Monday, 23 October 2017

Saving Europe

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  • IMF New arrangements to borrow financing

The IMF has had a roller coaster ride – from near-redundancy pre-crisis it was cast back into the limelight and its funding overhauled, following the market volatility of 2008. With the crisis seeing no end in sight does it need to be reformed again?

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The IMF’s role and the financing arrangements enabling it to fulfil that role were expanded at the London Summit in 2009 to meet the increased demands that were being placed on it amid the financial chaos. It was agreed the Fund’s resources should be trebled, from US$250bn to about US$750bn. The representation of dynamic, emerging market economies on the board was also increased. The full package of changes has been phased in over a number of years, constituting significant reform of the IMF’s structure. Part of the increase came in the expansion of the New Arrangements to Borrow facility. According to the IMF: “NAB is the facility of first and principal recourse in circumstances in which the IMF needs to supplement its quota resources.”

It allows the Fund to receive voluntary, bilateral loans, traditionally from rich countries, but recently from some emerging markets too. If the Fund’s financing requirements were to suddenly expand significantly, NAB could be expanded to include more emerging markets, said Peter Chowla, programme manager at The Bretton Woods Project, a group working as a watchdog focusing on the IMF and the World Bank. He believes that would allow resources to be expanded with only a limited concession of control to those countries making the loans.

“…Questions are again being asked about the role the IMF will play if the worst-case scenario unfolds…”

The real influence comes via quota subscriptions which constitute the bulk of the IMF’s financing. The US, for example, pays 17.7% of the IMF’s total subscriptions, with Japan paying just under 6.6%. For that, the US receives just over 16.7% of the voting rights, making it the only country able to block an IMF decision on its own. Japan has voting rights worth more than 6.2%. The subscriptions were also doubled in early 2011. According to the IMF, the subscription amount is determined as a weighted average of GDP (50%), openness (30%), economic variability (15%), and international reserves (5%). With greater subscriptions come more voting rights for the larger, developed economies.

Few at the time could have envisaged its newly bountiful coffers would be put under pressure. But few at the time could ever have envisaged a sovereign debt crisis would have been ignited in Europe, or that the contagion between European markets would be so swift or devastating. The sums the IMF needs to lend are therefore not as huge as the overall liabilities of the European sovereigns involved, but they are still quite considerable. Its exposure to Greece is only US$43bn, compared with its US$77bn exposure to Mexico and US$31bn exposure to Poland.

“Lending at the scale that is now required in Europe was never considered,” said Jens Larsen, chief European economist at Royal Bank of Canada. With Greece, Ireland and Portugal ablaze and all eyes on Spain, Italy and even France, questions are again being asked about the role the IMF will play if the worst-case scenario unfolds, and whether it will have the resources to make a meaningful difference. If Italy, for example, were to be dragged fully into the crisis, the problem would dwarf anything seen so far, even going back to former crises in Argentina or Asia, said Gabriel Sterne, economist at Exotix, the frontier market investment banking group.

The IMF is a small organisation by historical standards, relative to the size of the global trade flows it was originally conceived to help manage. Its war chest once represented about 10% of those flows, compared with a mere fraction of a percent now. Over time its function has also evolved, so that where it once helped with balance of payment problems, it now has to contend with capital movements, in which context its resources look even more meagre. There is little doubt the IMF has access to further financing if it sought it. The real question is where it would look for the capital that would be needed if it were to find its current arrangements insufficient to satisfy demand. “The instruments it has in place to raise funds are probably satisfactory,” said Larsen.

“The real debate is about the scale of the resources and the level of flexibility offered.” “Emerging markets could quite easily triple or even quadruple the size of the fund if they were given the voting rights to entice them,” said Chowla. “But the West, particularly Europe, doesn’t want that input because it doesn’t want to cede control of the Fund.” “The important issue is governance,” said Chowla. Emerging markets have the resources to stump up more cash for the fund that would allow it to play a significant role in bailing out European sovereigns, but they will only hand it over if they also get influence over how the institution is run, he said.

Defining its role

The IMF receives a lot of criticism from free market capitalists, emerging markets themselves and anti-poverty campaigners alike. Many critics on all sides make similar calls for this greater emphasis on debt restructuring. The left argue the socio-economic costs of the IMF’s measures are too high to be justifiable. “Let’s be clear: the IMF is bailing out the banks, not the countries,” said Mark Weisbrot, co-director at the Center for Economic and Policy Research in Washington DC.

Banks have trillions of dollars of exposure to countries with little prospect of paying the money back, but they are still able to report them as performing assets in many cases because the IMF is keeping the countries’ economies on life support. “It is a creditor’s cartel,” he added. The right notes that the IMF’s mandate is to assist with crises of liquidity, but that it is too often drawn into crises of solvency, where loans do not address the causes of the problems. This is a criticism that extends well beyond its part in the Greek bail-out. “The politics is driving the economics,” said Sterne. “The institution is caught between two positions, and ultimately is too often caught playing the role of wanting to act as a beacon to instill confidence. But that is not its role, it should be an honest broker – that is its job.”

The IMF’s real successes come when it is dealing with smaller programmes, where the politics has a less insidious influence, said Sterne. He cited aid to Bosnia, Serbia, Uruguay, Seychelles and even Iraq as successes. It is hard to see how the lessons learnt from these programmes can be scaled up to be applied to larger European countries. “But ultimately the Fund works more often than it doesn’t and that is its real strength,” said Sterne. “The IMF has some excellent programmes but Greece is insolvent and yet the IMF lent to it, which calls into question its debt sustainability analysis,” said Sterne.

“Austerity can work if a country is solvent but you need to know there is a high probability of it working and in Greece it just is not probable that it will work.” The Independent Evaluation Office should be beefed up to allow it to deliver feedback quicker and to ensure the body is accountable and its advice is transparent, he said. “The aim should be to get better IMF policy by making its reputation increasingly sensitive to its actions, and that is what greater transparency and accountability can do.”“The IMF should not be lending to any country where debt is unsustainable, and if public debt is over 80% of GDP the Fund needs to be particularly accountable,” said Sterne. The Fund enjoys the safety net of knowing it is senior to any other lender in the capital structure, and is therefore unlikely to lose money itself.

“That makes its lending to Greece especially reckless because it is pushing existing lenders down the pecking order and could make it less likely they will be paid,” said Sterne. “It is gambling for redemption,” he added. “Maybe the IMF should only be providing analytics input, then the onus would be on EU governments to decide whether they wanted to take the risk of proceeding themselves.”

“The institution is caught between two positions, and ultimately is too often caught playing the role of wanting to act as a beacon to instill confidence”

The IMF’s view, however, is that defining a crisis as one of solvency or liquidity is subjective. While the market might assess a country as insolvent, the IMF could take the view that, if a country takes the measures as prescribed in conjunction with its loan, it will no longer be insolvent. And it rejects the charge of recklessness, noting its loans are made precisely in order that existing creditors can be paid. Critics point to Argentina as the classic example of a failed loan to an insolvent country. But the IMF cites its loan to Brazil, which helped usher a period of prosperity for that country, and which it claims was made under similar circumstances, as vindicating of its actions. “The risk is the Fund is becoming a giant CDO, and is simply using its own superior rating to pass money on to lesser rated members,” said Sterne. “This is exactly what happened with Macedonia, where it offered an unconditional line that was meant to be for a rainy day but which was drawn when the sun was still shining.”

Adapt and survive

There is considerable debate about the IMF’s track record in learning from its mistakes and successfully evolving its practices. For its fiercest critics it is inseparably wedded to a counterproductive dogma, with too little regard for the human impact associated with the implementation of its policies. In Europe it appears to have softened its stance, with some decrying the hypocrisy of its favourable treatment of European member states relative to Asian or Latin American countries in the past. But most have welcomed the change and hope it will continue to rebalance its priorities towards debt write-offs and restructuring, and away from austerity and cuts. It is possible this change as evidence of the growing influence of an increasing number of its own staff who accept that the “recessionary spiral” resulting from the Fund’s measures is taking its toll around the world, said Chowla. But he is pessimistic, believing the IMF will continue with the status quo, which he sees as playing second fiddle to the ECB in Europe. Others are more upbeat. “The intellectual move the IMF has made since it began is huge,” said Larsen, citing capital controls, the sequencing of financial liberalisation, the mix of monetary and fiscal policies and the focus on the financial sector among the areas in which its position has evolved. “What the Fund does now compared to ten years ago is a lot more relevant and it is learning with every crisis,” he added.

“The IMF comes in for a lot of criticism but to be fair if you look at it compared to, say, the United Nations, clearly it is more functional”

The institution may not change as quickly as some would like, admitted Larsen, but its inherent conservatism can be an advantage too: the fund seldom makes rushed statements that exacerbate crises, and fosters a culture than encourages learning and debate, he said. “The IMF comes in for a lot of criticism but to be fair if you look at it compared to, say, the United Nations, clearly it is more functional.” The IMF, too, insists the process of change is already under way, but admits the pace of change is frustrating for some. The perception of the Fund has seen perhaps an even more dramatic shift. “Less than 10 years ago the fund was not taken seriously at all, and was seen by many as something of a nuisance,” said Larsen. “Now it is crucial to the discussions.” “The real risk is for the second tier emerging markets that may require IMF assistance in the future,” said Chowla. “Of course the Fund will find some money to assist its member states when they are in trouble. But how much will be left over when the European problems have been resolved and the crisis is outside Europe? There wont be much money left and the IMF will swing back towards demanding more austerity and less debt restructuring.”

IMF to the capital markets? If the fund were to seek additional capital one option available to it would be to go through the capital markets, a route that is explicitly envisaged in its Articles of Agreement. But while it is possible to imagine the Fund taking such a route theoretically, and there has been talk of it considering a bond, as the World Bank already does, it is a very unlikely measure that would be the last resort. The main problem is an issue of this sort would subject the IMF to market considerations, for example the need to maintain a credit rating, that might conflict with its role as a lender of last resort. If a country was in need of financial assistance and the market had concluded it was too high a credit risk, IMF exposure to that country through a loan might have consequences of its own credit rating, creating a disincentive for it to make that loan. Others have also pointed out if the fund were to raise money in the capital markets, that would also see it concede influence to external forces. An interesting idea is of a bond denominated in SDRs, an alternative currency maintained by the IMF. Some emerging markets, notably China, have cited SDRs as a possible reserve currency to replace the dollar and IMF bonds denominated in the currency would make an interesting first step towards realising this goal.

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