The Fund has much at stake in the euro's survival
As this column appears in print, the so-called “make or break” summit of European Union leaders (the European Council) will be entering its second day in Brussels. Past meetings have typically not met the exaggerated expectations that preceded them; this time is unlikely to be different. The key document to be discussed is a paper produced by the President of the Council, Herman Van Rompuy. Titled “Towards a Genuine Economic and Monetary Union”, it seeks political support for institutional changes needed to address flaws and tensions in the project of European integration cruelly revealed by a global financial crisis that began elsewhere.
This meeting of the European Council follows hard on the heels of the G20 leaders’ meeting at Los Cabos, where the global consequences of the European crisis dominated the proceedings. This was also the case when the same group of leaders met in Cannes some seven months earlier. The return to recession in most countries of the European Union, with the financial crisis of the euro zone sovereigns and banks at its core, is rightly seen as a global problem, not just a parochial European concern.
While trade and finance are obviously the most important channels by which the euro crisis affects other G20 countries, an additional concern is the potential reputational and financial exposure of the International Monetary Fund (IMF). It is now difficult to recall how reluctant European governments were to induct the IMF as a partner in resolving the crisis, at that time expected to be limited to Greece alone. In the three decades before the Greek programme in 2010, the IMF’s financial support had been exclusively directed to developing countries, broadly defined. It was, therefore, a major step for Greece to apply to the Fund for financial support. It did so largely at German urging, which in turn was motivated by a desire to exploit the IMF’s experience in designing and monitoring adjustment programmes, as well as to introduce a buffer in an increasingly charged bilateral relationship.
As per information available on Wikipedia (http://en.wikipedia.org/wiki/Greek_government-debt_crisis), of the original financial package of euro 130 billion, the IMF pledged euro 30 billion from its resources, with the remainder coming on a shared basis from other countries in the euro zone on a formula reflecting their economic size. As is now well known, that initial programme was a failure and the final tranche of Fund resources was not released. The euro zone countries were compelled to assemble a second package (of euro 100 billion) in July 2011, under the framework of the newly constituted European Financial Stability Facility (EFSF). The Fund did not commit additional resources to this package but re-entered with additional funding to support the third bailout package in March 2012 with an Extended Arrangement in the amount of SDR 24 billion. Over the period of the Greek saga, the IMF has also entered into large extended arrangements with Ireland and Portugal, whose fate has so far been much better than the experience with Greece. Fund data as of last week indicate that the Fund’s total exposure to the three countries stands at approximately SDR 67 billion, or around $100 billion (euro 80 billion).
As is well known, the latest Greek package was accompanied by a massive “voluntary” write-down of the face value of debt held by private creditors. In all, private debt in the amount of euro 206 billion ultimately participated in the bond exchange, representing a reduction in face value estimated at euro 100 billion. Of greater concern, however, is that after the restructuring the great bulk of Greece’s sovereign debt is owed to the official sector. If it is indeed the case, as many observers fear, that Greece will need further reduction in its sovereign debt in the future, it will be difficult for official lenders, including the Fund, to be exempted as they were the last time.
So far the IMF has not been asked to support the rescue package for Spain. Unlike Greece, but like Ireland, Spain’s underlying problems are not ones of external competitiveness or even profligate spending (although the nation’s chronic problem of high unemployment does point to the need for greater domestic flexibility). They are largely the product of an enormous property crash, one that is still underway. Spain’s public finances are stressed because of the recession generated by the crash, and are in a poor position to take on the additional burden of capitalising several major and medium-sized banks. The reaction of the Spanish debt markets to the prospect of support from the EFSF is revealing. The fear that Spain will take on additional debt that will be preferred over existing private debt has caused yields to rise rather than fall, perhaps partly reflecting fears that the precedent of the write-down of private debt established in the case of Greece may ultimately also become necessary in the case of Spain.
Finally, there is the issue of the IMF’s stance towards the construction and governance of the euro zone itself. Given the significant presence of euro zone members in the IMF’s executive board and in the staff, including all past managing directors, it is perhaps not surprising that a somewhat indulgent stance was taken in the early years of the common currency. This was despite warnings from leading Anglo-Saxon academics of the vulnerabilities inherent in its design. As the crisis has continued and intensified, the Fund’s analysis has become sharper and its diagnoses better, with the present managing director being prepared – and able – to utter blunt truths that national leaders may prefer not to hear. Indeed the Fund’s report on the eve of the forthcoming summit argues that a “determined move” toward a banking union and more fiscal integration would be needed to arrest the decline in confidence engulfing the region.
More broadly, the euro crisis has shown, more than ever, why the world needs a truly bold, professional and intellectually independent IMF. The global economy has suffered enormously as a result of financial miscalculations by politically powerful, systemically important countries. The Fund’s role is to create a global climate of opinion in which the riskiness of such behaviour is analysed and exposed through careful, sophisticated analysis. It may not prevail — but it must keep trying.
The writer is chief economist at Shell International.
These views are his own
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