CCL, a new weapon in the IMF arsenal?

The IMF has launched a Contingent Credit Line for member countries which, despite their implementation of sound economic policies, are threatened by financial contagion. Irfan ul Haque wonders whether, with its onerous conditions for qualification and high cost of financing, the facility is not more a means to extend the Fund's influence over the management of members' economies.

by Irfan ul Haque

GENEVA: The IMF's Executive Board recently approved the institution of Contingent Credit Lines (CCL) for member countries that are threatened by international financial contagion, a situation where financial crisis in one country spreads quickly to other, usually neighbouring, countries. The scheme responds to the buildup of concern over countries that face a loss of market confidence, leading to economic and financial distress, for reasons unrelated to their own economic management. The idea is that if a country has a credit line from the IMF, it is less likely to fall victim to speculative runs on its currency.

While the new instrument will surely enhance further the IMF's power and control over the management of national economies (of developing and transition countries), it seems unlikely that CCL will be particularly effective in overcoming the problem of contagion.

There are basically two reasons for this conclusion: the virtually impossible conditions that countries must fulfil in order to qualify for CCL and the exorbitant cost of this financing in case they do have to resort to it.

In fact, there is a real risk that the problem could worsen for countries that fail to obtain, for whatever reason, the IMF's explicit seal of approval and do not get included in the list of qualifying countries.

Conditions

The Fund has laid down four conditions that a country must satisfy in order to qualify for access to CCL.

* One, at the time the country seeks CCL resources, it must be implementing policies considered unlikely to give rise to the need for the IMF resources and must not be "already facing contagion-related balance of payments difficulties."

* Two, the country's economic performance should have been assessed favourably by the IMF during the previous Article IV consultations (which are routine) and nothing should have happened in the interim to modify this assessment.

This condition is accompanied by a sub-condition, namely, the country is also expected to have met "relevant internationally-accepted standards", particularly with respect to fulfilling requirements of the Fund's Special Data Dissemination Standard.

* Three, the country, threatened by financial contagion, must continue to maintain "constructive relations with private creditors" and must satisfactorily manage its external debt and international reserves.

* And last, but not least, the country must submit a "satisfactory economic and financial programme, including a quantified framework."

Let us consider each condition in turn.

While it may be possible, though usually difficult in practice, to arrive at a consensus on whether or not government policies were the primary reason for financial difficulties that gave rise to the need for IMF financing, the latter portion of the first condition raises the hurdle to a point of insurmountability. The country in question is required to seek external resources prior to facing balance-of-payments difficulties caused by the contagion. In other words, the country's economic management should be not only sound but also prescient in foreseeing a possible financial crisis. The idea presumably is that the CCL is intended to prevent contagion rather than deal with it when it actually happens.

The second condition, on the surface, appears to be fairly straightforward. It only requires that the IMF team, at the time of Article IV consultations, must have returned satisfied with the country's economic performance. However, the IMF must at no stage get dissatisfied with the country's performance, that is, economic management must remain faultless in its handling of the incipient crisis. It is hard to imagine that there would be a convergence of views on how a crisis ought to be handled, especially because all crises have some new, unforeseen elements.

In terms of reporting requirements, which are part of this condition, the IMF is explicit on the standards to be achieved. This includes subscription to the IMF's Special Data Dissemination Standard, under which key macroeconomic and financial data are made available to the public. In addition, the country is expected to adhere to the Basle Core Principles for Banking Supervision as well as to the evolving codes on transparency in various areas of economic policy.

While it is hard to take issue with transparency, it remains a rather opaque notion itself because there are degrees of transparency. It is a fact that withholding information strategically can be beneficial without hurting anyone. For example, a degree of ambiguity about a country's foreign- reserve situation might conceivably avoid market panic.

The third condition requires that the government must continue maintaining "constructive" relations with private creditors. Since the term "constructive" is basically contextual, the IMF's Managing Director has taken pains to define it precisely and stringently. In order to qualify, a country must as a minimum not run arrears on its sovereign debt nor on its private debt as a result of exchange controls. A country would be hard put to satisfy these conditions in a situation where it faces a run on its currency from foreign speculators.

Final hurdle

The risk of default is endemic to a financial crisis. If the candidate country somehow manages to overcome all the above hurdles, it could still stumble on the final condition. The country facing a serious financial crisis must come up with an economic programme, including quantitative targets, satisfactory to the IMF.

What is needed in a crisis is an instantaneous response from the institution, not lengthy negotiations on key macroeconomic variables. In fairness, the Fund management recognizes this potential problem, but leaves it basically at the country's door: the country must ensure that its submissions on compliance with stipulated conditions are amenable to rapid assessment by the IMF staff and Board.

The cost of the IMF's assistance to a qualifying country is self-evident and needs little comment. Such a paragon of economic virtue will be able to borrow up to a figure of 300- 500% of its IMF quota at a cost of 300 basis points above the cost of regular drawings from the IMF. The duration of the loan is not expected to exceed one year, but in case it does, the rate is increased by 50 basis points every six months up to a limit of 500 basis points.

This indeed is an extremely high penalty for good behaviour and falling victim to a situation not of one's own making. More fundamentally, this ignores the fact that containing financial contagion is every bit as desirable for the world community as containing the spread of a serious epidemic.

The question in the end is, by setting such onerous terms and conditions, what is the IMF really trying to accomplish?

Clearly, the scheme would fail if there are no, or very few, countries that could qualify for the CCL facility. It seems, therefore, that the articulated criteria will be applied with considerable latitude in practice, which implies that the Fund staff will have enormous discretion in their choice of eligible countries. This discretion could be an extremely powerful means for policing and disciplining especially those developing countries whose economic performance would generally be considered satisfactory and would normally not require Fund assistance.

Thus, for example, the East Asian economies, until the crisis, managed their economies reasonably well and were able to dispense with the IMF's interference. However, now, whether or not such countries seek CCL, they would need to stay in the Fund's good books. It would not matter henceforth if the country's absence from the list of qualifying countries is on account of its own decision to stay out or because of inadequate performance as judged by the IMF. (TWN/SUNS4437)

Irfan ul Haque, formerly an economist at the World Bank, is now at the South Centre. He wrote this article for the South-North Development Monitor (SUNS).

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