Like an alcoholic with a dodgy liver promising this drink is his last, the International Monetary Fund (IMF) has a lot riding on its latest effort to rescue a crisis-hit economy.
The fund has staked its future on last week’s $30-billion loan, providing the Brazilian government with enough financial firepower to keep the speculators at bay. The loan — the fund’s largest ever — is intended to stop the plunge in the country’s currency, which was threatening to push Latin America’s largest economy into default at the worst possible time for jittery world markets.
It was not supposed to happen this way. When the international community washed its hands of Argentina last December, it argued that the era of big bailouts was over. At their April meeting, G7 finance ministers agreed that in future large-scale IMF lending would be limited to exceptional circumstances.
One senior G7 official described the progressively larger loans that the fund shelled out during the Asian crisis as a ”welfare system for Wall Street”. IMF money was going straight into the coffers of Western banks that had made reckless loans to vulnerable economies.
Six months later, with the world economy looking sickly and share markets in turmoil, policymakers appear to have had a change of heart. The Bush administration, once the sternest critic of large bailouts, has done the sums and realised that, with United States banks owed $26-billion by Brazilian borrowers, the last thing needed was for the country to follow Argentina into default.
”I think the Brazil package was phenomenal, but it had nothing to do with the country and everything to do with Wall Street. Such a dramatic turnaround in their previous stance suggests they are very concerned,” says Gerard Lyons, chief economist at Standard Chartered.
The new guiding rule in Washington seems to be: no bailouts except for countries that are too big to fail.
Argentina was not big enough to bring down the rest of the world economy when it defaulted on its $140-billion foreign debt last December. Now in its 10th month of negotiations with the fund for a stabilising loan, the country is unlikely to receive any backing from the Bush administration.
Washington blames Argentina’s politicians for the mess they have got the country into with their free-spending ways. Never mind that for most of the 1990s Buenos Aires was the poster child of the neo-liberal economists who rule the roost at the US Treasury and in the fund. It is not obvious, either, that spending was out of control: without the costs of servicing its debts, the government’s budget would have balanced last year.
But with the economy contracting investors began worrying that the country would not be able to repay its loans. That pushed up the cost of borrowing, which made it even more difficult for Argentina to service its lending.
In such circumstances, the IMF’s remedy has been to step in with a stabilising loan, demanding in return tough measures to control government budgets to restore investor confidence. In the case of Brazil, last week’s loan will act as a straitjacket for the left-wing candidates leading the race to October’s presidential elections. The IMF has postdated the cheque for 80% of the money until after the election and will pay only if the winning candidate agrees to abide by the present tight budgetary policy.
When the fund tried similar medicine last year after Argentina first got into difficulties, investors were not convinced. They rightly doubted that more fiscal austerity would help a country already in its fourth year of recession.
The real problem is that, 20 years after the first Latin American debt crisis, the international community has failed to develop a rational approach to dealing with countries whose debts are unpayable. A month before Argentina defaulted Anne Krueger, the IMF’s deputy director, pointed out there was a ”gaping hole” in the international financial architecture. ”We lack incentives to help countries with unsustainable debts resolve them promptly and in an orderly way. ”
When a company gets into trouble, statutory procedures prevent its creditors from exacerbating its difficulties by grabbing back their money and heading for the exit. No similar mechanism exists for insolvent countries. So, at the first sign of trouble, investors dump a country’s bonds and sell its currency, placing it under even more pressure.
Krueger suggested that countries, like companies, should enjoy an automatic protection from creditor lawsuits. Her original idea was that countries would apply for a stay of execution from their creditors, while the IMF supervised a debt restructuring process. In some cases, debts would not necessarily need to be written down. For example, Brazil’s overall debt is not large by international standards, but it does face a liquidity problem because of the build-up of short-term loans.
If a country’s debts were unsustainable, private sector investors would be forced to write some of them off instead of receiving a cheque for the full amount from the IMF, courtesy of Western countries’ taxpayers.
Unsurprisingly, Krueger’s proposal ran into opposition from the US Treasury. Officials preferred a system where creditors decided whether to grant a standstill and how much debt to write down.
Now that it has become obvious that nobody, even in Washington, cares what the US Treasury thinks — the White House apparently overruled Treasury Secretary Paul O’Neill when it backed the bailout for Brazil — Krueger’s ideas should receive more attention.
In the absence of any alternative, policymakers had no choice but to help Brazil and the banks that lent it the money. The risk is that even $30-billion will not be enough to convince investors that the country is a safe place for their money. The fund’s resources as the world’s financial firefighter are no match for international capital markets, where $1,5-trillion changes hands each day. If the speculators decide to take apart the Brazil package, the fund’s credibility and its future look uncertain. — Â