The IMF will offer a new credit line program to allow sovereigns to “break the chain of contagion.”
A new “Precautionary Credit Line” would allow governments with sound financials who have made prior agreements with the IMF to access liquidity of 1000% of a member’s quota for 1-2 years. It would also allow them to access up to 500% of their quota in liquidity on a 6-month basis.
The funds would be offered to sovereigns suffering from “exogenous shocks.”
Markets and the euro spiked immediately on the news.
There are, however, a few big problems with this new proposal.
First, it is unclear whether the IMF actually has access to the amount of funds that would be necessary to bail out a sovereign like Italy.
Italy currently has $2.2 trillion in gross external debt, far exceeding the IMF’s current available resources of about $540 billion. While that would significantly add to the resources the eurozone bailout fund—the European Financial Stability Facility—has available, this still falls short of the estimates for funding necessary to truly stem the crisis. Citi’s Willem Buiter recently suggested about €3 trillion ($4 trillion).
This suggests that the IMF might have to rapidly expand its funding resources to act as an effective bulwark against contagion. But that’s not likely to happen either.
The United States—which provides the largest percentage (17.7%) of IMF funds of any individual country—will also have to approve the plan. Previous bids to expand the IMF’s funding have hit a wall with U.S. opposition, primarily led by the GOP.
This press release from the IMF describes how the new program will work:
IMF Enhances Liquidity and Emergency Lending Windows
Press Release No. 11/424
November 22, 2011The Executive Board of the International Monetary Fund (IMF) approved on November 21 a set of reforms designed to bolster the flexibility and scope of the Fund’s lending toolkit to provide liquidity and emergency assistance more effectively to the Fund’s global membership. These reforms, which have been under preparation for some time, will enable the Fund to respond better to the diverse liquidity needs of members with sound policies and fundamentals, including those affected during periods of heightened economic or market stress—the crisis-bystanders—and to address urgent financing needs arising in a broader range of circumstances than natural disasters and post-conflict situations previously covered.
“I commend the Executive Board for the expeditious response to support the membership in these difficult times,” said IMF Managing Director Christine Lagarde following the Executive Board meeting. “The Fund has been asked to enhance its lending toolkit to help the membership cope with crises. We have acted quickly, and the new tools will enable us to respond more rapidly and effectively for the benefit of the whole membership.
“The reform enhances the Fund’s ability to provide financing for crisis prevention and resolution. This is another step toward creating an effective global financial safety net to deal with increased global interconnectedness,” she added.
The reform replaces the Precautionary Credit Line (PCL) with the more flexible Precautionary and Liquidity Line (PLL), which can be used under broader circumstances, including as insurance against future shocks and as a short-term liquidity window to address the needs of crisis bystanders during times of heightened regional or global stress and break the chains of contagion. The Fund’s current instruments for emergency assistance (Emergency Natural Disaster Assistance and the Emergency Post-Conflict Assistance) are consolidated under the new Rapid Financing Instrument (RFI), which may be used to support a full range of urgent balance of payments needs, including those arising from exogenous shocks.
The Precautionary and Liquidity Line:
- Qualification criteria remain the same as under the PCL. A member needs to be assessed as having sound economic fundamentals and institutional policy frameworks, having a track record of implementing sound policies, and remaining committed to maintaining such policies in the future. A member can seek support when it has either a potential or actual balance of payments need at the time of approval of the arrangement (rather than only a potential need, as was required under the PCL).
- Can be used as a liquidity window allowing six-month arrangements to meet short-term balance of payments needs. Access under a six-month arrangement would not exceed 250 per cent of a member’s quota, which could be augmented to a maximum of 500 per cent in exceptional circumstances where the member faces a balance of payments need that is of a short-term nature and results from exogenous shocks, including from heightened regional or global economic stress conditions.
- Can also be used under a 12 to 24-month arrangement with maximum access upon approval equal to 500 per cent of a member’s quota for the first year and up to 1000 per cent of quota for the second year (the latter of which could also be brought forward to the first year where needed, following a Board review). As under the PCL, arrangements of these durations include Executive Board reviews every six months.
The Rapid Financing Instrument:
- The RFI broadens coverage of urgent balance of payments needs beyond those arising from natural disasters and post-conflict situations, and can also provide a framework for policy support and technical assistance.
- Funds are available immediately to the member in need upon approval with access limited to 50 per cent of the member’s quota annually, and to 100 per cent on a cumulative basis.
- The member needs to outline its policy plans to address its balance of payments difficulties, and the IMF must assess that the member will cooperate in finding solutions for these difficulties.
Review of Flexible Credit Line and PCL:
The Executive Board also reviewed the FCL and PCL and found that that these instruments have bolstered confidence and moderated balance of payments pressures during a period of heightened risk. The rigorous qualification framework has worked well and access decisions have reflected the evolution of risks facing users of these instruments. The review calls for focusing qualification discussions more on qualitative and forward-looking aspects of policies and policy frameworks, and enhancing the transparency of access decisions.