U.S. Agriculture and the
International Monetary Fund

Charles E. Hanrahan
Senior Specialist in Agricultural Policy
Environment and Natural Resources Policy Division

July 6, 1998

98-589 ENR

The IMF's Role and Current Financial Circumstances

The International Monetary Fund (IMF), created in 1946, is the international financial institution whose purpose is to support global economic growth and trade by helping maintain stability in the international monetary system.1 The IMF, as the "lender of last resort," provides financial and technical assistance to countries experiencing currency exchange problems and balance of payments deficits. Throughout much of its history, the IMF served the needs of the industrialized countries by supporting currency convertibility and providing short-term financing to help them maintain exchange rate stability. With the demise of fixed exchange rates and the growth of the private international capital market, the IMF's attention has turned from industrialized to developing countries with more severe and longer-term financial problems.

Funds used by the IMF to meet the financing needs of members come from Capital subscriptions or quotas that each member country agrees to deposit with the Fund and for short.term borrowing. The current financial crisis in Asia and Mexico's in 1994-95 have substantially reduced the IMF's financial resources. The IMF-brokered financial support packages for Indonesia, Korea, and Thailand total around $112 billion, with $34.7 billion of that coming from its own resources, the rest from other multilateral and from bilateral sources. Estimates are that the Fund's resources available to deal with future financial crises total no more than $38.5 billion. In order to reestablish its capacity to respond to future problems, the IMF has taken decisions to increase both its capital subscriptions or quota contributions and its short-term borrowing authority. The U.S. portion of the quota increase is $14.2 billion and the U.S. share of the increase in short-term borrowing authority is $3.5 billion. Under legislation implementing U.S. participation in the IMF (the Bretton Woods Agreements Act, P.L. 79-171, 22 U.S.C. 286), both the increase in the U.S. quota and its contribution to the IMF's short-term borrowing authority require authorization by Congress. In addition, both amounts must be appropriated but since they are considered to be an exchange of assets, neither has any budgetary impact. 2

The Asian Financial Crisis

The role of the IMF and its implications for U.S. agriculture can be illustrated with reference to its recent activity in dealing with the ongoing Asian financial crisis. 3

During the early 1990s, East and Southeast Asian countries attracted capital flows that were large in relation to the size of their economies. These large inflows allowed countries to finance increasing current account deficits without drawing down their international reserves. Most countries also were able to maintain stable exchange rates vis-a-vis the U.S. dollar. Beginning in 1996, however; the exports of the Asian countries began to contract as the value of the U.S. dollar increased and demand for their exports slowed. By early 1997, currencies in several Asian countries were coming under pressure. The event that precipitated the current crisis was the decision by Thailand's central bank on July 2, 1997 to allow the Thai currency, the baht, to float. The ensuing 15% fall of the baht came after the Thai central bank severely depleted its foreign exchange reserves as it tried to defend the baht's value. International investors, fearful that capital inflows had been put to questionable uses, pulled out their shorterm loans. The baht crisis spread to other currencies in the region. Investors wanted their debts paid, but debtors were unable to cover their short-term obligations.

The financial crisis affects most severely Thailand, Malaysia, Indonesia, the Philippines, and South Korea. The financial downturn in these countries has resulted in higher import prices, losses in stock markets, weak domestic demand, credit problems, and slower economic growth. Though not directly affected by the currency crises that the five East and Southeast countries are experiencing, Japan and Taiwan, whose problems are different, are also confronting increasing prices for imports and slower economic growth.

The IMF has arranged financial assistance programs for Korea, Thailand, and Indonesia. These programs include a substantial infusion of loans to deal with shorterm balance of payments problems and conditions that must be met as the financing is provided. In exchange for the emergency financing, countries have to agree to a number of reforms intended to strengthen their economies, restore monetary stability, and stimulate economic growth in the longer term. The IMF is requiring the countries receiving loans to reduce their current accounts deficits, cap inflation rates, and rebuild international reserves. In addition, countries must restructure their financial systems (including banking systems) to make them sounder, more transparent, and more efficient. Other Thailand conditions are that the countries take steps to liberalize trade, keep markets open to foreign investment, and free up labor markets.

Most economists expect that IMF-required reforms together with increased exports by these countries will foster recovery in the region, especially in the affected countries. Analysts agree, too, that it will take some time before these countries experience the robust growth rates of recent years. Forecasters expect that the recovery of the Southeast Asian countries and Korea will take up to 3 years. This pace of economic recovery differs from that of Mexico whose economy showed substantial recovery in just one year after its 1994 peso devaluation. A key difference between the Mexican and Asian situations is that there is no large market to absorb the increase in Asian exports as the United States did for Mexico.

The Asian Financial Crisis and U.S. Agriculture

The Asian financial crisis is expected to have two principal impacts on U.S. agriculture. 4 As discussed below, the slowdown in U.S. economic growth expected from the Asian crisis likely will, by putting downward pressure on prices for some U.S. agricultural commodities, result in lower farm incomes. In addition, the Asian crisis is expected to reduce demand for U.S. agricultural exports.

U.S. economic growth is expected to slow as a result of the Asian financial crisis. Estimates are that the drop in income will be in the range of 0.5% to 10%. Agricultural economists think that slower U.S. growth will initiate a chain of events leading to lower farm income: Slower economic growth likely will reduce disposable income and consumer expenditures. Falling demand will lead to lower retail prices and lower farm prices. The overall effect likely will be downward pressure on U.S. farm income. The U.S. Department of Agriculture (USDA) forecasts that net cash income to farmers will be $51 billion in 1998. That is about $3.5 billion less than in 1997, and $5 billion less than the approximately $56 billion originally forecast for 1998. other forecasters think that farm income will be even lower. The WEFA Group, a private forecasting organization, estimates that net cash income to farmers could be as low as $50 billion in 1998. The Asian economic slowdown is a major factor in these projections of a decline in farm incomes.

U.S. agricultural exports are expected to fall as a result of the Asian financial crisis. (See Table 1.) Economists identify three factors in connection with the crisis that will affect demand for U.S. agricultural exports. The depreciation of Asian currencies relative to the U.S. dollar will raise the price of imported food and agricultural products in Asian countries. Even though world prices for major traded U.S. products have been falling in recent months, prices to Asian consumers are increasing and resulting in lower demand for imported U.S. products. The slowing down in economic growth will lead to a decline in consumer spending in the region and reduce the demand for imported foods and farm products. Finally, the response of producers and and consumers globally over the next few years could alter patterns of supply and demand for U.S. agricultural products. Producers in importing Asian countries may try to increase production of like products or of import substitutes. Competitor countries in the region such as Australia, whose dollar is also depreciating vis-a-vis the U.S. dollar, may become more competitive in wheat, beef, and cotton markets. Thailand could become more competitive in the region for poultry products or feed grains. USDA forecasters estimate currently that as a result of the Asian financial crisis and its spread, U.S. agricultural exports will decline in FY 1998 to $55 billion, about $3 billion or 5% less than originally forecast. The Food and Agricultural Policy Institute (FAPRI), an independent forecasting group, expects U.S. agricultural exports to be lower still, $54.5 billion in FY 1998, $3.5 billion or 6% less than its initial FY 1998 forecast.

Not all of the reductions in U.S. agricultural exports can be attributed to the currency crisis in Asia and its effects. Supply and demand conditions in other countries will also affect demand for U.S. agricultural products. For example, large feed grain crops in China, Eastern Europe, and Ukraine will affect demand for U.S. feed grain exports. Similarly, large wheat crops in Australia and Canada will lower demand for U.S. wheat exports. The U.S. dollar's strength relative to competitor countries' currencies will also weaken demand for U.S. products in world markets.

Both USDA and independent forecasters think that U.S. agricultural exports will recover by 2000. USDA forecasts that FY2000 agricultural exports will exceed $60 billion; FAPRI forecasts FY2000 agricultural exports at $58.6 billion. These forecasts reflect the assumption, among others, that IMF assistance programs (short-term financial aid and required reforms) will be an important factor in the economic recovery of the region.

Views of Agricultural Interests on the IMF

In the current debate over increased IMF funding, agricultural interests generally support the efforts of the IMF in contending with the Asian financial crisis as well as the increase in the U.S. contribution in financing Fund activities. For example, the Agriculture and Fast-Track Coalition, a group of 68 farm, commodity, and agribusiness organizations that is broadly representative of U.S. agriculture, has voiced support for IMF assistance to financially troubled Asian countries and endorsed increases in U.S. contributions to the IMF's financial resources to deal with future financial problems. These groups argue that without the beneficial effects on growth from the economic restructuring that is required in exchange for IMF emergency lending, U.S. agricultural exports and farm incomes might even be lower than expected in economists' forecasts. Both USDA and independent forecasts assume implicitly that economic growth in Asian markets will recover as the affected countries implement IMF-required economic and financial reforms.

USDA and U.S. agricultural exporters argue that IMF assistance makes it possible to extend credit guarantees to the Asian countries currently in crisis. 5 USDA has allocated over $2.5 billion in short-term export credit guarantees to promote exports of U.S. agricultural products to the financially troubled Asian countries. Without IMF assistance, USDA argues, the Asian countries would not be able to secure the short4erm loans for which the guarantees are allocated and U.S. agricultural exports would fall further. IMF lending helps reestablish the creditworthiness of the borrowing countries, a requirement for participation in the progrun, and enables them and U.S. exporters to benefit from the export credit guarantees.

Farm interests, however, are not uncritical of the IMF and its approach to dealing with the Asian financial crisis. While generally endorsing IMF reform conditions, some argue that agricultural trade liberalization should receive greater emphasis as a component of an IMF reform program. Economists generally have pointed to the agricultural trade provisions of the North American Free Trade Agreement as preventing Mexico from resorting to trade protectionism as it sought to recover from the 1994 peso devaluation. The drop in U.S. agricultural exports to Mexico was less than might otherwise have been the case, and the subsequent recovery of U.S. agricultural exports greater, economists argue, because NAFTA precluded Mexico from raising tariffs on U.S. products.

Some in U.S. agriculture join in often-expressed criticisms of IMF operations. One criticism is that IMF lending represents a "moral hazard" 1 in that it encourages the kind of behavior that it seeks to remedy and prevent. With respect to the Asian financial crisis, critics argue that IMF financing will encourage governments and private borrowers to engage in the kind of imprudent borrowing that led to the crisis in the first place. Proponents of IMF assistance hold that by imposing reform conditions, particularly in the banking sector, in exchange for new loans, moral hazard can be avoided. IMF conditionally has also been raised as an issue. Criticism of the IMF's Asian support programs for not including extensive agricultural trade liberalization has already been mentioned. In addition, some critics question the effectiveness of IMF conditions. They fear that IMP programs will slow rather than speed economic recovery, forcing companies out of business, increasing unemployment, and at worst theatening social and political stability. Most in agriculture do not share this view and point to the expected positive contribution to growth, farm incomes, and agricultural trade of IMP assistance in Asia.

In addition to moral hazard and conditionally, critics of the IMP charge that its operations lack transparency, making IMP programs difficult to evaluate and adding to uncertainty about their success. There appears to be widespread support, including among agricultural interests, to make IMP operations more transparent in hopes that it will enhance the effectiveness of the institution in anticipating financial crises and in dealing with them once they have occurred.

Table 1. U.S. Agricultural Reports: Value by Region, 1997-98

Source: U.S. Department of Agriculture, Economic Research Service, Outlook for US. Agricultural Exports, May 29, 1998 and previous issues.

References

1 For details on the operations of the IMF see The International Monetary Fund: A Short Overview, CRS Report 97-228, February 12, 1997, by J. F. Hornbeck.

2 The international Monetary Fund's (IMF) Proposed Quota increase: issues for Congress, CRS Report 98-056, January 16, 1998, by Patricia A. Wertman. In addition, CRS Issue Brief, IB97038, The International Monetary Fund's Proposed Quota increase and "New Arrangements to Borrow" (NAB), updated regularly, provides information on the status of legislation in the 105th Congress to provide supplemental resources to the IMF.

3 For an analysis of the Asian financial crisis and IMF assistance programs, see The Asian Financial Crisis, the IMF and Japan: Economic Issues, CRS Report 98-434, April 17, 1998, by Dick K. Nanto.

4 This section draws on the analysis of the impact of the Asian financial crisis on U.S. agriculture in "Events in Asia Lower Prospects for U.S. Farm and Rural Economy," by Greg Gajewski and Suchada Langley, Agricultural Outlook, U.S. Department of Agriculture, Economic Research Service, February 1998, pp.9-12; on more recent forecasts of farm exports and income in Agricultural Outlook, June-July, 1998; and on forecasts of independent agricultural research organizations.

5 See CRS Issue Brief IB98006, Agricultural Export and Food Aid Programs, updated regularly, for a discussion of the export credit guarantee program and the extent to which it is being used currently in Asia.