July 2015

6 July 2015

The institutional dimension of Greece’s default to the IMF

Greece's default to the IMF marks the low point for the IMF’s engagement in Greece. It exemplifies unambiguously the failure of Greece’s IMF-supported arrangement and now leaves the IMF facing its single biggest arrears case. Greece’s default has caused severe reputational damage for the IMF and is expected to call into question the financial safeguards at the IMF and the independence of the IMF and the IMF Managing Director. It may lead to calls for an overhaul of the very foundations of the IMF.

The institutional dimension of Greece’s default is at least four-fold (see also below, IMF arrears):

  1. Greece risk burdening directly the IMF membership with its plight. The IMF operates similar to a credit union. It borrows from creditor member countries and lends to debtor member countries. If monies are not repaid, the IMF cannot repay its creditors. This fundamental principle implies that the IMF membership countries could be faced potentially with a considerable financial burden from the Greek default.
  2. Greece has revealed weak internal controls at the IMF. Greece’s default illustrates that the IMF has insufficient internal controls to exercise adequate financial risk mitigation. The IMF normally relies on its lending policies as essential risk mitigating measure including conditionality and access limits. The de facto preferred creditor status, a similar important risk mitigating measure, will also be tested if Greece attempts to meet obligations to other creditors.
  3. Greece illustrates poor judgement by the IMF. The IMF overestimated significantly Greece’s willingness and/or capacity to implement its IMF-supported arrangement. The outcome of the Greece referendum, showing a clear majority for a no hence rejecting the measures Greece’s creditors asked for, affirms that there has been little to no ownership for the proposed measures. The IMF showed poor judgement in gauging both government and popular attitudes vis-à-vis the arrangement.
  4. The Troika has severely undermined the IMF’s independence. The Troika, the tripartite agreement of ECB, EU and IMF, has implied that the IMF lost control over the parameters normally guiding IMF lending policies curtailing significantly the independence of the IMF and the IMF Management Director.

IMF arrears

Greece missed its payment deadline on 30 June and is now in arrears to the IMF. Greece has overdue obligations of US$1.72 billion and with another payment due on 13 July, arrears would increase to a cumulative US$2.23 billion. Greece is already the single largest arrears case in the history of the IMF. While Greece’s arrears are unlikely to cause serious financial damage to the IMF, the IMF looks ill prepared to handle a significant increase in arrears. Greece is due to make payments to the IMF of US$6.20 billion through end-2015.

The IMF normally distinguishes between protracted arrears, payments overdue for more than 6 months and late payments. There are currently three protracted arrears cases Somalia, Sudan and Zimbabwe. Many protracted arrears cases have been associated with severe domestic conflicts and similar dislocations. The IMF today has protracted arrears of US$1.80 billion (May 2015).

Arrears to the IMF started to accumulate rapidly during the 1980s amid a series of payments difficulties in emerging markets and developing countries. The IMF at the time was criticised that it extended too many loans, many based on political motivations and under conditions that failed to offer adequate safeguards. The largest number of countries with protracted arrears was 25 in 1985. Total protracted arrears peaked in 1991 at US$5.10 billion. Subsequently, arrears to the IMF receded almost monotonically with the number of countries with protracted arrears dropping to the three arrears cases in 2008 (Chart 1).

Countries normally always repay the IMF largely out of concern that a non-payment to the IMF would cut the country off all other sources of finance. This rests in large part on the preferred creditor status of the IMF but also on the fact that the IMF acts as lender of last resort. Overdue payments to the IMF should therefore be treated as a generalised default where no creditor should accept any payment as long as there are overdue payments to the IMF.

The arrears will trigger a series of possible steps the IMF could undertake as remedial measures towards recovery. The country is immediately not permitted to use any IMF resources nor can any request for use of IMF resources, e.g. a new arrangement, be considered by the IMF Executive Board before all arrears are cleared. The IMF immediately sent a communication to Greece urging prompt repayment and will within two weeks of the due date send a formal communication to the Governor of Greece at the IMF, Greece’s finance minister. Within one month, the IMF Managing Director notifies the IMF Executive Board. Within 3 months, the IMF will post Greece’s arrears on the IMF website. The IMF Board may consider a motion towards a declaration of ineligibility of using IMF resources within 6 to 12 months, a suspension of voting rights within 18 months and the possibility of a procedure on compulsory withdrawal from the IMF within 6 months after the decision on suspension.1

The losses arising from arrears have been addressed principally through a burden sharing mechanism adopted in the mid-1980s. The notion of burden sharing, by which both IMF creditor and debtor countries make equal contributions towards the losses rests on the fundamental notion that the IMF Executive Board through its collective decision to support an arrangement needs to take responsibility for such decision equally collectively.2 Under burden sharing, the contribution from debtors and creditors is obtained by increasing the rate of charge, the interest charged for debtors borrowing from the IMF, and reducing the rate of remuneration, the interest paid to creditors lending to the IMF. This reflects the fundamental multilateral nature of the IMF. As such, Greece risks contaminating the entre IMF membership with its woes.

The IMF maintains precautionary balances to safeguard directly against credit risks and has various other ways to manage arrears. The IMF has reserves for its general resources of about US$23 billion. The IMF’s first line of defence upon recognising an actual loss (the IMF differs from other financial institutions regarding the recognition of losses), is the Special Contingent Account (SCA)-1 funded primarily through burden sharing contributions. Any loss would be charged against SCA-1 and losses exceeding balances in the SCA-1 would lead to a reduction of the IMF’s income and possibly the IMF’s reserves. The SCA-1 holds US$1.66 billion in January 2015 compared with US$2.64 billion in January 2008 suggesting the IMF has decreased provisions to guard directly against potential losses in the course of the financial and economic crisis.

Greece is still undoubtedly to become a protracted arrears case. If it does, given the size of payments due, it would critically undermine the income of the IMF. While it is unlikely to significantly impair the IMF’s financial strength, it may lead to fundamentally rethink if the mechanism adopted to date to safeguard the IMF against credit losses remain adequate. It may trigger a whole new approach to assessing the cost of operating the IMF.

IMF arrears

SDR basket review: Beyond the renminbi

The SDR quinquennial valuation review timetable has slipped. The IMF Managing Director’s work programme originally envisaged the first reading of the SDR valuation review by the IMF Executive Board during May, it may now only take place by end-July.3 This seems to reflect a good thing. Initial consideration for the SDR valuation review may not have taken into account possible complications arising from an inclusion of additional currencies into the SDR basket. The best approach would still be to simply change the SDR basket inclusion criteria.

The existing currency inclusion criteria were set in 2000. The existing currency basket comprises the dollar, euro, yen and sterling. The inclusion criteria are two-fold stipulating that currencies should be included of IMF member countries with the largest exports and that the currency is deemed by the IMF to be freely usable (must not mean freely convertible or freely floating). Freely usable has been determined to denote that a currency is widely used in the principal foreign exchange markets and in international transactions. While the renminbi naturally meets the first criterion it may struggle to satisfy the second. The renminbi has made considerable progress on the freely usable criterion, as shown in international payments transactions monitored e.g. by SWIFT (SWIFT RMB Monthly Tracker),4 despite known persistent other restrictions to use the renminbi freely, above all to make investments in local fixed income markets. However, the question should be if the renminbi were to be included why not other currencies that on that basis equally qualify for inclusion.

The lack of sufficiently unambiguous criteria, there will always be irrespective of the criteria used, to allow the renminbi in and keep others out seems to pose the main obstacles for this year’s SDR valuation review. However, the currency inclusion criteria are outdated and meant to serve a specific objective to allow the SDR to be a close substitute to any reserve currency in particular the dollar. However, the SDR has never come close to be considered a substitute to the dollar. This also rests largely on the fact that total SDR issuance has remained comparatively small to total foreign exchange reserve assets. The SDR could therefore usefully serve instead a different purpose.

The better solution would be to modify the inclusion criteria. It would allow to establish a new basis to guide SDR basket participation possibly shifting emphasis towards currency inclusiveness rather than exclusiveness. The SDR could usefully be repositioned to serve as a framework for integrating more currencies into the international monetary system. As such it would fully support the International Monetary and Financial Committee’s (IMFC), the steering body of the IMF, call for “collective efforts to strengthen the international monetary system and facilitate further integration of dynamic emerging markets.”

The inclusion only of the renminbi into the SDR basket seems hard to justify on objective grounds. It would look highly politically motivated. It may reduce the verifiability and transparency of the SDR. This over the medium-term may do more harm to the SDR as the welcome addition of the renminbi in the short term. It is therefore important to distinguish between a major international currency, which the renminbi is not yet, and a currency to be included in the SDR basket, which the renminbi should be. The SDR basket should represent a transition for currencies towards becoming important international currencies. Once they are, the SDR provides little value of including them. The best illustration would therefore be to open the SDR basket to several new currencies.

Foreign exchange reserves: Euro blues

Recent data on currency composition of central banks’ foreign exchange holdings affirms the continued decline of the share of the euro.5 In March 2015, the euro share in allocated foreign exchange holdings was 20.7 percent, its lowest level since June 2002 (Chart 2). The share of other currencies, in particular including the Australian dollar and Canadian dollar, has also receded slightly from its local high in June 2014. The reserve pattern seems to mark a retrenchment of an earlier trend of increasing reserve currency diversification. Total foreign exchange reserves continued to decline to US$11.4 trillion, the third consecutive fall since June 2014 though reserves of advanced economies reached a new peak in March 2015.

Foreign exchange reserves currency composition


1 The IMF initiated compulsory withdrawal procedures for Zimbabwe in December 2003.

2 See e.g. Boughton, J., The Silent Revolution, the International Monetary Fund 1979-1989, IMF 2001; IMF Executive Director Mtei (Tanzania) observed during a Board discussion in December 1985 that “the entire membership had approved the arrangement that had subsequently gone wrong, and equity required that all members share in the cost.”

3 Statement by the Managing Director on the Work Program of the Executive Board Executive Board Meeting November 24, 2014.

4 href="http://www.swift.com/assets/swift_com/documents/products_services/RMB_June_2015_final.pdf">

5 IMF Composition of Official Foreign Exchange Reserves (COFER) survey, 30 June 2015.