Friday, 24 July 2009

The IMF Should be Taken Seriously but Not Followed Blindly

 24th July 2009
The Malta Independent - Friday Wisdom

The International Monetary Fund (IMF) has two basic functions for member countries, particularly regarding their foreign payments imbalances and other macro-economic disequilibria: crisis treatment and crisis prevention.

Thankfully Malta has never needed to tap the IMF for crisis treatment. For all problems we have in public sector recurrent deficits and accumulating debt levels, the country as a whole is financially well resourced and never had any problems in financing itself internally i.e. the private sector producing enough savings to finance the public sector deficits without need to resort to foreign borrowing on any significant scale. On the contrary we are seeing the local capital markets financing the external ventures of local entrepreneurs and foreign banks using their passporting rights to access the local deposit base without in any way involving themselves in any local lending activity.

Of more relevance to us is IMF’s role in crisis prevention, in particular through annual Missions undertaken in terms of Article IV of IMF’s Articles of Agreement as part of the review of the member country’s economic development. Such reviews are of a consultative nature and the IMF just published its Malta report on 22 June 2009.

This year’s report has particular relevance as it is framed in the context of a harsh international recession and very poor visibility regarding future economic developments. IMF obviously takes this into consideration and concludes that the GDP for 2009 will contract by 2%. It also concludes that recovery in 2010 is doubtful at best as it depends on factors outside our control, mostly foreign demand for our exports of goods and services. The report warns that Malta may experience deterioration in the balance of payments position from an already elevated level.

IMF warns government not to remove the economic stimulus too quickly in 2010 but that fiscal consolidation should be targeted over a medium term period between 2011 – 2014. This goes against the EU imposition to come back within the Euro Maastricht criteria by end 2010.

The IMF further counsels that government should look beyond the impact of the current recession and pursue with vigour structural reform of the economy not just by planning fiscal consolidation but also by strengthening the financial supervisory framework, and pursuing labour and product market reforms.

The Report says that it would be risky for government to be complacent about the need to strengthen financial supervision even though the financial sector has so far withstood the global financial turmoil relatively well. It warns that the financial sector remains vulnerable to further instability especially if the economy drags on in a no-or-low-growth environment for a long time and property prices remain depressed through falling demand and increasing supply of pipeline projects.

It prods regulators to insist on higher provisioning on their loan book and for government to change to international tax practice allowing tax deductibility of such charges at the provisioning stage and not only at the write-off stage. It further advises local banks to take advantage of the current liquidity of the capital markets to strengthen their capital base and be more prudent in dividend distribution policies.

It also expresses doubt whether the local regulatory system is coping well enough with proper supervision of internationally oriented banks under its jurisdiction. The total assets of such banks now are equivalent to five times Malta’s GDP! As such banks are normally funded by inter-group exposures to their parent or related banks it warns the regulators to include such inter-group risk exposures in their stress testing mechanism.

While the IMF is silent about it, I think this need to strengthen our supervisory regime has to reconsider the tri-partite system with regulation responsibilities shared by the Central Bank, the MFSA and ultimately the Ministry of Finance who is always in the background in case banks need forced recapitalisations or wider deposit guarantees. We should follow international developments and debates going on to learn from the experiences of other countries. Many people don’t know what a close shave we had. Just imagine if rather than by HSBC, Mid-Med Bank was bought by RBS or Lloyds Bank or if BoV 25% share still in government's hand was bought by some aggressive Icelandic bank.

In the end IMF makes yet another appeal for government to move away from the mandatory inflation indexation of wages inbuilt in our COLA mechanism. Such recommendations were ignored in the past. We could have afforded to ignore them when the economy was growing. Can we afford to ignore them now that the economy is contracting? Can we make the socially unjust choice of favouring those in employment at the expense of those losing their job through lack of competitiveness caused by COLA legislated wage increases? Or have we all become conservative economists with blind belief in the creative destruction forces of the free market?

Finally IMF make a recommendation which we should boldly refuse. Indeed one wonders how in the present circumstances IMF have not adjusted their reading and are again suggesting privatisation of government’s remaining 25% holding in Bank of Valletta. Bank of Valletta is a significantly important bank for the economy and implicitly enjoys a taxpayers’ guarantee against insolvency. Consequently the taxpayer should not relinquish any of its controls to ensure that it is not placed in the untenable situation of privatising profits and socialising problems and losses. If anything we should be moving in the opposite direction with regards to other significantly important banks who similarly enjoy an implicit taxpayers’ indemnity by the nature of their size and importance.

We should take the IMF views seriously but not follow them blindly.

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