The fund has agreed a $30 billion rescue package for Brazil but some believe this will just prolong the inevitable agony and worsen the crunch.
As if to mark the fifth anniversary of the onset of financial crisis in Asia, the International Monetary Fund (IMF) this week exceeded all its bail-outs during that painful episode with a $30 billion (€30.9 billion) loan for Brazil.
The Brazil package, the largest ever in dollar terms, represents a decisive intervention designed to break the vicious circle of falling currency, rising debt, weak growth and sliding confidence that is undermining one of the world's largest emerging market economies.
However, it leaves the IMF highly vulnerable to criticism if things go wrong. It also leaves the much-trumpeted ambition of the IMF and its rich shareholder countries to limit crisis-lending looking more than a little forlorn.
The Brazil deal has been crafted to ease fears of political instability arising from October's presidential election. Most of the money will not be available until 2003, holding out a carrot for the candidates to promise to stay with the IMF.
But while the politics may hold, the economics is more risky. Some economists do not think it gives Brazil much more than an even chance of avoiding default on its $250 billion debt. With about 80 per cent of its debt linked to the dollar or domestic interest rates, Brazil is severely circumscribed in using either currency or borrowing costs to manage the economy. So the burden of adjustment falls on fiscal policy - the centrepiece of the IMF deal.
The agreement maintains the target for the primary fiscal surplus, the surplus before interest payments, at 3.75 per cent of GDP, and gives the IMF the flexibility to raise the target if necessary.
Economists calculate that if growth recovers to 3 per cent this year, real interest rates come down to 9 per cent (currently at 14 per cent) and the fiscal target is maintained, Brazil should be able to grow out of its debt burden and achieve stability. But any sign of faltering confidence could rapidly prove self-fulfilling and the IMF recovery programme could easily go off track.
The IMF does not have to disburse the majority of its money until next year, by which time the political and economic situation could be very different; and, as things stand, Brazil has only to maintain its fiscal regime, not tighten it further.
At the back of policymakers' minds may be the Argentine experience in 2000-2001, where every tightening of fiscal policy to restore confidence made investors doubt even more that that recovery would arrive. Moreover, keeping the fiscal target unchanged at this stage makes it politically much easier for the candidates to support the deal. Yet even the existing target will not be easy to achieve.
SOME sceptical economists say the programme will merely prolong the agony and worsen the crunch when it comes. Mr Walter Molano of Connecticut securities group BCP says: "The IMF package authorised the outgoing administration to strip clean the central bank vaults and leave the bill to the incoming team. The probability of default is now higher than it was before."
If the Brazil bail-out fails, the reputation of the IMF and its large shareholder countries will be severely dented.
The Bush Administration came into office seeking to distance itself from the large bail-outs associated with Mr Robert Rubin and Mr Lawrence Summers, the former Democratic Treasury secretaries. Mr Paul O'Neill, Mr Bush's Treasury Secretary, indicated that he shared concerns that bail-outs induced reckless lending or "moral hazard".
In practice, the US has already backed large loans for Argentina and Turkey. But the rhetoric has still focused on the dangers of throwing good money after bad. As recently as June, Mr O'Neill declared: "Throwing the US taxpayers' money at a political uncertainty in Brazil doesn't seem brilliant."
This view of crisis-lending is partly shared by other members of the Group of Seven (G7) leading industrial countries, notably Britain and Canada. An action plan, announced with much fanfare at the G7 finance ministers' meeting in Washington in April, called for stricter rules on rescue lending and for an orderly system for countries to restructure debt.
Yet both these elements are conspicuous by their absence from the Brazil package, even though the deal is supported by the G7. Concerns about irrationally nervous markets and the destabilising regional impact of Brazil's economic difficulties have, it seems, overridden doubts about protecting reckless investors. The get-out clause in the G7's action plan that massive loans are acceptable in extraordinary circumstances has been exercised at the first opportunity.
Until now, some observers had suggested that the US Treasury's hostility to bail-outs was being overridden by broader geopolitical priorities. The O'Neill Treasury, they argued, exerted far less influence within the Bush Administration and in the IMF's dealings with borrower countries than it did when Mr Rubin and Mr Summers were in charge.
But this week's deal makes abundantly clear that large rescue packages do not require the IMF or the rest of the US Administration to railroad the Treasury. Treasury officials followed the negotiations closely and issued a separate statement backing the deal. Just before the programme was announced, Mr O'Neill said that the US's low profile in IMF negotiations did not imply inactivity or lack of support.
There is a lot riding on the Brazil programme. If it fails, it will hand fresh ammunition to those who say the IMF encourages reckless lending and lacks the self-discipline to resist a bail-out when trouble arrives. Until recently, some of those critics were running the US Treasury. Now, remarkably, the Treasury has agreed to a $30 billion bet on what many see as a 50:50 gamble. - (Financial Times Service)
