Partial Greek default... to allow another loan.

In the largest partial debt default in history, 85% of private investors have agreed to take steep losses on their holdings of Greek debt. They will lose more than 70% of their investment. They accepted - in the end - that this was a better deal than allowing Greece to go bankrupt, in which case they would have lost everything. This agreement with private investors is an essential part of Greece's second "bailout". It paves the way for the EU and the IMF to sign off on a €130billion loan - called a "rescue package". Greece, which was facing bankruptcy within two weeks, can breathe again - and so can its creditors.

However, even after the latest loan, the country will still be left with debts of €250billion. The economy is in its fifth year of recession - never, in recent times, has an economy of a Western country shrunk so fast - 16% in just four years. The earliest any overly optimistic economist is predicting growth is 2014.

As expected, the markets reacted positively to the default news. The markets for want of a better term tend to "forgive" quickly. We have already seen this with other structured defaults in Russia, Brazil, Iceland etc. Why? Because all the markets care about is the future - not the past. Basically, a default means you are then a better bet than you were, to be able to pay in the future, the face value of any newly issued Govt bonds plus any interest payments - end result: they will allow you to play. It makes you wonder about our Government telling us all how hell would break loose in the markets if we burned Anglo Irish bondholders.

At the end of the day, this latest episode is yet another in a series of events designed to protect the Euro - at all costs, as well as saving the international banks from a total Greek default. The Greek problem is far from over yet...

IMF releases its report on the Irish economy

A new report released yesterday on the Irish economy says that it was perhaps the most overheated of all advanced economies. The detailed analysis by the International Monetary Fund says the collapse of tax revenue could push the budget deficit up to 12% of national income this year, compared with a Government target of 10.75%.

The IMF says Ireland's seemingly unstoppable economic growth of recent years masked serious problems - including the fragility of the public finances. It says generous rises in public sector wages pushed up wages elsewhere, making Ireland less competitive. In recent years, the IMF says, Ireland became the most expensive economy in the euro zone with the possible exception of Luxembourg.

The report says losses now faced by the banks could be about €35 billion by 2010 - although the bulk of that would be absorbed the banks' reserves. The IMF is broadly supportive of the Government's NAMA project to buy back bank debt. But it says setting a price for the purchase of those assets could be easier if the banks are nationalised. Not paying the right price, it says, opens the taxpayer to huge risks. The report says nationalisation could also be used to effect necessary mergers.

The IMF is projecting that the Irish economy will shrink by 8.5% this year, with another 3% drop in 2010. It says unemployment will reach 15.5% of the workforce next year.

WHAT IS... the IMF?

This is the start of a new series called "WHAT IS...?" in which I'll explain some term, event, institution in simple terms. We will begin with the International Monetary Fund (IMF).

What is the IMF?
The International Monetary Fund is a global organisation founded in 1944 at Bretton Woods. It aims was to help stabilise exchange rates and provide loans to countries in need. Nearly all members of the United Nations are members of the IMF with a few exceptions such as Cuba, Liechtenstein and Andorra.

What does it do?
It has three central activities:

1. It monitors national, regional and global economic and financial developments. It advises members countries on their economics policies. This is termed their 'surveillance role'. A list of IMF reports on member countries can be viewed here.

2. It lends members strong currencies to help them design programmes to redress any Balance of Payments problems.

3. It offers technical assistance - such as training for government and Central Bank officials.

Where does it get its money?
The IMF is financed by member countries who contribute funds on joining. They can also increase this throughout their membership. The IMF can also ask its member countries for more money. IMF financial resources have risen from about $50 billion in 1950 to nearly $300 billion in 2007, sourced from contributions from its 183 members. This initial amount depends on the size of the countries economy, e.g. the US deposited the largest amount with the IMF. The US currently has 16% of voting rights at the IMF, a reflection of its quotas deposited with IMF. The UK has 4% of IMF Voting rights. Loans are also available to developing countries to 'deal with poverty reduction.'

Is there any criticism of the IMF?
There are many critics of the IMF. Most of the criticism centres on the following:

1. Conditions of Loans -
On giving loans to countries, the IMF make the loan conditional on the implementation of certain economic policies. These policies tend to involve:

• Reducing government borrowing - Higher taxes and lower spending
• Higher interest rates to stabilise the currency.
• Allow failing firms to go bankrupt.
• Structural adjustment. Privatisation, deregulation, reducing corruption and bureaucracy.

The problem is that these policies of structural adjustment and macro economic intervention often make the situation worse.

2. Lack of Transparency and involvement -
The IMF have been criticised for imposing policy with little or no consultation with affected countries.

3. Exchange Rate Reforms -
When the IMF intervened in Kenya in the 1990s, they made the Central bank remove controls over flows of capital. The consensus was that this decision made it easier for corrupt politicians to transfer money out of the economy (known as the Goldman scandal). Critics argue this is another example of how the IMF failed to understand the dynamics of the country that they were dealing with and insisting on blanket reforms.

4. Free Market Criticisms of IMF -
Some criticise the IMF for being too interventionist. Believers in free markets argue that it is better to let capital markets operate without attempts at intervention. They argue attempts to influence exchange rates only make things worse - it is better to allow currencies to reach their market level.

5. Moral Hazard Criticism -
There is a criticism that bailing out countries with large debt only creates 'moral hazard', i.e. the possibility of getting bailed only encourages those in debt to borrow more.

Will the Irish Government ask the IMF for help?
It is quite likely, I believe. Over the New Year there was much speculation (reported by RTÉ amongst others) that Taoiseach Brian Cowen had been talking about IMF intervention with the social partners - Cowen immediately dened this. In January 2009 the IMF said it did not think Ireland needed such financing.  However, Ireland will be looking for IMF assistance later in 2009 or 2010, in my view.

IMF Report is downbeat

The Irish Independent is reporting this morning that an imminent report on Ireland from the International Monetary Fund (IMF) is likely to stress the unprecedented nature of the economic challenge the country faces.

Sources say the IMF's projections on the budget deficit and medium-term recovery in the economy may be somewhat gloomier than those of the Government. Official figures put the underlying deficit at around 8pc of output (GDP) this year, but budget projections see a return to growth of more than 3pc in 2011.

The IMF is believed to have calculated that the "structural" deficit could be as much as 10pc of GDP, or €18bn, and that correcting this will require very difficult choices on public spending. It will endorse the widespread view that most of the correction must now come on the spending side, rather than through more tax rises. This would include serious examination of public sector wages.

The IMF's report is likely to repeat previous views that Ireland needs to target its welfare benefits more precisely, in view of the pressures on public spending. Even if it is not spelt out directly, this will be taken to include the universal payment of untaxed child benefit.

The report does not find fault with the Government's approach to the crisis, or its controversial plans to set up the National Asset Management Agency (NAMA) to remove development loans from the banks' balance sheets. But the report does emphasise the amount of effort it will take to solve these problems. The Government's plans see a return to borrowing of less than 3pc of GDP by 2013, from this year's level of around 11pc. Such an ambitious plan will require sustained action on the Government's part, the analysts in Washington say.

On bank rescue, it is likely to emphasise that it is essential that NAMA pays the correct value for the banks' development loans. This has been a political bone of contention, with opposition politicians claiming the Government is planning to bail out the banks and developers, by paying too much for the loans. Taoiseach Brian Cowen has insisted the loans will be valued by experts on an independent basis.

The IMF recognises that the Government has moved quickly on the banking crisis in comparison with some other countries, and that guarantees, re-capitalisation and removal of bad assets must all be part of any re-structuring. Such is the scale of the twin budgetary and banking challenges that the report is expected to state clearly the risks that the Irish economy still faces and the lack of any certainty that the ambitious recovery targets can be met.

Source: Irish Independent 19-Jun-2009