Interview: Brad Setser and Nouriel Roubini on the International Monetary Fund
Published by The Straits Times, Singapore on 2004-11-07
The Council on Foreign Relations in New York has published a book titled "Bailouts or Bail-Ins? Responding to Financial Crises in Emerging Economies."
It is written by Mr Brad Setser of the Global Economic Governance Programme at University College, Oxford. The Yale-educated Mr Setser is the former Acting Director of the US Treasury's Office of International Monetary and Financial Policy. His co-author is Mr Nouriel Roubini, Associate Professor of Economics and International Business at the Stern School of Business, New York University, and a former senior economist for international affairs at the White House Council of Economic Advisers. Advance word about their book has already generated considerable discussion in top policy-making circles in the capitals of G-7 countries.
Mr Setser and Professor Roubini ask a central question: How should G-7 policy-makers and the International Monetary Fund respond to financial crises? There are no simple answers, according to the authors, because countries experience currency crises, banking crises, corporate crises, and sovereign debt crises in various combinations. They can run out of cash despite having modest debts, or can run out of cash in large measure because they already have too much debt. The Third World's cumulate debt to foreign governments and private-sector institutions is estimated at US$3 trillion.
The authors say that the tools needed to respond to a wide range of financial crises already exist, and the core challenge facing the G-7 and the IMF is to do a better job of matching existing tools to different types of crises. There is no need to dramatically expand the IMF right now, or to create a sovereign bankruptcy regime. But there is a need to develop a rigorous, hardheaded approach to managing crises. Among the authors' recommendations:
_ The G-7 needs to stop pretending the IMF will be getting out of the business of providing rescue loans to crisis countries. The IMF's lending norms need to be adjusted to reflect the actual amounts necessary to help emerging economies, not kept at the low levels the IMF routinely breaches.
_ The IMF should be more willing to distinguish between countries and make hard judgments early on. Countries that get into trouble despite modest deficits and little accumulated debt are better financial bets than those that get into trouble with larger debts and little proven ability to reduce their deficits.
_ IMF lending and a coercive debt restructuring can be complements, not substitutes. In some instances, IMF financing can be most effectively deployed to support a debt restructuring, not to try to avoid one.
_ Banks remain every bit as important as bonds. Cross-border bank credits have gotten off the hook too easily in recent crises: coordinated rollovers are at times necessary. And in some cases, the IMF should be wiling to help to finance a domestic lender of last resort during an external restructuring.
_ The G-7 should not rely on the IMF to save countries that are too strategically important to fail. If the G-7 wants to give a country like Turkey a special break, it should do so on its own dime.
The authors gave The Straits Times a joint interview over the weekend. Following are excerpts:
What explains the timing of your book?
We started in late 2002, when we thought it made sense to take stock of the debate on financial firefighting - given that it was by then clear that the Sovereign Debt Rights Mechanism (SDRM), the International Monetary Fund's bankruptcy for countries proposal, would fail and that the Bush Administration's policy, in practice if not in rhetoric, was to provide very large bailouts, and often to provide large bailouts to countries with much more debt than the countries the Clinton Administration had bailed out. We don't mean to imply that IMF policy is just set by the United States: the rest of the G-7 was going along with these bailouts as well. We did not finish until now. While there are not any current, burning crises, we expect - unfortunately - that there will be future crises.
Why do you think that IMF has been long considered a secretive organization?
The IMF long has focused on communicating with its members, and specifically with the governments of its member countries, not on communicating with the broader public. It has changed, and is now much, much more transparent. Go the IMF's web page. It will overwhelm you with a deluge of papers. So we think that public perception lags reality. The IMF now puts out so much it is hard for the uninitiated to know where to look. There are exceptions - places where the IMF does not publish as much as it should - but they usually reflects the country's unwillingness to reveal more. China and Brazil, for example, has resisted making the IMF staff reports on its economy public. We think the IMF suffers from one other problem: it tends to write for other economists and for those already well versed in the IMF's own intricacies and jargon, which makes it harder for it to communicate effectively with a broad audience.
What specific tools already exist to respond to Third World foreign exchange and currency crises?
For currency crisis, there really is only one tool available to other countries that want to help - IMF lending. That allows the crisis country to borrow reserves from the world; reserves that can in some instances be used to intervene directly in currency markets, and in other cases keep the country's stated reserves from falling to levels that would risk adding to a loss of confidence. In general, we don't think the IMF should lend to a country that is trying to defend an unsustainable peg; IMF lending is far more likely to make a difference if it is used to try to avoid "overshooting" after a country has let its currency float.
What steps can countries take themselves to back their own currencies?
Countries themselves can also take steps to support their currency, notably by tightening monetary policy to make it more attractive to invest in short-term local currency assets. And in some cases, countries can impose exchange controls, as Malaysia did - though the IMF rarely supports this in the absence of a sovereign default. Such controls typically have a bigger impact on locals than on foreign investors; after all locals residents typically have most of their savings in the country.
Why else is IMF lending significant?
IMF lending also is an important tool for handling debt and payment crises. It can let a country pay debts while it takes steps to regain the confidence of its creditors - this is the catalytic approach. But there are also other tools - whether a coordinated rollover of bank claims like was done in Korea or a bond exchange, like was done in Uruguay. These are what we call bail-ins. Here, the IMF supports a country's efforts to convince its creditors to extend the maturity of their claims on the crisis country, and in extreme cases, even to reduce their claims.
What's your take on whether the IMF should be disbanded, or at least totally overhauled?
Simple. We don't think the IMF should be disbanded, and we also don't think it needs a complete overhaul either. In "Bailouts or Bail-ins?" we argue that problems in crisis resolution stem more with the software - how existing tools to respond to crises have been used - than from gaps in the institutional hardware for handling crises. Consequently, we think that there is room to improve the IMF's approach to currency and debt crises without a complete overhaul of the institution.
But does the structure of the IMF still make sense at a time when there aren't pressing crises such as what happened in Argentina in 2000, or in Korea?
The basic structure of the IMF still makes sense - the IMF is way for countries to join together to pool a portion of their reserves, and then to lend their joint reserves to a crisis country in return for a country making commitments to improve its policies. That is a solid institutional design. We do think, though, that in some cases, the IMF's lending capacity can best be used to support a debt restructuring, not to try to let a country avoid one altogether. So in cases like Argentina, the IMF's approach should have been different; it should have only lent if Argentina was willing to drop the currency board (since Argentina's exchange rate was overvalued) and to initiate a restructuring of the government's external debt.
Is there a need for a new Bretton Woods conference in this age of globalization?
If the goal of a new Bretton Woods would be to completely overhaul the IMF, we don't think a new Bretton Woods conference is needed. The basic institutional structure set up 50 years ago still makes sense. There is a need for a global institution that pools reserves and then lends them out to countries with a strong need for reserves. The ability to obtain an injection of reserves - a surge in foreign currency - is something that countries in trouble rightly value. One of the points we make in the book is that reserves can be used to help limit the damage from a wide range of different kinds of crisis. Since reserves still serve an important function, the IMF still serves an important function.
But aren't there major institutional problems at the IMF that really need to be addressed?
Yes. There are some institutional problems that do need to be addressed, though they probably don't rise to the level of a new Bretton Woods conference. The first is that Asian countries are under-represented on the IMF's board relative to their current weight in the global economy. The second is that some Asian economies - notably China - are now so large and important that ways need to be found to bring them into the world's informal global economic decision making bodies more fully. It is hard for the G-7 to talk meaningfully about global imbalances like the US current account deficit if China is not at the table, even though it was given a one-time invitation at the recent G-7 meeting in the US.
Where do you see globalization headed?
We are not great seers, but we will offer three observations. First, the global trading system is much more globalised than the global financial system, and even if the global financial system is becoming more integrated, that is likely to remain true for some time. Most Chinese savings are invested in China - in part because of China's capital controls - and most US savings are invested in the US, even in the absence of any formal controls. We are a long way from complete global portfolio diversification. Second, emerging markets are likely to continue to encounter difficulties as they integrate themselves into global financial markets. We don't think we have seen the last emerging market crisis. Third, the global economy faces some enormous challenges over the years ahead, and none is larger than ending the United States unsustainable demand for Asian financing to finance its budget deficit (and more generally, to offset low US savings), and Asia's unsustainable dependence on US consumption growth to fuel export-led growth.
How worried are you about the US deficit?
The United States' need for foreign financing to meet the deficit has become truly enormous - it may be over $800 trillion next year, taking into account the United States need to raise money abroad to fund both its current account deficit and its outward foreign direct investment. US firms have been investing more abroad than foreign firms have been investing in the US, so FDI is not helping to finance the US current account deficit. Continued global integration will likely hinge on successfully addressing this imbalance. We think it can be done, but it won't be easy.
What would be an ideal relationship between the G-7 and the IMF?
Two points. The first is one we make in "Bailouts or Bail-ins?" - that the G-7 should not look to the IMF to bail out countries that are too strategically important to fail. Some countries like Turkey are politically important, but if they need large 10-year loans to avoid a default, that kind of financing should not come from the IMF. The IMF simply is not set up to provide that kind of large-scale long-term financing to all its members. The second point is that the G-7 and the IMF are not completely separate entities. The G-7 is basically an informal club of the IMF's biggest shareholders, and having such a club makes the IMF work better than many international institutions. The G-7 may not bring the right set of countries together any more - China needs to be brought to the table permanently in some way - but there is a role for that kind of informal coordination, just as there is a role for an institution like the IMF where in principle, all countries are represented.
How can the World Bank and the IMF complement one another in ensuring greater global economic progress and security?
We don't really touch on this our book - our focus is on the IMF. The IMF's basic role is financial firefighting. The World Bank's basic role is financing long-term development. Those are different missions. In very poor countries, the IMF and the World Bank's roles overlap a bit, as the IMF sets out a country's basic macroeconomic policy framework even as the World Bank provides the longer term financing for development projects. We don't really touch on the frictions between the two institutions that arise in these countries.
What's your view of why Asian central banks are building up dollar reserves but not buying into more T-bills?
We don't know for sure. One possibility is that they are buying treasury bills, but doing so in ways that don't show up in the US data. Central banks often can "hide" their purchases if they go through the banking system. Suppose an Asian central bank deposits money in Switzerland that is used to buy T-bills. The US reporting system may register that as a Swiss, not an Asian, purchase of Treasuries. The other possibility is that central banks don't like the low yields in the Treasury bill market, and are buying more long-term Treasury bonds, agency bonds and even corporate debt. Certainly Asian central banks hold so many reserves that they don't really need to keep all their money in the most liquid of all markets, and can afford to look for yield with a portion of their reserves. (Asian central banks currently are holding on to more than US$2 trillion in cash assets.)
Do you foresee a global recession in 2005?
We are not forecasters, so anything we say should be taken with a grain of salt. Right now, it looks likely that higher oil prices will just lead global growth to decelerate from its very strong 2004 pace, not an outright recession. But Nouriel would add that the risk of a recession is certainly there. Economists have often underestimated the impact of higher oil prices. And analysts like Mr Steven Roach of Morgan Stanley have noted that global growth still depends on continued strong spending by already over-extended US consumers. US consumption cannot rise faster than US income indefinitely. That means that the foundation for future global growth is somewhat more unstable than either of us would like.
How do you determine which countries are too strategically important to fail, and which aren't?
No country is truly too strategically important to fail. After all, Russia failed. At the same time, not all countries have the same strategic importance, and it is not hard to see why. Big US bases were built in Turkey, Mexico and Korea, which shared borders with the US or the EU; and nuclear weapons, whether in the country or in the region (Russia, North Korea) - all tend to increase a country's strategic significance. Some countries are probably too big or too important not to try to help, but no country is too big or too important to fail.
So how are decisions to be made concerning which countries to bail out during crises?
The hard question is deciding what countries are worth providing large amounts of financing too, and whether that money should come from the IMF or from the G-7. We believe the IMF should only provide large amounts of financing to help a country avoid a debt restructuring is there is a strong chance the country will able to repay the IMF quickly, as Mexico and Korea did. Some strategically important countries are good financial bets: they may have run down their reserves, but their overall debt levels remain manageable. Other strategically important countries are not as good a financial bet, and we don't think the G-7 should look to the IMF to provide these countries with what is likely to be long-term financing. In these cases, we generally think that the IMF should use its financial capacity to soften the blow associated with a debt restructuring, not lend to help a country avoid any restructuring. But if the G-7 thinks that is too harsh, and wants to give a strategically important country a break even though its debt levels and policy track record suggest it won't be able to repay quickly, the G-7 should provide such long-term financing on their own, not through the IMF.
Is this going to be the Asian Century?
In part. But not entirely. Asia certainly will account for a rising share of global output. The world's population is concentrated in Asia, and at some point, Asia is almost sure to be the biggest component of the global economy. In time, China is likely to surpass the United States as the world's largest economy. But it will take longer for China and India to become as wealthy as the US and Western Europe than it will for their economies to surpass the US economy in absolute size, so the US and Europe will remain important.
Moreover, there will be hiccups along the road. India's large fiscal deficit is a problem that will need to be corrected, even if India is financing that deficit domestically right now. We are also worried about the fast pace of credit expansion in the China, the large and likely growing portfolio bad loans in the Chinese banking system, and property bubbles in some parts of China. Moreover, for Asia to sustain its current expansion, it will have to learn to depend less on the US consumer, and rely more on the demand generated by Asia's own growth dynamic.
Senior Writer and Global-Affairs Columnist