Martin Wolf: IMF must stand up to blackmail
(February 2, 2004)

If you owe a bank a hundred pounds, you have a problem, but if you owe it a million, it has. Argentina's relationship with the International Monetary Fund provides a compelling demonstration of the truth of this famous remark by Lord Keynes.

Argentina owed the Fund not a mere million, but $16bn at the end of last year, which is 16 per cent of outstanding IMF credit. At the end of last August, Argentina also owed $18.3bn to the World Bank and another $1.9bn to the Inter-American Development Bank. So large are Argentina's debts to these institutions that, in a reversal of normal roles, its government holds their health hostage to the Fund's good behaviour.

In essence, the Fund is relending the principal Argentina owes. The stand-by agreement reached last September was explicitly designed to achieve this result. But the Fund is doing this even though Argentina's fiscal effort, structural policies and treatment of its non-preferred creditors are inadequate. It is, in effect, yielding to blackmail. This damages the IMF itself, Argentina's private creditors and the Fund's other borrowers. It must stop.

In making this criticism, I do not argue that Argentina was wrong to default. On the contrary, a default was inevitable long before the end of 2001. Between early 1994 and the end of 2000, the average premium of Argentine external dollar debt over US treasuries was just above seven percentage points. Big risks must come with such high rewards. Those who failed to diversify their portfolios in response deserve nobody's pity. They took on the risk knowingly. Ordinary Argentine citizens did not.

Nor am I arguing that the Argentine authorities have played their economic policy hand that badly. Despite the devaluation, year-on-year inflation never exceeded 41 per cent and is now below 4 per cent. The real exchange rate is some 40 per cent below its level before the devaluation. This jump in competitiveness has given a big boost to the economy, which grew by about 8 per cent last year, though output remains 13 per cent below the peak it reached in 1998.

Nevertheless, the case for continued lending is weak. Lending by the IMF when a country is in arrears is, quite properly, subject to stiff conditions. While it is right to permit the Fund to lend in such circumstances, rather than allow recalcitrant creditors to hold the country (and the IMF) hostage, that country must also, in the words of the IMF's policy statement on the topic, be "pursuing appropriate policies and making a good faith effort to reach a collaborative agreement with its creditors".

Does Argentina meet these criteria? On balance, my answer is no. In two ways at least, Argentina's programme falls short. First, the basis of its offer to private creditors is a primary fiscal surplus (balance before interest payments) of no more than 3 per cent of gross domestic product. This is less than half what Turkey is achieving and substantially below Brazil's target of 4.25 per cent. Second, the programme fails to provide a credible cure for the ravaged banking system or the privatised utilities, whose solvency is being destroyed by unrealistically low prices imposed by the government.

This combination of a modest fiscal effort, by the standards of other crisis-hit countries, with a far from compelling economic programme makes the IMF's decision to continue lending problematic. The fact that it is a response to Argentina's willingness to default to the international financial institutions rather than, say, use any of its foreign exchange reserves, worth $13.5bn last November, makes it even more so.

Why is bowing to this blackmail so dangerous? One answer is that it cuts the ground from under the feet of other governments that are trying to run a tighter fiscal position or implement deeper reforms. An equally obvious reason for refusing to lend is that the Fund is engaged in exactly the practice it would condemn in commercial banking: refinancing an insolvent debtor in the hope that something will somehow turn up.

Worse, what is most likely to save the Fund's credit is a very deep reduction in the net present value of the bonds upon which Argentina has defaulted. If the Fund continues to refinance its debt, thereby making it easier for Argentina to impose huge losses on its creditors, the value of its own claims will rise. This a monstrous conflict of interest. The losses likely to be imposed on other creditors are huge. The Argentine government's proposals would impose losses of about 90 per cent of the present value of the defaulted bonds.

For these reasons, the position into which the Fund has manoeuvred itself - or, more precisely, been manoeuvred by its leading shareholders, above all the US - is intolerable. It would have been far better to confront Argentina's blackmail head on. A stronger programme, with a primary fiscal surplus of, say, 4-4.5 per cent of GDP and more far-reaching reforms, would have imposed a less dramatic reduction in the value of the claims of other creditors and better prospects of sustained recovery. Failing that, a more comprehensive default would have left the Argentine government to struggle on alone, thereby strengthening the position of leaders struggling to meet higher standards.

Last, but not least, a default to the IMF would be just. The Fund continued to make huge loans to Argentina in 2001, long after default had become overwhelmingly probable. As the IMF would normally insist, institutions should pay for their mistakes. They should certainly not be rescued at the expense of other creditors. By being forced to share in the losses, the riskiness of lending long after countries should have reversed course would be made more evident to the Fund and its shareholders.

Changing course completely is now impossible, since the IMF agreed a three-year credit only last September. But the Fund can still insist upon meticulous implementation of every condition, including those relating to the financial system, the predictability of the legal and regulatory frameworks and the conduct of debt negotiations. The managing director, Horst Köhler, has decided that Argentina has passed the first review of this programme. Another is due in March. The shareholders must then insist on a frank evaluation. If a default does come, the cost should then be borne by the rich countries that have connived at all these mistakes.