7 April 2015
The Greek government affirmed over the weekend that it will remain current on its obligations to the IMF. However, the possibility of a default to the IMF remains if no agreement can be reached on needed measures to extend its existing borrowing arrangements. Greece is due to repay the IMF EUR8.6 billion in 2015 (5 percent of GDP), of which EUR0.5 billion on 9 April and a total of EUR3.2 billion in April-July, which will likely be impossible without external assistance. Greece owes the IMF EUR24.5 billion (13 percent of GDP). A default would be unprecedented in scale and likely to severely damage the IMF. Greece would contaminate directly the international community at large.
Countries normally always repay the IMF and defaults or arrears are very rare. Even serial debt offender Argentina remained current on its IMF obligations. Defaults in the past have been incurred mostly by then conflict countries like Honduras, Liberia, Sudan, Vietnam and Zaire. The IMF has total arrears today of EUR1.3 billion.
The IMF operates like a credit union. IMF lending involves in essence a transfer of foreign exchange from creditor to borrowing member countries’ central banks. In the event of a default, the economic impact depends on the country’s central bank’s ability to fund the foreign exchange loss. Eventually fiscal resources may be needed to recapitalise the central banks for the loss.
There are currently 51 creditor countries to the IMF including France, Germany, Italy, Spain, U.K. and U.S. but also e.g. Algeria, China, Korea, Mexico, Russia, South Africa, Thailand and Trinidad and Tobago plus participants in the IMF’s borrowing arrangements. If a country does not repay the IMF, the creditor does not get its money back.
The IMF’s underlying approach is that countries in distress obtain external assistance against economic adjustment. This adjustment has to be sufficient to ensure the country recovers on a sustainable basis and can repay the IMF. The capacity to repay the Fund, featuring prominently in any IMF arrangement, is critical to ensure that an arrangement is viable.
The IMF Managing Director, IMF staff and country authorities are the main actors in designing IMF arrangements. Sometimes though, the staff may get it wrong, may be unduly coerced if so told by major IMF member countries and/or the country gets it wrong or is unduly optimistic in its ability to act. In the case of Greece, the Troika has critically upset the relationship between IMF and member country and institutionalised political meddling in IMF arrangements.
But the IMF Executive Board, representing the 188 member countries of the IMF, has the final say. IMF arrangements need simple majorities at the Board to be approved but are normally endorsed by broad consensus. While IMF Executive Board voting patterns are not disclosed, rumours have it that the Greece programme had attracted considerable dissent. This matters as the European Union holds 31 percent of voting shares and has thus considerable control. However, the European Union cannot approve an arrangement on its own. Greece’s default would be shared by the international community but can also be blamed on the international community.
A Greece default, given its size, would significantly dent the IMF’s credibility and capacity to act. The delayed governance reforms at the IMF already undermine legitimacy and effectiveness of the institution as reiterated by the G20 in Istanbul. A Greece default would surely call for more reforms in particular about the quality of economic adjustment itself and independence of the IMF. However, meanwhile, the European Union cannot tolerate an outcome that would require Trinidad and Tobago to shoulder its members’ problems.
The ability of countries to conduct economic policies without immediate regard of external constraints has remained the privilege of a few. It may represent one of the most important features of a country and one that seems to divide the international economy like no other. Countries without international monetary power (WIMP) will find it far more difficult to maintain a desired economic policy course if external conditions change (see also column in the Financial Times in March)
The expected tightening of U.S. monetary policy may represent such critical change in external conditions. While of course widely anticipated its effect on international credit conditions and capital flows remains uncertain. Emerging markets like many other countries are concerned that a tightening of U.S. rates may trigger a capital outflow amid less favourable relative interest rate differentials. While this holds for most countries, the difference lies with countries that seem unduly adversely affected by sudden capital flow reversals given either dependence on external funding or a high level of explicit or implicit dollarization.
Short-term interest rate movements indicate that average and median short term interest rates in key emerging markets have remained significantly higher than prevailing economic conditions may suggest and relative to levels preceding the start of the economic and financial crisis (Chart). WIMP countries remain bound to maintain monetary policy stances that may not fully reflect domestic conditions. The establishment of greater economic policy autonomy remains one of the most important challenges for emerging markets to overcome.
The euro has depreciated about 20 percent against the dollar since mid-2014. The significant depreciation seems inconsistent with the interaction of price and quantity effects of quantitative easing. The euro looks oversold.
The remarkable euro move coincided with the anticipated end of the quantitative easing of the Federal Reserve and the peak of the expansion of the monetary base of the U.S. relative to the euro area. Prima facie evidence suggests that the relationship between monetary base expansion and the exchange rate was firm at least between June 2010 and February 2013. The subsequent sharp expansion of the U.S. monetary base relative to the euro area monetary base has not translated fully in a pronounced appreciation of the euro. However, the peak of the relative U.S. monetary base expansion was accompanied by a significant depreciation of the euro.
QE seems to have had a relatively predictable effect on eurodollar. Yet, QE could affect the euro at least through three channels. The price channel, by which QE supports domestic asset prices through bond purchases which should be euro supportive; the quantity channel by which QE increases the monetary base which should be euro unsupportive; and the interest rate channel by which QE changes the interest rate differential where an increase in interest rate differential, e.g. euro rates become lower than dollar rates, should be euro unsupportive. Historic data seem to suggest that different channels dominated at different points in time.
The recent eurodollar weakness seems inconsistent with the significant relative level of monetary expansion. The euro’s depreciation against the dollar appears to indicate a significant relative expansion of the euro area monetary base relative to the U.S. amid complete dominance of the quantity channel (Chart 1). This seems in contrast to the relationship between relative monetary expansion in the U.S. and Japan and dollaryen (Chart 2). Given that the ECB will like the Federal Reserve had done (and still does) offer massive support for euro-area bonds, the euro looks like it overshot on the downside.
International portfolio investments have expanded slightly through 2014. The IMF’s latest Coordinated Portfolio Investment Survey (CPIS) shows that total cross-border portfolio investments in equity and debt securities in June 2014 stood at US$44.5 trillion (58 percent of world GDP) compared with US$44.1 trillion at end-2013 (59 percent of world GDP). International portfolio investments have continued to expand since 2007 albeit have remained still below the 2007 level at 62 percent of world GDP. The allocation to emerging markets excluding off-shore centres increased slightly to 8.5 percent in 2014 of total international portfolio investments but remains below its high of 10.0 percent in 2012. Investments to the euro area and other advanced economies excluding the U.S. expanded modestly (Chart).
Emerging markets remain minor investors only with 2.3 percent of total investments made by emerging markets excluding China and off-shore centres (China does not report as investor under CPIS). Emerging markets continue to make larger allocations to other emerging markets. The U.S. maintains the largest allocation of advanced economies to emerging markets excluding China and off-shore centres at 14.4 percent.
The latest IMF survey on currency composition of official foreign exchange reserves (COFER) shows broad maintenance of dominant allocations by currency. The overall level of central bank foreign exchange reserves has declined modestly to US$11.6 trillion in Q4 2014 from its peak in Q2 2014 of US$12.0 trillion. Recent sharp exchange rate movements against the dollar may have adversely affected reserve composition.
The dollar has continued to expand its share since 2009 while the euro has continued to decline to reach its lowest level since Q2-2002 of allocated reserves. Other currencies, including in particular the Australian dollar and Canadian dollar have largely maintained their share. Emerging markets have continued to sustain a significantly higher share in other currencies than advanced economies representing 8.1 percent of total allocated emerging markets holdings. Since 2000, the trend of continued albeit gradual reserve diversification has thus been preserved (Chart 1).
The annual decline in reserves is the first since significant reserve accumulation started in 2003-2004. International reserves have been largely accumulated by emerging markets amid large current account surpluses and significant exchange market interventions. The close correlation between cumulative reserves and current accounts affirms emerging markets’ willingness to convert external surpluses into official reserve holdings (Chart 2). The decline reduces further reserves in percent of emerging markets GDP. Subsequent reserve accumulation will likely depend to a large extend whether continued current account surpluses can be maintained. Recent developments suggest including greater exchange rate flexibility that reserve accumulation will not continue at its prior pace.