Many countries interpret the IMF’s actions in Europe as confirmation that they are members of an institution that speaks about uniformity of treatment but makes large exceptions for its historic masters. As the institution’s credibility and balance sheet suffer, its programmes are less effective in attracting co-financing from the private sector.
The world needs a strong and legitimate multilateral institution if it is to avoid costly fragmentation; and Europe needs a credible IMF to help it overcome a deepening crisis. This will only be achieved if there is a change next year in the overly cosy relationship between Europe and the IMF.
What is required goes beyond enlightened restraint on the part of European leaders. The IMF must find the courage to resist European bullying; and the rest of the world must help by making a collective effort to accelerate reform of the institution’s governance and representation. Only then would an enhanced IMF be able to help the global economy back to growth and jobs.
Mohamed El-Erian is CEO and co-CIO of Pimco.
Copyright The Financial Times Limited 2011.