IMF and the Eurozone imf's outstanding General Resources

Account (gra) credits, the European Union

(which includes the eurozone) for about
A Developing Country Perspective
two-thirds, and Europe for almost 80%.
Second, while fiscal problems can no
doubt often spill over into the balance of
ALOK SHEEL payments, imf support is clearly intended
to cover the unfunded liabilities arising out
of balance of payments difficulties, deno-
The International Monetary Fund
their sixth summit at Cannes, minated in reserve currencies included in
has made an assessment that an
Group held their heldof ininsixth Twenty2011November
November against summit (G-20) 2011 at leaders Cannes, against at its basket. This is envisaged in Article i(v)
additional global firewall of $1.1 the backdrop of a rapidly escalating crisis of the imf's Articles of Agreement:

trillion is required to address the emanating from the eurozone, resolved to
ensure the imf continues to have resources to
fallout of the eurozone crisis. But
play its systemic role to the benefit of its
a number of very valid reasons whole membership, building on the substan-
tial resources we have already mobilised
make it clear that the European since London in 2009. We stand ready to en-
Central Bank or some other sure additional resources could be mobilised
To give confidence to members by making
the general resources of the Fund temporarily
available to them under adequate safe-
guards, thus providing them with opportu-
nity to correct maladjustments in their
balance of payments without resorting to
measures destructive of national or interna-

in a timely manner. tional prosperity.

quasi-fiscal mechanism, rather
The International Monetary Fund (imf) The underlying assumption is that the
than the imf must be empowered subsequently made an assessment thatimf steps in as an international lender of
by the eurozone authorities to an additional global firewall of $1.1 trillionlast resort when a country, including its
central bank, has lost market access to
provide the liquidity required. The was required to address the fallout of the
eurozone crisis, of which it needed to raisefund its external liabilities denominated
imf's resources should be used in international reserve currencies. Do-
$600 billion ($250 billion for the euro-
primarily for developing countries zone, $250 billion for innocent bystanders mestic liabilities, no matter how exces-
that lose market access to reserve and other countries, and $100 billion assive and imprudent, can always be funded
liquidity backstop for its membership),through domestic market borrowings,
currencies and need to square and eurozone countries $500 billion. Thisand/or by the central bank by printing
their international payments. was over and above the $750 billion col-domestic currency. No external lender of
lected recently under the auspices of thelast resort is necessary.
G-20 in the wake of the global financial The imf has now been called upon to
crisis. Of this, $500 billion was throughsupport countries in a currency union
new arrangements to borrow (nab) andwhere the domestic currency is also a
$250 billion through a fresh special draw- reserve currency. Since they are both
ing rights (sdr) issue. The imf's proposaldenominated in the same - reserve - cur-
was endorsed by the G-20 at the seventhrency, the divide between fiscal and bal-
(Los Cabos) summit in June 2012, where ance of payments problems of eurozone
its leaders committed to increase the countries is blurred in terms of Article i(v)
firewall by more than $450 billion. of the imf's Articles of Agreement, which
Stabilising the eurozone is critical forenvisages imf liquidity provision only on
developing countries, since a meltdown balance of payments grounds.
there will have catastrophic effects onThird, it is unclear why the imf back-
them. However, the eurozone problemstop is is necessary since the eurozone
collectively has the capacity and tools to
too big for the imf to intervene effectively,
as key resources and solutions lie within address the problem. It has a balanced
the zone. Indeed, the imf's financial in- current account and its public debt is not
out of line with the rest of the world. It is
volvement can seriously cripple its capa-
true that individual countries within the
city to firewall its traditional developing
eurozone have unsustainable deficits that
country clients. There are therefore sev-
need to be financed. The eurozone's col-
eral concerns regarding these additional
resources raised for the imf. lective firepower, however, far exceeds
First, the amounts talked about are very
anything that the imf can hope to mobilise
These views are personal. since the unfunded liabilities are in the
large in comparison to the imf's existing
Alok Sheel ( aloksheel@aloksheel.com ) a currency issued by the European Central
resources. The imf already has an unusu-
member of the IAS is currently at the ally large exposure and concentration Bank
of (ecb). The ecb or some internal fiscal
Department of Economic Affairs, Ministry of
or quasi-fiscal mechanism, such as the
risk in Europe. As of 31 July 2012, the
Finance, Government of India.
eurozone accounted for about half of the
European Financial Stability Facility (efsf)

20 December 29, 2012 vol XLVii no 52 {HQS Economic & Political WEEKLY

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or the European Stability Mechanism be paid in through capital contributions
eurozone countries, it is unlikely that the
(esm), can make the funds available to the market would have allowed such large
over a period of time. This defeats the very
stressed country by purchasing sovereign purpose of a firewall, which is expected
imbalances to build-up in the first place.
bonds, providing liquidity to the banking It has been well known since the time ofto provide an insurance against market
system, or printing money if empowered John Maynard Keynes that the inter- revolt. Eurozone countries expect to raise
to do so, as the ecb has indeed been doing national monetary system has an inbuilt money from the market at a time when
from time to time to calm markets. mechanism for penalising current account bond markets are unstable. The ability to
deficits through the market mechanism. raise the targeted amount in such a situ-
IMF's Possible Role
Such large bailouts would therefore have ation is uncertain, especially since some
It could be argued that since under Sec-
been unnecessary. The absence of such a of the major contributors have recently
tion i of Article rv "each member under-
clear demarcation of responsibilities has been downgraded by rating agencies,
takes to collaborate with the Fund and
created a moral hazard in which the and further downgrades are imminent.
other members to assure orderly exchange Seventh, it is not clear where additional
eurozone can shift its responsibilities to the
arrangements and to promote a stableimf, and through it to the wider inter- resources would come from if the $1.1
system of exchange rates", the imf has national
a trillion of fresh resources raised by the
community, by using the limita-
role to play if the liquidity requirements
tions imposed by the Maastricht Treaty
imf and euro area prove to be insufficient.
The imf's own assessment was that its
of reserve currency issuing countries are soas an argument. But if the ecb is barred
great that money creation would materi- projections were not based on a worst-
from fiscal bailout of eurozone countries,
ally affect the exchange rate stabilitythe imf is also barred from doing so. The
case scenario. The requirement could
that members are obligated to maintain.limitations imposed by the Maastricht be much more if the expected policy
Section 3 of Article iv mandates that Treaty can be corrected through political
response and application of resources are
(a) The Fund shall oversee the internationalnegotiations within the eurozone. not timely, and still higher in the event
monetary system in order to ensure its effec- Fifth, this moral hazard has created
of a global meltdown. The imf's assump-
tive operation, and shall oversee the compli- an anomalous situation where big, poor
tions about growth rates, borrowing costs,
ance of each member with its obligations un-
and credit ratings could also go awry, as
countries with large developmental needs
der Section i of this Article, (b) In order to
fulfil its functions under (a) above, the Fund
of their own are being called upon tothey
as- have in similar cases in the past.
shall exercise firm surveillance over the ex- sist much richer countries unable or un- Such as in the case of Greece. Or even in
change rate policies of members, and shall willing to adjust. This may be difficult to the case of the extant efsf/esm firewall.
adopt specific principles for the guidance of justify and defend in their parliaments. Such dynamic factors make it difficult to
all members with respect to those policies.
Till recently, imf lending was mostly draw a fine line between illiquidity and
However, whereas the imf's intervention directed at low to middle-income develop- insolvency, as the former can easily turn
on balance of payments considerations ing countries facing balance of payments into the latter. Some eurozone countries
under Article i(v) envisages making its problems arising out of macroeconomic in trouble, such as Spain and Italy, are
general resources temporarily available, mismanagement or external shocks. The too big to bail out by the esm and imf put
its intervention under Article iv(3) is larger developing countries now have their together. It is therefore unsurprising
limited to surveillance and determination own insurance mechanisms in the form that far from a "shock and awe" effect on
of par values (Article iv Section 4). In any of large reserves. As a result, while mostmarkets, Spanish and Italian bond spreads
case, to the extent that the eurozone crisis of the funding sources were traditionallydid not evep respond to the "big bazooka"
is largely a crisis of confidence because from developed countries, the share ofcommissioned by the G-20 at Los Cabos.
of the absence of sovereign backstops, emerging market economies is increasingThe Los Cabos firewall was conceived as
clarification regarding monetary or quasi- sharply, especially after the recent nab anda one-off exercise. So what happens now
fiscal sovereign backstops might restore quota reform. The share of Brazil, Russia,that the big bazooka is perceived as
market confidence without the need for India and China (bric) countries in the mere field artillery by markets? Would
large amounts of liquidity creation. nab was about a fifth. On the other hand, members be willing to commit still more
Fourth, in retrospect it appears that the share of developed country borrowers,resources to the imf?
when some members of the imf unilater- especially those in Europe, has been Eighth, while the imf's resources are
ally entered into a reserve currency union, increasing. This has created an anomalouslimited and the eurozone's requirement
the articles of the imf should have been situation in which large emerging coun- is primarily denominated in euros, the
amended, clearly demarcating the re- tries with relatively low per capita incomesultimate backstop that can provide
sponsibilities of eurozone country central are coming to the rescue of much richerunlimited liquidity in that currency area
banks, the ecb and the imf, because of the developed countries. can only be the ecb, which has a mono-
blurring between domestic and external Sixth, unlike imf resources that are poly in creating euros. The conventional
liabilities, and because members of the already sitting in the reserves of member wisdom is that countries are constrained
currency union could no longer use one countries, the eurozone component ofto turn to the imf when their own public
critical instrument of macroeconomic the global firewall would be mostly in the finance backstop is of no use in financ-
adjustment in imf programmes - the ex- form of commitments to be raised from the ing deficits. This backstop is the central
market as and when required. Only 15% ofbank.
change rate. Indeed, had the exchange rate It is not possible to manage a
the esm of $500 billion would actuallycountry's public finances without the
instrument been available to peripheral

Economic & Political WEEKLY HTTT] DECEMBER 29, 2012 VOL XLVII NO 52 21

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central bank backstop, even though this Ninth, the ecb or a quasi-fiscal back- Tenth, for these, or at least some of these
backstop is rarely used. Not having this stop can be an effective liquidity buffer to reasons, the us, the biggest shareholder of
backstop deprives sovereign countries of insulate crisis-ridden governments from the imf, was unwilling to commit addition-
a critical policy instrument, the inflation market revolt and buy time, but the prob- al resources to the Fund at the Los Cabos
tax, which is sometimes required to put lem of excessive domestic and external G-20 summit as it was of the view that the
public finances back on a sustainable deficits within the eurozone will not go eurozone had both the resources and in-
track. Without this policy instrument, away, and additional policy action would struments to resolve its internal crisis.
governments would be forever hostage to be required. Or else, the sovereign debt For the above reasons, the decision to
markets. The eurozone's public finances of peripheral countries would simply be enhance the imf's resources yet again was
are hostage to markets precisely because transferred to the balance sheets of the deeply flawed from both the macroecono-
its sovereigns do not have such a back- imf, and to eurozone sovereigns through mic and developing country perspectives.
stop. This is perhaps why the borrowing the ecb and esm. The debts would still The analysis here indicates that far from
spreads of some sovereigns whose public need to be restructured, and a determi-augmenting the resources of the imf for
finances are on a sound footing have risen nation made on sharing haircuts. Govern-eurozone bailouts, the imf's resources
to surprisingly high levels, and higher ments would also need to redeem the need to be ring-fenced against this moral
than those of European countries with remaining debt in future through sur- hazard, so that they are used only as a
worse public finances but outside the pluses, both internal and external, gen-
last resort, and primarily for poor devel-
eurozone. Now that markets seem to erated by tough adjustments and struc- oping countries that lose market access
have discovered a flaw at the heart of the
tural reforms, including a roadmap for to reserve currencies and need to square
Economic and Monetary Union (emu), fiscal and banking integration. Since the
their international payment commitments.
inflation tax instrument is not available
long known to economists, it may be dif- While the imf may well have a role to play
ficult to permanently restore market
for stabilising domestic public deficits (as in resolving the eurozone crisis, this can
confidence till this is fixed to their satis-
individual countries do not have mone- only be as a policy advisor and monitor,
tary independence), and the exchangerather than a provider of resources, where
faction, at least as long as there are lin-
gering concerns over debt dynamics.rate instrument is also not available for it can only be a marginal player, and that
Therefore, more resources for the euro-
external adjustments (with all its flaws, too by vastly worsening its risk profile.
zone might kick the can further down the Bretton Woods "non-system" has a The question that needs to be asked is
the road, and might restore confidence mechanism for adjusting the externalthat if imf funding for the eurozone is so
deficits of countries through currency de-patently indefensible, why did it escape
for some time, as the earlier imf package
and the efsf/esm did, but the problem preciation forced by markets; the euro'sstricter scrutiny by the G-20, the imf, and
may not go away till this basic flawexchange
is rate, however, responds to theboth developed and developing countries?
cumulative current account position of theThere could be a number of reasons why
fixed to the satisfaction of markets. Plug-
ging this weakness permanently should zone, which is balanced, and not to theall the stakeholders came on board. As far
current accounts of individual countries,as the imf is concerned, there was a clear
have been considered as part of the issue
of imf resources. Eurozone countries which are highly imbalanced), individualconflict of interest as its extant quota
have taken a number of hard and coura- countries cannot force real depreciationallocation and top leadership is dominated
geous decisions. Markets, however, are through inflation. That leaves a down-by European countries. The imf no doubt
tough and heartless taskmasters. Having ward adjustment in nominal wages as has an army of well-trained economists.
seen agreements to maintain fiscal disci- the only option for improving the pro- But as a study of the imf's internal func-
pline in the past not work, they might be ductivity necessary to bridge external tioning by its own Independent Evalua-
equally sceptical of tighter rules in the deficits and increase domestic savings. tion Office has observed, its culture is
absence of the tried and trusted back- This carries the threat of social unrest andcharacterised by "group think" that does
stop that is known to work. a downward deflationary spiral, whichnot encourage contrarian thinking.
could make the debt even more unsustain-
Another major stakeholder, the fast-
Responsibility of ECB able in real terms. It could be partly growing Emerging Market and Developing
In the light of the above, the bottom line countered by propping growth by switch-Economies (emdes), including those with
is that the ecb, or some other quasi-fiscal ing expenditure from consumption to large net external liabilities that could ill
mechanism, must be empowered by the investment, especially in infrastructure. afford large contributions, such as India,
eurozone authorities to provide the li- There appears to be no other solutionmay have become willing parties to
quidity required rather than turning to to resolving the eurozone's problems shortdemonstrate their entry to the global
the imf, whose resources should be used of some countries leaving the emu alto-stage. But, perhaps, most importantly,
for developing countries whose currency gether, either temporarily or perma-given the potential of the eurozone to
is not a reserve currency. The imf has nently, the costs of which could be evendestabilise the global economy, the G-20
adequate resources to meet their re- higher. By remaining within the euro-may have wanted to lend moral support
quirements. The bigger emerging mar- zone, the ecb backstop could insulate to its leaders, cheering them on the side-
kets do not need imf cover at this stage governments from the vagaries of thelines, with the full knowledge that the
as they are self-insured on account of market, giving them more time for carry-resources they were raising would not
their plentiful hard-currency reserves. ing out necessary adjustments. make a material difference.

22 December 29, 2012 vol XLVii no 52 CEES Economic & Political weekly

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