ANALYSIS:The fund's involvement in private sector insolvency raises questions over what its purpose really is
IN SHARP contrast to the cacophony of comments from European politicians, the International Monetary Fund has kept its voice down as it enters negotiations to provide rescue loans to Ireland.
But the fund will provide about a third of the money and a lot of the policy credibility of the bailout. Having first tried to go it alone during the Greek crisis, euro zone governments have now accepted they need the IMF’s reputation and expertise.
Yet former officials say that, while the IMF’s involvement further boosts the institution’s standing, which has risen sharply during the global financial crisis, the size and nature of the Irish question could place the fund in a politically awkward position.
Domenico Lombardi, a former Italian representative at the IMF and now at the Brookings Institution, says: “With Greece you could argue that it was just a single country in trouble. But with Ireland it is now clear that this [loan] represents an attempt to underpin the entire euro area.”
The IMF funded rescue packages to central and eastern European countries in 2008 and 2009 by putting together ad hoc co-financing deals with the European Commission. Through more durable methods created during the Greek crisis, it runs joint rescue programmes with the European Financial Stability Facility. Although there is no set formula – the IMF does not have a fixed pot of money dedicated to the euro zone – it seems to have settled on providing around a third of any loan package.
So long as the views of the IMF and the European governments controlling the EFSF are roughly the same, the joint programmes can work smoothly. But former officials and experts feel those interests may diverge. They fear EU governments will be too concerned with protecting their own financial institutions exposed to the Irish system, and resist the restructuring of senior bank debt.
“The key issue is when they recognise that they will seriously have to write down bank debt, and the IMF is likely to be much keener than the EU,” says Simon Johnson, a former IMF chief economist. He says the fund is likely to be less eager to force Ireland to raise its corporate tax rate, which European politicians see as unfair competition.
Arvind Subramanian, of the Peterson Institute in Washington, notes the IMF gets into enough difficulties when appearing to condone defaults on the sovereign debt of governments to whom it lends directly, let alone urging the restructuring of commercial bank liabilities. “The issue with Greece is one of public sector insolvency,” he says. “This is a question of private sector insolvency.” For Subramanian, it is perverse to try to deal with an insolvent banking system through fiscal adjustment, which will take more resources out of the Irish private sector.
The Irish case shows how far the fund has drifted from its original purpose. Some officials say it needs to hold a debate about its role. Originally set up to administer the post-war system of fixed exchange rates, the IMF was constructed to tide over countries suffering balance of payments problems while the governments returned to solvency by cutting spending or raising taxes.
With rescues to countries such as Greece and Ireland, inside a monetary union, the emphasis has shifted. “It is strange for the IMF to be lending to a region which has a reserve currency and no balance of payments problem,” Johnson says. One G7 official says: “If the IMF is going to expand its mission to include lending to promote financial stability, we need to revisit exactly what its function is.”
These questions will take a long time to resolve. For the moment no IMF country seems to want to rock the boat by questioning the legitimacy of the Irish lending programme. – (Copyright The Financial Times Limited 2010)