Indecent Financial Proposal: IMF Lending to Ireland

♠ Posted by Emmanuel in ,, at 11/28/2010 04:36:00 PM
No, no, I'm not talking about further dalliances by IMF Managing Director Dominique Strauss Kahn with his underlings which have spawned a bestseller in France on his alleged penchant for indecent proposals. However, I am still talking about Europeans abusing power at the international lender of last resort. (Even with a rather timid redistribution of voting shares away from European countries to fast-growing Asian ones, the impression remains that the Fund is dominated by Western voices--especially since it's still customary that the Europeans get to choose its head and the Americans its first deputy managing director.) A few days ago, I read former IMF Chief Economist Simon Johnson repeat an entirely legitimate criticism of the IMF being asked to help bail out Ireland in an FT article by Alan Beattie:
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.”
To understand what Johnson means is very simple. Consider the plight of the countries in question. In the IMF Articles of Agreement, the purposes laid out say nothing about assisting countries with essentially fiscal rather than BOP woes alike Greece and Ireland. Rather, lending is supposed to occur when a country has a balance of payments problem. That is, it doesn't have enough foreign exchange to pay for its imports, especially necessities such as food or fuel. A BOP problem can occur in any number of ways, commonly a lack of export receipts that help earn a country much-needed foreign exchange.

Here are the pertinent clauses discussing when the IMF should provide such assistance:
(v) To give confidence to members by making the general resources of the Fund temporarily available to them under adequate safeguards, thus providing them with opportunity to correct maladjustments in their balance of payments without resorting to measures destructive of national or international prosperity.

(vi) In accordance with the above, to shorten the duration and lessen the degree of disequilibrium in the international balances of payments of members.
Previously, I discussed my belief and those of several others that the IMF isn't supposed to lend to Greece since its didn't really have problems availing of euros (since it can simply issue debt and exchange it at the ECB for euros under the ECBs emergency arrangements), the currency most of its imports from neighbouring EMU countries are denominated in. True, it is of course arguable that allowing Greece to go would have posed systemic risks to the international monetary system according to the third clause. You can also argue an IMF seal of approval lends confidence to others EU countries that Ireland will eventually find its footing. However, such lending could have been done through arrangements that didn't involve the use of IMF funds. And again, Ireland's particular woes stem largely from guaranteeing its banks' solvency in a manner which ultimately undermined its own solvency--it's a fiscal and not a monetary issue. In any event:
(iii) To promote exchange stability, to maintain orderly exchange arrangements among members, and to avoid competitive exchange depreciation.
In percentage terms, Greece's external deficit remains fairly large, making it arguable to some that Greece does have a BOP problem. However, few would probably argue that this external deficit has been a more important driver of its woes than its fiscal deficit. Turning to Ireland, it shares the same, internationally accepted reserve currency as Greece. Moreover, while Ireland did run a fairly sizeable current account deficit a few years ago, its external imbalance is now quite manageable. In fact, the IMF estimates that it will have a current account deficit of less than 3% this year. Click on the following table for a larger image; it is taken from the October 2010 World Economic Outlook:

Once more, it's an issue of fairness. Developing countries have put in their hard-earned foreign exchange at the IMF. Presumably, they are interested in seeing their contributions used towards alleviating troubles they themselves are likely to encounter like FX shortages as per the IMF's Articles of Agreement. How can you justify using poor countries' contributions meant for addressing BOP problems for rich countries' fiscal woes? It's something IMF brass hasn't really clarified, and this inaction does nothing to reduce the impression that the Fund remains a rich country club. (Think about that before asking LDCs like China to put in more money there.) Why it's...downright indecent.

UPDATE: The IMF's contribution amounts to EUR 22.5 billion