Today we are fortunate to have as a guest contributor Joseph Joyce, Professor of Economics at Wellesley College, and author of the new book, The IMF and Global Financial Crises: Phoenix Rising? (Cambridge University Press).
The rise and fall of the IMF's reputation
The latest twists and turns in the saga of the Greek debt crisis are signs that the brief honeymoon the Fund enjoyed in the wake of the “Great Recession” has ended. The wide-spread approval the IMF received for its “first wave” of lending in 2008-09 has been followed by debates over the size and effectiveness of its lending in the more recent “second wave.” The Greek government won narrow legislative approval for a new round of spending cuts and tax hikes, but its debt/GDP level is projected to rise to 190% by 2014, far ahead of the IMF’s recent predictions. The publication by the IMF of a range of fiscal policy multipliers higher than those used in past projections of the impact of fiscal consolidation in Europe displeased advocates of those policies while providing support to those who believe that the fiscal conditions attached to these programs were too strict.
The IMF’s initial lending followed a period when the demand for its assistance had dwindled. During the early 2000s, there was a decline in the incidence of bank, currency and sovereign debt crises, and as a result the need for the IMF’s resources fell. In 2007, when there were ten new concessionary programs for low-income countries funded by the Poverty Reduction and Growth Trust (PRGT), only two new non-concessionary programs for middle- and upper-income nations financed through the IMF’s General Resources Account (GRA) were approved (see Figure 1).
Figure 1: Numbers of IMF Arrangements Approved in Financial Years ended April 30. Source: IMF Annual Reports.
But when the U.S. and European financial crisis turned into a global economic downturn in the fall of 2008, the IMF under Managing Director Dominique Strauss-Kahn took on the role of international lender of last resort. In the “first wave” of lending to 17 nations, it moved quickly to provide large amounts of credit to those members most affected by the disruption of trade and financial flows. The Ukraine, for example, received a Stand-By Arrangement (SBA) of $17.3 billion, which represented 802% of its quota. Iceland, the first upper-income country to enter a Fund program since the 1970s, received $2.2 billion, 1,190 % of its quota, after a spectacular collapse of its banking system. Pakistan received $11.3 billion, 700 % of its quota.
The policy conditions that accompanied these loans reflected an awareness of the nature of the global downturn (Ghosh et al. 2009, Ghosh et al. 2011). The contraction in global economic activity required an easing of domestic macroeconomic policies, including lower interest rates and some fiscal stimulus in countries with records of stable policies. Exchange rate devaluations could be useful, but their size depended on a country’s conditions, and the IMF warned of possible contractionary effects. Moreover, the IMF agreed that capital controls have a place in policymakers’ toolkits, a significant departure from its past policy stance. The IMF also revised its programs in order to enhance their effectiveness. It established a new facility, the Flexible Credit Line (FCL), which allows countries with strong fundamentals to draw funds without conditions that can be repaid over a period of up to five years. The new facility was more acceptable than its predecessors, and Mexico, Poland, and Colombia signed up.
The members of the G20 group of nations, which replaced the G7 as the “premier forum” for international economic governance, showed their support for the Fund by endorsing an increase in its financial resources of $500 billion. The G20’s national leaders also pledged to establish a process for the mutual assessment of their economic policies, assisted by the IMF. They approved a shift in the quota positions of the IMF of at least 5% to the underrepresented countries, and endorsed a call for the selection of the next managing director of the IMF through a merit-based process rather than following the traditional practice of allowing the European governments to appoint one of their nationals to the position.
By the second half of 2009, the global crisis had moderated and there were signs of recovery. The IMF’s efforts were generally seen as timely and effective, and its reputation soared. But the advanced economies’ slow recovery from the global crisis had troublesome consequences for their fiscal positions. Increased government expenditures and declining tax revenues had resulted in budget deficits. Rising sovereign debt levels also reflected the absorption by governments of distressed assets on their banks’ balance sheets. The IMF’s response became part of a “second wave” of lending which eventually encompassed 13 countries.
The bond markets responded to the increases in European debt levels by demanding higher returns from sovereign borrowers. Greece, which had taken advantage of low borrowing rates for members of the Eurozone, was their first target. After its government announced that the fiscal deficit for 2009 would be twice as large as previously estimated, the return on Greek bond yields soared. In April 2010 the Greek government requested support from the other European governments and the IMF.
The IMF joined the European Commission and the ECB (the “troika”) in providing $145 billion in financing, with $40 billion from the IMF in the form of a three-year Stand-By Arrangement (SBA). The IMF’s commitment was equal to about 3,200% of Greece’s IMF quota at that time, a record amount. The IMF’s program with Greece included conditions that were similar to those the Fund had sought in the 1980s and 1990s. The program stipulated a reduction in the government deficit, which would be accomplished through spending reductions, increases in the collection of taxes, and the curtailment of entitlement programs.
Ireland became the next country to require a financial rescue by other European governments and the IMF in December 2010. The amount committed under the agreement totalled about $113 billion, which included a three-year Extended Fund Facility (EFF) from the IMF to provide $30 billion, worth about 2,322% of Ireland’s IMF then-quota. Since the source of Ireland’s debt problems was very different from the fiscal deficits in Greece, its program’s conditions had a different focus. They called for a restructuring and downsizing of the banking sector, although fiscal consolidation was also a component.
Portugal followed in May 2011. The IMF and the EU approved a financing package of $116 billion, including a three-year EFF for $39 billion, worth 2,306% of its quota. The policy conditions included a reduction in the government’s deficit, and the fiscal curtailments included cuts in public sector wages and staff positions.
These European loans dwarfed the other country arrangements in the “second wave” of Fund lending. The amount of the IMF’s outstanding credit doubled from 41.2 billion SDRs in fiscal 2010 to 94.2 billion SDRs in 2012 (see Figure 2), and the IMF was obligated to borrow $438 billion from its members. The European loans were far above the conventional rules on access to Fund credit, which had been lifted to 200% of quota within one year and 600% over three. The IMF had issued criteria to govern exceptions to these rules in 2003, and one of these was a high probability that the country’s public debt is sustainable. In the staff report that accompanied the announcement of the Greek SBA, the IMF’s economists admitted that there were “significant uncertainties” over the sustainability of its debt in the medium-term, but claimed that the arrangement was justified because of the high risk of systemic spillover effects.
The measures designed for Greece proved to be inadequate. In 2012, a new financing package, linked to a substantial restructuring of Greece’s sovereign debt, was arranged. Bondholders agreed to a write-down of about 75% of the present value of their bonds, and the Greek government received a commitment for $170 billion in new financing from the official sector. The IMF’s share took the form of a four-year EFF of $36.7 billion, which replaced the cancelled program of 2010. The new program established a new fiscal target of a primary budget deficit in 2012. But a youth unemployment rate of 50% has raised doubts about the viability of these measures, and a similar situation in Spain shows that Greece is not alone. Several European countries faced the prospect of a new "lost decade."
There are several significant differences between the two waves of IMF lending. First, the former followed a financial shock in the advanced countries, while the latter reflected domestic fiscal and regulatory policies that need correction. Consequently, there was relatively limited conditionality associated with the first group of programs, but more extensive measures in the European programs. There are contributing to the general European economic downturn.
Second, while the IMF lent substantial amounts during the first wave of lending, the size of the European programs surpassed previous records. The emerging market governments are suspicious of IMF programs that appear to be more generous than those extended during earlier crisis periods. In addition, the relaxation of the criteria for exceptional access raises doubts (Schadler 2012) about the IMF’s ability to withhold credit in future debt crises.
Third, the Fund’s traditional “crisis manager” role in previous crises gave it control over the recovery programs and disbursements of credit. But in Europe it works in partnership with governments that also give assistance, particularly Germany, one of the IMF’s largest members. Chancellor Angela Merkel faces opposition from indignant taxpayers who do not want to pay the bills of profligate governments, while public officials differ over the degree of involvement of the private sector in any debt restructurings. The European Central Bank is also a major player in these negotiations and under President Mario Draghi takes independent positions. Consequently, the IMF is forced to reconcile the efforts of governments and organizations with different interests and goals. In addition, the IMF itself went through a change of leadership when Strauss-Kahn resigned and was replaced by Christine Lagarde, another French national. The IMF missed an opportunity to appoint a non-European and meet the G20’s call for a merit-based process free of regional influences.
The events in Europe pose challenges to the IMF. The Fund is caught in the crossfire among Eurozone governments and their citizenries over how to deal with members in financial distress. The IMF is rightly concerned that it will lose its newly-won credibility if it approves plans that are unrealistic. Meanwhile, the slow pace of implementation of quota reform perpetuates the image of the IMF as an organization under the control of the U.S. and European nations.
Figure 2: Outstanding IMF Credit in Financial Years ended April 30. Source: IMF Annual Reports.