Outlook: After 10 years of doing little, other than produce worthy reports and forecasts, the IMF finds itself back in business playing the role for which it was created – to act as lender of last resort to distressed countries. Already, outline packages have been announced for three countries – Iceland, Ukraine and Hungary. It is certain there will be many more emergency calls for international rescue before the crisis plays out.
The financial storm started with banks. Now it is whole countries which are being afflicted by the flight of capital back to perceived safe havens. The run on banks is being replaced by a run on national economies as investors reacquaint themselves with the meaning of risk.
Perhaps oddly, the developing world had, until a month or two back, managed to escape the worst consequences of the credit crunch. These fast-growing economies were said to have decoupled from their Western counterparts and were widely thought to be capable of motoring on, a world unto themselves, as the developed world went to hell in a handcart.
This thinking has turned out to be flawed. Many of these economies were as much living on borrowed money as the rest of us, and even those, such as China, which have been built on export success, are suffering as demand in America and Europe plummets. The definition of an emerging market, it used to be said, was one from which it was impossible to emerge in an emergency. Once again, this old truism is reasserting itself.
Almost everywhere, assets thought risky are being liquidated as loans are called in and credit becomes contracted. One consequence of this process is the unwinding of the so-called "yen carry trade", under which hedge funds and others would borrow cheaply in yen and lend at higher rates in riskier currencies.
As hedge funds retreat from these positions, they sell the risky assets they have bought in emerging and other high-interest rate markets and buy yen to pay back the money they have borrowed. This is causing the yen to appreciate in value, undermining the competitiveness of Japanese industries already hit by the fall-off in export demand. The capital markets seem to have become like a doomsday machine, decimating everything in their path.
The last time the IMF was tapped on the scale now envisaged was during the emerging-markets crisis of the late 1990s. Back then, it was judged to have done a thoroughly bad, even counter-productive job. By imposing austerity measures on countries as a condition of its lending, the IMF greatly added to the economic and social pain that recipient countries suffered.
One country, Malaysia, resisted the IMF's embrace and, to almost universal international condemnation, instead imposed its own controls to halt the flight of capital. To the bewilderment of the IMF's free-market thinkers, it seemed to work much better than the medicine the IMF was imposing on others. There is indeed a perfectly respectable, though not wholly convincing, school of thought which traces the entire credit crunch back to the IMF's actions at that time.
So shocked were the Asian economies by the deep recessions which the IMF's austerity packages helped bring about that they vowed never again to get themselves into a position where they needed to be bailed out with Western money. Instead, they began to save with a vengeance in an attempt to build up unassailable reserves of foreign currency. These capital surpluses had to go somewhere, and in no small measure, they helped to fuel the Western credit binge.
It is to be hoped that, this time around, the IMF has learnt its lesson. Little is yet known except in outline about the conditions being attached to the present round of lending. For the Ukraine, the IMF wants a more flexible exchange rate, more privatisation, and a smaller current account deficit. More ominously, it wants progress towards a balanced budget, this to be achieved by paring down on social spending.
It scarcely needs saying that this latter demand is the exact opposite of what Western nations, including Britain, propose for themselves in their efforts to mitigate the downturn. Yesterday, Gordon Brown, the Prime Minister, vowed to spend his way out of recession, a quite high-risk strategy for an economy with its own currency. To be further adding to public borrowing in the hope of addressing the contraction in private debt may not seem entirely wise.
If there is a fully blown sterling crisis, and he's eventually forced to go cap in hand to the IMF, like Denis Healey in the 1970s, he would be dismayed by the sort of medicine the IMF likes to impose. Tempting though it is for reasons of moral hazard to impose austerity on countries that have borrowed too much, it is not the answer.
If the conditions are too harsh, countries will retreat into capital controls, a form of beggar-thy-neighbour protectionism which would set the cause of globalisation back decades and might tip what already promises to be a severe global recession into an outright slump.Reuse content