Is an EMF the right solution?

It was only in the fall of last year at the G20 meeting in Pittsburgh that the Europeans, led by French President Sarkozy, advocated an increase in funding for the IMF. They were driven by the fear that the financial crisis would extend at an alarming rate to an ever-increasing number of countries.
So when Greece was badly hit by the crisis early this year many eyebrows were raised when the two biggest economies of the eurozone, France and Germany, were adamantly opposed to IMF intervention, despite fears that Italy, Portugal and Spain could be next in line.
Greece’s credit rating, being the lowest of the eurozone, is a black hole within the European economy. With ongoing speculation that the country will default on its debts, the credibility of the euro can take a blow, and fears are that IMF intervention would make matters worse. Since early 2010 debate has been raging about the best mode of intervention in resolving the Greece situation.

My big fat Greek problem

Greece has been a cause of some embarrassment for the European Union. Currently, the country’s national debt is bigger than its economy. An ironically consistent mismanagement of the economy has been reflected through years of unrestrained spending, cheap lending and failure to implement financial reforms. The crisis struck the country hard and exposed a mass of fiddled statistics that revealed debt levels and deficits that exceeded limits set by the eurozone.
There are actually two parts to Greece’s current insolvency: it is a result of a failure to roll over debt as well as a result of the country’s long-term structural solvency problem. The recent eurozone rescue deals may solve the first issue but in order for Greece to avoid default it looks like some debt restructuring is going to be necessary.

Currently, we are still far from an actual solution to the Greek crisis. The problem with spending so much time negotiating among the EU members in order to arrive at some sort of consensus (necessary before Greece can touch any loans) is that there is a chance that investors will get cold feet. Even if EU money manages to stabilize markets long enough to allow Greece to avoid default, this will not necessarily solve Greece’s long-term financial worries.

The Greek government faces a tremendous task to fix its financial house and its bold austerity measures are facing entrenched resistance from certain elements of society (mainly public sector employees). This means uncertainty about Greece will persist in global financial markets for the moment.
It is clear from a domestic point of view, however, that Greece does not have any choice. In order to be able to benefit of a stimulus package the Greeks have been told to tighten their belts. Even if the eurozone countries will come together in solidarity, they come with clear warning signals for Greece.

Domestic politics

Recently, communication has heated up between Germany and Greece, with the media in the former calling for Greece to withdraw from the eurozone. Their argument being that the latter does not just have a liquidity problem, but also a fundamental growth and structural problem.
What in fact seems to be at stake here are the upcoming elections in Germany. The German public is resenting the fact that it seems to be them who are having to pay the bill for bailing out Greece. Very few Germans favour a Greek bailout and there is similar sentiment against a European monetary union that would be heavily subsidized by German taxpayers.

The Greeks, in turn, are blaming Germany for forcing unacceptably tough conditions on them and are resenting the lack of solidarity from their northern members. The country’s president recently requested a EUR 45 billion EU-IMF aid package in order to buy time while the government activated radical public spending cuts.
In order to receive this package the Greeks are being questioned about the credibility of their reform plans as well as liquidity, not only this year but also next year. The IMF can only contribute about 30% of the aid package leaving the eurozone to cover the rest. German involvement would unfortunately not end after this initial aid package, as Greece will need refinancing over the next three years.

The EMF

There has also been some debate about the possible creation of a European equivalent of the IMF that would take upon itself the responsibility of dealing with default or restructuring debt in a more efficient manner than its big brother.
There are many concerns that arise with the establishment of a new funding institution and the biggest of these is the legal basis. The Lisbon Treaty, which has already been in the spotlight many times, will require further changes, which entails that the Treaty on the European Union would have to be amended. Another concern is the source of the funds and whether eurozone states would be contributing to the fund’s financing.

One expert who does not think the proposed EMF should be implemented concluded his analysis of the merits of the proposal by stating, “I will not be surprised that in two years, the idea of creating a European Monetary Fund is completely forgotten.” (Cédric Tille, professor of economics, Graduate Institute for International and Development Studies, Geneva, quoted in the Swiss financial daily L’AGEFI, 25 March 2010).
In any case, any new body at this stage will not be up and running in time to pull Greece out of its predicament. Even if it could be useful in the future for the autonomy of the eurozone, the question is, is it necessary?

A new fund would be going one step higher in euro area economic coordination and for countries that fail to observe the fiscal policies this could include the suspension of EU subsidies, known as cohesion funds.

The IMF: In the line of fire

There are numerous factors that come into play when speaking about the creation of an EMF, but all of them linked in one way or another to the 60-year-old IMF. The IMF is notorious for having imposed strict fiscal policies under the Washington Consensus regime, which advocated that “the market knows best” and minimal government intervention. It lost a great deal of its credibility with its mishandling of the 1997 Asian financial crisis, as well as the failure in helping transition economies (think here of `shock therapy` that was conducted on Russia) in the 1990s.

Although last year the IMF turned a new page by repudiating the Washington Consensus, there is a belief that overall an IMF monopoly may not be a good thing. On the other hand, putting the IMF into competition with another institution may also trigger a race to the bottom with each institution proposing softer conditions to appear more attractive, ultimately undermining their own existence.

There is also the question of why the EU refuses to let the IMF handle the situation. There is first and foremost clear embarrassment at the idea of turning to the IMF for a country in trouble within the eurozone. Yet the nations of the developed West have shown little hesitation forcing developing countries into such programmes, but they suddenly get queasy with the thought of imposing the IMF on one of their own.
But despite its headquarters being located in Washington DC, the IMF remains a mainly European institution: both its director and chief economist are French and the Europeans have a larger collective vote than the USA. However, fingers also point to the rivalry between the current French president and the IMF’s director, putting in an edge of power politics.

The eurozone

With the signing of the Maastricht Treaty in 1992, the European members were bound by an essential clause: there will be no bailouts. The reason was simply that it was a necessary condition to get countries with strong central banks, such as Germany, to sign up for the euro. A condition that made sense because, as it so happens in times of heavy deficit, countries with central banks close to the political authority can attempt to use monetary policy to fix a fiscal problem, triggering high inflation.
A certain amount of sovereignty was therefore relinquished in exchange for the assurance that members would not find themselves bailing out irresponsible governments. And it is no secret that Germany wants to find a way to impose budgetary policies on the EU’s more recent members that did not sign the Maastricht Treaty, and if necessary punish those who go astray. But this is an elusive task. The pact of stability was created for this purpose, but so far has more symbolic than practical value.

There is good reason why European governments are wary of taking drastic action to support Greece. They would be taking the politically unpleasant step of bailing out a reckless neighbour, thus setting bad precedent, full of moral hazard issues. So far the Europeans were trying step-by-step procedures rather than going straight to the IMF.

What Greece ultimately requires is a final, comprehensive, far-reaching plan to map out the resolution of its financial mess. Greece is in need of an old-fashioned IMF-sponsored debt restructuring, in which Greece gets loans in return for fiscal reforms. The eurozone, faced with an existential threat, has, as we go to print, demonstrated that it can act fast if necessary: A EUR 750 billion plan, agreed between EU finance ministers, central bankers and the IMF in 11 hours of talks over the weekend of 8 May, marked the biggest bailout since the collapse of Lehman Brothers in 2008.

The immediate crisis has apparently been resolved by a rescue package the scale of which was described by a number of analysts as “shock and awe”. Hopefully, such a move will alleviate deep-seated scepticism about the instability of Greece, the quality of its promises and the future of the euro itself. Nevertheless, the crisis did bring to surface one major underlying worry: just how secure is a monetary union?

Article by Farva Kaukab