27 May by Bodo Ellmers
The creditor community has another shock and awe moment this week, as more and more influential actors argue that Greece should stop repaying the International Monetary Fund (IMF) loans and rather use scarce public resources to tackle its economic and humanitarian crisis. While Prime Minister Tsipras still tries to ease the creditors, the idea is here to stay. And it is a good one: Greece should not just postpone loan repayments but default on them – stopping payments to the IMF for good. This would help to finally reform the IMF from the political puppet that it is now into a real and effective crisis response instrument.
Risk-free lending can quickly become irresponsible lending
Whoever loses in a debt crisis – and usually there are many losers – the IMF is always off the hook. It is common practice that borrowers grant preferred creditor status to the IMF, and pay off the IMF loans in full and in a timely manner. While it isn’t written down anywhere in international law that there’s such a thing as an IMF preferred creditor status – not even in the IMF’s own Articles of Agreements – all countries traditionally stick to this practice. This even goes for countries such as Argentina, which have been branded recalcitrant debtors by US judges and have no intention of maintaining good relations with the IMF.
Repaying the IMF often comes at high opportunity costs for borrower countries’ development, and for the other creditors who do have to take a haircut, and a larger one if the IMF does not participate in a debt restructuring. The fact that everyone’s repaying the IMF means that lending is essentially risk-free for them. And as in all other cases when lending is considered risk-free, the lender is encouraged to act irresponsibly, and to do really stupid things.
IMF’s track record is disastrous
Just one of these things has been the IMF’s participation in the Troika bailout operations to the benefit of Greek’s private creditors, which started in 2010. It was clear from the start that Greece was insolvent, that the bailout loans were not going to put the country back on a debt sustainability track, but that they would just refinance payments to private creditors who would leave the country. It was also clear that Greece would never be able to repay the bail-out loans, as these measures did not solve or even begin to address the insolvency problem, but simply changed the creditor structure from bondholders to Troika. Ninety percent of the loans went straight to creditors. Actually, the IMF’s own rules of the game forbade such stupidity, as they require a country with an unsustainable debt burden to restructure and reduce its private debt burden first, before it can access IMF loans.
However, some of the IMF’s ‘major shareholders’ were interested in the bail out of their own banks and investors who had lent recklessly and were overexposed in Greece. As a result, the IMF Executive Board quickly passed the ‘systemic exemption clause’, which legalised the bailout loans to Greece, in spite of the fact that these loans violated the rule that the IMF cannot lend into a clear situation of unsustainable debt (i.e. to an insolvent state).
Support from IMF’s management was not hard to get, as then Managing Director Dominique Strauss-Kahn was still considering running for the French presidency, and French banks were the number one profiteer of the bailout operation among the foreign banks. As German and British banks were second and third on the bailout list, the coalition of ‘major shareholders’ in favour of a bailout was quickly growing strong enough to overcome resistance by more prudent voices.
Safeguards against political hijacking badly needed
This Greek tragedy is just one of many irresponsible lending cases that the IMF has had to conduct due to political pressure by the ‘major shareholders’, which tend to hijack this international institution with its nearly universal membership of 188countries for their vested economic and geostrategic interests. Earlier examples include IMF support for pro-Western military dictatorships all over the world. A more recent example is the generous IMF lending to belligerent Ukraine, which is clearly beyond any debt sustainability considerations.
Often it is the smaller IMF members that try to prevent the IMF from engaging in irresponsible lending operations. Paulo Batista, for instance, who represents Brazil and other Latin American countries at the IMF argued that the Fund “gave money to save German and French banks, not Greece … [and] put too much of a burden on Greece and not enough of a burden on Greece’s creditors”. Their position is weak, however. On the one hand because the IMF’s “one dollar – one vote” voting-system gives small economies little influence. But also because, under the current system, the IMF always gets its money back. No matter how irresponsible the lending act was in the first place, third parties are still paying the price. So it is all too easy to convince the IMF’s Board to sign off on politically-motivated lending operations that make no sense from an economic point of view.
IMF reform: from political puppet to crisis management tool
The most effective way to prevent irresponsible lending is to make clear to lenders that they won’t see their money back if they lend irresponsibly. This is why Greece should default on the IMF loans and force the IMF to write them off. This would substantially strengthen the more prudent voices in the IMF decision-making processes.
Only introducing a default-risk can turn the IMF into a responsible lending institution. Only bailing-in the IMF in sovereign debt restructurings when these are needed can ensure that IMF resources are not used in future to bail out private creditors. Greece now has the chance to trigger an overdue IMF reform process, or better an accountability process: This is to make the IMF stick to its core business, to refrain from political lending on behalf of ‘major shareholders’, and to provide emergency liquidity to countries in exceptional situations of liquidity squeeze, according to clear and just rules.
Of course, great powers will continue to engage in political and geostrategic lending, even if they can’t continue to instrumentalise the IMF for it. And in any case, someone will need to replenish the IMF for losses incurred through past irresponsible lending operations. However, paraphrasing Yanis Varoufakis, the wider IMF membership might want to stick two fingers up at the ‘major shareholders’ and tell them: you now solve these problems by yourselves.