Column  International Exchange  2012.01.10

-The Ongoing Economic Crisis- Series 1: The Comprehensive Strategy to address Debt and the Financial Crisis, announced in the early morning of October 27 at the EU Summit

Newsletter from Daisuke KOTEGAWA

1.  According to the media, the "concrete" measures of the comprehensive strategy are as follows:
(1)  The ESFS, which now has the capacity to lend up to 440 billion euros (about 46 trillion JPY) as a safety net, will be expanded to a level of 1 trillion euros (about 105 trillion JPY).
(2)  Creditor banks accept a 50% write-off of their credits to the Greek government.
(3)  Net capital of banks will be increased by 106 billion euros (11.13 trillion JPY).

2.  The problem is that the proposal does not specify the framework of this strategy, particularly how the ESFS will be expanded. Further, it does not explain the difference between 105 trillion JPY and 46 trillion JPY, nor:
1)  Who will undertake this burden
2)  What is the modality of the scheme
Accordingly, it is unclear whether this expansion is realistic. In particular, judging from the demarche at the time of the G20 to solicit contributions from advanced countries outside the EU and BRIC, it is likely that EU member countries do not intend to pledge additional contributions to the ESFS. Against this backdrop, it is difficult to dispute the claim that EU member countries might be trying to free-ride.

3.  At a session of the IMF Board after the strategy was announced, many questions were raised about the above-mentioned points. The European chairs did not offer any concrete answers. IMF management was desperate to maintain control of the session. Although Ms. Lagarde, Managing Director of the IMF, has been touring BRIC countries to solicit their commitments, it would be impossible for these countries to even begin internal discussions on the subject without the following details:
(1)  Do EU member countries intend to make additional commitments to the ESFS? What is the burden-sharing among EU member counties? What is the burden-sharing between EU member countries and others?
(2)  What is the modality of the contribution? Would it be contributions to the ESFS fund, loans to the fund, or purchase of bonds to be issued by the fund?
(3)  What kind of repayment assurance is there in the case of loans or bond investments? Would a collective guarantee by EU member countries be preconditioned? How would the interests of creditors be assured in case of default?
(4)  What modalities are there regarding the use of fund resources? More specifically, would resources only be used to address the liquidity problem; or, if necessary, would they be used to address the issue of a nation's solvency?
(5)  What is the decision-making mechanism of the fund? How would the rights of contributors or creditors who participate in the decision-making process of the fund be assured?
(6)  Last but not least, what kinds of concessions are EU member countries prepared to make in response to the contributions by other countries with regard to the governance issue of international organizations such as the IMF?

4.  Meanwhile, burden-sharing among the EU and the IMF of IMF assistance to European countries after the Lehman shock was as follows:
  Iceland (non-EU member) ⇒ only IMF (2.1 billion USD)
  Latvia ⇒ 3:1 (5.1 billion euros : 1.7 billion euros)
  Greece ⇒ 8:3 (80 billion euros : 30 billion euros)
  Ireland ⇒ 2:1 (45 billion euros : 22.5 billion euros)
  Portugal ⇒ 2:1 (52 billion euros : 26 billion euros)
If the scope is broadened to include any historical cases of IMF assistance, such as the Asian crisis in 1997-98 in South Korea, Thailand, and Indonesia, the crisis in Russia in 1998, and the crisis in Brazil in 1998, most financial assistance was extended by countries in the region to the IMF. In all cases, tough conditions were imposed by the IMF to guarantee repayment. The EU, as a political and economic community, goes beyond independent countries in the region. Hence, the ongoing crisis among EU member countries should be addressed, in principle, by the EU itself. The initiative by the EU to try to solicit contributions from countries outside the region also marks a major departure from the past cases described above.

5.  Furthermore, major European countries' sentiment to refuse tough conditions attached to IMF assistance due mainly to pride is a source of dispute among BRIC and non-EU countries, typified by the Italian government's decision to decline an offer of assistance by the IMF. The IMF has various resources in addition to the general resource account (GRA), such as the New Arrangement to Borrow (NAB), which was expanded in 2010 to around 60 billion USD under my chairmanship. Assistance from these resources requires conditions. It is being examined whether it would be possible to buy government bonds from European countries without conditions through a new trust account which will be established from contributions of member countries. Such an idea, though, would hardly be psychologically acceptable as it represents inequitable treatment of Asian countries such as South Korea, Thailand and Indonesia, Latin American countries, and Russia, which all accepted and followed tough conditions when they received assistance from the IMF. In the case of South Korea, for instance, candidates for president sat an oral interview with the IMF mission to ensure they would be firmly committed to such conditions should they become president. In addition, the purchase - without conditions - of government bonds from such countries as Italy or Spain as a guarantee of the IMF fund runs a high risk as to whether these governments might default on the bonds. Such purchases can be compared to investing in debentures issued by a private company or making additional loans which may be insolvent, without going through the process of Chapter 1.

6.  It is therefore conceivable that most countries believe it would be more desirable to extend loans or invest in the IMF rather than doing something similar for the ESFS. If any contribution by Japan should become necessary, additional support directly to the IMF would be the only possible way, considering that it would go towards assisting all member countries (not only EU member countries) and that attached conditions would assure repayment. It should also be noted that extending credit to the IMF is the safest investment, because it is inconceivable that the IMF, which is basically the central bank of all countries, would not be able to repay the investment.

7.  Against this backdrop, expanding the ESFS to upwards of 1 trillion euros would be difficult unless European member countries could make additional contributions. Whether such additional contributions are feasible would depend on negotiations inside the EU. If it turns out to be unfeasible, the safety net for a potential economic crisis would remain flawed even if the resource base of the IMF were bolstered in terms of burden-sharing between the IMF and the EU. The fate of the world economy depends on the decision of European countries to stem the ongoing vicious cycle of its economy through renewed efforts to improve their fiscal condition. If such efforts prove unsuccessful, the world will have to expect a second economic shock larger than the one which followed the Lehman shock.