A bailout by any other name...
If at first you don't succeed, try, try again.
Undeterred by the mixed results of recent multilateral financial bailouts (ranging from reasonable success in Mexico to unqualified disaster in Russia), the International Monetary Fund recently proposed yet another financing mechanism - Contingent Credit Lines (CCLs) - in the hope of avoiding future economic crises.
The CCL contains two key "improvements" that will purportedly help avoid the pitfalls of prior bailout packages. First, in language unfortunately reminiscent of credit-card applications, the IMF will grant CCLs to countries that "pre-qualify" under strict new criteria. Second, the credit lines will be preventive - disbursed preemptively to economies not yet experiencing a balance of payments crisis, but that may be susceptible to one.
Unfortunately, an institutionalized financing system such as the CCL will likely perform no better than its predecessor ad hoc bailouts. The new criteria are unrealistic and in some cases counterproductive, while the preemptive approach may unwittingly spark the very crises the IMF is seeking to contain.
On the surface, the criteria appear reasonable. Only countries already implementing sound economic policies will be eligible. And the country's economic performance must have been "assessed positively" in the latest IMF review. Eligible economies must also be making progress in "adhering to relevant internationally accepted standards" of financial practices, and must have "constructive relations" with private creditors.
It isn't clear, however, that the IMF can always accurately identify those economies pursuing "sound" policies or even correctly assess short-term economic prospects.
In October 1994, the IMF' World Economic Outlook asserted that Mexico had adequately "coped with exchange rate pressures" and GDP was "projected to increase in 1995." Just two months later, Mexico devalued its currency, and GDP contracted by more than 6 percent. Similarly, in March of 1997 IMF chief Michel Camdessus praised the Asian region as "open, dynamic economies that continue to amaze the world with their rapid economic growth and development." Within three months, the Asian crisis broke out, plunging the region into economic depression.
The IMF seal of approval is hardly reassuring. Moreover, uniform international standards of financial practice may not prove best for all emerging markets.
For example, the Bank for International Settlements core principles of banking supervision - which the IMF explicitly supports - call for a minimum international standard of 8 percent for bank capital adequacy requirements. However, many analysts believe that financial institutions in emerging economies need a higher capital requirement due to increased market risks. Argentina, for example, has set its bank capital requirement at 11.5 percent. If the IMF makes a multibillion-dollar credit line to Argentina contingent on adherence to (weaker) international standards, it could implicitly encourage domestic authorities to soften, not strengthen, the policy regime.
Perhaps most important, the logic supporting the CCL's preemptive approach is faulty. If only economies that aren't currently in a crisis are eligible for financing, then applying for such funds is tantamount to an admission of impending financial distress. CCL funding would be a red flag to spur, not prevent, a crisis. Under this framework, few governments would want to access the CCL until they are already experiencing severe financial difficulties, at which point they would no longer eligible for the financing.
Ultimately, it's unlikely an institutionalized bailout mechanism would be able to control market forces. At best, its effect would be neutral, in that few governments would choose to use it. At worst, it would temporarily insulate vulnerable economies from the reform-inducing discipline of the free market, rendering the eventual crisis only more damaging.
*Carlos Lozada is an economic analyst in Atlanta.