Who’s afraid of the IMF
14 November 2010
They’re the bogeymen of international finance – so what can we expect if they impose their medicine on Ireland?
For some, they are seen as the ultimate signal of economic failure. For others, they are seen as the only way of achieving necessary corrective measures to get back on the road to economic growth.
It is ironic that the International Monetary Fund (IMF), set up to assist advanced economies around the world deal with the foreign exchange rate system, later became associated with what some would call economic ‘‘basket cases’’.
It is also ironic that, as recently as 2007, the IMF was being seen as increasingly irrelevant in global economies. Its loan commitments that year were just $2 billion. They are now closer to $200 billion as the fallout from the global financial crash continues.
In Ireland’s case, the big question is whether the country will need to apply for external assistance and, if so, what form it would take. Greece set the precedent earlier this year when, as a full eurozone member, it sought outside financial assistance.
The European Financial Stability Facility (EFSF) was set up, consisting of €750 billion from the IMF, the European Commission and the European Central Bank (ECB). This is available to lend to eurozone countries that get into trouble. If Ireland needed to avail of outside help, this is where the money would come from.
Commentators who believe a bailout loan of some kind will be necessary suggest it could be in the region of €48 billion to €50 billion.
Ireland must apply to avail of the fund, and there would be terms and conditions attached. They would have to be agreed between the government, the IMF, the EU, and the ECB, particularly where there is a banking dimension to the need for a bailout.
Long seen as the ‘‘bogeymen’’ of troubled economies, actual teams from the IMF and the EU would arrive in the country to hammer out a deal. In 2008 when the IMF landed in Latvia, there was such trouble they had to re-locate - or ‘‘retreat’’ - to Poland.
Availing of loans from the fund would do one very positive thing immediately. It would ensure that Ireland had access to money it needed. In other countries, it is not unusual that, once an IMF deal has been reached, the bond spreads for that country’s debt improve, and it doesn’t even have to draw down all of the IMF money.
That certainty would be a positive. Another big positive is that it provides political cover for painful and difficult cuts to be introduced on issues like reform of the public sector.
The downsides are obvious. There is a loss of economic sovereignty, as the bailout fund involved insists on various measures. In other countries where the IMF has become involved in recent years, slashing public sector numbers and wages has been common. Raising retirement ages, re-organisation of government quangos and sales of state assets have all been on the table. Targets are set for getting back to a deficit of 3 per cent within a certain time in the case of EU countries.
Every case is a little different. For Ireland, the country has already made budgetary adjustments of close to €14 billion. It has agreed a four-year €15 billion programme of cuts and taxes. The European Commission has had staff in the Department of Finance in recent weeks, agreeing all of these measures.
The government has set up a working group to examine state privatisations. Outside intervention would simply mean continuing with that programme. But if the situation deteriorated, or the promised austerity measures were not being met, the fund would very publicly insist on further changes. It is hard to imagine a bailout agreement which kept the Croke Park deal intact.
Earlier this year, the Hungarian government said it would not implement certain measures that had been agreed, and a stand-off ensued.
The IMF isn’t all about cutting. The Hungarian government wanted to introduce an enormous bank levy to help improve the state finances. The IMF felt this was too severe and would reduce growth and recovery, and make the country less attractive for financial services.
In Ireland’s case, there is enormous sensitivity about losing the 12.5 per cent corporation tax. But any bailout fund wants its money back. It is by no means certain that Ireland would be forced to cripple its recovery prospects further by having that measure taken away.
According to Mark Copelovitch, author of The International Monetary Fund in The Global Economy, the most influential players in the IMF are the US and Britain. He believes it has a track record of going easier on countries where US and British banks have significant financial interests. Because of the likes of the IFSC, and Ireland’s massive foreign multinational presence, that could augur well for us.
But the EU has an entirely different dynamic. Our European partners - Germany, for example - are not happy about the 12.5 per cent corporation tax, the reckless handling of the public finances during the boom and the risk to German banks now posed by Ireland’s difficulties.
As the first country to avail of the fund, Greece got a reasonably good deal. Its €110 billion bailout funding facility was priced at an interest rate of just 5 per cent. Opinion is divided about how much Ireland could end up paying. A low rate creates a moral hazard which may be seen as too soft and which could encourage other countries to move towards the fund early, before trying to fix their problems themselves. A rate that is too punitive could just be a further financial burden.
The hope would be that the certainty provided by a flow of funding would actually reduce Ireland’s sovereign debt rates, and help it to move more quickly back to raising funds itself.
The impact on Ireland’s reputation is harder to gauge. External assistance would surely damage our ability to attract new inward foreign investment. Equally, a shot of cash in return for further tough medicine might improve the country’s ability to attract foreign investment quickly.
Where the IMF has struck before
Latvia
Although part of the EU, Latvia is not a member of the single currency. After a major banking collapse, it had to call in the IMF for external assistance. As an EU member, it was already in receipt of some outside EU funding.
The package implemented amounted to €7.5 billion. Really tough austerity measures followed, including a 30 per cent cut in public sector employee numbers, a 30 per cent cut in public sector pay, the closure of 37 out of 76 state agencies, a new financing model for education including higher student/teacher ratios and the closure of 17 of the country’s 59 hospitals.
On the revenue side, it increased excise duties and gambling taxes, personal tax allowances were cut and Vat went up from 18 per cent to 21 per cent.
Latvia is a case of a country taking the pain upfront rapidly to try and get back on track. To a certain extent it has worked. The country has not had to draw down all of the funding available and it is looking at economic growth of around 3 per cent next year. It is targeting a budget deficit of below 8.5 per cent for 2010 and 6 per cent by 2011. This is in a country that saw an 18 per cent contraction in GDP in 2009.
Iceland
The financial collapse in Iceland was one of the most high-profile crises of the global economic crisis. Iceland, after years of reckless lending by its banks, went into meltdown in 2008 and needed a €4.3 billion bailout.
The IMF provided about $1 billion of emergency cash, with the rest coming from Norway, Sweden and Denmark. Its economic situation has been mired by a row over the repayment of debts from a nationalised bank to British and Dutch deposit holders.
So far, the country has honoured all of its other international sovereign commitments and wants to join the EU. But, just as there are tentative signs of growth and the country is borrowing again, the domestic situation for consumers remains very tough. The currency fell by 80 per cent in value against the euro in 2008.
However, since then, interest rates have come down from a high of 18 per cent to 5.5 per cent. The government and the banks are beginning talks about a debt relief programme following proposals which included forgiving 15.5 per cent of mortgage debts.
Thousands of Icelanders have protested about the growing number of repossessions and evictions. There are concerns that its deficit will be greater than expected next year, and the economy is far from out of the woods yet.
Hungary
Hungary agreed an €18 billion funding package with the IMF and EU in 2008. The relationship between the parties has not been smooth. Problems in the country’s financial markets sparked other problems which resulted in the need for external assistance.
Outside the single currency, the Hungarian forint lost 20 per cent of its value in the run-up to the assistance package. The country has already borrowed over €75 billion from abroad. The IMF walked away from discussions last summer over disagreements with the government. Hungary had a new government in April, and the new prime minister said he needed to talk to the EU about restoring economic self-rule, not the IMF.
The original facility was agreed in October 2008, but was not touched as Hungary sought to get back on its own feet. The new government had been elected on a platform of tax cuts. The country has broadly stuck to tough austerity measures since, even before the bailout funding, and it is now showing signs of growth.
The Hungarian economy grew by 2.1 per cent between July and September this year. Among the austerity measures was a 98 per cent tax on public sector severance pay over €7,300. The proposal was shot down by the country’s constitutional court.
Hungary plans to cut 30,000 public sector jobs next year. However, it is now seen as preparing to ease some austerity measures as it gambles on growth beyond 2012.
Greece
Greece is probably the best test case for any possible external financial intervention for Ireland. It was the first eurozone country to need assistance and agreed a €110 billion package with a new IMF, EU and ECB fund.
The terms of the loans are seen as quite good, with an interest rate of just 5 per cent. However, the austerity measures that have gone with it have been met with violence on the streets and a major political challenge for the government. But in an international context, they weren’t that tough.
The payments of the 13th and 14th month public sector pay cheques were not abolished, but capped. Government workers get a flat €250 Easter bonus, a €500 Christmas bonus and an additional €250 ‘‘subsidy leave’’. It also included higher excise on fuel and cigarettes, a three-year public sector wage freeze, tax on buildings erected without a permit, and new taxes on luxury items.
It wasn’t spartan by the standards of many countries. But change always hurts, as people get used to what they have. The real problems arise from continuous reviews of the funding. This week, the IMF and the EU are expected to press Greece for deeper spending cuts after a government official acknowledged that the country’s budget deficit this year would be worse than expected.
Greece is set to miss its targeted budget deficit of 7.8 per cent of gross domestic product (GDP) this year, a government official told Reuters last week, adding it would come in around 9.3 per cent.
Britain
Britain was the last truly advanced western economy to need a bailout from the IMF. It came in 1976 and it caused an enormous political row as members of then prime minister Jim Callaghan’s cabinet resisted the austerity measures being sought.
Britain was a different country back then and had borrowed from the IMF many times before. But the crisis in 1976 was very serious. Britain sought a then record £2.4 billion from the fund, which needed extra money from Germany and the US to cover it.
Britain’s budget deficit was only around 6 per cent at the time, but the pound had come under serious pressure. The IMF sought severe cuts to public expenditure.
Following the loan, the economic situation improved. Interest rates were soon reduced and the pound quickly appreciated in value.
Britain did not need to draw the full IMF loan, but the crisis reinforced a change of policy orientation away from full employment and social welfare towards the control of inflation and expenditure. It is widely seen as a major turning point in British economic policy.http://www.sbpost.ie/newsfeatures/whos-afraid-of-the-imf-52832.html
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