January 22, 2012 2:28 pm
The IMF should stay out of the eurozone crisis
The International Monetary Fund has earmarked 91 per cent of its definitive commitments to programmes in Europe. There is now a proposal on the table that suggests this is not enough and should be significantly increased.
Would an increase in IMF funds to bail out the eurozone be justified? In particular, should non-eurozone countries participate in raising this new capital?
I think not.
The IMF is right, of course, to conclude that the eurozone crisis is the main risk facing the global economy right now. The world has a strong interest in the resolution of the crisis. But greater IMF involvement in specific EU programmes is not necessary, and quite possibly counterproductive.
It is not necessary because the eurozone has the financial capacity to help itself. The combined region runs a small current account surplus with the rest of the world. As a result of this, it does not depend on outside finance. It has its own central bank, which can, in theory at least, act as a lender of last resort. The eurozone operates, of course, under political and legal constraints, such as the deficit rules of the Maastricht treaty, the “no bail-out rule”, or the rules preventing the European Central Bank from funding governments. However, an outsider would be right to argue that these rules are all self-imposed, and hence reversible. The eurozone should change its rules before crawling to others, cap in hand.
Considering that the eurozone is economically unconstrained, and among the richest regions in the world, the request to involve the IMF in hypothetical future rescue operations is morally reprehensible. What is happening here is that eurozone member states find it hard to commit additional funds to the rescue operations, and find it politically more expedient to channel resources through the IMF as a way to bypass national parliaments.
But there is an even more important argument in my view. The way the eurozone member states have been dealing with the crisis has increased the chances of a catastrophic outcome. An extension of the IMF’s commitments is very likely to support current policies.
The developing recession is to a large extent the result of a premature interest rate rise by the ECB, a hesitant crisis response, a failure to recapitalise the banking sector after the 2008 financial crisis and knee-jerk fiscal procyclicality. The new Spanish government admitted last week that there is no way it can meet this year’s deficit target of 4.4 per cent of gross domestic product, set up at a time when the authorities were in a position to pretend the economy would rebound.
Italy has already tightened fiscal policy despite the recession, and Spain, too, will come under pressure to do so. Everyone is following in the footsteps of Greece.
The eurozone’s cumulative policy errors are turning a liquidity squeeze into a solvency crisis. And herein lies an acute risk for the IMF. If Italy were to become trapped in a long recession, the probability would increase significantly that it would not be able to repay its debt, currently at 120 per cent of GDP. News reports from Italy suggest that the IMF is about to forecast a two-year recession for the country, which could well lead to an increase in the debt-to-GDP ratio at the end of that period.
Italy’s future solvency is entirely dependent on market interest rates and the prospect of a return to strong and sustainable economic growth. I struggle to think how this can be accomplished without a fiscal union and much greater burden-sharing.
There are additional technical arguments that would favour more cautious IMF involvement. Mario Blejer, the former governor of the central bank of Argentina, argued recently that the IMF’s preferred creditor status could become a problem, as an IMF loan would automatically subordinate every other bondholder. The probability of a default on those defaultable bonds is thus significantly higher.
Furthermore, the situation could become so acute that the IMF’s seniority might fail, which in turn would endanger its capacity to lend at low interest rates.
There are several proposals on the table for how to involve the IMF in a clever way. But they all are subject to the same problem. Any outside liquidity assistance would encourage the eurozone to proceed with policies that are aggravating the crisis.
The best contribution the IMF could conceivably make, therefore, is to stay out of programmes beyond those it is already committed to. If it has to become involved, it should at the very least try to make any further commitments conditional on fundamental policy shifts, both at national and eurozone level. In particular, the IMF should insist on a minimum degree of joint economic management to address some of the underlying issues, including the fragility of the banking sector, and policies to remove the interdependence of national banks and national governments.
The IMF would be unwise to become mixed up in those debates.
Copyright The Financial Times Limited 2012.
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