Wavering IMF adds to investor uncertainty

Latin America faces what one analyst calls the worst period in its economic history since the middle of the 19th century. The decade of reform appears to be ending with little having been achieved. Political crises abound. Much needed foreign capital is drying up. And those looking to the IMF for salvation are likely to be disappointed.

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Adam Lerrick

It is July, and Adam Lerrick is on a roll. The conservative Carnegie Mellon economics professor and adviser to the US Congress is saying that Brazil is no different to United Airlines: in neither case should public money bail out private creditors. Brazil is "a political problem which has economic consequences" he says, and although the Brazilian people are perfectly free to elect a leftist as president, it's not the job of the IMF to step in and provide enough money to minimize those consequences.
"The new IMF, the new US Treasury, no longer have any sympathy for the idea of large-scale bailouts," Lerrick says. If and when the next Brazilian administration starts implementing fiscally responsible policies of its own accord, then and only then should the IMF step in to help reduce the cost that ordinary Brazilians must pay.
Three weeks later, the new IMF is a thing of the past - if it ever existed in the first place. Its $30 billion aid package for Brazil is the largest single loan it has ever extended, and comes on top of a $15 billion deal only a year ago. The episode is almost a textbook case of Lerrick's criticism of the old IMF. "The Fund was more afraid of a default than either the country or its lenders," he asserts.
The markets were cheered only briefly, and investors face nagging worries. The IMF's response to crises in developing economies appears inconsistent and unpredictable. Policy appears to be being made up on the hoof. Coordination between the IMF and its masters at the US Treasury is poor: all this while much of south America faces severe economic and financial worries and political instability.

The scale of this regional crisis will test the IMF to the limit. Nancy Birdsall, president of the Center for Global Development, says: "A new paradigm is emerging which says that IMF money alone is insufficient to rescue countries in crisis. This is because the amounts of money the IMF provides are small relative to the potential exit of private capital in what are now usually capital account crises."







Nancy Birdsall

The IMF alone cannot prevent a sovereign default. Indeed, if it merely serves to delay a default that is going to happen anyway, Fund money is contraindicated: if a bullet has to be bitten, it's always better to bite it sooner rather than later. In any case, as Mark Dow, a former Treasury official now at fund manager MFS in Boston, says: "The Fund doesn't have enough money to solve this problem."
And so south America, even after huge IMF packages for both Brazil and Uruguay, continues to look alarmingly similar to the way it looked before those bailouts. The economic and political prospects for the region remain grim, and Argentina's debt-default crisis is still capable of spilling over into Uruguay, Brazil and the Andean countries.
One thing that seems certain is that Brazil's response to the 2002 bailout is not going to be simply a happy repeat of what happened in 1999. Then, in one of the most successful IMF interventions in recent years, a massive package orchestrated in conjunction with the US Treasury and other G7 nations got confidence and capital flowing back. Domestic interest rates, under the control of universally admired central bank president Arminio Fraga, started falling quickly; foreign direct investment reached a level of $30 billion a year; and bullish portfolio investors started loading up on Brazilian stocks and bonds.
This time around, no one's talking about the catalytic effect of IMF funds any more: the idea that a large package can boost private-sector confidence to the point where none of the public money ever needs to be drawn down seems laughable.
Investors have been burnt badly in Argentina and, more important, in the US: the general mood is a lot more risk-averse than during the go-go years of the late 1990s, and there's no chance that the foreign capital on which Latin America has always relied is going to materialize from the private sector soon.
The new teams in Washington at the IMF and the Treasury therefore have a much tougher task than their predecessors. Michel Camdessus, Stanley Fischer, Robert Rubin and Lawrence Summers faced down major crises by persuading everybody to keep capital flowing to the countries concerned. But Horst Köhler, Anne Krueger, Paul O'Neill and John Taylor know that they can't expect the same reaction today.
Seeking a role in the post-bailout world
Take any of the major investors in Latin America: Grupo Santander, say, or Citigroup, FleetBoston, Telefónica, BellSouth, Allianz Capital. Given the choice between increasing their current exposure to the region or writing it off, in today's environment they're more likely than not to take the loss.
The reduction of capital flows to Latin America is not just a private-sector phenomenon. Bilateral aid, which constituted a very large part of previous emerging-market bailout packages, has come to a complete halt - even August's record-setting IMF deal is smaller than the total package that Brazil got in 1999.
More broadly, the IMF seems more confused than ever about its role in what was meant to be a post-bailout world. As Birdsall says: "The recipes for dealing with these things are getting less predictable and more diverse." Turkey, Uruguay and Brazil have all received outsized packages this year but all of them have been aimed more at shoring up the sovereign's creditworthiness than at providing the foundations for sustainable growth.
No lessons seem to have been learnt from Argentina, where the IMF continued to lend to the country long after it diagnosed an unsustainable fiscal deficit. In Brazil, because fiscal and monetary policy has been excellent, the Fund has been happy to target the primary surplus, rather than the soaring fiscal deficit and national debt. The new plan, too, asks only that the incoming government maintains a 3.75% of GDP primary surplus, which will do nothing to reduce either the deficit or the debt so long as the real remains weak and domestic interest rates stay high. Meanwhile access to finance is reduced.
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Wavering IMF adds to investor uncertainty

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