Why Involve the Private Sector in Crisis Resolution?
The IMF was established in 1944 in part to help countries to resist the balance of payments problems by providing temporary financial assistance. The purpose was to stop feeling the need to resort to measures such as devaluation or the imposition of excessive trade barriers, which would unnecessarily harmful consequences to themselves and to other countries. But now that the balance of payments problems occur sometimes in the form of substantial and sudden outflows of capital, could do much more extensive resources are needed to help countries overcome the problems. That is why the spotlight is now on the role the private sector to help resolve the crisis.
When capital flows were restricted during the years following World War II, the volume of external resources needed to attract a country to maintain a reasonable level of economic activity was essentially equal to the shortfall in its current account balance, ie The money needed to buy imports minus foreign exchange earnings derived from exports, sending abroad. (Hence the traditional view that the adequacy of the reserve currency of a country is measured by the number of months of imports that could be paid.) In the emerging market economies, current account deficits have rarely exceeded 5 % of national income.
The volume of capital flows far exceeds the vast sums needed to pay the trade in the extreme situation could happen that a country faces a crisis of confidence needed to have sufficient foreign exchange to pay immediately all its external creditors. In the typical case, that amount is much higher than the current account deficit on average over 30% of national income in emerging market countries. The capital requirement would be even greater if domestic investors try to get their money, which is what happened in the recent crisis in Indonesia, Russia and Brazil.
As the needs have increased potential to support the balance of payments have also increased the resources available to the IMF for a loan, but nowhere at the same pace. The IMF is a credit association in which member countries make contributions in proportion to the global importance of their economies. The country is in difficulties, is entitled to receive credit for an amount that is proportional to the contribution it has signed, subject to agreement on measures of economic adjustment and reform to address the root causes of the problem of balance of payments.
The IMF has agreed to significant lines of credit with several major industrial countries and emerging market economies, according to the so-called General Arrangements to Borrow and New Arrangements to Borrow. But the bulk of the resources available to the IMF comes from the shares held by member countries with balance of payments position is strong. Since 1970, and expressed in U.S. dollars, the total number of shares in real terms has grown by 170%. However, in the same period, according to some studies, emerging market economies have grown by 250%, world trade and a 440% capital flows from the private sector by almost 850%. The IMF currently has around U.S. $ 200.000 million to provide. But this amount represents less than one tenth of the total external debt of low-and mid-to late 1997.
To address this limitation of resources, the IMF has less leeway to the central bank of a country which faces a similar crisis of confidence in its banking system. The central bank of a country can offer an absolute guarantee to reimburse the depositors, because you can print an unlimited amount of currency to inject into the banking system (unless they operate a compensation fund has adopted the currency of another country through “dollarisation”.) The inability of the IMF to intervene in this way, as a classic example of “lender of last resort” is one of the reasons for which countries can sometimes be taken to intensively negotiate with creditors to maintain access to funding and for which, ultimately, it may be necessary in extreme cases limit the ability of creditors to demand repayment in a country which is in serious difficulties. This is what “private sector involvement in crisis resolution.
Moral hazard
Even if the IMF had unlimited resources, would not necessarily be desirable or acceptable from a policy to provide all the currencies you may need in case of a panic by investors. The reason is called “moral hazard”, ie the danger that countries will be encouraged to follow steps lax, and that investors are encouraged to create grant credit considering abandoning the international community to intervene and ensure the repayment if the is twisted. Those who criticized the rescue plan organized by the IMF for Mexico in 1995 argued that, by reimbursement to those who invested in Mexican government bonds denominated in U.S. dollars, the IMF and other international institutions to encourage investment in reckless Southeast Asia.
However, the evidence does not confirm this. Investment in Asia is not headed for the kind of assets that probably would have benefited from the IMF rescue launch. Holders of public debt were the main beneficiaries of the rescue organized to Mexico, but the holdings of public debt rose only slightly in Asia. Similarly, we could have expected a higher volume of credit to Asian banks because the course was likely to enjoy protection in the event of a crisis. Again, it was not. However, this does not mean that moral hazard is insignificant. It is clear that investors were encouraged to put money in Russia partly due to the mistaken belief that the country was “too big” or “too nuclear” to let it fail. Failure to control the moral hazard, it is likely that crises are more frequent and more severe than otherwise.
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May 4th, 2009
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