ANALYSIS:Depicting IMF as the big bad wolf we don't want to let in ignores the fact that we have implicitly ceded aspects of sovereignty to the ECB, writes MICHAEL CASEY
MARY HARNEY’s recent assertion that if the Government doesn’t make the necessary cuts to public spending, then, just like the big bad wolf, the International Monetary Fund will come in and do it instead, is based in part on a stereotypical view of the IMF as some kind of demonic institution best avoided at all costs.
Yet, given the ad hoc approach of the Government to solving our economic problems, some commentators are beginning to ask, reasonably, whether we should approach the IMF sooner rather than later.
What the IMF essentially does is provide credit to a government (on more or less commercial terms) to buy time while it is implementing needed economic policies. In other words, finance is provided during the adjustment period. Nothing is imposed on governments. There are usually in-depth discussions and negotiations of required policies, and when these are agreed on, the government in question signs a Letter of Intent which is basically a commitment to implement the agreed policies.
If the government departs from the agreed policies, then the programme will be reviewed by the board of the IMF. Some tweaking may be needed to get the programme back on track. Repeated or major “breaches” may result in finance being withdrawn. In that event, the government concerned would lose face and might find it harder to borrow from capital markets. That may be one reason why governments are afraid of the IMF. In a sense it is the last resort, and if the process fails, a government is really looking into a void.
There may also be a degree of snobbery involved. For many years now the IMF has tended to lend exclusively to developing countries. The last developed country to “go to” the IMF was Britain in the 1970s, and that was regarded as a humbling experience.
In the early 1980s, when Ireland was also in serious trouble, the IMF did become involved, albeit in a peripheral way. Because the international banks were still flush with oil dollars, Ireland had little difficulty borrowing abroad. Hence it did not need IMF finance.
However, there were two occasions when the state of the Irish economy was brought to the attention of the IMF board by the organisation’s managing director. In two successive quarters, he had Ireland on his list of “basket case” economies, alongside several seriously recidivist third world economies. This caused consternation in Merrion Street, but it did help concentrate the mind, and we began our own programme of fiscal consolidation shortly afterwards.
The third reason why governments don’t like the idea of recourse to the IMF is because it conveys the impression that the government itself cannot (or will not) introduce the necessary economic policies. It may appear to be an admission of failure and/or a temporary ceding of sovereignty. Even though this happens much of the time (eg the “advice” currently offered to us by experts in the European Commission and the European Central Bank), it is somehow not as overt as it would be if the IMF were involved.
There is also the possibility that the euro zone countries would feel that if Ireland went to the IMF, it might raise questions of credibility about the euro and the viability of monetary union. Ireland would certainly have to discuss the matter with its euro zone partner countries before taking such action.
What kind of policies would the IMF seek? Clearly a devaluation of the currency is out of the question, as is any form of monetary policy, and it is most unlikely the IMF would recommend Ireland’s departure from the euro zone. Consequently, the problem of competitiveness would have to be addressed by wage reductions and by ensuring market forces drove down other business costs, such as utilities and professional fees. Real wage reductions of about 5 per cent a year over a three-year period would probably be required.
Cuts in public spending would be along the lines of those already raised by the McCarthy report. Public sector reform would be brought to the top of the agenda, and it is likely that significant staff reductions would be sought. It is probable the IMF would seek to close up to half of our 850 public bodies and quangos.
The IMF might not go much further on taxation except for a property tax which would be seen as a way of broadening the tax base without too many distortional effects.
The IMF might accept the Government’s goal of reducing the general deficit to 3 per cent of GDP by 2013. Although it would clearly prefer if the deficit could be reduced to zero, it is unlikely to go against the Government’s own target, which has been cleared with the EU.
The structure of Nama would likely remain, but the IMF would have good advice to offer on how it should be run, regarding appropriate safeguards to prevent abuse, methods of valuing property, and so on.
There is another option, apart from the IMF – one that would involve a bailout by the EU. If this were to be arranged in an overt way, then economic policy conditions would also be negotiated and agreed. But isn’t that what is, in effect, happening now behind the scenes? Our fiscal targets have all been cleared with Brussels. Nama has had substantial input from the ECB. Thus the EU is acting as a sort of IMF behind the scenes.
What about the finance? The Irish banks are already borrowing from the ECB, but they are not lending on much of that money to private businesses. Instead, they are investing in Irish government securities, thus helping to finance the deficit. When Nama is up and running, the banks will be able to borrow far greater amounts from the ECB. Some of this money may be lent to the private sector (one hopes), but it is likely that substantial funds will be made available to the Government to finance the budget deficit.
This may be the main reason why the Irish banks were not nationalised. If they had been nationalised this transfer of funds could not occur, since the ECB cannot lend directly to government. So now we have a situation where the EU is not only formulating economic policy in Ireland but also providing substantial finance to government. This is very like what would happen under an IMF programme! The latter would of course be overt and transparent. The other major difference is that the EU programme is crowding out the private sector – not something the IMF would endorse.
So, even though an IMF programme would help the Irish economy, our Government would be most reluctant to sign up. Politically, it is unappealing. We actually have a shadow EU programme in place, although this has not been revealed to the general public. If this does not work we may have to seek further, more formalised assistance from the EU.
This step is more likely than recourse to the IMF, which is viewed, wrongly in my view, as a big bad wolf.
Michael Casey is a former chief economist at the Central Bank and board member of the IMF