Sun, Jul 31, 2022
by Danny Leipziger
There are many high-profile examples these days of shifting the problems of the “state” on to other institutions, thereby placing the latter in impossible situations. Looking at Europe, we see the European Central Bank grappling with widening bond spreads caused by deeply entrenched fiscal problem, such as those facing Italy. No matter how skillfully the ECB operates in bond markets, it cannot substitute for national actions, including those which raise political uncertainty and then increase spreads within the Eurozone. Trying to fix these problems jeopardizes the ECB’s main goal of price stability with new rounds of bond purchases to avoid so-called fragmentation.
This dilemma of preserving the fiction that all Eurozone members have similar risk profiles flies in the face of data showing some countries to be much more highly indebted and thus requiring more bond financing than others to meet fiscal targets. Thus, the central bank is being asked to deal with issues that the EU’s other bodies should, but cannot, adequately address. The disparity of fiscal positions and debt levels means that unless the ECB wishes to ultimately guarantee all members’ bonds, it will need to continuously intervene in capital markets on the buy-side, an unhealthy policy stance.
The same dilemma faces the International Monetary Fund in severe distress cases, such as Argentina or Sri Lanka. It is impossible for the world’s lender of last resort or “central bank for central banks” to overcome the policy intransigence of governments. In Argentina, the IMF has already replaced a failed program that could not be repaid with a minimalist program that again is likely to fail. Blaming the Fund is convenient but misplaced at this juncture. Argentina is a country with long-standing policy inconsistencies that reflect a flawed political system. The result is rampant inflation and flight from the national currency. Argentina received special treatment, and, compared to many other countries, a lenient program. If the program fails, it will reflect state failure.
In the sad case of Sri Lanka, the authorities are asking the IMF to find a “humane solution;” however, is that the correct role for the world’s central bank? Many may argue that it isn’t.
Of course, state failures leading to defaults are difficult to address since, unlike firms, countries don’t go out of business. There was a proposal originally promoted by former First Deputy Managing Director of the IMF Anne Krueger, the Sovereign Debt Restructuring Mechanism, to create an official default mechanism for countries to be guided by predetermined rules on relief measures, distinct from normal Fund programs. Might this SDRM or equivalent not seem appropriate for some countries like Pakistan or Argentina today, each of whom has come to the IMF more than two dozen times for balance of payments relief in the face of severe debt distress?
The IMF has been eager to provide unconditional support to indebted Emerging Market and Developing Countries (EMDEs) because of the pandemic, a legitimate stretching of its mandate under the circumstances. In addition, some relief has been gained from the new large SDR allocation, although only a fraction goes to those needing it most. Now the issue becomes how to provide conditional BOP support to countries with debt repayment difficulties, those that are facing severe liquidity problems as distinct from essentially solvency problems. In the latter cases, such as those faced by say Sri Lanka or Argentina, government is not able to undertake the normal set of IMF-led reforms because of failures of the state. Since the Fund cannot easily walk away, it becomes part of the political morass rather being a lender of last resort.
The basic point is that continually expecting international or supra-national institutions to remedy national economic policy failures simply doesn’t work. Moreover, it taints the legitimate work of these entities and helps tarnish their reputations. State failures are the responsibility of the state to fix.
Danny Leipziger is Professor of International Business, George Washington University and a former Vice President at the World Bank.