Do We Really Need More Large-Scale IMF Lending?
In an almost Pavlovian fashion, at the first sign of an emerging market currency crisis, Christine Lagarde, the IMF's Managing Director, has offered IMF financial support to the countries gripped by the crisis and she has questioned whether the IMF has sufficient financial resources to meet this new emerging market challenge. She does so in seeming disregard of the lack of systemic importance of the countries concerned and the very different economic circumstances of the emerging market countries from those in the European economic periphery. She also does so seemingly unmindful of the moral hazard that a new round of large scale IMF lending would pose to the global financial system and the corresponding risks that would be involved for the global taxpayer so soon after the unprecedented scale of IMF lending to the European periphery.
The proximate cause of the synchronized currency weakening across major emerging market countries like Brazil, India, Indonesia, Turkey, and South Africa is the market's anticipation that we might be at the start of a normalization of US monetary policy after several years of extraordinary global monetary policy accommodation. During the period of ample global liquidity, as is their wont, markets turned a blind eye to mounting problems of currency overvaluation and policy complacency in the emerging market economies as they continued to pour money into those countries. However, at the first sign of U.S. monetary policy normalization, markets began focusing on the large external and public finance imbalances that had developed across the emerging market economies during the period of easy global liquidity. And doing so they started a rush for the exit.
Markets have also now come to focus on the high degree of corporate domestic external indebtedness across the emerging market economies as well as on the serious political constraints in countries like Brazil, India, and South Africa to come up with a coherent policy response that might address these countries' underlying domestic and external imbalances. Little wonder then that the emerging market currencies are now plumbing new multi-year lows and are showing little sign of stabilizing
In formulating an appropriate IMF response to the emerging market currency crisis it would seem important for the IMF to recognize that while the emerging market economies have certainly been an important engine to global economic growth, they do not pose a systemic threat to the global economy that requires massive multilateral lending support. In particular, unlike the countries of the European economic periphery, which are locked into a monetary union and which owed extraordinarily large amounts to the European banking system, the emerging market economies all have flexible currencies and their debt to the international banking system is of a manageable order. As such, they pose neither any real risk to the unraveling of a currency bloc as important as that of the Euro nor to the solvency of the international banking system.
A further reason arguing in favor of only limited IMF financial support for the emerging market economies is their relatively large international reserve holdings. With the notable exception of South Africa, the major emerging market economies all have comfortable international reserve positions both with respect to months of import cover as well as with respect to their short term external debt holdings. As such, there would seem to be little justification for IMF lending to these countries on anything like the scale that it did in the case of Greece, Ireland, and Portugal. Rather it would seem that the IMF should revert to its traditional role of being a catalytic lender to these countries and should refrain from effectively bailing out foreign lenders from their ill-judged lending decisions.
The most useful role that the IMF can play in the current emerging market economic crisis is to help those countries get back to an economic policy path that restores both domestic and external investor confidence in those economies. However, to do so the IMF will need to practice tough love by insisting that those countries correct their wayward public finances and that they undertake those sort of structural reforms so necessary to restore their past economic growth momentum. By helping countries to design such policies and by providing those countries with a seal of good housekeeping, rather than by helping these countries to kick the can down the road by providing them with large lending programs, the IMF will be exercising the public good for which it was set up to do.
While it must be expected that Mrs. Lagarde will use the emerging market crisis as an excuse for a bigger IMF, there is little real reason to go down this route. If the IMF sticks to its role in the emerging market economies of being a catalytic lender and a provider of a seal of good housekeeping, the IMF has more than enough resources to do the job. This would seem to be particularly the case now that the European Central Bank has effectively relieved the IMF of its major lending role in Europe through the creation of its Outright Monetary Transaction program.
