ANALYSIS: Although the latest sale was suspended in mid-August as a result of market volatility, joint sales of Argentine and Venezuelan government debt (packaged as the 'Bond of the South') illustrate both attempts to promote greater regional integration, and further distancing of a group of Latin American countries from the IMF. In the past two years, outstanding debts to the Fund have been repaid by Argentina, Brazil, Ecuador and Venezuela.

The justification for distancing from the international lender has been twofold, namely:

• that IMF conditionality has been responsible for imposing damaging economic policies, worsening inequality and failing to generate growth; and

• that the IMF has been politically motivated in its dealing with borrower countries, in particular by dealing unduly harshly with governments inclined to break with Fund orthodoxy.

Research findings. This claim of IMF bias has been supported by research carried out at the left-leaning Center for Economic and Policy Research (CEPR) in Washington. The authors analyse two cases in which they claim that the key IMF forecasts of GDP growth systematically overstated the prospects where they supported policies or leaderships, and understated prospects in countries with leaderships that tended to oppose standard Fund recommendations.

Source: CEPR, IMF, Ministry of Economy

1. Argentina. The main analysis focuses on the case of Argentina, in two separate periods:

• Recession. First, the authors examine the years 1999-2001, after the mid-1998 onset of recession. Following seven years of economic restructuring under IMF guidance, Argentina had the Fund's full support. In the face of credit rating agency downgrades, then-Managing Director Michel Camdessus publicly stated his expectation of a "prompt reverse". His successor Horst Kohler is also quoted as publicly supporting the government's continuation of Fund-backed policies. The authors then detail how IMF projections throughout this period remained strongly positive, despite actual annual growth being increasingly negative.

• Post-default. The second period considered is that following the default and devaluation at the end of 2001. In January 2002, then-First Deputy Managing Director Anne Krueger wrote that countries should honour their debts "and suffer when they fail to do so". In the event, growth rebounded strongly, coming in above 8% in each of the four years from 2003-06. However, Fund forecasts ranged from 1.0% to 4.2% (although for 2004-06 these were in line with the government's own budget projections), and the public message was consistently negative.

2. Venezuela. The absence of a stand-by arrangement with the Fund since 1997 limits the authors' access to equivalent data, but they nonetheless identify continuing underestimates of growth for the period from 2003 onwards -- in some cases of as much as ten percentage points.

Assessment. Three elements need to be considered before the CEPR's claim of IMF bias can be substantiated -- not least because the former were involved in a long-running disagreement with the Fund over the appropriate approach to Argentina.

1. Scale of error. In considering developing country growth forecasts, it is important to note the higher volatility of the underlying series. Errors of plus or minus ten percentage points are not comparable to an equivalent error in the growth forecast for a high-income country. In 1990, researchers in the International Journal of Forecasting found that overall, IMF forecasts for developing countries' growth (and six other key indicators) were "inferior to those generated by a naive model, a simple random walk". Errors in Argentina forecasts are thus not necessarily incompatible with broader trends. A study in 2000 by a Michigan State academic found that IMF projections for OECD countries were "certainly superior" to a random walk; but no similar recent evidence exists for the institution's developing country forecasting.

2. Direction of error. The evidence presented suggests directional errors that responded closely to whether the IMF approved of a country's choices. More robust is the work of an IMF researcher in 2001, who found that consensus forecasts are typically overoptimistic, and that this phenomenon is especially strong in developing country forecasts. IMF forecasts were found to be highly correlated with private sector forecasts. As such, positive errors for countries with which the Fund is engaged are not necessarily evidence of deliberate bias -- although the apparently systematic nature of the bias does raise questions over all forecasters' approaches. However, this evidence does not explain the Fund's negative forecast errors when Argentina and Venezuela followed contrary policies.

3. Honesty of error . There is no evidence short of personal testimony by which it could be demonstrated that the highlighted errors in IMF forecasts were motivated by political bias. There is, moreover, a reasonable alternative explanation. The Fund was committed to a set of policies in Argentina. Assuming that staff working on forecasts were convinced of these policies, they would by implication expect a higher growth path with these policies than others -- and in particular would expect a reversal of course to have disastrous effects. In this scenario then, the mistakes may be large and systematic but they are honest. While the CEPR researchers show that Fund staff were in fact privately sceptical of the policies they were publicly supporting, there is no reason to think this extended to the forecasting team.

Finally, in the case of Venezuela, it may well have been reasonable to expect much less successful outcomes to economic policies pursued in the face of deep political divisions and the failed military coup. Certainly the surge in oil prices surprised many and has been central to much of the country's success.

IMF prospects. The Fund under Managing Director Rodrigo Rato has seen its developing country loan portfolio shrink -- not only in Latin America -- and has begun to carve out a more prominent role instead as the guardian of the international financial system (see INTERNATIONAL: IMF exchange monitoring will be tested - June 29, 2007). This process would be likely to continue under his probable successor, Dominique Strauss-Kahn, who has been quoted as saying that his priorities will be to address both financial and equity imbalances in the world economy and to improve the governance of the Fund; and that the IMF can 'adapt' to make itself more relevant to the challenges of globalisation.

Central to the role in preventing global financial imbalances is the Fund's ability to be seen as both:

• highly competent -- if it is to be seen to act for the good of the financial system in total, then its modelling and forecasts must be respected; and

• politically neutral -- to make valuable recommendations on, for example, the level of the Chinese exchange rate, the Fund must be seen as absolutely non-partisan.

CONCLUSION: The IMF must re-establish its credibility and a reputation for high-quality economic policy analysis if it is to fulfill its changing goals -- and if it is to be widely trusted again in parts of Latin America. However, Venezuelan efforts to challenge the Fund as a preferred lender are likely to founder on its own economic limitations, as well as regional resistance to financing an alternative, Caracas-based regional lender.