Back from the dead

IMF pumps out loans and conditionality

27 November 2008

A few months ago pundits were calling time on the Fund, but the financial crisis´ impact on emerging markets has brought it roaring back to life, with its usual dose of austerity and conditionality.

The countries in trouble have tried hard to avoid the IMF, more publicly than usual. It is not clear whether this was to avoid the stigma attached to going to the Fund, the austerity measures required, or both. However, policies pursued by rich countries, such as tax cuts and looser monetary policy, will not be allowed under IMF programmes elsewhere.

Iceland’s economy freezes

Iceland was the first to go cap in hand to the IMF. After bank failures, in late September, Iceland approached its Nordic neighbours, then Russia in early October, to ask for loans, but negotiations failed. Other European countries refused to lend unless Iceland went to the IMF first.

a tightening of fiscal and monetary policies

The IMF austerity package, the first in Western Europe since Britain’s humiliating Fund rescue in 1976, relies on standard conditions including massive interest rate hikes and lower government spending. These are similar to those used in Asia in 1997 and 1998 and, critics argue, are likely to exacerbate the recession, and increase economic insecurity and unemployment.

After initial agreement with the Fund, Iceland raised interest rates from 12 to 18 per cent, to try to bolster the currency. With trading in the Icelandic krona already halted because of the collapse and nationalisation of Icelandic banks that had served as currency trading clearing houses, it is unclear what this will accomplish. It will raise borrowing costs for Icelandic households and businesses, already hit hard by the devaluation, having borrowed in foreign currency in recent years.

Iceland’s IMF package was held up at the Fund’s board for more than a week in early November. The UK, the Netherlands and Germany wanted assurances from Iceland on repayment of their citizens who held money in Icelandic banks before approving the deal.

Eastern European dominoes: Hungary starts…

After Iceland, the financial crisis continued to spread, hitting countries most at risk: those with heavy foreign currency borrowing and large current account deficits. A crumbling housing market and a currency under severe pressure, made it clear from early October that Hungary would turn to the Fund. The IMF concluded negotiations at the end of October for a $16 billion programme which requires deep cuts in government spending across all departments. Additionally, all public sector employees face losing their yearly bonus, worth almost 8 per cent of pay, as well as a wage freeze, which with nearly eight per cent inflation in 2007 means a further serious real wage decrease. Pensions are also being slashed and the government has promised not to reduce taxes.

These pledges were made by the Hungarian government in the letter of intent to the IMF. Formal IMF conditionality is fairly minimal, including standard targets for inflation and payment of foreign debts, as well as a condition on the overall fiscal balance. Structural conditions called for a banking bailout package, a fiscal responsibility law, and a law speeding up the process for dealing with failed banks.

The Hungarian official appointed to serve on the board of the European Bank for Reconstruction and Development, László Andor, was one of the few officials to speak candidly about the deal: “Where the IMF appears with its strict conditions, the requirement of consolidation inevitably leads to real economy and social consequences.” He tried to look on the bright side saying the coming depression might help Hungary meet the requirements for joining the euro zone.

…Ukraine, Belarus follow

The Hungarian package was complemented by over $8 billion in European Union loans: not available to other countries in the region such as Belarus and Ukraine who approached the Fund in October. Negotiations with Belarus had not been completed by mid-November, but Ukraine finalised a $16.5 billion IMF package.

The letter of intent for the Ukraine loan was unavailable, an article on the IMF’s website said: “The package includes a flexible exchange rate, measures to recapitalise the banking system, and prudent fiscal and incomes policies, which take into account the need for additional social spending to address the impact of the recession on the population.” The IMF resident representative indicated to a Ukrainian news programme that the government´s fiscal deficit would be limited to 1 per cent of GDP this year, down from original plans of 2 per cent, and would need to be eliminated in 2009.

Serbia also entered into a Stand-by Arrangement with the IMF in mid-November, although the small $500 million programme was viewed as precautionary. The IMF deal reportedly includes a pledge by Belgrade to keep its 2009 fiscal deficit at 1.5 per cent of GDP, down from 2.7 percent in 2008. Further rumours of IMF programmes have centred on Romania and the Baltic countries of Estonia, Lithuania, and especially Latvia.

Damage spreads

Recent political turmoil has left Pakistan´s economic policy foundering. Long before the financial crisis in Western markets, commentators were expecting Pakistan to return to the IMF, but the seizing up of credit markets further battered the South Asian nation. The Pakistani currency has lost one third of its dollar value in the last year.

Knowing that a crisis was looming, the Pakistani authorities sought other support to avoid the IMF. The “friends of Pakistan” group met in early November but refused to help. Though securing delayed payment on oil imports from Saudi Arabia, the government was forced to turn to the Fund. More than $7 billion in IMF loans was secured in mid-November, the IMF announcing that the package will include “a tightening of fiscal and monetary policies”.

Much debate has focused on Turkey (see Update 61, 60, 59) where the government has been keen to avoid a return to the Fund after the expiry of the Turkish IMF programme in May this year. However, the financial crisis may hit the country hard, as speculative capital, that has kept the country afloat, becomes scarcer. On the sidelines of the November G20 summit, the prime minister signalled that negotiations for a new precautionary arrangement with the Fund were near conclusion.