by Joseph Joyce
The IMF and Sovereign Debt
The continuing inability of the Eurozone economies to break out of their current impasse means that any optimistic projections of declining debt to GDP ratios are unlikely to be achieved. As long as European governments continue to raise funds in the financial markets on favorable terms, the current situation remains sustainable. But the IMF is thinking ahead to the day when there is a change in the financial climate, and is proposing a change in the rules governing its ability to lend to governments that may need its assistance if they are to continue repaying their debt.
The Fund’s rethinking has been prompted by its concerns over its lending to Greece. The IMF, as part of a “troika” with the European Commission and the European Central Bank, participated in a loan arrangement in May 2010. The IMF’s contribution consisted of a $40 billion Stand-By Arrangement. The Fund had a problem, however: this amount far exceeded the normal amount of credit that the IMF normally provided to its members. Exceptions were allowed, but there were criteria to govern when “exceptional access” was permitted. One of these was a high probability that a government’s public debt was sustainable in the medium term. It was difficult to claim that was true for Greece in 2010, so an alternative criterion was established: exceptional access could also be provided if there was a “high risk of international systemic spillover effects.” This was used as grounds to justify the lending arrangement to Greece.
A restructuring of the Greek debt did take place in 2012. The IMF subsequently issued a reviewof its own response to debt crises, and found that “debt restructurings have often been too little and too late, this failing to re-establish debt sustainability and market access in a durable way.” The IMF was concerned that its money was used to pay off creditors who would otherwise have been forced to negotiate changes in the debt’s conditions with the Greek government.
The IMF has come back with a new lending framework for governments with problems in paying off their debt. The new option would be relevant for a country that has lost access to the capital markets, and when there are concerns about the sustainability of its debt. The government would ask for a “reprofiling” of its debt by creditors, which would consist of an extension of its maturity without a reduction in the principal or interest, while the IMF offered financial support with a plan for economic policy adjustment. Fund officials claim that “reprofiling tends to be less costly to creditors than debt reduction, less disruptive to financial markets, and hence less contagious.”
The new option would allow the IMF to operate in situations where the sustainability of a country’s debt is ambiguous. Those cases are more common than creditors want to admit. Ireland and Portugal have graduated from their respective IMF programs, and can obtain credit again. But the “good outcome” occurred in part because Mario Draghi, President of the European Central Bank, pledged to do “whatever it takes” to preserve the euro, and market participants took him at his word. To date, no one has called upon Mr. Draghi to back up his pledge, and lending rates to all the Eurozone members have fallen. But it is not too difficult to imagine a scenario in which the ECB’s credibility crumbles, particularly if deflation takes hold. What then happens to perceptions of debt sustainability?
As an agent of 188 sovereign principals (the member governments), the IMF is constrained in what it can do on its own initiative. But any ambiguity of the sustainability of debt gives the IMF some scope for autonomy. In addition, differences in the objectives of the members provide policy “space” for the IMF to maneuver.
Extending the maturity date of an existing bond would lower its net present value of the debt. Lenders, therefore, are unlikely to embrace the IMF’s proposal. But the concerns over the repayment of Argentine debt threaten to extend to other markets (see here), and are another source of uncertainty. An association of lenders has issued a call for more flexibility in the terms governing collective action clauses, but these take time to implement. Moreover, European finance ministers are preoccupied by other, more pressing concerns.
As long as debt markets remain calm, “reprofiling” will be considered as an interesting policy proposal, which will be sent off for further study. But once the interests of the major stakeholders—which continue to be the G7 countries—are involved, then there will be an assessment based on the financial interests at stake. The response to the Greek debt crisis demonstrated that the European countries are quite willing to rewrite the rules governing the IMF’s policy options when they see an advantage for their national interests. But the response to a similar situation in another part of the world could be very different. And it is precisely that perception of unequal treatment that is driving dissatisfaction with current arrangements at the IMF.
cross posted with Capital Ebbs and Flows