The question, whether the eurozone firewall is sufficiently big, does not matter any more because at its spring meeting the IMF board agreed a double increase of its lending capacity together with the G20. The participation of countries outside the euro area or even outside the EU was expected ever since the end of last year, when the Union leaders came up with ideas for reforms of the temporary rescue fund, aimed at allowing external funding through various instruments. Alas, this did not catch the interest of foreign investors or governments. This is why at its December meeting the European Council decided that the best way to secure external funding for the rescue operations of the eurozone was through increasing the International Monetary Fund's resources.
The euro area countries and some non-euro area EU members committed to increasing their resources in the Fund to a total amount of 150 bn euros. The big stumbling block was whether the rest of the EU partners in the G20 would agree to increase their contributions to the Fund. On the one hand Britain, USA and Japan, which are going through some serious budgetary constraints and are heavily indebted against the backdrop of quite unconvincing economic growth, warned that they would agree to increase their resources but only after the eurozone showed how much it would participate with, aside from the 150 bn euros IMF resources. The emerging economies, for their part (mainly China, Russia and Brazil), announced their full readiness to help, but in exchange for more representation in the global financial institutions, that would respond to their economic might.
The eurozone came up with a decision in end-March to increase its "firewall" to 800 bn euros, but not the entire amount is disposable. In this number are included the already agreed loans for the rescue operations for Greece, Portugal and Ireland. It was this detail that raised the question whether this amount is sufficient to convince the G20 partners to get in with an increase of their contributions to the IMF. This decision had to be taken at the spring meeting of the board of directors of the IMF, which took place last week. Initially, there were no volunteers, but in the deafening silence and inaction the voice of Japan was heard, which pledged $60 bn. This unleashed the bets and thus the common decision was reached the IMF lending capacity to be doubled - by $430 bn.
In a statement from the joint meeting of the International Monetary and Financial Committee (IMFC) and the financial ministers and central bank governors of the G20 countries, it is pointed out: "There are firm commitments to increase resources made available to the IMF by over $430 billion in addition to the quota increase under the 2010 reform. These resources will be available for the whole membership of the IMF, and not earmarked for any particular region", which is obviously a signal as to the poorer members of the Fund, so to the euro area that no one will be left aside for the sake of saving Europe's monetary union.
These resources will be provided through temporary bilateral loans and note purchase agreements to the IMF’s General Resources Account and should it become necessary to use these resources, adequate risk mitigation features, conditionality, and adequate burden sharing among official creditors would apply. As with the eurozone firewall, the IMF firewall also has some conditionalities. For example, to the $200 bn of the euro area the following countries add the following sums:
- Japan - $60 bn
- South Korea - $15 bn
- Saudi Arabia - $15 bn
- UK - also $15 bn
- Sweden - 10 bn
- Switzerland - at least $10 bn
- Norway - circa 9 bn euros
It is worth mentioning that Poland, which is not a member of the euro area but is very active in calling for its rescue and for avoiding a division of the union to a eurozone and the rest, will participate with 6.27 bn euros. Denmark, which has an opt-out for eurozone accession, will help its main trading partner with 5.3 bn euros. The Czech Republic has also committed 1.5 bn euros but there is a question mark there, because this commitment needs parliamentary approval. Outside Europe, specific sums have also committed Australia (around $7 bn) and Singapore with $4 bn.
What remains unclear is the precise amount of money which China, Russia, Brazil, India and other countries will put on the table. With a question mark are also Indonesia, Malaysia and Thailand, which need national consultations, making it unclear how will the remainder to 430 bn be distributed among the big countries. As far as we can judge from the statement, it is certain that they will participate, because there is a commitment for a continuation of the quota reform of the Fund.
You have probably spotted already the absence of the US. This is so because the country, at this stage, will not participate with an increase of resources, mainly because of the election campaign, during which every cent will be severely criticised. For now, after the withdrawal of one of the main candidates of the Republicans - the social conservative Rick Santorum - the main opponents for the race in November seem to be Mitt Romney and Barack Obama. However, Romney is a big critic of the "pro-European" behaviour of Mr Obama. Romney is even talking about Obama's efforts to work well with the US European partners with disdain. But officially, the reason for the American non-participation is the tough budgetary problems of the country.
In a statement after the end of the meeting, Tim Geithner, US treasury secretary, points out that the leaders in Europe had undertaken important actions in the last weeks and months to strengthen their crisis response, for reducing financial stress and for laying the foundations of greater stability. "The success of the next phase of the crisis response will hinge on Europe’s willingness and ability, together with the European Central Bank (ECB), to apply its tools and processes creatively, flexibly and
aggressively to support countries as they implement reforms and stay ahead of markets". This is an unequivocal hint that Europe is on its own and cannot rely financially on the US. If necessary, the ECB should take the hit.
In Mr Geithner's statement there is another thing, clearly stated, that the IMF can and should play a complementary role in Europe's crisis response. "We welcome the pledges by several International Monetary Fund (IMF) members to provide bilateral loans to the Fund. [...] We also welcome the commitment by the G-20 and the International Monetary and Financial Committee (IMFC) to incorporate additional safeguards to protect IMF resources. The United States continues to support the smooth functioning of international financial markets, including through the central bank swap lines with the ECB". The latter is the only financial commitment the US is ready to make.
After the otherwise good news from Friday night, that the IMF is increasing its firewall two-fold in support of eurozone's efforts, the minister of finance of Singapore and chairman of the IMFC, Tharman Shanmugaratnam, said that, although the moment was very appropriate for this decision and that it was essential, the firewall was not a solution in itself. The real solution to the crisis has nothing to do with firewalls. The firewall is a necessary but insufficient condition for solving the crisis, he added. "The real solution has to do with the fiscal and structural reforms that address the real causes of this crisis, particularly in Europe, but also elsewhere".
So far the main issue was whether the eurozone firewall is big enough to withstand a possible rescue of countries of systemic importance, like Spain, whose borrowing costs of its 10-year bonds soared to the unbearably high level of 6% - a level, at which other countries were forced to ask for a bailout. Of the totally 800 bn euros lending capacity of the eurozone, the real money which it can provide is 500 bn, but given that none of the currently bailout countries does not ask for a second/third loan. Up to the moment, the temporary rescue fund has lent 78 bn euros to Portugal, 85 bn for Ireland and 130 bn for the second bailout of Greece. The simple math shows that the 500 bn would be highly insufficient if Spain has to be saved - only for recapitalisation of its banks the country would need 50 bn euros.
Moreover, Italy should not be excluded from the risk - another country of systemic importance for the eurozone, the borrowing costs of which also soared, in spite of PM Mario Monti's efforts. The question whether the combined firewall of the eurozone and the IMF will withstand still stands, moreover that, as it became clear the $430 bn lending capacity of the IMF is not dedicated to the eurozone only.
What will protect the firewall?
Another important issue on the agenda is the context in which the decision to double the IMF lending capacity was taken in addition to the efforts of the monetary union. As if for a starter to the spring meeting of the IMF board, the Fund published in the beginning of last week its World Economic Outlook (WEO), the part of which concerning Europe to a large extent repeats the expectations of the European Commission in its revised forecast, of which euinside wrote in details. The Fund's expectations are for a gradual return to recovery in 2012-2013, but the possibility the crisis to escalate again remains a major downside risk for Europe's economic growth and for the stability of the financial sector, because the banks hold a significant quantity of government bonds, which, for its part, has led to soaring borrowing costs.
The expectations are Europe to reach economic growth of a quarter of percent in 2012, which is weaker than last year. It is important to note, however, that there are significant variations among the member states. For example, the forecast for the eurozone is the gross domestic product to contract by half percent in the first half of 2012 and then to start recovering. Recession is expected to be shallow and short-lived in many economies but in the bailed out countries, like Greece and Portugal, as well as Spain and Italy, it will be deeper and recovery is expected only in 2013.
In the more advanced countries in Europe recovery is expected this year, mainly because of improved global demand and strengthening prospects in the euro area core. The Fund thinks that appropriate fiscal consolidation should be a priority with a focus on the word "appropriate". This means that the countries that have good economic perspectives can mitigate the austerity measures in order to avoid suffocating growth. In many other countries, though, the belt-tightening must be strong.
One of the biggest risks, outlined in the forecast, is related to the capitalisation of the European banks. This is an issue which the Fund has been raising for a long time. In order to limit damaging deleveraging, banks need to raise capital levels, as was agreed with the new bank rules Basel III, which are still not applied everywhere. The Fund allows for direct government support in some cases, where it might be needed, as such a case, though not mentioned explicitly, could be Spain. This is why the Fund recommends the creation of a special facility for the eurozone, a pan-euro-area facility with the capacity to take direct stakes in banks, including in countries with little fiscal room to do so themselves.
Another idea that the Fund offers is the eurozone rescue funds (the temporary and the permanent) to be flexible enough to buy directly stakes, thus increasing the capital levels of the banks, where necessary. At this stage, the temporary fund is allowed to directly lend to banks but the permanent European Stability Mechanism (ESM) cannot. Quite recently, Irish PM Enda Kenny proposed changes to the ESM to allow the fund to help banks directly.
One of the main conclusions from the spring meeting of the IMF is that the eurozone is getting a huge and it seems a last chance to put its house in order. The main recommendations are given, that include much deeper integration than the current political trends in Europe could allow. For their contribution to saving the euro area, the growing ever more influential emerging economies will get a larger share of global power. The US is trying to emancipate itself from its ally, Europe, that weighed like a mill stone on its shoulders, while trying to create something the future of which is more and more vague. Against this background, another government is falling in Europe, another good election performance of nationalist and euro-disintegrational parties and another lack of vision of the European institutions. In other words, the main question is not whether the IMF/eurozone firewall will be sufficient but whether Europe will squander its last chance to remain intact.