by Vazil Hudák and Soňa Muzikárová
Will Corona-pandemic Alter IMF's Traditional Role of a Global Financial Watchdog?
A Crisis Manager
The International Monetary Fund (IMF) is a lender of last resort and stands at the vanguard of global economic crisis management. Its job is to prevent contagion from spreading throughout the global financial system. A Member turns to the institution, when it can no longer service its debts to creditors, or when it is unable to obtain adequate financing on affordable terms in the capital markets to make its international payments and maintain a prudent level of reserves.
The IMF has been rigid about the money borrowed being spent in line with the stated economic objectives and loan conditionality. The IMF loans are extended at a voluntary basis, accompanied by a manageable debt-repayment schedule, and conditioned by economic reforms designed to tackle the balance of payment problems, stabilize economies, and restore sustainable economic growth. The crisis resolution – including reform programs to regain market access and foster economic recovery – lies at the core of IMF lending.
The 2010 European Sovereign Debt Crisis
The 2010 European sovereign debt crisis marks a turnaround for the IMF and its role. The IMF has conventionally provided helping hand to emerge markets at the periphery of the global order. Countries that had – prior to 2010 – benefitted from the institution’s financial intervention include Argentina, Brazil, Mexico and emerging East Asian markets. Beginning in 2010, instead of providing the bulk of its financial assistance to emerging markets, the Fund’s focal point suddenly shifted to debt-ridden advanced euro area economies, such as Ireland, Greece, and Spain.
IMF’s intervention in Europe became most notorious in Greece – where it, along with the European Commission, and the European Central Bank (the informal alliance of three institutions dubbed as ‘troika’) – pledged $375 billion in three bailouts over an eight-year schedule. Some of the troika-imposed loan conditionality from the IMF’s structural adjustment playbook included increasing taxes, lowering pensions and other spending, and privatizing industries. These measures have grown controversial and, in some cases, have been blamed for deep recessions and high unemployment rates that ensued in Greece and Spain years later. On the other hand, other bailed out European countries, such as Ireland, have prospered above pre-crisis levels.
Navigating the Post-Covid19 Terrain
The Fund has received both praise and criticism for its past efforts. In the aftermath of the 2010 sovereign crisis, the IMF had ramped up its playbook with additional tools, including flexible credit lines, precautionary and liquidity lines, and increased capacity to lend. The corona-pandemic, dubbed as ‘crisis like no other’ by the IMF Chief Kristalina Georgieva, has been met with an unprecedented global response on the part of governments, central banks, and international institutions, and is also catalyzing important changes in the IMF’s function.
Members can benefit from the Fund’s emergency assistance without having fully-fledged programs in place, and notably, without the classic IMF conditionality. To deal with the record number of assistance applications (over 100 countries so far), it has secured $1 trillion in lending capacity and also doubled the access to its emergency facilities. It has also granted a 6-month debt service relief and suspended debt service payments of its poorest members, so they can channel their finances to vital industries, such as healthcare.
IMF’s response is part of a broader mobilization to counteract COVID-19 negative fallouts. In Europe, the ECB has allotted a total envelope of €750 billion early in March as part of the Pandemic Emergency Purchase Programme (PEPP) to protect the transmission of its monetary policy, within its mandate of euro area price stability. Additional liquidity has been supplied by national authorities and central banks. In the US, between Congress and the Federal Reserve, the government has committed over $6 trillion to try to stop an economic calamity.
Stark economic contractions combined with unprecedented spending measures will blow a deep hole in countries’ public finances. According to the IMF latest forecast, net public debt is to reach 85.3 per cent of GDP in 2020, up from 69.4 per cent in 2019. In the US, the institution forecasts general debt to hit 131.1 per cent of GDP, and Japan’s debt at astonishing 251.9 per cent. In the meantime, the global economy is expected to shrink by at least 3 per cent in 2020, and all countries’ standards of living are to deteriorate.
But in yesterday’s fireside chat, the Fund’s chief backed the unprecedented spending as a necessary short-term tool to support the global economy. ‘Spend as much as you can but keep the receipts’, she said. In the post-covid19 environment, the narrative seems to have softened away from free-market fundamentalism, and the IMF’s strict loan conditionality is suspended (for now). How is this important global institution to fulfil its mandate in the post-COVID era?
The Fund is faced with a tough role of providing for a fine balance between liquidity support and letting debts rise (for now), and monetary and fiscal stability. Mrs Georgieva acknowledged that a too-early return to austerity – like in the aftermath of the 2009 Global Financial Crisis – would be a mistake. In the aftermath of 2003 Severe Acute Respiratory Syndrome (SARS) epidemic in Asia, the financial guardian welcomed the temporary fiscal relief package to provide much-needed support to economic activity in the short run, but swiftly noted the long-term importance of improving the countries’ fiscal position through reducing deficits through consolidations and revenue base expansions. Currently, the IMF Chief sees several tools at policymakers’ disposal.
The global ultra-low interest rate environment combined with the post-2009 fortified global banking system has been helping with sustaining debt. Countries with sound macroeconomic fundamentals do better, but overall, ‘we have managed to place a floor underneath the world economy’, said the IMF Chief.
But there is more to recovery than free money. According to Georgieva, countries should also zoom onto structural areas, such as tax reform. We need tap into tax to help decarbonize, and ask ourselves, whether we are comfortable with the digital domain ‘not contributing to society’ in terms of taxation? More will also need to be done in the European education arena to underpin the recovery. ‘How on earth are we to compete in the knowledge economy with only two European countries in top ten in PISA?’ she asks.
The IMF boss is also hopeful. She sees the EU recovery plan coined Next Generation EU as a tool for restarting the stalling real economic convergence in Europe. Policymakers should, moreover, embrace this is an opportunity for greener, smarter, and fairer world.
More uncomfortable questions will need to be asked down the road to foster recovery and safeguard debt sustainability. It remains to be seen when the global economic and healthcare situation is deemed adequately stabilized for the Fund to revert back to its role of a strict fiscal watchdog, or whether the COVID-19 pandemic introduces a more permanent shift into the Institution’s operation.