Sunday, October 4, 2009

Daily Hurriyet Column: Lorenzo’s Oil heats EMs

The unedited version of my second column covering The Meetings is below; you can read the final version at the Daily News web site. And yes, I think I reached the apex of the cheesy titles with this one, but Lorenzo, to whom I showed the title to make sure he wouldn't be offended, liked it, so all is well:)

Coming to more serious stuff, Lorenzo told me more on the Latvian FX issue after the seminar, but I am not getting it here because as they say, what happens in the Meetings stays at the Meetings. We hope to do an interview with him tomorrow; if that materializes, I'll refer you to that interview.

Coinciding with the latest stint in the tragicomic efforts of the government to create a financial center out of Istanbul, one of the seminars in the meetings likely to have a lasting influence did not get the attention it deserved.

A Brave New Fund

One of the beneficiaries of the crisis has been the International Monetary Fund. Its existence questioned before the crisis, it has since then seen its influence grow virtually by the day. Recently, it was asked to help the G-20 with its analysis of how national or regional policy frameworks fit together at the Pittsburgh Summit. As noble as these and other initiatives may be, without some power to enforce its writ and, if necessary, wrath, I am not sure how this and other similar mechanisms will work out.

In the short run, the Fund will still be evaluated on its usual area of fame, how it helps out crisis-stricken countries. The Fund has been zealous in this area as well: While getting its resources tripled following the April G-20 Summit in London, it conducted a major overhaul of its lending policies. Of course, we would need to know if deed has indeed followed word, and a new paper by the Emerging Markets Division of the Strategy and Review Department, under the supervision of Lorenzo Giorgianni, who presented the paper at yesterday’s seminar, does exactly that.

Aptly named Review of Recent Crisis Programs, the paper evaluates the most recent 15 Stand-By Arrangements, in comparison to non-crisis countries in the current episode and past crises in terms of program design, fiscal policy, monetary & exchange rate policy, financial sector policies and crisis recovery.

The results are striking: Program countries have usually fared much better than crisis-stricken countries during previous episodes of turmoil and not much worse than non-program countries. For example, output losses have been comparable to non-program countries, once you account for differences in initial conditions, and external balance adjustments more modest relative to the past. Perhaps most importantly, sharp moves in interest & exchange rates and banking crises, ghosts of crises past, have been largely avoided. What has worked the magic?

For one thing, IMF support has been rapid and frontloaded, as well as being directed to the funding needs of the private and public sectors, rather than simply deposited in Central Bank coffers as in the past. Program ownership has been ensured by working with the full range of exchange rate regimes, enacting capital controls where necessary and working with institutional constraints such as the EU. Conditionality has been more focused than in the past, with the Fund opting for fewer conditions essential to the success of a program rather than a comprehensive laundry list.

With the adequate financing pouring in, there has been much more room for an expansionary policy stance, and the Fund has been glad to oblige. It used to be Mostly Fiscal, but fiscal policy has been more accommodative than in the past, keeping in mind medium-term sustainability. In fact, there is not much of a difference in fiscal stance between program and non-program countries once controlling for initial conditions. The same has been true of monetary policy, with program countries easing monetary policy, albeit to a lesser degree than non-program countries.

What about Latvia?

One striking feature of the report is that Latvia and Iceland emerge as exceptions to the rule, glitches in an otherwise-perfect track record. Iceland’s case is special, as it was hit with a major banking crisis before the global turmoil began. But the woes of Latvia beg for further scrutiny, and there are hints sprinkled throughout the report.

When you add everything up, it seems that Latvia’s plight had much to do with its pegged exchange rate, as its room to maneuver was severely limited. With prices (the exchange rate) unable to adjust, it was the quantities (GDP) that took the burden of adjustment. The report summarizes the immediate economic costs of abandoning the peg, referring to country reports for the benefits. I am not sure costs would have outweighed benefits if only economic costs were considered.

Latvia’s troubles bring to mind important questions: Is the EU the right economic anchor? Where does the jurisdiction of the IMF end and that of the EU start? The euro area has been deemed a success story, as the sovereign spreads of the lax Mediterraneans have been shielded by the stoic brother up north. Look further east, and the Latvians are sighing with envy.

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