IMF changes policy on troubled economies

In a dramatic policy change, the fund now says austerity may not be the best medicine for sick economies, but some in Europe do not agree

PUBLISHED : Wednesday, 17 October, 2012, 12:00am
UPDATED : Wednesday, 17 October, 2012, 3:31am

It is hard for a leopard to change its spots. How much harder for the International Monetary Fund, prime deviser of the ABCD - austerity, budget cuts, conditionality, deficit reduction - regimen forcing indebted countries to swallow bitter economic medicine, to change its mind and suggest that sometimes it might be better to build up the strength of sickly countries than resort to blood-letting.

The IMF's almost Damascene conversion from severe austerity to a more balanced approach stressing the importance of growth in building up economic strength was one of the main talking points of the annual meetings of the IMF and World Bank that ended in Tokyo over the weekend.

(The other was whether China's refusal to send its top finance officials to Tokyo in its sulk over territorial disputes with Japan was evidence of uncertainty in Beijing as the top leadership changes hands or of a more assertive China unafraid to show the world its bulging economic muscle to promote political causes.)

Christine Lagarde, the managing director, was the public face of the IMF's new friendly attitude.

She said that she was happy for Greece to be given two more years to meet its targets for deficit reduction.

Her attitude seemed to set her on a collision course with Germany, whose finance minister Wolfgang Schaeuble insisted that there was "no alternative" to making big cuts in budget deficits.

Lagarde and Schaeuble spent the meetings pretending that they were reading from the same text, with the German minister saying that, "We are in complete agreement with the IMF, and especially with Ms Lagarde, that in a mid-term view the reduction of too-high debt levels is completely unavoidable".

Lagarde also claimed that the dispute was more about perception than reality and that medium-term deficit reductions were essential, though they must be carefully "calibrated on a country-by-country basis. It cannot be one size fits all".

The formal communique of the IMF's main committee spelled out that "fiscal policy should be appropriately calibrated to be as growth-friendly as possible".

Reports from Brussels, however, suggest that Berlin has not bought the new deal. There, furious arguments are going on in a potentially dangerous game of brinkmanship over Greece.

"A shouting match" and "an eyeball to eyeball contest to see who will blink first" are just two of the expressions used. The IMF wants Greece's official creditors to write off up to €30 billion (HK$300 billion) and to extend the rescue plan by two years.

Germany and the European Central Bank are resisting fiercely any suggestion that official creditors, that is governments, should have to suffer losses.

But the still-continuing review of Greece's progress by the IMF, ECB and EU Commission is yielding the gloomy conclusion that there is no way that Athens can meet the target of getting its debts to 120 per cent of GDP by 2020. The estimates are that debts may be between 128 and 145 per cent.

The issue is not just Greece, although that is the most immediate question that may finally precipitate the break-up or the beginning of the end of the euro and even the European Union.

The Nobel committee in controversially awarding the EU the peace prize last week spoke correctly of the statesmanship that brought a continent from the disaster of war to reconciliation and democracy.

Why was the award made now rather than last year, or five or 10 years ago? Was the Nobel committee warning today's nationalistic European politicians of the dangers of their selfishness?

It is certainly annoying for the rest of the world to spend so much time listening to the petty squabbles of Europe. That resentment was also a strong undercurrent at the Tokyo IMF/World Bank meetings. But a break-up of the EU would have dangerous repercussions for the global economy.

Lagarde's plea for time for indebted countries had substantial backing from the IMF's own bureaucrats who discovered what commonsense might have told them - that piling austerity on to budget cuts could be dangerously self-defeating, especially when the options of devaluing the currency or increasing exports are not available in a world that is growing more slowly.

The IMF's bottom line is that there are no quick fixes, and merely slashing deficits can be dangerous in itself.

Its analysis was not merely a historical exercise. There are important lessons for today, especially when the global economy is weak.