It’s been the subject of more rumours than Kim Kardashian but the ECB-IMF switcheroo is increasingly likely, at least according to reports from Bloomberg and Reuters.
One would think the involvement of the credible-again IMF would be good news. But in a note out Monday, Nomura’s Desmond Supple warns of three “significant drawbacks” to using the IMF as a conduit for ECB or National Central Bank (NCB) funds.
First, although using the IMF allows the ECB/NCBs to get around Article 123, it can’t of course buy bonds. Thus, the success of any switcheroo is still limited by the size of the already troubled NCB balance sheets.
While lending to the IMF is easier for the ECB than having to determine its own conditionality on its SMP programme, it still leaves us concerned about the ECB’s commitment to significantly expanding its balance sheet at this stage. Conditionality is only one of the ECB’s concerns on this front, others being its concern that the effectiveness of monetary policy will be undermined. For instance, the EUR270bn of NCB loans to the IMF mooted in press reports last week would be far too small, especially considering next year’s wall of debt issuance from eurozone sovereigns, SSAs and banks, and the current deleveraging forces in the financial sector.
Second, the IMF is senior to all other creditors and thus “if you use the IMF as a conduit it needs to be provided with overwhelming resources to make investors confident that default risk is markedly reduced”, Supple writes.
Third, if the IMF funds are “precautionary” (i.e. can only be drawn upon after a country loses market access) then this would limit the impact.
There is a risk that the IMF would only be able to extend these funds to countries on a proactive basis, as if some form of IMF agreement had been signed. Indeed, there is a strong possibility that the IMF could only disperse ECB/NCB loans to countries that had already engaged in a formal borrowing arrangement or a precautionary arrangement, which in each case would require countries to engage in a full IMF programme. This would further reduce the ability of the IMF conduit to be preemptive in altering the asymmetry of risk.
All good points, although Nomura are being a bit unfair to judge the switcheroo’s effectiveness on whether it delivers the longed-for balance sheet expansion. Given the size of the trust fund required, US political calculations, and the size of the loans already committed to Europe, a backstop is about as much as could be expected. And don’t discount the psychological importance of having the IMF as part of any so-called “grand bargain” that emerges later this week. All in all, it’s better to have the IMF involved than sitting on the sidelines.
However, it is worth asking whether the presence of a precautionary fund would actually change the behaviour of private creditors. Does it just frontrun — and take off the main IMF balance sheet — what the IMF is there for anyway?
The FT’s Alan Beattie reports that some IMF insiders “doubt the wisdom” of lending large amounts to, say, Italy — if the IMF lent Rome enough to cover the flow of its debt for the next year, it could prove tricky for Italy to return to debt markets. Beattie suggests that an alternative might be to follow the IMF’s approach to Turkey in 2001, “which helped Ankara roll over its giant financing needs while still borrowing in private markets.” (It also had social and political consequences we’re unqualified to comment on.)
That works so long as these are liquidity crises rather than solvency ones — but it’s hard to tell one from the other these days.
Related links:
Talismanic IMF ponders future role – FT
IMF Shouldn’t Aid Europe Financially, Blejer Says – Bloomberg