Integration Economics Paper - LOLR

8/6/2019 Integration Economics Paper - LOLR

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Winter Semester 2009 / 2010

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D O WE NEED AN INTERNATIONAL LENDER OF LAST R ESORT ?


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Contents

I. Int oductio n

A. General introduction

B. Key definitions

II. The Len der of Last Resor t : The ory an d Practice

A. Liquidity provider

B. The distinction between illiquidity and insolvency

C. Deterrent measures and definition of good collateral

III. Peculiar ities of the In terna tional Do ain

A. Replicating LOLR features at international level

B. Possible solutions

C. Section Conclusion

IV. The Ca talytic eff ect of the IMF

V. Conclusion

Ref erences

Ancillary shee t

Tab le of figures


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I ntroduction

A. General Introduction Central Banks s uff er f r o the li itation that they are national central banks. On ly

in a na tional econo y that is lar gely se lf contained, can a central bank be a central bank;with the develop ent of wor ld marke ts, and of wor ld financial marke ts, national central

banks take a s te p down, becoming single banks in a w or ld wide sys tem, not at the center any

longer. Th us, the pr o blem that was s olved by the institutio n of national central banks has

rea ppeared, and is still unres olved on the wor ld level.(J ohn HICKS , The two Tr iads, p.60)

Dur ing the Bre tton Woods se t up, the immoderate recourse for ca pital flow contr ol,

the par celed regulatory f rame wh ich a llowed for multilateral fixed exchange ra tes but with

modific ation possi bilities contr i buted maintaining the lender of last resor t function within

national limits. Ar ticle VI of IMFs char ter , which has never been m odifi ed, suppo r ts clear lythe f act that creators of the a fter-war interna tional monetary or der tr ied deli bera tely to avoid

IMF be ing in char ge of the LOLR r ole. Nowadays, given f ree ca pital flows (v ir tually

achieved), str ong com petition in interna tional financial market and the numer ous emer ging

marke ts w ith pegged exchange ra te, the nee d for an interna tional entity committed to lend in

last resor t to countr ies is undeniable.

Whichever pr oject is to create an interna tional lender of last resor t should be

considered carefully. The IMF has a cted like a LOLR in the past years , refining considerab ly

its r ole; it handles out the Ar gentina cr isis as we ll as Me xican or As ian cr isis. It pr ovides

liquidit y in arrear to countr ies f acing dr ought financing sour ces be cause of self -fulfilli ng

behav ior f r om investors. La ter on, cr itics have emer ged f r om many o bservers re gar ding the

mana gemen t of the cr isis and the es tablished polic y.

If the pur pose is to foster the interna tional sys tem a imed at resolving cr isis, it is

necessary to work a t the mar gin. One of those im pr ovemen ts would answer to one of the

emer ging marke ts expectation. They do not want to rely too much on externa l exchange ra te

but nonetheless they wan t to dis pose of credi bility. A ccor dingly, they do not need ca pital

since some have s u bstantial savings ra tes an d the ma jor ity can a ccess the financial marke ts to

bolster up their gr owth. The pr opor tion of member wh ich ha d entered into IMFs pr ogram

has never been s o high; however , the de pendency over IMFs res our ces has never been s o

low. G lo bally, it seems that the IMF wh ich lent to countr ies w ith difficult access to financial

marke ts, become a mean to increase countr ies credi bility in the f ace of foreign pr ivate

inves tors. Th us the initial function of sustaining the e xchange ra te loses gr ound for a s im ple


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reason: the m ore the IMF im pr oves its credi bility re infor cemen t function, the less the IMFs

members nee d for drama tic action such as fixed- peg, in or der to establish discipline in

domestic polici es.

The ne cessity of str onger interna tional regulation an d better mana ged incentive s uch

as outr ight credit line guaranteed by the IMF sh ould pr op up the financial system.We consider a ll these as pects in our pa per , star ting with theoretical pr inciples ab out

the lender of last resor t, first at national level, then e xamining the prere quisites for an

interna tional trans position. Ne xt we pore over the catalytic eff ect of the IMF. F inally thr ough

the conclusion we em phasize both the cr itics f acing the IMF an d the res ults of our resear ch.

B. Key definitions

WHAT DOES A LENDER OF LAST RESORT MEAN?

The name lender of last resor t owes its or igins to Sir Fran cis Bar ings, who in 1797

ref erred to the Bank of England as the dernier res or t f r om wh ich a ll banks could o btain

liquidit y in times of cr isis.1 The lender of last resor t ( LOLR) r ole of the central bank

rema ins a ma jor ra tionale for most central banks ar ound the w or ld, in both developed and

developing countr ies.2 Wh ile other central bank functions have re cently come under fire (e. g.

bank ing supervision), the im por tance of having the LOLR under the umbre lla of the central

bank is seldom contested.3 It is the immediacy of the ava ilability of central bank credit (thecentral bank be ing the ultimate suppli er of high- powere d money) that makes the LOLR

par ticular ly suitable to conf r ont emer gency situations.

An institutio n, usually a country's central bank that off ers loans to banks or other

eligi ble institutio ns that are exper iencing financial difficult y or are considered highly r isky or

near coll a pse. In the U.S. the Fe deral Reserve a cts as the lender of last resor t to institutio ns

that do not have any other means of borr owing and whose f ailure to o btain credit would

drama tically aff ect the economy.

The lender of last resor t functions both to pr otect individuals wh o have de posited funds, and to preven t panic withdraw ing f r om banks wh ich have tem porary limited liquidit y.

Commer cial banks usually try not to borr ow f r om the lender of last resor t because s uch

action indicates that the bank is exper iencing financial cr isis.


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Cr itics of the lender-of -last-res or t methodolog y sus pect that the sa f ety it pr ovides

inadver tently tem pts qualif ying institutio ns to acqui re more r isk than ne cessary - s ince they

are m ore likely to per ceive the pot ential conse quences of r isky a ctions to be less severe.

WHAT DOES A CENTRAL BANK MEAN?

This is the en tity res ponsi ble for oversee ing the m onetary sys tem for a na tion (or

gr oup of nations). Cen tral banks have a w ide ran ge of res ponsi bilities, f r om oversee ing

monetary polic y to im plemen ting s pecific goals s uch as currency s tability, low inflation an d

full em ploymen t. Cen tral banks a lso genera lly issue currency, function as the bank of the

governmen t, regulate the credit system, oversee commer cial banks , mana ge exchange

reserves an d act as a lender of last resor t.

The central bank ing system in the U.S. is known as the Fe deral Reserve Sys tem

(commonly known as " the Fe d"), which is com posed of 12 re gional Federal Reserve Banks

located in ma jor cities thr oughout the country. The ma in tasks of the Fe deral Reserve are to

supervise an d regulate banks , im plement monetary polic y by b uying and selling U.S.

Treas ury b onds an d steer interest rates. Ben Bernanke currently serves as the chairman of the

Boar d of Governors of the Fe deral Reserve.

WHAT DOES IMF MEAN?

The IMF is the w or ld's central or ganization for interna tional monetary coop eration. I t

is an or ganization in wh ich a lmost all countr ies in the w or ld work together to pr omote the

common good .

The IMF's pr imary pur pose is to ensure the s tability of the interna tional monetary

system the sys tem of exchange ra tes an d interna tional paymen ts that enab les countr ies (an d

their citiz ens) to buy good s an d serv ices f r om ea ch other. Th is is essen tial for sustainable

economic gr owth and r ising living standar ds.

To maintain stability an d preven t cr ises in the interna tional monetary sys tem, the IMF

reviews na tional, regional, and glo bal economic and financial developments. It pr ovides

advice to its 184 member countr ies, encouraging them to adopt polici es that foster e conomic


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stability, reduce their vulnerab ility to economic and financial cr ises, and raise living

standar ds, and serves as a for um where they can discuss the na tional, regional, and glo ba l

consequences of their polici es.

The IMF a lso makes financing tem porar ily ava ilable to member countr ies to help them a ddress ba lance of paymen ts pr o blems that is, when they find themse lves sh or t of

foreign exchange because their paymen ts to other countr ies exceed their foreign exchange

earn ings.

And it pr ovides technical ass istance and training to help countr ies b uild the e xper tise

and institutio ns they nee d for economic stability and gr owth.

WHAT DOES CURRENCY BOARD MEAN?

The currency boar d is a technique binding entirely the gr owth of the m onetary base to

the gr owth of the reserves of exchange with the a doptio n of a fixed exchange ra te, as for

exam ple 1 peso = 1 dollar , and su bstitutability per f ect between b oth currencies. In other

wor ds, a sys tem wh ile a llowing to mana ge the em ission of the na tional currency of a country

which a llows to have a " local" currency the va lue of which is called on an other currency

which we use for the interna tional regulations. Th is sys tem is more used by the sma ll

countr ies be cause their size does not allow them to have a re cognized currency in a

interna tional way on the marke t.

Advantage of the currency boar d: guarantee of a m onetary a uster ity. In deed, to emit a

peso, for exam ple, the central bank has to acquire an a dditio nal dollar , by ba lance of

paymen ts sur plus.

Inconven ience of the currency boar d: if the e conomy loses in com petitiveness ,

entrances to currencies are going to decrease an d the central bank w ill be s lowed down in its

ca pacity to be created of the currency ( change), what can pull a cr isis of liquid asse ts. I f the

bank is called to play its lender's r ole in the last resor t, she cannot create so much liquid

assets as the bank ing system in deman d. Severa l solutio ns are then possi ble:

It maintains the currency boar d. It cannot satisf y the nee d of liquid assets of cer tain

banks , which will make, for some of them, def ects r isk sys tem.


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It aban dons the currency boar d. It devalues the local currency with re gar d to the dollar

to be ab le to create m ore liquid assets. C onsequence: loss of credi bility of the central bank +

reliable loss in the na tional currency? R isk of doll ar ization of the economy, the leaks of

ca pital, a bank ing panic, a decline of the va lue of all the asse ts (a ctive persons) denominated (drawn up) in this na tional currency + increase of the debts in dollar. Aban donmen t of the

currency boar d to avoid cr isis of liquidit y can pull (entail) mass ive re treats (withdrawa ls) of

the de positors, tak ing refuge with the doll ar.

Consequence: bank ing cr isis? Sys tematic r isk

This exam ple illustrates we ll that a central, oppo site bank in its ca pacity to create

liquid asse ts, cannot play its lender's r ole in the last resor t. The difficult y of a central bank played its lender's r ole in the last resor t settles for the a ppear ing countr ies b ound (connected)

by a sys tem of binding fixed exchange rate.

Exam ple: Hong K ong's C urrency Boar d system ens ures that the M onetary Base

in H ong K ong is fully ba cked by foreign currency reserves a t the fixed exchange ra te of 7.8

Hong K ong doll ars to the US dollar.

Under the monetary r ule wh ich governs the Currency Boar d system, any change in the

Monetary Base - whe ther increase or decrease - m ust be ma tched by corres ponding changes

in foreign reserves.

Currency Boar ds were intr oduc ed in Br itish colonies in the n ineteenth century to

reduce the cost of trans por ting silver coin an d bullion. Hong K ong first im plemen ted a

currency boar d sys tem in 1935. A t least eight jur isdictio ns in the w or ld now have currency

boar d systems. The chara cter istics of a pr oper ly r un currency boar d system are:

- simplicity- re liability- transpa re ncy- pred ictability- cred ibility


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In recent years , Hong K ong has s trengthene d and developed its currency boar d sys tem

to make it more r ule base d and less v ulnerab le to externa l shocks.

Other inconven iences of the currency-boar d: the central bank loses its power of

issues. The local currency is em itted at the same time of the re f erence currency. The countryloses its autonomy concerning its monetary polic y an d concerning its polic y of exchange

because he has to follow the re f erence currency. Th is sys tem is acce pted with difficult y by

the var ious States but the pr o blem is, for some of them, that they have n ot a conver ti ble

currency, and thus acce pted by the others w ith a n ot too weak e xchange ra te. Th is sys tem

allows them to trade on the interna tional stage. Fur therm ore, if the currency of chosen

ref eren ce knows " disturbances", the local economy w ill suff er f r om it.


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C. The Lender of Last Resort : Theory and Practice

While the theory of lending of last resor t seems to be f air ly s im ple indeed, its ma in

elements ha d alrea dy been es tablished in the n ineteenth century by s uch authors as Henry

THORNTON an d Wa lter BAGEHOT its im plemen tation is f ar more nuanced. Lending of

last resor t would be be tter descr i bed these days as a tool box, with the choice of the s pecific

tool to be used left lar gely to the discretion of the cr isis mana ger , than as a s ingle well-

identified instr ument or pr ocedure. The ga p between theory an d practice is lar ge and should

deserve our attention.

It is common sense hen cefor th that financial marke ts carry a coor dination pr o blem

which finds its or igin in the very na ture of financial asse ts: claims on future income s tream

whose va lue de pends on the investors expectation re gar ding these s treams , themse lves

de pending on the current value of the asse ts. Consequently multipl e equili br iums are

possi ble. A s udden rev ision of inves tors sentiment and the asse ts value would change.

This coor dination pr o blem is s uffici ently ser ious to warran t pu blic action. The central

f eature is the willingness to take over r isk to an en tity since any others w ould find it

unacce ptable. S ince then, the doct r ine of the lender of last res or t could have s ummed up by

the ma xim: lend f reely to tem porally illiquid but solvent banks a t a penalty ra te and on good

collateral (W. BAGEHOT , 1873).

D. Liquidity provider

In or der to restore confidence, the LOLR sh ould mo bilize s uffici ent resour ce to meet all the liabilities of financial interme diar ies f acing a bank r un. On ly central bank have

unlimited resour ce since they can pr int money b ut this is s im plistic. First the central bank

must pr otect itself against mis judg ment: lending res our ce to a bank wh ich in the en d turns out

to be insolvent is socially costly (m oney is a claim on the s ociety wea lth). Se cond, pr inting

money m ight pr ove difficult to reconcile with the preva iling monetary re gime ( inflation

tar get for instance). One way to sk ir t these pr o blems goes by the name of concer ted lending

and consists in res cue operations be ing carr ied out by a sma ll gr oup of banks w ith the central

bank help under cer tain cir cumstances ( it must exist!). In Fran ce, before 1999 , the bank ing law en titled the central bank to or ganize a bank consor tium in or der to save a tr ou bled bank.

However , the financial li bera lization an d the re lated s pur t in bank com petition an d

inter connection have diminished the ab ility of central bank to mount a consor tium of pr ivate

banks. Never theless this is an interes ting scheme wh ich should be trans posed at the


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interna tional level; we could ref er to regional cr isis mana gemen t for instance. The sh ift has

had an im pact on taxpayers as their m oney is now the ma in sour ce of funding.

E . The distinction between illiquidity and insolvency

Even if not unlimited, the very e xistence of the lender of last resor t genera te moral

hazar d among agents (here marke t par ticipants). E xcessive r isk tak ing behav ior must then be

eliminated by the LOLR. The pr o blem was identified f r om the or igin, so that BAGEHOT an d

THORNTON s tated that it was ne cessary to distinguish be tween insolvent and illiquid banks.

While theoretically there is no need for bank s upervision, it a ppears that the distinction was

excessively har d to make , e.g. the cr isis of the ear ly 1930s taught regulators that most of

good se cur ities be come ba d one dur ing cr isis times. M oreover the decision to save a given

bank is highly su b jective s ince there is not enough time to assess its financial situation.

Finally even sav ing lame duck is wor thwhile an d recent f acts re flect this trend (not in the

USA though). A ltogether these e lemen ts could seem to pr otect inves tors wha tever ha ppened,

a f eeling of im punity ar ise.

Author ities have to make s ure that neither mana gers nor shareh olders are sh ielded

f r om the consequences of their own mistakes. Thr ough re gulation such as Base ls three

pillars the goal has been par tially achieved. Supervision a llows central banks or re gulatory

author ities where central banks haven t such res ponsi bilities, to exer t continuous press ure on

banks to kee p on a pr udent course. I t also pr ovides quic k discr iminating cr iter ia as to the

soundness of banks given that supervisory track re cor d. LOLR re ly definitely on informa tion

technology an d any interven tions could not be im plemen ted without punishmen t.

F . Deterrent measures and definition of good collateral

The last com ponent of the BAGEHOT r ule is the prescr iption that the lender of last

resor t lends at pena lty an d on good collateral. BAGEHOT h imself off ers severa l reasons to

contain moral hazar d. First, marke t effici ency is trans lated in that the a ccess to scar ce

liquidit y is res tr icted to those wh o would put it to the bes t uses , just as a h igh pr ice ra tions

any s car ce commodity in a f ree marke t. Second, the pr otection an d secur ity a ffor ded by the

LOLR sh ould be paid for. Th ir d, the pena lty ra te would pr ovide an incentive for banks to exhaust all their existing sour ces of liquidit y before turning to the LOLR. A t last, the penalty

rate would ensure the quic k retiremen t of emer gency finance once the cr isis is over.


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de pr ive the cr isis mana ger of the technical discretion nee ded to fine-tune liquidit y suppo r t

packages an d contain m oral hazar d. The ultimate r isk is that of increas ing politiciz ation, with

resour ces ultimately be ing used, with very little amb iguit y, in the interest of the s tr onger

members ra ther than the coll ective interes t. As a consequence, in the long r un it could pr ove

har d for the cr isis mana ger to sustain its legitimacy.A fur ther pr o blem is re lated to the f act that, when dealing with sovereign countr ies,

the r isk of polic y reversa ls after last-resor t lending has taken place cannot be disregar ded.

That is, the lender of last res or t has limited enfor cemen t powers. As a res ult, it will have to

ration its liquidit y suppo r t and rely on the continuous collaboration of the debtor.

Finally, while a na tional LOLR has , thr ough the s pecial body of legislation re gulating

the bank ing business , at least some contr ol over the legal claims of ultimate creditors

(de positors), interna tional or ganization cannot. To contain mora l hazar d on the creditor , the

cr isis mana ger w ould therefore nee d to rely on the coop eration of the a uthor ities located increditor countr ies, over wh ose behav ior , however , it cannot be expected to have m uch

levera ge.

B. Possible solutions

Any sa tisf actory s olutio n to the pr o blem of coping with interna tional financial cr isis

has to pr ovide an answer to all pr o blems men tioned above. Re gional lending of last resor t

and concer ted lending could, in pr inciple, pr ovide a lterna tives to a universa l, and centralized,

LOLR. B oth, however , suff er f r om ma jor weakness in the presen t context. In a w or ld of

glo balized financial marke ts, regional lending of last resor t exposes the en tire sys tem to

regulatory f ailures in one or more re gions. C oncer ted lending, for its par t, a ppears

incom pati ble with the highly com petitive climate of todays wor ld financial marke ts, and is

therefore likely to pr ove unf easi ble in most cir cumstances. In deed, to be viable, such

str uctures w ould need to be designed and mana ged in a coheren t manner , accor ding to a

unique conduct . C oor dination is the key b ut as re gion could bene fit f r om li bera lization even

if all the other re gions ke pt their trade res tr ictions in place, it seems har dly en dorsab le. Th us

leaving each re gion to decide the r ules accor ding to which LOLR serv ices sh ould be pr ovided may we ll result in a sys tem of destr uctive amb iguit y.

Pr oposals to address the pr o blem have re cently a ppeare d in the literature, ranging

f r om the s uggestion that the IMF sh ould be trans forme d into a full-fledged LOLR , willing to

pr ovide unconditional liquidit y to countr ies sa tisf ying cer tain cr iter ia ex ante; or to abolish

the IMF a ltogether an d let the marke t work. A m ore modest, but seem ingly more practical,


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course w ould be to devel op contingent li uidity f acilities in whi ch the private se ctor would

take an im portant stake an d to im pr ove w ork out arran gements in the presen ce of moratoria

on foreign debt. This stren gthens the r ole of the IMF as len der int o arrears b ut also as a

signalin g device.

The way the K orean crisis was han dled could be cited as an e am ple case. That isone could ar gue that the partici pation in De cember 1997 of foreign banks in the r ollover

operation s ponsored by the G10 a uthorities off ers a m odel of how bur den-sharin g should

work : f irst res cue package aimin g at reduc ing overall risk then private bankers take over.

Another case pr ovides relevant insi ght demonstratin g the o bvi ously politici ed world

envir onment an d lack of coor dination. The current Greek crisis a ppears t o be a case in f avor

of regionalism an d the diff iculty t o assign clear r ules at internati onal level t o bailout country.

The me chanism is similar t o the Asian

crisis ; however sin ce Gree ce bel ongsto the E ur o area the strain a pplies on

soverei gn debts s pread.

Many in Gree ce and the rest of

Eur ope see calling in the IMF as a

humiliati on (as en matter of f act it is

f eared that the si gnalin g eff ect of IMFs

interventi on would incur a converse

eff ect than e pected , for the e ur o as

much as for the Gree ce. They als o f ear strin gent IMF conditionality. Yet strin gency is j ust

what is nee ded. I n princi ple the E ur opean Commissi on cou ld monitor per formance an d

im pose conditions. But because Gree ce is a full member of the EU an d the eur o, any

Eur opean len der w ould f ind it har d to convince markets that it cou ld han g toug h against

political press ure an d social pr otests. I n contrast , the IMF is in de pendent, can a ffor d to be

un popu lar an d has e perien ce of bailin g out indebted governments that n o body in Br ussels

shares. I t is , moreover , alrea dy dealin g with other EU countries s uch as H ungary , Latvia an d

Romania.

IMF plays a si gnif icant r ole in dealin g with near bankr uptcy country, of ten t o off er

classi cal balan ce-of - payment s uppo rt. T o avert a s overei gn debt crisis w ould be the pr oper

evolution.

F igure 3 : Greece p rem ium


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C. Section conc lusion

Interme diar ies in the interna tional financial sys tem assess an d trans form economic

exposures. B ut interna tional actors nee d not im ply that an interna tional LOLR is nee ded.

While there is no parallel in the interna tional context to the conduct of national monetary polic y, the interna tional relationships and ca pital flows w ithin an d among national financial

and cor porate entities are increas ingly im por tant for glo bal gr owth. These financial

interme diar ies trans form sav ings in one e conomy into inves tment in another , which (a t least

in theory) y ields h igher re turns than could be o btained within na tional boundar ies. H owever ,

each of these interna tional firms has a na tional LOLR; wha t is the va lue-added of an

interna tional LOLR?

Cr oss-bor der financial interme diation can involve multipl e currencies; in times of

cr isis, does the na tional LOLR have a ccess to the currency to match the o bligations of itsdistresse d institutio ns? In the interna tional context, not only do financial interme diar ies off er

matur ity trans formation, but trans forma tion of currency exposures is the key. As interna tional

trade in good s an d serv ices continues to gr ow f aster than w or ld output, the deman d for these

financial serv ices increases. A na tional LOLR may w ish to suppo r t a par ticular institutio n to

contain a cr isis, but not have a ccess to the currencies of the open o bligations. "Swa p"

networks am ong Central Banks can serve this pur pose, but the am ounts are limited. Whereas

the IMF has a ccess to many currencies thr ough its callable ca pital, some currencies have

rather little va lue in an interna tional cr isis. If an interna tional LOLR were created, who would

decide how much of a war- chest and of which currencies to have on han d?

Trans parency of balance shee ts is worse, but would an interna tional LOLR have

better information than any of the na tional LOLRs? F inancial institutions par ticipating in the

interme diation of savings interna tionally are perha ps the least trans paren t of all financial

institutio ns. S ome of these institutions operate on the f r inges of the na tional LOLR's

supervisory an d regulatory env ir onmen t. The IMF does n ot have a ccess to these institutio ns,

and is difficult to imagine how a s upra-na tional interna tional LOLR w ould o btain more

detailed data than do national LOLRs. Can' t national Central Banks w ork together (s uch as

though the lead regulator conce pt br oached by s ome Cen tral Banks) to assure that an

a ppr opr iate level of financial serv ices is being pr ovided and is a ppr opr iately supervised?


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Interna tional financial sys tems are pr one to contagion; is an interna tional LOLR

needed to avoid coor dination f ailures am ong national LOLRs? There is clear ev idence that

f ailures in one na tional marke t can a ff ect other na tional marke ts thr ough contagion of

financial institutio ns as we ll as thr ough ca pital marke ts. Never theless, a coor dinated res ponse

of national LOLRs could o bviate the nee d for an interna tional LOLR. B ut, is an interna tional LOLR , a single (inde pendent?) institutio n, needed because na tional author ities may be unable

to agree on an a ppr opr iate res ponse w ithin a time f rame ne cessary to preven t disastr ous

contagion? C oor dination f ailures am ong national institutio ns are a distinct possi bility, due in

par t to the diff erences in behav ior an d mandate of national LOLRs. M oreover , in some cases ,

if a domes tic cr isis becomes an interna tional one, it may indicate the f ailure of the na tional

LOLR. In b oth cases , the IMF may be called upon, but it is not the inde pendent supra-

national author ity that may be nee ded.

The ne xt section pr ovides fur ther insight of the IMFs catalytic function. Tha t is ther ole of confidence-enhan cer wh ich rema ins of cr ucial im por tance for countr ies wh ose a ccess

to ca pital marke t is re latively limited.


17/44

III . The I nternati onal Monetary F ound: Catalyti c Finance

I n this thir d and last part, we will s peak ab out the I nternati onal Monetary F ound and

its catalyti c eff ect in f inance.

But, f irst , lets make a sh ort presentati on ab out the IMF.

A. Presen t ati n abou t t

e In t erna tiona l Mone t ary

ound

The I nternati onal Monetary F ound was establishe d on December

27, 1945 during the conf erence of Bretton W oods. The IMF was create d

in or der to be the kee per of some r ules an d also to be the main instr ument

of pu blic internati onal mana gement. The a dvises of IMF are ab outthe

monetary system of each country. I n other w or ds, the I MF is playin g a

r ole of internati onal economys supervisi on.

John Maynar d Keynes sai d, during the creation of the IMF, that the h ope was that

the br otherh ood of man will have be come m ore than a phrase.

One of the main USs pref erences was a s u bscri ptions and uotas system in the

IMF.

Each country contrib utes in a t otal am ount of its uote- part with 25% of foreign

currencies an d 75% of its own currency. Af ter these contrib utions are l ocated, some f igures

are drawn. I n f act, the countries whi ch are b orr owing some m oney can o btain foreign

currencies f r om the I MF an d give s ome of its own currency. The ri ghts of the draws are

tem porary be cause they can be re paid in 3 or 5 years an d are limite d. So, the I MF is n ot able

to create m oney, in contrary t o a world central bank.

At the be ginnin g, the uotas were ab out $ 8.8 billi on. T oday, the res our ces of the

IMF, in term of uotas, are ab out $ 300 billi ons. But, during the meetin g of the Gr oup of

Twenty (G-20) , on A pril 02 , 2009 , they decided to increase si gnif icantly these res our ces at

the hei ght of $ 1000 billi on in or der to f ace better the crisis. If a member country nee ds loans,

the I MF can hel p it imme diately at 25% of its uota. The s um of money a country can b orr ow


18/44

f r om the I nternati onal Monetary F ound is de pending on its contribution. The debts sh ould be

re paid during a period f r om 18 m onths t o f ive years.

The v oting rights of each country de pend on the uotas pr oportions. Sin ce the

contrib ution of the Unite d States , they have a pre po nderant in f luence that we can callLea dershi p (see the case of Me ico).

Some current in formati on ab out the IMF:

- The hea d off ice is l ocated in Washin gton

- Since N ovember 2007 , D omini ue S t rauss- K ahn is the mana ging

director of the I MF

- The off icial an d only lan guage of the I MF is En glish

- The emer ged countries , during the G-24 , ask a review of the ta citr ule, that says that the e e cutive director sh ould be an E ur opean

Source: www.imf.org

The t otal number of the members in theIMF is 186 countries. As we can see in this

chart , the USA are als o im portant t oday, with 17% of the IMFs uotas. I ts uite hi gh

com paring with the n umber of countries in cluded in the R est of the W orld an d also the

E ur opean Uni on. But with the a ctual gr owth of China , we can e pect an in crease of its

partici pation in the IMFs uotas. I ndeed, China committe d itsel f to give $ 50 billi on m ore in

return of more power. The IMF previewe d to trans f er 5% of the ri ch countries uotas

IMF's quotas

32%

1%

17%6%2%4%3%

35%

U.E

Brazil

USA

Japan

India

China

Russia

Rest of the World

Source o f t he

f ot ograph :

htt p://europeor ient . fil es.

wordpress.com/2009/04/


19/44

towar ds the emer gent countr ies, which are a ctually under re presen ted. Concerning the

Eur opean Un ion, Germany is the m ost im por tant country in term of quot as, with about 6%.

We can say that the IMF plays a r ole of preven tion an d resolution of the cr isis. It

means that the IMF m ust supervise re gular ly the na tional politic s an d, if needed, has to stressthe f actors permitting the countr ies to adopt a polic y for being less v ulnerab le.

Then , the IMF , thr ough its interven tions, plays the par t of a ra tional regulator an d also

an interna tional arbitrator. I t means that the IMF is a catalyst of help and loans , but also the

guarantor of the interna tional financial stability. In f act, the IMF a llowed mak ing eas ier the

regulation of the pr o blem of debt, contr i buting of the Bra dys plan ( short explanations of this

plan in the annexe of this file ) and of the agreemen ts. In this way , every country wh ich aske d

a res tr ucturation of its debts ha d the re gulation of these ones. F or these s tr uctural adjustments, there are s ome ass ociations be tween the IMF an d the commer cial banks for the

loans in or der to avoid the conse quences of some loans , which could be n ot rea lly effici ent.

So, we can conclude that these banks are an e lemen t of the functions of the interna tional

lender that exer cises the IMF.

The ne xt ste p for the IMF is to negotiate s ome ser ious cr iter ions for the use of these

founds in or der to allow the economic stabilization an d the re paymen t of the banks. T o get

the bene fit f r om this serv ice, the banks m ust accor d more money to the countr ies in cr isis. In

this way , the IMF gets the pursuit of the loans f r om the banks , which av oids the interr uptio n

of the externa l financing, like it was dur ing the Grea t De press ion in 1929. L ike this, the FMI

succeeded in be ing a macr oeconomic stabilizing, in par t in the inflation of the countr ies like

Madagascar or the S outh-Saharan A f r ica. But sometimes, in one han d, the ma cr oeconomic

recommen dations that did the IMF ha d negative e ff ects, and in the other han d, sometimes, it

had good eff ects, as we w ill see in the ne xt section, which ab out the success of the IMFs

interven tions.


20/44

A. Explanat i n and def i ni t i n of catalyt i c effect

The catalytic eff ect is an offici al suppor t and polic y that may w ork to restore

confidence. Th is means that, when a country is f acing a financial cr isis, the tr ust of the

stockholders is missing. Then , the IMF he lps this country to res olve the pr o blem of financial cr isis. In m ost cases , this presence of the IMF in the country convinces the shareh olders to

give s ome m oney to the country just because of the presen ce of the IMF. In other w or ds, the

catalytic eff ect is an im pact due to the presen ce of the In terna tional Monetary F ound thr ough

a s pecial pr ogram in the country involved. In this way , catalytic eff ect de pends on:

- The s ize of liquidit y suppor t br ought the IMF

- The precision of the informa tion that have the IMF ab out the counties in cr isis

- The se quence of moves in the game (F or exam ple, if IMF m oves be fore or simultaneously with pr ivate agents)

Another case in poi nt to understand the Ca talytic eff ect: Catalysis is a pr ocess in

which the ra te of a chemical reaction is e ither increase d or decrease d by means of a catalyst.

The catalyst takes n o par t in the rea ction and rema ins unchanged.

In the rea ction 2 H O 2 H O + O , the catalyst is ion Fe +.

B . Success of the IMF and i ts catalyt i c effect

The s uccess e pisodes are the cases when the countr ies are s olvent (countr ies wh ich

can re pay their creditors) b ut illiquid (countr ies wh ich cant res pect their expir ies). In this

case , the nee ds are m ostly a polic ys adjustment and a politic al willingness for star ting this

adjustment. For this par t, we have to explain concrete exam ples for illustrating the success of

the IMF: the case of Mexico and the one of South K orea. F irst, lets talk ab out the case of

Mexico.


21/44

A. Mexico

Before s peak ing about Mexico, it will be interes ting to explain the context and the

reasons of the new k ind of cr isis of the 1990s. The ir evolutio ns re flect in a sense the

trans forma tions of the interna tional finance.

Until the middl e of the 1980s , the foreign financing took essen tially two forms:

- Foreign Direct Inves tments of multinationals firms: FDI only in the politic ally stable

countr ies.

- Credits granted either by bank pool or by S tates within the f ramew ork of bilateral

agreemen ts. (Fran ce-Me xico for the development helps or signed contracts)

The b orr owers are e ither S tates, or borr owers wh o bene fit f r om a pu blic guarantee.

Fr om the middl e of the 1980s , the na ture of the lenders an d debts of the borr owers are

going to change:

- The debts are changing into o bligations, often in shor t matur ity (instead of the credits);

and it a ppears an interna tional bond marke t for emer gents economy.

- The b orr owers w ill consist more and more in pr ivate com panies ( instead of State or

pu blic com panies). In 1990 an d 1994 (a t the be ginning of Mexican difficulti es), on a ll

the developing countr ies, weight of the pr ivate debt on the foreign debt is more going

than to dou ble.

- In the hear t of the lenders, the institutio nal inves tments r ole increases. In other w or ds,

we have an increase of the inves tments of por tfolio (regar ding to the FDI)

Because the interna tional finance evolves, the financial cr ises are a lso evolving. The

cr isis of Mexico in 1994-1995 , (and other like the As ian cr isis, notably Tha iland)

corres ponds to this pr ofile. These e conomies received increasing externa l ca pit al flows in the

1990s , ca pital which f ed interna tional financial interme diar ies an d pr ivate com panies but not

really for States. The im por tance of the foreign debt and its str ucture re turned these

vulnerab le sav ings for three reas ons:

- The debt is essen tially in doll ars. An d it is used to finance national activities in

national currency.

- The v olumes of ca pital entrances are s uch as any reversa l in flows w ould reclaim the

means of financing the economy.


22/44

- The s tr ucture of the foreign debt gradually deformed towar ds shor t matur ities wha t

causes two pr o blems:

y The inadequacy be tween the time of the uses of this ca pital and the duration of

their ma intaining.

y A high r isk of insolvency in case of genera lized refund by the claims.Illiquidit y leads to Insolvency.

We are in f r ont of vulnerab le sav ings because of the financing mode of their

economic gr owth. An d because they are intr insically vulnerab le, they are n ot going to be ab le

to res ist when they are going to under go cer tain shocks.

For the IMF , the pesos cr isis corres ponds to the first financial cr isis of the XXI

century. The IMF interven tion was ra pidl y an d a successfully. Tha t illustrated that the

glo balisation nee ds f ast reaction f r om the interna tional actors. Le ts first explain the reas ons

of the cr isis and then list the re forms w ith res ults.

In the be ginning of the year 1994 , Mexico has a s tr ong economy, integrated into

glo bal marke ts with its membersh ip in NAFTA. S o, what went wr ong?

The ma jor Pr o blem is that there are s till weaknesses in this economy:

- The e xterna l current accou nt deficit, at a s tage of -8% of GDP in 1994 , is financing by

shor t-term ca pital inflows.

- The a ppreciation of the peso contr i buted to deficit .

The country's r isk premium was a lso aff ected by an arme d rebe llion in Ch ia pas, causing

inves tors to be wary of inves ting their money in an unstable region. The rev olt s pread over

the country, it aler ted the pu blic opinion an d es pecially worr ied the inves tors wh o are a f raid

of the instability. In the se cond semes ter 1994 , there was a r ough reversa l of the por tfolio

inves tments, and thus a pr o blematic re patr iation for the S tate, which has to finance these

deficit s, pay the interests on his debt and pay off the ca pital of the b ond arr ived to matur ity.

Chan ge of governmen t, peso devaluation on De cember 20 th, teso bonos, contr i buted to the

er uption of the cr isis. The cr isis br oke out at the en d of the year 1994.

In 1995 , the year following the cr isis, an im por tant pr ogram of $ 17.8 b illion, that is

700% of IMFs quota for Mexico, is se t up ( plus $ 20 b illion f r om the Amer ican fund, $ 10

billion f r om the G10 central banks thr ough the Bank for Interna tional Settlemen ts an d $3


23/44

billion f r om commer cial banks in a dditio n to IMF). Th is pr ogram is un precedented in s peed

of negotiation; indeed, loan arr ived just one week a fter the be ginning of the cr isis.

In 1992-93 , the Ne t Pr ivate Ca pital Inflows (NPCI) ha d ranged between 6 an d 8% of

GDP. Then the year the pesos cr isis (1994) occurred, net pr ivate inflows re duced to about 5%of GDP. An d finally the year following the cr isis: 2% of GDP. I t is outstanding that there was

not ca pital withdrawa l. Mexico sor ts out in a re cor d time of this cr isis. (C ontrary to Ar gentine

at the same time) In deed, f r om 1996 to 1998 , NPCI re gained a level of 4% of GDP.

The two main goals of the pr ogram were: the re ductio n in the externa l current accou nt

deficit (by conver ting shor t-term debt into long-term o bligations wh ich could be re paid

gradually), and a lower ing of the ann ualized rate of inflation. T o o btain this, the pr ogram is

centered on a polic y of wage, pr ice, and credit res traint suppo r ted by an im pr ovemen t in thefiscal position. C oncerning social cost, it is a s uccess too. The n umber of f amilies living in

extreme pover ty decrease d between 1980 an d 1990. Th is is due to the e conomic gr owth an d

the increase in rea l wages dur ing this per iod com pleted with a s ocial expenditures pr ogram

(exam ple: he lp sma ll f armers).

It was a s uccessful catalytic e ff ect. The disbursemen ts of IMF, added to

commitments f r om pr ivate creditors (that means n o ca pital withdrawa l even in the m ost

severe cr isis per iod), permitted to Mexico to avoid bank r un an d pull thr ough. As a res ult, the

ma jor par t of IMFs res cue loan has been re paid 3 years a fter the cr isis, and the sys temic r isk

has been we ll contained. Moreover , the s uccess of IMF is still visi ble a f ew years later.

Mexico is saf ed of cr isis.

$ bi llion 9

99

20

00

2

00

2

002

2

003

2

004

Economic

Increase

3,

6 %

6,

6 %

-

0,2 %

0,

7 %

1,

5 %

2,

7 %

Inflation16

,6 %

9,

5 %

6,

4 %

5

%

4,

6 %

3,

9 %

Pu blic sale (% of GDP)

-

4 %

-

3,7 %

-

3,7 %

-

3,4 %

-

3,2 %

-

3,2 %


24/44

Balance trade-

5,6-8

1

0

-

7,9

-

7,2

-

9,2

Externa l debt 16

7,3

15

9,4

1

62,8

1

75,6

1

88,5

2

00,7

Sour ce: COFACE 2004

The E conomic decrease of - 0.2% of the year 2001 can be e xplained by two f actors;

the terr or ist attack on Amer ica at the W or ld Tra de Cen ter but also, and none the less, the

Ar gentine contagion. The gr owth took ba ck a weak gr owth ra te f r om 0.7% in 2002 to 1.5%

in 2003.

Due to the s peed of foreign inves tors fled the Me xican Marke t and the sever ity of the

cr isis res ulting f r om the m oney ( peso) deva luation, IMF rea lized that it needed to adjust to

the new rea lities of the glo bal economy. In J une 1995 , the G7 decided that IMF nee ded more

vital economic informa tion to preven t cr isis (for exam ple exchange ra tes, central bank

balance shee t, reserve m oney, interest rates, externa l trade, GDP) , additio nal financial

mechanisms to res pond and a new b orr owing arrangemen t (current holdings are insuffici ent

to res pond to new cr isis).

B.

South Korea

In or der to understand the s uccess of the IMF for this case, we will, first, explain the

reasons of the cr isis in South K orea. The cr isis was in July 1997. I t begun because of the

str ong de preciation of the As ian m oneys , which led to over- investments (as y ou can see in

the followed gra phic).


25/44

Another pr o blem in this crisis was the level of e ternal debt. I n f act, this level was t oo

high. I ndeed, when the crisis be gun in S outh K orea , there was a bi g leak of ca pitals. I ndeed,

the crisis be gun in J uly 1997 an d for the wh ole 1997s year , the leak was ar ound 20 billi ons

and the currency of the cou ntry crashe d signif icantly. S ome private people gave 200 t onnes

of gold but it was n ot stopping the crash of the m oney. But the IMF was really f ast t o

intervene for containin g the crisis sin ce the start of the re forms a pplications by S outh K orean

Government re commen ded by the I MF was in De cember 1997. 57 billi ons of dollars were

borr owed to South K orea for contr olling the crisis an d some meas ures were done. I n f act, the

biggest meas ure was the stabilisati on of the markets conditions, with , for e am ple, the

suppression of the dou btful dou bt of the banks in the country an d also a bi g redundancy, like

the banks se ctor , with one thir d of the em ployees. There was als o, as I MF re commen ded, a

high emissi on of shares an d bonds ma de by the a uthority. These meas ures ha d some e ff ects

for the country sin ce it in crease the markets tr ust in S outh K orea b ut als o it allowed the

reconstit ution of the K orean reserves an d in July 1998 , the val uation of the w on could be

com pare d with the val uation of the dollar. I n f act, in De cember 1997 , the reserves of South

K orea were ab out $5 billi ons, but in 1998 , these reserves were ab out $50 billi ons with a

sur plus of 12,5% of the GDP. Fr om July 1998 , the a uthorities re duced the interest rate as the

level be fore the crisis be gun. Then , during this year , South K orea be gun to re pay the l oans

Exchange rate of the Asian currencies compared to the

Source of t

e graph: htt p://par l emen t -ue2008. f r/rap/r98-063/r98-


26/44

contracted in De cember 1997. A fter this cr isis, the tr ust of the inves tors wen t back.

Nowadays , South K orea is a pr os per ous country an d in 2008 , it became the 13 th economic

Wor ld power.

These two exam ples, of Mexico and South K orea

showed that the IMF is guarantor of the interna tional

financial stability. Then , we can conclude, as y ou see w ith

the little car icature here , who pays h i s debts i s gett i ng

r i cher . In the most successful catalytic e pisodes, there

was n o net ca pital outflo w but only reduced ca pital

inflows in the cr isis year , followed by a re covery of

ca pital inflows in the year following the cr isis. Then , wecan conclude that mid-terms e ff ects of catalytic finance are m uch more s ignificant and

successful in a n umber of cases.

But the IMF , as the mana ger of the cr ises , could nt succeed in stemming the

expans ion of the cr isis. Tha ts what we w ill see in the ne xt par t, which is about the f ailures of

the IMF.

C. Fa i lures of the IMF and i ts catalyt i c effect

Catalytic pr ograms f ailed when the countr ies were insolvent. In m ost of the f ailure

cases , the conditions to re pay ra pidl y the IMFs initial loan were n ot created or not created

f ast enough. The e xposure of pr ivate creditors to the cr isis country did not stabilize, so it

f ailed to rebound str ongly. An other name given to the countr ies cases is slow re paymen t

cases. IMF cr itics would say that f ailure cases are due to the IMF interven tion that announces

the im possi bility of the country to resolve a lone its pr o blems an d give the s ignal of the

withdrawa l: because of its interven tion, pr ivate inves tors can withdraw their money

confident, they w ill be paid off . For this par t, we have concrete exam ples to illustrate the

f ailure of the IMF: the case of R ussia, the Tha iland cr isis in 1996 an d the one of Indonesia in

1997. F irst, lets talk ab out the case of R ussia.


27/44


28/44

Source of t he graph:

htt p:// www.deve l oppemen t -

A. Russ ia

The Russian crisis be gan in 1998. The pu blic def icit of Russia was t oo high an d the

country was f aced of a bi g decrease of the e ports. F urtherm ore, there was als o no per ce ption

of the ta es a f ter thegovernments decision to

not acce pt the ta es

payments in the form of

moneys su bstit utes.

There was als o a f all of

the r ou bles val uation (as

you can see in the

followed gra ph). An d theRussian crisis is the

result of the Asian crisis

in 1997 , which ha d

slowed the wh ole

economic system. I n

1998 , the in f lation in Russia was ab out 84%.

The interventi on of the I MF be gun in J uly 1998 an d this instit ution contributed of

$4,8 billi ons in or der to hel p and to contain the crisis.

But on July 14th, 1998 , the crisis b urst, which pulled the break- up of the Russian

bankin g system an d the pursuit of the r ou bles colla pse. I t also led to the la ck of the

invest ors tr ust.

The only good eff ect in this crisis was that , in s pite of the hi gh inf lation, the

deval uation of the r ou ble ha d a good eff ect for the Russian market sin ce the pr oduc ts ma de in

Russia ha d a normal part in the nati onal market. H owever , if we take st ock of this crisis

analy ing the a f ter crisis , the balan ce sheet is n ot good . I n f act, Russia s ucc eeded to take

off its economy with out the hel p of the I MF because this one was t oo late (the crisis b urst

af ter the be ginnin g of the hel p f r om the IMF). The others a f ter crisis pr o blems are that ,

even i f the in f lation decrease d, it staye d in a hi gh an d critical level an d the debt staye d to be a

big pr o blem for Russia.


29/44

As we sai d before, the only good thing was

that the Russian pr oduc tion be came a gain

com petitive , which all owed it to take up place in

market a gain. F urtherm ore, the in crease of the petr oleums prices an d the economics re forms that

made Vla dimir P outine f r om 1999 all owed Russia

to be a good actor in the internati onal e conomy.

Thats one of the reas ons why the e conomic gr owth

of the cou ntry was ar ound 6% between 1999 an d

2005. N ow, in term of GDP, Russia is the 9 th

economic World po wer. An d as you can see in this

gra phic, now, the Russian e ports are in creasin g every year , mainly due to the e ports of the Russian

petr oleum.

B . T ha il and

The conte t of the Asian crisis is the same as Me icos crisis with the trans formati ons

of the internati onal f inance. Asia cann ot resist t o the ma cr oeconomic decline in 1996 an d

es pecially in Thailan d. I t comes f r om the sl owing down of the e ports owed to the re cession

in Ja pan an d the Thai bahts relative a ppreciation under the in f luence of the Ameri can

restri ctive m onetary policy. (The in crease of key rates when there is a f i ed parity system

im plies that baht a pprise be cause of the dollar a ppreciation. By in creasin g of key rates ,

I nvestments are better paid. Thus the in crease of interest rates in duc es that investments are

more attra ctive).

E ternal ca pital f lows in crease d in these cou ntries in the 90s. The gr owth of e ternal debt

and its str ucture make these e conomies v ulnerable for three maj or reas ons:

- The debt is essentially in dollars , but it is used to f inance nati onal a ctivities with

national currency.

- The ca pital in comes are s uch as any t urnar ound, (it mean ca pital with drawal) it w ould

cut of the e conomys supp lies.


htt p:// www. financ ial sense.com/ f su/ed it or ial s

/dorsch/2009/ images/0203_c li p_ image012.jpg


30/44

- The s tr ucture of the foreign debt is gradually deforme d towar ds sh or t matur ities. I t

leads to the pr o blem of inadequacy of matur ities an d high r isk of insolvency,

Dur ing the years 1997 1998 , the credit-cr unch is tr iggered by a mass ive reversa l of

ca pital flows, added to an im por tant f actor , which is contagion.

Tha iland cr isis burst on 2 J uly 1997. The IMF a gree d a first financial help of 505% of the

country quot a ($ 2.9 b illions of S pecial Draw ing R ights or SDR) , after that the governmen t

offici ally called the IMF for a grant. Th is financial help is accor ding for 34-M onths long. The

initial economic reform pr ogram contains (A ugust 1997):

- Reor ganization of the financial sector , ca pable of identif ying and closing

unsustainable financial institutio ns ( for exam ple f ragile banks an d notably 56 financial

societies);

- Increase in the budgetary meas ures to 3% of GDP to develop a rea l social polic y

- A new f rame of monetary polic y (float exchange rate);

- R ole of the pr ivate sector an d the pr ivatizations

- Establish a calendar of restr uctu r ing the finance sector;

- Acceleration of social plans im plemen tation.

The pr ogram was a gain modifi ed on Febr uary 24 th, 1998. These m odific ations ha d a

dou ble o b jective: to stabilize the interest rate and to intr oduc e the re turn on interna tional

financial marke ts. The new pr ogram was:

- To quicken the reconstr uction of the financial system, and more par ticular ly

pr ivatization of the four banks in which the author ities got involved

- To revise downwar d the o b jectives of budget deficit, f r om + 1 to - 3%, to strengthen

the social welf are ( to finance the hea lth sa f ety)

- Im pr oved pu blic sector an d give a new r ole to pr ivate sector to attract ca pital

The fundamen t of IMF pr ograms was catalytic. Confidence of the foreign creditors of

banks an d firms w ould be res tored, in theory, thanks to the ava ilable funding and the polic y

adjustment. But IMF lending f ailed in both cases. Tha ilands banks ma in pr o blem was

enormous shor t-term e xterna l debt: $ 46 b illion. I ts one of the reas ons why the IMF didnt


31/44

lend as much money to Tha iland as to other countr ies. W ith am ounts sma ller than in other

lar ge catalytic pr ograms , IMF f ailed in preven ting a mass ive ca pital flight. We have to re peat

that IMF he lps was just $ 4 b illion i.e. 2% of pre-cr isis GDP ( or 505% IMFs quot a) but we

have to add the $ 10 b illion commitment f r om other As ian countr ies, the W or ld Bank an d the

Asian Deve lopment Bank that ar ise the am ount to 6.3% of pre-cr isis GDP. Never theless isthe es ca pe of cr isis har d to o btain, because the ma in pr o blem h is shor t-term e xterna l debt,

higher than m ost countr ies. The T otal externa l claims s lowly f ell ($ 102.2 b illion in 1996 to $

45.9 b illion in 200) an d the Net Pr ivate Flows va lue (11.2% an d 9.6% of GDP in 1995-1996 ,

past to negative va lue of 5.3% of GDP the cr isis year , decrease until 15% in 1998 , to finally

become a gain positive two year following the cr isis, with 10% of GDP) illustrated the

difficult y of Tha iland to sor t out the cr isis.

Des pit e the he lp of IMF, Tha iland wont o btain access to pr ivate financing on the s caleneeded to both cover its ongoing financing needs an d re pay the IMF quic k ly. Tha iland

doesnt re pay the IMF ra pidly. I f it had done s o, it will have s uff ered of a persistent and

terr i ble current accou nt adjustment. It will have re duced its foreign reserves that will be used

to pay off the country loans ( to IMF).

C. Indonsia

In the case of Indonesia, severe polic y an d politic al pr o blems led to a f ailure of the

catalytic a ppr oach. In donesia doesnt succeed to avoid bank r un. Ins tead banks closed.

The country has a re lying pr o blem. N o body in the interna tional community was

motivated to help the dictator Suhar to, unless he sh owed rea l commitment to reform.

The In donesian pattern is similar to the Tha iland cr isis: Ne t pr ivate inflows a lways

positive (4% to 6%) the three years be fore the cr isis an d + 6% of GDP in 1997 for the cr isis

year. The cr isis emer gency comes in the se cond half of the year , following by three year of

ca pital outflows (ab out 3% of GDP).

An externa l suppo r t came dur ing the f all of 1997. I t was the peak of Indonesias

cr isis, which mean too late. The first financial help on the 5 th of November 1997 of the IMF

(disbursemen t of $ 2.2 b illion of SDR) , agreed for three m onths, wasnt enough com pare d

with wha t the country nee ded. Then on the 26 th of January, the IMF was sa tisfied with the


32/44

Indonesian intention to intr oduc e a res tr uctu r ing pr ogram of the bank ing sector and to set up

a mechanism a llowing creditors and debtors to adjust individually and voluntary the outside

debts pr o blems of Indonesian s ocieties. Tha t conduct s to an a ugmentation of $ 1 b illion SDR

of the financing gran t by the IMF , on the 15 th July 1998 , added additio nal multilateral and

bilateral credits.

Des pite these pr ograms , the debt levels are h igh; the countrys commitment to reform

is non-credi ble (notably because of the dictator Suhar to and violence in Indonesia), so that

severe polic y an d politic al pr o blems lead to the IMF f ailure to catalyze a positive res ponse. A

second reason of the non-success is the sma ll amount disbursed. Catalytic finance f ailure is

cause by under funded Pr ograms.

$ bi llion 9

99

20

00

2

00

2

002

2

003

2

004

Economic

Increase

0,

8 %

4,

8 %

3,

5 %

3,

6 %

3,

8 %

4

%

Inflation20

,4 %

3,

7 %

1

1,5 %

1

1,9 %

6,

6 %

6,

1 %

Pu blic sale (% of GDP)

-1,6 %

-1,5 %

-1,8 %

-1,8 %

-1,9 %

-1,5 %

Externa l debt 10

5

92

,4

9

0,3

7

5,1

6

0,9

5

2,6

Sour ce: COFACE 2004

Even if the gr owth ra te increases this last year (5 ,1% in 2005 an d still positive in 2009

s pite of the re cent cr ises) the externa l debt is a lways a b ur den on the economy ( in 2009 it

re presen ts 27% of GDP) an d pu blic sale is yet negative (-2 ,6% of GDP in 2009). The IMF

interven tion hasnt done away w ith corr uption, trans parence lacks, unem ploymen t, and

pover ty so that foreign inves tment is still low.


33/44

D . Argen tina

This crisis was between 1998 an d 2002 b ut some eff ects are still present n owadays,

and the internati onal f inan cial crisis of 2007 didnt hel p the cou ntry t o be f inancially an d

economically better.

Ar gentina was the vi ctim of

a ba d mana gement of the pu blic

s pending with a n ot a ppr opriate

political regime. The bi ggest

pr o blem of this country is the

adoption by the government , in

1991 , of a law , which all owed the

system of the curren cy boar d in

or der to stop the hy per-in f lation (in

1989 , the in f lations rate was ab out

5000% , which means that the prices

were m ulti plied by 50).

I n f act, they decided to have the dollar for re f eren ce money, with the parity 1 peso =

$1 b ut the dollars were n ot enoug h t o go in Ar gentina an d the in dustries of the a gricultural

pr oduc ts of Ar gentina couldnt e port as the same uantity as be fore: the Bra ilian pr oduc ts

inva ded the market of Ar gentina. The pr o blem was that the deval uation of the peso was n ot

possible be cause of the curren cy boar d. I ndeed, every a ccou nt was w or ding in the dou ble

money dollar/ peso and the contra cts were all si gned with the princi pal that the tw o moneys

were def initely in parity. I f Ar gentina chooses t o pr ovide the e uilibri um of its balan ce of

payments , the e conomy w ould suff er of a slowing down, which could lead to the ins olvability

of the country. But if Ar gentina chooses t o increase, the debt w ould be s o big that it could

lead also to the ins olvability of the country.

I n 1999 , the Ar gentinean government aske d the hel p of the I MF in or der to dont stop

the currency boar d and to avoid an internati onal conf lict but the instit ution deman ded the

government t o reduce the pu blic s pending before. F urtherm ore, the I MF or gani ed a really


http://www.melchior.fr/Les-currency-boards.3922.0.html

M onthly inflation in Argentina in 1990 (in %)


34/44

big deflation. Then , if every thing would be done like the IMF aske d, the institutio n could

lend some m oney to Ar gentina, even if the IMF is rea lly against to the sys tem of the currency

boar d. In a dditio n to this IMFs he lp, the W or ld Bank , S pain an d also the Panamer ican Bank

lent some m oney. B ut for the year 1999 , Ar gentina lived the recession even if there were he lp

and the economy is not so well, like the unem ploymen t, which was increas ing.

The sys tem of the currency boar d was s till a pr o blem for Ar gentina an d in N ovember

2001 , the budgetary goal that fixed the IMF two years be fore was n ot rea ched. Tha ts the

reason why IMF re fused to lend the $1 , 25 b illions it pr omised. Indeed, IMF thought that the

Ar gentina was s pending much more money that it could s pend. Dur ing the same year , the

tr ust of the na tional money was m issing, leading every people to conver t peso into dollars

and to kee p their doll ars a t their home. Then , Ar gentinean banks were f acing a liquid asse ts

cr isis because of the lack of doll ars. A t this time too, IMF re fused to help Ar gentina.

Ar gentina was f acing, after this, a deva luation of the peso, which a llowed the

expor tations to recover a n orma l place in the na tional marke t and for the governmen t, to

re pay, too late, the IMF. In 2004 , Ar gentina was a b it better b ut asked its creditors to

reduce the ca pitals at about 65% b ut they re fused at the first time. Th is question f r om

Ar gentina s poil ed its re lation w ith the IMF , but then, the Ar gentinean country convinced the

ma jor ity of its creditors to reduce the ca pitals, as aske d before. I t allowed Ar gentina to pay

back its debts.

As we can see in this case of Ar gentina, the reas ons why the interven tion of the IMF

was a f ailure are rea lly clear. In deed, the he lp was maybe too late, the meas ures aske d to do

too str ong and also because when Ar gentina rea lly nee ded a help f r om the IMF , the

institutio n didnt want. The pr o blem, here, was clear ly the lack of tr ust (f r om the inves tors,

the na tional people an d the IMF). We a lso can see in this case the limits of the sys tem of the

currency boar d. Indeed, the country could nt ask the Cen tral Bank to create money be cause

of the par ity with the dollar , and it also could nt ask he lp f r om the IMF be cause of the too big

amount of debts it had.

Nowadays , Ar gentina is one of the members of the Gr oup of Twen ty (G-20) , and even

if there are a lso now pr o blems w ith the inflation (25% in 2008) an d financial mana gement, it


35/44

is the se cond economic power of South Amer ica, after Bra zil. Th is country has a lot of

natural wea lth and between 2003 an d 2007 , the GDP was ab out 9% per year.


36/44

D . Open cases of t he I MF and i t s ca t a l ! t ic effec t

We called this part the open cases of the I MF an d its catalyti c eff ect be cause we

cant say that these cases were s uccessful for the internati onal instit ution but we als o cant

say that there were really f ailures. Th us, the open cases have weaker fundamentals than thes uccessful countries b ut har der fundamentals than the f ailing countries. There are

diff erent reas ons for not bein g succ essful or f ailed countries , like:

- The countries ha d to eliminate primary ga ps an d stabilise the rati os of debt

- The e ternal sh ocks absorbed because of f le ible e chan ge rate

- I m plementati ons start of ma cr oeconomic an d str uctural re forms

For this part, we will e plain the cases of Turkey , Ur uguay an d Bra il.

A. T urkey

The T urkish crisis be gan in Febr uary 2001. This crisis was due to the deteri oration of

some ma cr oeconomics fundamentals. The crisis was als o launched because of some r umours

about a political instability.

At the be ginnin g of 2000 , a pr ogram of stabilisati on of the m oney was la unched,

which was com posed with US dollars an d Eur os. I t was for ann ouncing the val ue of the

e chan ge rate an d this pr ogram was la unched with the hel p of IMF (stan d-by credits). The

pr o blem was that this pr ogram was als o acco m panied with a m onetary an d a budg etary policy

but it was t oo restri ctive an d the Central Bank of Turkey cou ldnt increase the internal

li uidities. The only s olution for the Central

Bank in or der to increase these li uidities

was only the in f lows with the system of the

currency boar d.

The other pr o blem was that the

inf lation was really t oo high. I ndeed, Turkey


htt p:// www.im f .org/ex t erna l /pubs/ ft / f andd/ f re/2005/0

/ d / u r . d

Economic growth in term of real GDP


37/44

committed itself to decrease the inflation ra te (25% in 2000 an d 12% in 2001). D ur ing the 9

first months of 2001 , the GDP com pletely crashe d (-8.3%).

The last pr o blem be fore the cr isis is that the military expenses were rea lly too high. Inf act, we es timate these e xpenses ar ound 10% of the na tional budget. As an e xam ple, we a lso

estimate that the Turk ish governmen t s pent about $ 10 b illions per year , dur ing 15 years , only

for the war , which conf r onted the Turk ish a gainst the K ur dish.

The consequences of this cr isis are rea lly im por tant since the T urk ish pou nd was

de preciated more than 35% com par ing to the US dollar in only one day, and the T urk ish

pou nd lost about 70% of its va lue in 2 m onths. F ur thermore, the unem ploymen t rate was

about 10,6% a t the en d of 2001 an d as we sa id before, the GDP crashe d dur ing the 9 first months of 2001. Th is led to the mass ive withdrawa l of the ca pitals.

In De cember 2001 , the IMF intervene d with a loan of $ 3,1 billions. F ur thermore,

some other meas ures were done, like:

o Pr ior ity of the pr ivatisations

o Fiscal reform

o Institutio nal budgetary re form, which led to some earn ings

o An ener getic pr ocess of budgetary s tabilization

All the meas ures re infor ced the countrys credi bility with the presence of the IMF.

But, the e conomic stabilization plan that im posed the IMF ha d not only good eff ects

for Turkey s ince it enfor ced the country to destr oy its own economical and human res our ces.

Nowadays , the unem ploymen t rate s tays h igh in T urkey. In deed, this one is a t height

as 7 , 9% ( in 2008) an d even if the e conomic gr owth, in 2005 , was the se cond highest in the

Wor ld (after Ch ina) w ith 9, 5%, the inflation stays a lso high (9 , 5% in 2007). The other

pr o blem s tays the military e xpenses be cause T urkey plans to s pend about $ 150 b illions in

the ne xt f ew years in or der to modernize its army.


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B. Uruguay

The case of Ur uguay has s imilitude w ith T urkey or K orea. The year be fore the cr isis,

net ca pital inflows were positive. The cr isis was tr iggered in Jan uary 2002 by de posit

withdrawa ls f r om cash-s tra pped Ar gentine res idents. The w ithdrawa l of liquiditi es is due to the Ur uguay decision to stop Ar gentinas Im por t because of foot-and-mouth disease. The

cr isis soon develop ed into a more genera lize r un on the banks (many Ar gentines were

holding de posits). M oreover , the bank ing sys tem is vulnerab le due to the dollar ization of

economy an d the insuffici ent pr udential regulation an d supervision. As a consequence,

ca pital flew over 33% of GDP in 2002.

Interven tion of the IMF occurs in Mar ch 2002 w ith an a gree d pr ogram. C oncerning

the meas ures, the first pr ogram was too sma ll, that mean 97% of IMFs quot a, and not catalytic in s ize. Tha ts a reas on why the IMF saw a gain an d reva lued it to 10% of Ur uguay

GDP. In A ugust the 4 th 2002 , the US lends $1.4 b illion, these am ount corres pond to the

Ar gentineans w ithdrawa l.

Cr oss bor der flow wasn t stop by IMF , but catalytic eff ect succeed on domestic

claims (heav ily the dollar ized bank ing system thr ough the r ole given to the central bank). The

bank r un came to end in the f all of 2002. The IMFs pr ogram for Ur uguay was un precedented

in ma gnitude. It was the time that IMF s uppor ted the central banks lender of last resor t

function, in a dollar ized economy. The positive e ff ect of the IMF a ction is that the ne gative

ca pital inflows in 2002 re covered positive in the year following the cr isis

C. Brazil

The im pact of the As ian cr isis re flects in Bra zil f r om Octo ber , 1997 an d becomes

more marke d dur ing year 1998. The inflow of pr ivate ca pital (3% of GDP in 1997 an d 2,5%

of GDP in 1998) com pensa te with difficult y the trade ga p and under IMF a dvice, its no good

Brazil try to increase its interest rates until 49,75 %, it cant avoid ca pital outflo w an d the

country reserve decrease in a b illion doll ars per day! On Jan uary 13 th, 1999 , the governmen t

Car doso res igns to deva lue the rea l of 8 %, but the flight of ca pital accelerates an d the

governmen t renounce on the fixed par ity with the dollar. The rea l coll a pses in 2.1 rea l for 1

dollar on Jan uary 28 th, 1999. An IMF plan of $ 41.5 b illion res cue f r om De cember , 1998 ,


39/44

o bliged Brazil to a pply a $ 28 b illion cup in the f ederal budget and to increase its interes t

rates, what make the recession dee per.

In 2000 , the cr isis seems to have been sav ing, but the "samba e ff ect" that was

pr ovoked in the re gion, in par ticular in Ar gentina , returns as a b oomeran g in 2002. The ne t outflo ws shar ply increase d about 5% of GDP. The Ar gentine cr isis s preads in the en tire

neighbor region an d pr ovokes an increase of the r isk premium on the Bra zilian loans, which

reaches ab out 25 %. Bra zil needs m ore than $50 b illion of foreign inves tment a year to fill its

current deficit and re paid its gigantic national debt, which has r isen f r om $ 128 to $ 288

billion between 1992 an d 2002. In J uly 2002 , it is the cr isis peak.

August 7th, 2002 , the IMF ann ounces the m ost im por tant cr isis plan of its history: $

30 b illion are lent in Bra zil, of which 20% ($6 b illions) are directly disbursed whereas thelast 80% ($24 b illions) w ill be disbursed after the Bra zilian pres ident election, conditionally.

The new pres ident should endorse the IMF ma cr oeconomic condition, notably a dras tic

budgetary a uster ity.

But financial marke ts an d inves tors arent reass ures by this IMF interven tion, at the

contrary, cr iticism a gain IMF polici es gr owth. Am ong others e xam ples, the s peculator and

the former gur u of financial marke ts, Geor ge Sor os, asser ts that the inca pacity of the IMF

cr isis plan to relieve Bra zil denounces a fundamen tal deficiency in the interna tional financial

system. The pr o blems of Brazil cannot be only im put ed to him, but its rather the

res ponsi bilities of the interna tional financial author ities, which be lieve in the marke ts se lf -

regulation. Th is confidence was an d is a lways ba dly placed. Another hea d of the IMF ,

Stanley F isher a dmits that their inca pacity to avoid current difficulti es in La tin Amer ica

suggests to them that they have to learn a lot again.

In O cto ber 2002 , Lula da Silva is elected pres ident. If he under took to res pect the

agreemen ts concluded with the IMF , Lula ann ounced that his politic al pr ior ity was to

over come the hunger an d the pover ty, which hit half of the Bra zilian popul ation. The

challenge, in a country where 20 % of the popul ation concentrates 65 % of incomes an d

where 1 % of the r ural owners possess ha lf of the f armlands, will be to make a s uccess of a

fiscal reform re distr i buting the wea lth an d a land reform re distr i buting lands to the 4 ,5

million f armers w ithout ear th. I t rema ins to be seen whe ther these meas ures w ill be


40/44

com pati ble with the constraints of the IMF an d if, as he ann ounced it, Lula w ill know how to

reform the re form. The country used its reserve to reimburse banks that desired to reduce

their exposure in this country. A fter that operation, brazil reserves were low an d thus, it was

difficult to re paid the IMF quic k ly. The bank r olloff stopped in 2003 , when Bra zils

governmen t demonstrated its commitment to maintain a credi ble fiscal polic y.

In ea ch OPEN CASES , the IMF e xposure ha d to be a ugmented or be m ore founded.

IMF doesnt succeed to res olve full pr o blem, but just a par t. We could say that in his absen ce

it would have been w or thier , with a m ore severe financial cr isis har der to sor t out. For

exam ple in Ur uguay, absen ce of IMF w ould have conduct the country to the same

catastr ophic situation that her ne ighbor Ar gentina in 2001. The en d of the cr isis is cer tain,

but the deadline of IMF re paymen t isnt.


41/44

Conc lusion

In a W or ld which is continuously conf r onted by the e conomic and financial cr ises in

multipl e areas a ll ar ound the W or ld, and by the way that there are m ore an d more re lations

between the countr ies, due to the glo balization, an interna tional financial institutio n is clear ly

necessary to preven t cr isis and to limit their influence thr ough the W or ld. A na tional

institutio n, if it has n ot interes t to save a foreign economy, wont do this.

That is one of the reas ons why the In terna tional Monetary F ound was founded.

But the IMF is conf r onted to some pr o blems, like:

- Determining whether a countrys pr o blem is ma inly illiquid or insolvent. F or this, the

IMF sh ould have en ough data f r om the im plied country

- Defining the optimal amount of lending. Th is am ount should be lar ge enough to

convince pr ivate creditors to r oll over their loans. Then , we can say that r ollover

arrangements can be a com plemen t of the catalytic financing.

Then , a lar ge-scale catalytic financing works be tter when debt levels are low an d

when there is the credi bility of the countrys commitment to reform.

As a consequence of our studi es of diff erent cases of the catalytic eff ect (success,

f ailures an d open cases) , we can conclude that the countr ies wh ich have lar ge debt levels

cant re pay quic k ly their lar ge loans.

To conclude, you also could see, in our demonstration, that the ana lytical models of

catalytic finance im plications are a lways s uppo r ted by the em pir ical evidence.

The other ma in pr o blem that the IMF is conf r onted is the multipl e cr itics against it.


42/44

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A nc illary sheet :

Source : htt p://www.treas ury. gov.a u/docu ments/677/ima ges/02%20 IMF%20an d%20the%20 challen ger-2. gif

IMF and the challenger

Br a ys p la n : This is a plan whi ch is re place the dou btful dou bts into new b onds,

which are called Bradys bonds. F or havin g the ri ght of using this Plan , the countries whi ch

are in nee d have t o contract a loan in the USA. This l oan re paid will all owthe tr ust of the

banks about the re payment of the Bradys bonds. As we sai d in this f ile, Me ico and

Ar gentina , for e am ple, used this Plan.


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Ta b le of fi # ures

Figure 1 : ECBs tar get rate ................................ ................................ ....................... 10

Figure 2 : colla pse in Eas tern E ur ope ................................ ................................ ........ 11

Figure 3: Gree ce premium................................ ................................ ......................... 13

Integration Economics Paper - LOLR

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