David Cameron yesterday warned that the UK could be forced to go cap in hand to the IMF, as it did in 1976 under chancellor Denis Healey. (This, by the way, at the launch of a new programme at Demos about ‘progressive conservatism’. Et tu, Demos?)
The question is, would the IMF have the cash. Click on more to read a story I recently wrote for my mag, www.emeafinance.com, which looks at the risk of the IMF running out of money in the next 18 months, and asks what the chances are of it receiving more funds from cash-rich G20 governments (answer: slim).
Who’ll bail out the IMF?
In January 2008, the IMF’s managing director, Dominique Strauss-Kahn, sent out a confidential document to the fund’s 2,400 full-time staff, telling them to get ready for the axe.
The memo said the staff should prepare for the “trauma” of sizeable downsizing, with around a sixth of the staff to be fired, and the staff budget of the fund to be reduced by US$100mn. “This is not a good time for staff”, the memo read. “Their expectation of a full career at the fund in exchange for their unflinching dedication and loyalty is in question.”
The fund had lost the great influence and power it had enjoyed during the 1990s, when it leant billions of dollars to crisis-hit Asian economies. Its power, then, was symbolised in the famous photo of then IMF director Michel Camdessus standing with his arms crossed like a strict schoolmaster, while the elderly Indonesian President Suharto bent over a desk to sign a humiliatingly-punitive IMF bail-out.
Emerging market governments learnt the lesson of that time. Many of them built up huge foreign exchange (FX) reserves, and bought back much of their existing public debt, so that they would never have to genuflect before the IMF. It gradually faded from the headlines and from the markets. “Some of my younger staff don’t even know what the words IMF stand for,” says Richard Luddington, vice-chairman of general capital markets at UBS.
Ousmene Mandeng, head of public sector investment advisory at Ashmore Investment Management, says: “I used to work at the IMF until October. When I left, I had the impression the fund would never play the role it once had in 1998. In hindsight, it seems absurd.”
Busiest month ever
A lot can change in a year. November was the busiest ever month for the IMF. It lent US$41.8bn in bail-outs for Hungary, Ukraine, Iceland and Pakistan, and is in talks to provide further big loans to Turkey, Belarus, Latvia and Serbia, with other countries, such as Bulgaria, Romania, Estonia, Lithuania and Poland also potential clients in the coming months.
At the end of October, the fund also launched a new US$200bn short-term facility, to help countries that have “a very strong track record but are nevertheless facing pressure on its balance of payments”, in the words of Strauss-Kahn. The facility would allow such countries to draw down 500% of their IMF quota (ie, the amount they contribute to the IMF annually) up to three times a year.
Having been criticised in the past for being too slow to respond to crises, and for imposing excessively harsh conditions on its loans, the IMF has drawn some praise for the speed and size of its November bail-outs.
At the beginning of the month, it provided €12.3bn to Hungary to help it cope with an FX crisis provoked by the government’s high levels of debt, high fiscal deficit and high current account deficit. The loan was part of a €24bn coordinated package with the World Bank and the EU. It was the first IMF bail-out of a stet country since the UK borrowed £2.3bn from the IMF in 1976.
Nigel Rendell, senior emerging markets analyst at RBC Capital Markets, says: “It was a huge amount of money, way above Hungary’s quota. Hungary probably didn’t need that much, but it was better too much than too little. I think both the Fund and the EU wanted to send a signal to speculators that they were ready to stand by other vulnerable markets in the region.”
The conditions were that the government further reduce its deficit, which it was trying to do anyway, via a wage freeze for public sector employees and an elimination of a bonus for pensioners. The bail-out also commits the government to recapitalising its banking sector.
This has already helped give some support to the forint, and has lowered the CDS spreads on Hungary’s sovereign debt by around 100 basis points to 380bp, from a high of over 600.
However, the cuts on public spending, and an expected steep drop in bank lending next year, mean the country is heading for a severe recession, with analysts predicting that GDP will contract by between 1 and 5% next year. Workers marched on the parliament in the last weekend of November protesting against the pay-cuts. And the banking system is likely to come under greater pressure if the forint devalues further.
The IMF’s US$16.4bn bail-out for Ukraine was, if anything, even more generous considering the size of Ukraine’s economy. The conditions were relatively relaxed, demanding that the National Bank has a more flexible currency strategy, which many analysts had been saying was necessary for some time.
This time, the IMF acted without the EU, which caused concern among some investors in Ukraine that the country would find itself on the wrong side of what Ukrainian prime minister, Yulia Timoshenko, called “a new financial Iron Curtain”.
Still, the IMF on its own acted very quickly to intervene and support Ukraine. And the government is, according to reports, relying heavily on the fund’s advice to guide its own rather slow responses to the crisis.
Ousmene Mandeng of Ashmore says: “I was surprised by the size of the Ukraine package. Why didn’t the government use its own reserves? Maybe it hadn’t been able to formulate its own policy measures. It might give the IMF some credibility, to be called in like that, but it undermines the authority of the Ukraine government, which could have coped with the crisis on its own.”
The stigma of IMF help
In some ways, calling in the IMF can be a political as well as an economic life-saver for struggling governments. Peter Elam Hakansson, the founder of East Capital, which is one of the biggest portfolio investors in the CEE region, says: “It allows governments to blame the fund for difficult policy measures like freezing wages and cutting government spending. And indeed, governments in Hungary, Ukraine, Latvia and elsewhere have been doing just that.”
But blaming the IMF for policy measures ultimately weakens a government’s own authority. It is, in effect, admitting that a country does not have the strength to be responsible for itself, that it is a colony rather than an autonomous sovereignty. This is a great blow to the prestige of some emerging markets, who a year ago were boasting about how much they had matured since the 1998 crisis.
Some emerging market governments can legitimately boast about no longer needing the IMF’s help. Several CEE countries are in good shape, such as Slovakia and the Czech Republic. Russia is also is excellent fiscal shape, thanks to its prudent build-up of petro-dollars during the boom years. Kazakhstan is also sufficiently wealthy to be able to clear up its financial system on its own.
What this means is a two-tier system is growing up within emerging markets – those countries which are capable of governing themselves, and those which need external assistance. And there is a definite stigma to being in the second group.
Mohammad El-Erian, co-CEO of Pimco and a former director at the IMF, says: “Some countries have self-insurance, and others have none. So emerging markets have gone from a homogenous bloc to one which has become very country-specific. It might not even make sense to talk about ‘emerging markets’ as an asset class that includes both China and Seychelles”
The two-tier system within emerging markets will be exacerbated by the fact that some governments, such as China, the US, UK, Russia and UAE, can afford multi-billion-dollar fiscal stimulus plans, while those countries that seek IMF assistance will be forced to cut public spending just as their countries head into recession.
Dennis Leech, an economics professor at the UK’s Warwick University who covers the IMF, says: “The IMF has told Hungary, Ukraine, Pakistan and Iceland to balance their budgets and cut expenditure. Meanwhile the US, the country with the most voting power in the IMF, is desperately trying to spend its way out of recession. There’s a clear double standard.”
The stigma of seeking help from the IMF is perhaps what has prevented any country so far from drawing some funds from the short-term lending facility. Mandeng says: “There’s a first mover issue there – who wants to be first to take advantage of the facility, and what kind of group will you be in if you participate? What kind of signal does that send to investors?”
IMF funds ‘inadequate’, but G20 governments unwilling to help
There is also the issue of how much help the IMF can give in 2009. The fund has reserves of US$200bn, but if the fund keeps spending like it did in November, this won’t last six months.
In November, Strauss-Kahn sent a letter to the members of the G20 saying that the IMF’s resources were “inadequate” to cope with the crisis, and calling for more funds to be made available. He wrote: “there may be concerns in markets that the official resources needed to stabilize the situation are inadequate, which could exacerbates the problem as investors head for the exits.”
Strauss-Kahn later said the IMF needed at least another US$100bn to help countries through the next six months. Where would this money come from?
Western governments have been hoping that oil-rich Gulf countries would foot the bill. In November, UK prime minister, Gordon Brown, went on a tour of the Middle East, trying to convince Middle Eastern governments to bail out the world economy, via a huge capital injection into the IMF. He said: “The oil producing countries, who have generated over US$1tn from higher oil prices in recent years, are in a position to contribute” to an expanded fund.
Brown then organised a G20 meeting in Washington on November 15, which was heralded as a ‘new Bretton Woods’, comparable in significance to the first Bretton Woods conference in 1944 that created the IMF and World Bank. The meeting, Brown briefed journalists, would lead to a new, improved IMF, with a greater global role and increased capital.
However, both the Middle East roadshow and the G20 meetings were complete flops. No emerging market country showed itself willing to commit any more capital to the IMF, and the ‘new Bretton Woods’ conference turned out to be a damp squib without the participation of the president-elect of the US, Barack Obama.
Ariel Buira, former executive director of the IMF, says: “The G20 meeting in November was not a big success. The Saudis said ‘thanks, but no thanks’. China asked what was in it for them. The Brazilians said they didn’t want merely to be invited to G7 meetings for coffee.”
Japan’s government did come forward and say it could commit a further US$100bn to the fund by issuing long-term bonds. But the announcement immediately led to a rise in Japan’s government bond spreads, and with the country heading into recession, the government might think twice about its generosity.
Reforming the IMF
There is a feeling among the more powerful and wealthy emerging market governments that if western governments really want them to bail out the IMF, then the IMF has to be radically overhauled.
In early November, the Bric countries – Brazil, Russia, India and China – held their own summit of finance ministers before the G20, at which Brazil’s finance minister, Guido Mantega, declared: “The Brics and the G4 (South Africa, Brazil, China and India) …have been managed by institutions from the 1940s and 1950s, when the US and the European countries represented the bulk of the global economy. Today the emerging nations represent 75% of global growth, but we have minority representation” in the G7 and the IMF.
Mantega said Bric countries were ready to add money to the fund, but only in return for a greater say in its governance: “None of the Brics said they are not prepared to put funds in, they have money, they have reserves. They only want greater participation. It is currently the fund that does not want to give us a greater share.”
Most analysts agree that the IMF has what El-Erian of Pimco calls “a massive legitimacy problem”. He says: “The voter representation is a reflection of the world 40 years ago. Why does Belgium have the same voter power as China?”
At the moment, the US has 16.8% of the vote on IMF governance, which is far more than any other country, followed by 2-5% votes for Japan, Germany, France, UK, China, Italy, Canada, Russia, Saudi Arabia, Belgium, India and Switzerland. The head of the IMF has traditionally been from western Europe.
Mandeng says: “The idea has been that the managing director has to come from estern Europe in order to have the ear of the G7. Still, all these European heads of the IMF, enough is enough.”
In April 2008, the IMF did announce, with much fanfare, a new quota formula to give emerging market countries a greater vote in the IMF’s governance. However, Leech of Warwick University says: “It was just hype. The changes make almost no difference to the distribution of voting power. It reduces the US vote from 16.8% to 16.7%.”
Ariel Buira, Director of the G24 Secretariat in Washington DC, says: “The results of quota reform were very disappointing. The inclination of the EU and US is to maintain the status quo as much as they can. But the system is broken, and the G8 alone is not able to fix it.
The US’s domination of the IMF’s governing structure may have caused what many experts believe to be the fund’s great failure of the last decade – the failure of its surveillance function over the US and Chinese economies.
Buira says: “The IMF is charged by Article IV of its constitution to exercise surveillance over the economies of both China and the US. But there was no effective surveillance. There was instead a major failure of the IMF to perform its duty. The overwhelming power of the US over the IMF prevented the fund from making proper criticisms of US policy.”
Many analysts agree that the IMF has an important role to play in its surveillance and advisory functions. But some question if the IMF’s expertise at the moment is in the right area. El-Erian says: “The expertise of the IMF has to change. It’s a macro shop at the moment, full of macroeconomists. But they don’t know much about finance. There’s now a recognition that the IMF needs expertise in finance as well as economics. The fund has homework to do.”
These issues are likely to make reform of the IMF a slow and acrimonious process. In the meantime, investors will have to keep their fingers crossed that the fund doesn’t run out of money in the next 12 months.
