Tuesday 21 May 2019

Kenny's chance to get Obama onside on new IMF chief

Kenny can use downfall of DSK to his advantage by ensuring successor supports current policy, writes Colm McCarthy

Since the financial crisis broke in mid-2008, Ireland may not always have pursued the best of policies but neither has the Government enjoyed the best of luck. The banks turned out to be even more bust than the Government's worst fears, the economy weaker, the sovereign debt markets less forgiving. The choice of successor to Dominique Strauss-Kahn (DSK) as managing director of the International Monetary Fund could turn out to be another example.

It has been an open secret that the IMF has favoured from the beginning rescue plans for Ireland and the other distressed Eurozone members which would have been rather more practical than the muddled prescriptions of our European partners. Mr Strauss-Kahn could now be replaced by a European politician identified with the inadequate European approach of which the IMF is now openly critical.

There have been broad hints at IMF dissatisfaction with the approach taken by the EU Commission and the European Central Bank ever since the rescue package for Ireland was negotiated last November. The IMF favours decisive rescue plans that are capable of implementation and offer a clear exit strategy to the troubled states which seek its assistance.

These are invariably unpleasant, involving severe budgetary cut and losses for private lenders to the country or its banks where debts are unmanageable. The intention always is that the rescue plan offers a clear route back to credit-worthiness and access to the markets.

The IMF report on Ireland released last Friday is, with the diplomatic language stripped away, an indictment of last November's deal for Ireland. It is already clear that the timetable envisaged for Ireland to re-enter the bond market will not be attained, barring a miracle, on current policies. It should have been clear last November and it seems that the IMF was concerned about the feasibility of the deal from the beginning.

The report states: "Risks to the programme, already high at approval, have risen in some respects. The combination of slower growth and higher unemployment rates, together with higher bond spreads and rating downgrades, have increased downside risks, especially risks to regaining market access. At the same time, some risks, such as those from the financial sector and political uncertainty would appear to have diminished.

"But these positive elements have had limited or temporary benefits in a context where external developments, such as the introduction of the forthcoming European Stability Mechanism or developments in other eurozone periphery countries, drive financial markets and the perception of the probability of default."

The reference to the European Stability Mechanism needs to be deconstructed. The IMF authors are saying that the EU's intention to include, from 2013 onwards, punitive haircut clauses in government bond documents will (surprise, surprise) deter buyers of Irish government bonds. They are further disadvantaged by plans to grant additional priority to official lenders since this makes sovereign bondholders subordinate. The phrase ". . .developments in other Eurozone periphery countries. . ." is a reference to the impossible situation that has been created in Greece, where a second rescue is now inevitable just one year after the first.

The opportunity to pronounce, as so many European officials have been doing, that the markets are wrong and that everything will be okay, arises naturally in this paragraph. Since the IMF has declined the opportunity (I can find no denunciation of the bond market's high implied default estimates anywhere in the document), we may safely assume that the IMF thinks that the markets are right and that the European officials are wrong on this crucial point.

It lauds the progress made thus far with the bank stress tests, but goes on to say: "...the deleveraging of bank balance sheets will need to strike an appropriate balance between improving liquidity and containing losses; greater confidence in the availability of ECB financing in the medium term could maximise the benefits of these efforts for the banks' ability to regain market-based funding."

Recall that the intention in the November plan was that the banks would sell off good assets, possibly at a discount, to pay down debt and shrink their balance sheets. The stress tests have revealed that this is quite impractical: the discounts would have been far too large and the November plan was hopelessly optimistic on this issue.

The IMF is now acknowledging that a rapid deleveraging of bank balance sheets is not advisable and it makes one wonder whether it was on board for November's optimism on this point.

But the next sentence is a straight potshot at the ECB's refusal to contemplate medium-term funding for the Irish banks in substitution for the current grace and favour arrangement. Banks will hardly be able to borrow in the markets when liquidity support is at the discretion of a central bank which has repeatedly threatened its withdrawal.

On budgetary policy, the IMF expresses satisfaction with the progress made to date but offers a less-than-ringing endorsement of the Government's only significant action to date, the 'jobs initiative'. It writes: "The authorities' plan to adopt a Jobs Initiative in the near-term does not undermine these fiscal consolidation goals."

This sounds like an expression of relief that the bill for election promises was not too large. The IMF concludes with a very clear sideswipe at the inadequate European policy response to the banking and sovereign debt crisis.

"This decisive approach to programme implementation, which should be supported by a more comprehensive European plan, offers the best prospect to overcome market doubts, regain market access, reduce the threat of spillovers, and restore growth.'

Back in the summer of 2010, when the prospect of failure in the markets and resort to an EU/IMF rescue began to emerge, many Irish people reacted with horror at the notion of IMF involvement. Those better versed in the way these institutions actually work were less concerned. The IMF is pursuing a disinterested and coherent approach to its involvement with this country and it is lamentable that the same cannot be said of our European partners.

Ajai Chopra, the IMF's principal adviser on the Irish programme, went further in his conference call on publication of the report (the transcript is on the IMF website): ". . .European partners need to make clear that for countries with programmes there will be the right amount of financing on the right terms and for the right duration to foster success. In other words, the countries cannot do it alone and putting a burden of the cost of adjustment on the country may not be economically or politically feasible. The resulting uncertainty affects not only these countries but through the high spreads and lack of market access it increases the threat of spillovers and creates downside risks to the broader euro area. Hence, these costs need to be shared including through additional financing if necessary."

The IMF's recent statements, with which the former managing director must be assumed to agree, constitute a stinging rebuke to the European institutions and the Franco-German political leadership. The IMF, in polite tones, has accused them of incompetence in the management of the banking and debt crises. It would be another setback for the distressed eurozone members if a defender of this failed policy were to be chosen as Strauss-Kahn's successor. But the early favourite to succeed him is French Finance Minister Christine Lagarde, an architect and proponent of the muddled policy which so disturbs the IMF.

There has long been a tradition of parachuting European (usually French) politicians and bureaucrats into the managing director's chair at the IMF. The USA gets the corresponding role at the World Bank, in a carve-up increasingly resented by the rest of the world. European politicians are beginning to assert the desirability of again having a European in charge at the IMF. The Irish Government has acquired a small amount of leverage through Strauss-Kahn's downfall. It should be used to ensure that the next managing director supports the IMF's current approach, which is to expose, diplomatically of course, the aspects of European policy which are most damaging to Ireland's recovery prospects.

Many commentators expect that the attitude taken by the US will determine who gets to lead the IMF. Taoiseach Enda Kenny should raise the issue with US President Barack Obama when they meet in Dublin tomorrow.

Colm McCarthy lectures in

economics at University College Dublin. He has headed an expert group examining State assets and chaired the Special Group on Public Service Numbers and Expenditure Programmes, aka An Bord Snip Nua. He is also the author of the report into the semi-state sector from the Review Group on State Assets and Liabilities

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