The IMF faces a big dilemma in its efforts to support the global economy at its time of desperate need. Simply put, the fund’s problem is that most of the $1tn that it says it can lend is effectively unusable.
There were several notable achievements during last week’s spring meetings. First, the fund’s frank set of forecasts for world GDP growth were a grim but valuable reminder of the scale of the crisis we are facing. Second, the organisation’s richer members will finance a temporary suspension on payments to the IMF for 29 very poor countries.
Finally, and most important, a boost to the fund’s main emergency facilities — the Rapid Credit Facility and the Rapid Financing Instrument — now makes $100bn of proper relief available to a wide range of countries.
But the core problem is that the vast bulk of the fund’s firepower is effectively inert. This is because of the idea of “conditionality”, which underpins almost all of the IMF’s lending relationships with member states.
Under normal circumstances, when the IMF is the last-resort lender to a country, it insists that the borrowing government tighten its belt and exercise restraint in public spending.
This helps to achieve three objectives. One is to stabilise the public debt burden, to ensure that the resources made available are not wasted. The second is to limit the whole economy’s need for foreign exchange, a shortage of which had prompted the country to seek the IMF’s help in the first place.
And the third is to ensure that the IMF can get repaid. Since the Fund does not take any physical collateral from countries to whom it is lending, the belt-tightening helps to act as a kind of collateral.
In other words, it helps to maximise the probability that the IMF does not suffer losses on its own loan portfolio — losses that would have bad consequences for the fund’s role within the international monetary system.
This is a perfectly respectable goal. Walter Bagehot, the legendary editor of The Economist, established modern conventional wisdom about managing panics. Relying on a medical metaphor that feels oddly relevant today, he said that a panic “is a species of neuralgia, and according to the rules of science you must not starve it.”
Managing a panic, therefore, requires lending to stricken borrowers “whenever the security is good”, as Bagehot put it. The IMF has had to invent its own form of collateral, and conditionality is the result.
The problem, though, is that belt-tightening is a completely inappropriate approach to managing the current crisis. Countries are stricken not because they have indulged in any irresponsible spending sprees that led to a shortage of foreign exchange, but because of a virus beyond their control.
Indeed, it would seem almost grotesque for the fund to ask countries to cut spending at a time when, if anything, more spending is needed to stop people dying or from falling into a permanent trap of unemployment.
The obvious solution to this problem would be to increase the amount of money that any country can access from the fund’s emergency facilities well beyond the $100bn now available.
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But that kind of solution would quickly run up against the IMF’s collateral problem. The more the IMF makes available as true emergency financing with few or no strings attached, the more it begins to undermine the quality of its loan portfolio. And if the IMF’s senior creditor status is undermined, then an important building block of the international monetary system would be at risk.
One way out of this might have been an emergency allocation of special drawing rights, a tool last used in 2009. This would credit member countries’ accounts with new, unconditional liquidity that could be exchanged for the five currencies that underpin the SDR: the dollar, the yen, the euro, sterling and the renminbi.
That will not be happening, though, since the US is firmly opposed, for reasons bad and good.
So in the end the IMF and its shareholders face a huge problem. It either lends more money on easy terms without the “collateral” of conditionality, at the expense of undermining its own balance sheet; or it remains, in systemic terms, on the sidelines of this crisis.
And since there will be some eye-watering increases in the public debt burdens of many emerging economies, the IMF’s struggle to find a way to administer its medicine will certainly last beyond this round of the coronavirus outbreak.
The writer is head of emerging market economics at Citigroup
Source: Economy - ft.com
