CIGI PIIE INSEAD Uni Mainz CEPR (in various combinations) 1
The basic argument Over the years, the IMF has struggled to balance insurance with good incentives The growth of alternative safety nets regional financing arrangements (RFAs)/central bank swap lines renders these efforts increasingly irrelevant Possible solutions: 1. Use IMF as anchor (e.g. link lending to IMF lending); 2. Get your own governance and lending policies that are at least as strong as those of the IMF The experience of ESM/IMF collaboration in Greece shows the limits of 1 for RFAs Hence, RFAs need to do 2.
Content of the essay 1. A brief history of the Global Financial Safety Net 2. A history/survey of the debate on IMF-induced moral hazard and how the IMF reacted to this debate 3. Complications due to entry of new players (swap lines and RFAs) 4. A policy approach for (emerging market) swap lines 5. Case study I: the Greek crisis and the creation of the Euro area RFA 6. Case study II: the debate on creating a sovereign debt restructuring procedure in the Euro area 7. Based on 5. and 6.: a policy approach for RFAs.
IMF lending: the original rationale Countries without (dependable) access to international borrowing from private sources. IMF lends to smooth consumption without requiring large scale reserve accumulation (efficiency gains from pooling reserves) devaluations or other beggar-thy neigbour-policies In this setting: IMF is generally effective in mitigating crisis spillovers Moral hazard, if any, at the cost of the international taxpayer (if countries do not repay) Remedy: IMF conditionality. Effective in the sense that repayment record very good.
IMF lending: the new rationale Countries with access to private international borrowing from private sources (except in a crisis) IMF lends conditionally to help restore market access In this setting: Harder to mitigate crisis spillovers (financial contagion) A new class of beneficiaries: private creditors Much larger volumes of crisis lending (after mid-1990s) Crises and bailouts can have large redistributional consequences, particularly with weak institutions Capital inflows benefit a small elite Crises hurt general taxpayer that suffers brunt of adjustment and needs to repay IMF
Potential for moral hazard in the new setting 1. At the expense of the international taxpayer: If ex-post conditionality is not enough to restore solvency 2. At the expense of innocent bystander countries. If safety net increases risk of contagious crises 3. At the expense of domestic taxpayer. If did not benefit from the preceding boom Relevance? Evidence? 1 less relevant for IMF: very good repayment record, interest charges roughly in line with risk. But could be relevant for RFAs 2 and 3 relevant if: (socially) worse public and private decisions in the presence of cheaper/more abundant financing (e.g. overborrowing) safety net makes financing cheaper/more abundant.
IMF policies in response to moral hazard concerns 1. Exceptional access policy : large scale borrowing only to countries that are (conditionally) solvent without doubt. Mostly directed against type-1 moral hazard, and a bit against type 2 and 3 (super-solvent countries tend to have had better policies).) A difficult history: first, tough but not credible (2002-03); then watered down (2010); now again tougher and perhaps more credible (2016). 2. Privileged access to countries with very good policies. Initially very little interest (CCL); now a bit more (FCL). Did not go along with less access to countries with bad policies, except via exceptional access policy. 3. Promotion of debt restructuring frameworks to create an alternative to large-scale crisis lending. Initially, via attempt to create statutory framework After this failed, via bond contracts (CACs, 2002-2014)
In the meantime, entry of other big players into the GFSN 1. After end of Bretton Woods era and oil shocks of 1970s: EU facilities; some developing country Regional Financial Arrangements (Arab Monetary Fund, FLAR) 2. After Asian Crisis: Chiang Main Initiative (CMI). 3. During Great Financial Crisis: Upgrading of CMI, creation of surveillance arm (AMRO) Central Bank swap lines: among major reserve currency central banks, and from Fed and ECB to some emerging market central banks (Korea, Mexico, Brazil, Singapore, Poland, Hungary) 4. 2011: unlimited swap lines between reserve currency central banks declared permanent. 5. During Euro area crisis: Euro area RFAs: the EFSF, followed by a permanent institution, the ESM.
Massive growth particularly since 2008 The size of the safety net has expanded significantly... (In billion US dollars)... driven in part by the growth of regional financial arrangements (in percent of GDP) 4,000 BSA's-AE's unlimited 14,000 ESM BSA's- limited 12,000 2015 CMIM 3,000 RFAs 10,000 CRA 2,000 1,000 0 IMF Borrowed Resources IMF Quota Resources Gross International Reserves (eop) 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 8,000 6,000 4,000 2,000 0 2008 0 0.5 1 1.5 2 2.5 EU BoP EU EFSM EFSD AMF FLAR Sources: Scheubel and Stracca (2016); IMF (2016a); Denbee, Jung and Paternò (2016); authors calculations. Notes: BSA = central bank swap arrangements, AEs = advanced economies, ESM = European Stability Mechanism, CMIM = Chiang Mai Initiative Multilateralization, CRA = BRICS Contingent Reserve Arrangement, EU BoP = the EU Balance of Payments Assistance Facility, EU EFSM = European Financial Stability Mechanism, EFSD = the Eurasian Fund for Stabilization and Development, AMF = Arab Monetary Fund and FLAR = Latin American Reserve Fund.
Result: a much larger, but fractured, global financial safety net. Two main issues: 1. Uneven coverage. 2. Governance, incentives effects, and relationship to the IMF In principle, moral hazard concerns apply to these arrangements too. In fact, they might apply even more if: New arrangements are junior to the IMF (higher credit risk than that of IMF). This is true of RFAs (but not swap lines) Closer political proximity between arrangements and borrowers.
What to do? Central bank swap lines Closer to pure liquidity assistance But could back foreign currency credit booms 1. Swap lines between reserve currency CBs: leave as is Mostly insurance global liquidity freeze Selective, to CBs that often have supervisory role 2. Swap lines to EMs: currently inactive but expectation that they could be activated; criteria unclear. Better to make explicit and tie access to quality of borrower supervisory/regulator framework One option: link with IMF s FCL. First drawing from reserve currency CBs. If still needed after 6 months, IMF lending. Would create clearer incentives and make the FCL more attractive.
What to do? RFAs. Alternative approaches 1. Tie your hands to IMF lending policies ( IMF as anchor ). 2. Get your own governance and lending policies that are at least as strong as those of the IMF Main conclusion of essay: in general, 1 will not work. Contradicts political rationale for RFAs Harder after 2016 IMF s exceptional access policy Allows IMF lending to insolvent countries if soft money from RFAs. Experience of European RFA (EFSF/ESM) in Greece IMF anchor may get pulled out (change of exceptional access policy to enable Greece program to go ahead in 2010) If anchor holds, RFA may untie itself from the anchor (i.e. go ahead without IMF anyway Greece, 2015).
Conclusion: RFAs need to develop or beef up their own frameworks. 1. Commitment devices not to lend to insolvent countries without some form of accompanying debt restructuring Extensive debate on how to do this in the Euro area context, surveyed in the essay. 2. Develop debt restructuring frameworks in your region (private and sovereign). 3. In regions that have not centralized financial supervision/resolution: link level of access to regional safety nets to the quality of a broader set of pre-crisis policies (including quality of financial sector institutions) Note: 1-3 should make cooperation with IMF more successful
An afterthought (not in essay) What future for GFSN in the Trump era? We can only guess. Best guess today: 1. Disengagement of U.S. from IMF (at least until first big crisis affecting U.S. interests) 2. More zealous/restrictive use of IMF s exceptional access framework (a condition for agreement of congressional Republicans to quota reform in late 2015). 3. (Even bigger) U.S. reluctance to use IMF in regions that have large reserves stocks and their own RFAs A further reason why RFAs need to grow up fast.