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Monday, 18 December 2017

Healing salve spreads the pain

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  • A patient buried in the hot sand looks out from under a shade
  • Mexico’s central bank governor Agustin Carstens, hinted of the problems that might lie ahead regarding the Greek package, relating to the 2010 loan, at the time Christine Lagarde was appointed

The IMF’s decision to help bail out Greece and other developed eurozone states irked many emerging countries. Getting out of Greece scar-free may be a challenge too and one that could indirectly change the Fund’s practices for the better.

The IMF’s decision to provide a third of the funds required to finance Greece when it could no longer access the market in 2010 backfired in spectacular fashion this July, when the recipient defaulted on a payment to its overly generous creditor.

Breaking the taboo, that no one defaults on the IMF, was Greece’s last act before accepting a humiliating deal with its European partners to release funds to repair the hole. That also ensured that further financial totems – the European Central Bank was next in line – were not questioned.

However, the wound had been administered. And although quickly patched up, the full implications of the IMF’s over-extension to Greece – achieved by changing its exceptional access rules at the peak of the crisis – remain unexamined.

Systemic?

To emerging market countries the debacle confirmed their long-held suspicion that the Fund had been hijacked by its major shareholders, the developed countries, who had amended the institution’s rules to support their own, on grounds of preventing a global systemic collapse.

The figures starkly bear out this accusation. European countries, which account for a third of the votes on the IMF’s board, are in receipt of two-thirds of the Fund’s outstanding credit (see chart).

“Many policy-makers, in particular those outside Europe, see the IMF’s exceptional access criteria and policies as having been fundamentally compromised by the fudges and exceptions made to allow approval of the IMF-supported program in Greece,” wrote Richard Gitlin and Brett House in a Centre for International Governance Innovation paper.

A first step to rectify the policy errors so that the balance between developed and emerging countries is more even could be to revoke these “systemic exemption” criteria, which allowed it to make such a disastrous loan to Greece in the first place, under the exceptional access policies.

An overhaul is already under consideration by the IMF but House, now chief economist at Alignvest, does not think the systemic exemption will be removed any time soon.

“The US Treasury, which has a de facto veto on major deisions at the IMF board, has been opposed to the removal of the systemic exemption. It wants to retain the option for the IMF to lend at massive scale so long as there is the possibility of an existential crisis in the eurozone,” he said.

Gabriel Sterne, head of macro at Oxford Economics, agrees. “The IMF board would be reluctant to let go of armoury once it is created in case it might need to use it in the future,” he said.

Signs of distrust

A more lingering sign of distrust between the two blocs is the stalled reforms to the Fund’s quota system that would give faster-growing emerging market countries, such as Brazil, China and India, a greater say in board decisions.

These proposals, which would also reduce the US’s votes so they no longer held a blocking stake at board level, were first set out in 2010. However, they remain on ice since the US Congress has refused to ratify the proposals to reduce its influence.

The suspicions that the IMF continues to be a trans-Atlantic cabal were heightened when yet another European, French finance minister Christine Lagarde, was appointed managing director in June 2011, succeeding the disgraced Dominique Strauss-Kahn, another French citizen.

At the time Lagarde’s main rival for the post, Mexico’s central bank governor Agustin Carstens, hinted of the problems that might lie ahead regarding the Greek package (relating to the 2010 loan), whose exact structure was being debated.

“If the problem is driven by high liquidity constraints, the Fund should lend, including in large amounts. If, on the other hand, the debt position is unsustainable, Fund lending would only overburden the member, and would lead to the postponement of other, more effective, decisions,” he said.

Several non-European members of the Fund’s board, such as Brazil, apparently expressed unease, behind closed doors, at the prospect of giving Greece such a huge loan when its debts already seemed unsustainable. An unofficial IMF staff paper subsequently said it had been a mistake.

And after July’s Greek default, the Fund itself in effect admitted its error saying a rethink was now necessary.

“Greece needs debt relief that goes well beyond what is currently being considered,” said an IMF spokesperson at the start of September.

Mistakes and delays

Given these mistakes over Greece and ongoing delays to reforms, it is hardly surprising that many emerging market countries seeking emergency financing have looked elsewhere, rather than to the IMF.

Both Venezuela and Argentina, which for different reasons have found themselves unable to borrow on the markets, have instead received loans from China or its state institutions, such as the Asian Infrastructure Investment Bank.

These countries, and others, might initially find such alternatives attractive, since there are fewer conditions attached than under a traditional IMF programme that usually requires stringent fiscal reforms in the recipient country.

But House points out that such deals are “no free lunch” since they commonly come with their own tough terms.

He said: “Both countries have pre-sold their major commodities to China at unattractive export prices. Compared with IMF financing, these loans are bad deals and the mark of governments desperate to prop up unsustainable economic policies.”

However, the Fund also appears to be encouraging the eurozone to use funding alternatives.

It provided only 10% of the bailout package for Cyprus in 2013, as opposed to the third granted to Greece, Portugal and Ireland. And it has not yet committed to supporting Greece’s third bailout.

Instead, the majority of the funds are likely to come from the European Stability Mechanism, the permanent vehicle set up to provide loans to distressed eurozone sovereigns and their banks.

This is only right, said House. “The rest of the world was sceptical that the original 2010 Greek bailout package would work. Now the US, Canada and many emerging markets want to see Europe take a larger role in financing Greece.”

But the fact remains that the IMF is one of Greece’s key creditors alongside the ESM, its predecessor the European Financial Stability Facility and the European Central Bank.

All these official sector bodies assert varying degrees of priority over other claims.

It is hard to see how this supposedly untouchable debt will be restructured without further long-held financial tenets being smashed. Some have even started to question whether the super senior status of official sector lenders should be relaxed.

One of the veterans of many sovereign debt restructurings – Lee Buchheit, partner at law firm Cleary Gottlieb – has even made the radical suggestion that the IMF should instead now become one of Greece’s most junior creditors in an effort to resolve this situation.

In a paper written with Mitu Gulati, law professor at Duke University, Buchheit, who advised Greece on its 2012 private sector restructuring, said the sovereign should prefer to pay private-sector investors rather than meet obligations to official-sector lenders.

Their thesis is that the official-sector insistence on seniority in effect prevents Greece from raising money from private-sector investors, leaving the country relying on handouts from its European partners for a lengthy period until those debts are relieved.

They say this is ultimately the cause of the current stalemate between Greece and its major creditors.

“Discussing massive new loans while simultaneously asking for a write-off of old loans extended by the same group of creditors will test the skills of any debt negotiator,” the paper said.

This also discourages the private sector from investing new money, since they are worried about Greece’s spiralling debt pile, its risk of exiting the euro and the threat that they would receive a haircut before the official sector suffered.

In July, the IMF acknowledged the problem, also pointing out that there was no incentive for Greece to seek alternatives to the low rates it currently enjoyed on its official sector loans.

The Fund said: “Debt cannot be assumed to migrate back onto the balance sheet of the private sector at interest rates close to the current Triple A rates [of the official sector loans] before debt levels have been brought to much lower levels.”

A trick is needed

Therefore the duo say the trick in the future will be “to make a country with a debt-to-GDP ratio in excess of 176% presentable to the markets without inflicting an immediate, and politically unpalatable, nominal haircut on that debt stock”.

A politically acceptable way to do this might be for the European institutions such as the EFSF and ECB to “consider formally subordinating their existing claims against Greece … to encourage new private-sector lending”.

Buchheit and Gulati say this would only work if such subordination was selective. Private-sector investors could also be reassured by a clause in any deal’s prospectus saying that in the event of a missed payment by the sovereign, the official sector would cure such defaults.

The duo acknowledge that such an option might cause official-sector lenders to recoil. The ESM treaty refers to the body having priority status over other lenders, except the IMF. And the ECB, until late 2012, maintained its priority despite buying bonds before then in the secondary market at deep discounts.

However, Buchheit and Gulati say this mild measure is preferable to the alternatives, which are either to lend more money to Greece that may “never be recovered at all”, or “immediately writing off a portion” of such loans.

“If the alternatives for the official sector are to lend the money itself (with the risk that the funds may never be recovered), or to write off their existing Greek loans now as a means of rendering the country presentable to the markets, subordination may be a more politically palatable option,” they say.

Buchheit and Gulati say the Fund, though, should retain senior status in this situation. Most others agree that this should not be put at risk.

“Preferred creditor status on IMF loans makes sense: the Fund lends into crisis situations when no one else will provide financing. As such, these loans should be carved out of any debt-restructuring that follows,” said House.

”Removing the preferred status from IMF lending would hamper the Fund’s scope to act just as global debt levels are at historic highs and more sovereign debt crises lie ahead.”

To see the digital version of this report, please click here

To purchase printed copies or a PDF of this report, please email gloria.balbastro@thomsonreuters.com

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