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Friday, December 02, 2011

ECB lending to the IMF

This is the third time the prospect of the ECB lending to the IMF has been brought up as a potential solution to the eurozone crisis. As such it might seem like old hat, but this time round it may have a bit more substance to it. Bloomberg reports that at Tuesday's meeting of eurozone finance ministers the ECB President Mario Draghi, who was also in attendance, approved the creation of a plan to allow the ECB to lend to the IMF, and then the IMF to use these funds to lend to struggling eurozone countries.

Very much an initial stage, but more than the recycling rumour which we had before. The report suggests the lending could top €200bn, so not pocket change but not enough to stem the crisis. The likely plan would see the IMF using the funds to provide precautionary lending programmes to the likes of Italy and Spain.

So could such a plan work? As you may expect, we think probably not. Here are a few of our initial thoughts on why:
- Ultimately, this proposal doesn’t change much may allow a small boost of liquidity but doesn’t solve the underlying competitiveness problems and structural flaws in eurozone. Italy and Spain need devaluation to become competitive again.

- IMF can impose conditions, so does circumvent the moral hazard problem posed by direct ECB lending. It does seem that ECB lending to the IMF is preferable to the ECB funding states directly with bond buying, due to this added conditionality.

- Although, may be conflict between ECB and IMF over best practice and use of money. Already disagreed over Greek restructuring (to the point where the ECB added a footnote into the troika report stating it did not agree with the level of write downs).

- ECB will essentially be ceding control over a large amount of funds, does again raise questions over its independence.

- Will not de jure break the ECB statute (Article 23 allows it) but definitely de facto against the fundamental principles of the ECB. The legal basis for it was never intended to sustain large bailouts. Will not be supported in Germany generally.

- German government has suggested it would support bilateral loans to the IMF. Not clear if this involves the ECB, unlikely, probably more in favour of countries boosting their IMF contributions.

- Where would the funds come from? The ECB would basically just create new money and lend it to the IMF. No indication that collateral would be taken on (not needed from IMF really, but separates it from usual lending options) or that this would be sterilised in anyway. Seems a big abandonment of ECB principles.

- Impossible to justify this as monetary policy (as ECB has done with SMP etc.) just direct lending to IMF to finance states.

- Still stigma attached to asking for IMF help. Not clear Italy and Spain are ready to cross that line yet. Once it is crossed will be more pressure for funding to continue if initial bout is not successful (which it looks unlikely to be – both countries need huge reforms which cannot happen overnight, yet have huge funding needs).

- Not clear who would take losses, should any occur. IMF is always senior so unlikely to take any losses. But existing debt holders may not like the introduction of €200bn in senior debt, especially if it originates at an equal creditor (the ECB).

- ECB exposure to PIIGS is around €630bn now, adding another €200bn to that, even through the IMF, cannot be seen as desirable.
All in all then, many of the same problems as with any massive ECB intervention. Legally and economically this plan could be preferable to the direct ECB financing of states (but then almost anything would be) but politically, it still raises a huge number of problems.

1 comment:

Rollo said...

The IMF is already compromised by having Lagarde at its head, the replacement for the last Frenchman. Her interests are torn between saving French banks, keeping France's image as a (near) equal of Germany, and overseeing good practise at the IMF. She knows that 200 billion or 5 times that much cannot save the Euro.