Tuesday, November 23, 2010

IMF Working On Ireland Bailout

The IMF is currently working with Ireland on a potential bailout loan with requirements that Ireland reduce its debt, following similar agreements with Greece and Spain. However, there is concern whether the EU/IMF stabilization fund has enough to continue to bail out countries like Portugal which could be next. See the following post from The Street.

The International Monetary Fund is in Ireland working with the European Central Bank to help Ireland get through its financial crisis. This follows negotiations for bailout packages in Greece and Spain. These efforts remind me of standby missions I took for the IMF a while back.

What is a Standby?

In essence, an IMF standby credit supports countries that:

...experience episodic, short-term financing and adjustment needs, including those caused by shocks. The Standby Credit Facility supports countries' economic programs aimed at restoring a stable and sustainable macroeconomic position consistent with strong and durable growth.... [1]

So what happens? The IMF is invited to visit, normally by the country's central bank. Eurozone countries do not have their own central banks, so the Prime Minister of Ireland called for help. As I have reported earlier, the model for EUR bailouts is already in place : The IMF, working with the EUR government, already has established a rescue mechanism of roughly $1 trillion set up last May by the European Union and the International Monetary Fund for bailouts.

The IMF has been criticized for policies used to help countries needing a stimulus package. But when belt tightening is needed, the IMF is at its best. It uses the following approach:
  • First, it will develop a comprehensive picture of the government's finances. This is more of an accounting job than economic analysis. But it is essential so governments do not have "wiggle room" to run deficits via a state enterprise not covered by the negotiations.
  • Normally, the IMF would be brought in when a country was running an excessive international trade deficit. The IMF would calculate how much the trade deficit would fall for different sized government deficit reductions. These calculations would serve as the basis for a standby negotiation. The IMF would agree to lend the country a certain amount of a hard currency provided the government agreed to reduce its government deficit by certain amounts over the next few years. Time-specific targets would be established for the deficit reductions, and the IMF would make its funds available in tranches, provided the agreed upon government deficit reduction targets were met.
IMF Assistance to Eurozone Countries

How has this approach been modified for Greece, Spain, and now Ireland? All three countries are running current account deficits: Ireland (1.6%) [2], Greece (5.8%), and Spain (4.4%). But these deficits are not the primary problem. The primary problem is the fear that the government financing needs are so large that nobody will lend them the money. What happens then? The governments default on their debt and expenditures are limited to what they get in taxes and other revenues. Not good. One can imagine all sorts of very bad scenarios -- like Germany abandoning the euro and riots in "have-not" eurozone countries leading to the collapse of governments.

So what does the IMF do in these circumstances? It tells Ireland, "We will lend you a certain amount of money in tranches, providing you reduce your government deficit in accordance with the following schedule." Negotiations then proceed over the timing and size of the deficit reductions called for.

The IMF has already entered into such agreements with Greece and Spain: "You reduce your government deficits by this amount, and we will lend you this amount of hard currency." And as I have indicated in an earlier posting, things will really be tough in these countries going forward: current unemployment rates in these countries (Greece - 12.0%, Spain - 19.4%, and Ireland - 13.5%) will go higher as a result of their bailout agreements.

And what about other eurozone countries? Will the EU/IMF stabilization fund of $1 trillion be enough? Portugal will be next. And with an international current account deficit of 23% of GDP, things could go south in Portugal very quickly.

Liberia

Many years back when I worked for the IMF, we tried to get Liberia to accept an IMF standby package "to get its house in order." My job was to examine its corporate tax structure. I concluded its rates were far too low by international standards. In a meeting with only President Tubman and two assistants, the IMF team recommended a corporate tax hike. When I got back to Washington, my boss at the IMF said he had gotten a call from the U.S. State Department and the recommended tax hike "was off the table."

What does this have to do with eurozone problems? First, Liberia is like the eurozone countries in that even though it has its own currency, the country runs on U.S. dollars. So it effectively does not have a central bank. But unlike the eurozone countries, it never needed a bailout. Why? Because the large rubber and metal extraction companies were always willing to lend the government money to cover its deficits.

Greece, Ireland and Spain have no such "sugar daddy."

This post by Elliott Morss has been republished from The Street, a site covering financial news, commentary, analysis, ratings, and business and investment content.
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