This is a joint post with Amar Bhattacharya of the G-24
It is more obvious every day that Europe cannot save itself. A meltdown in Europe would not only hurt Europe and the United States. It would also deal a blow to people’s livelihoods everywhere, with high costs especially to people living close to the margin in the developing world. The blow would hurt right away as trade, remittances and commodity prices collapse. And it would continue to hurt over the next two years and more, requiring a long slow slog of the United States and Europe out of stagnation, recession or worse, and knock-on effects in China, Brazil and other big emerging markets that until recently were powering global demand.
At their meeting in Cannes, the G-20 heads of state committed to ensuring the IMF would have the resources “to play its systemic role to the benefit of its whole membership” in the event of a crisis, and instructed their finance ministers to figure out how “by their next meeting” in February.
But the world cannot wait until February. The IMF needs sufficient upfront financing now if Europe is to be rescued. That is necessary – and unprecedented in terms of potential scale and focus. Moreover it is not sufficient. There is a second challenge: to deal with the effects of a European crisis on the four billion people in over 100 countries living on less than $4 a day. At best a quickly resolved crisis will slow growth everywhere. At worst, the crisis could precipitate a worldwide depression.
Last week on this site Arvind Subramanian called on Christine Lagarde to begin amassing additional resources at the IMF. How much is needed now, and over the next twelve months, at the IMF and the multilateral banks to 1) save Europe from itself while 2) filling a war chest that will insulate the rest of the world from a prolonged period of stagnation in Europe and the United States?
Compared to 2008-10 this time is really different. When the G-20 met in London in March 2009, the U.S. situation was already calmed (leading to a slowdown in growth but not even a recession let alone a depression). The heads of state agreed on a coordinated stimulus to lock in recovery. To protect the rest of the world they committed to ensuring $1.1 trillion would be available, by dramatically increasing resources at the IMF and “sweating” the equity capital at the multilateral development banks (for more on that then, go here). Increased access to multilateral resources, including for trade finance, shored up market confidence in developing countries – and helped poor countries pay teachers and maintain child nutrition and other social insurance programs when growth rates fell. The emerging markets and most developing countries returned to growth relatively quickly -- and for the last four years, it is their growth that has kept the global economy on an even keel.
This time the high-income economies (who still account for more than half of global GDP but only a quarter of global growth) are crippled by higher debt and deficits than in 2008. Europe is politically hamstrung. What was a financially manageable problem in Greece has blown up into an unmanageable problem, politically and financially, in Italy. After Lehman, the United States had the Federal Reserve ready to respond, and a political system that, with all its faults, led to the TARP and the 2009 $800 billion stimulus bill. Europe has neither a European Central Bank that can act like the Fed nor the fiscal will and political wherewithal for a big enough TARP. Approval of anything by the 17 Euro sovereigns is even more difficult than winning agreement from a fractious U.S. Congress. It doesn’t help that the deep-seated competitiveness problems in Greece and Italy are now on full display.
How much money is needed and where might it come from? Here’s a rundown of our estimates:
First Europe. Leaving the banks’ short-term liquidity problem to the beneficence of the ECB (and the U.S. Fed given European banks’ dollar liabilities), there remains the problem of the sovereigns. In the next 15 months, Italy and the other high-debt PIGS (Portugal, Ireland, Greece and Spain) need to refinance about $600 billion of their sovereign debt. To stop the contagion at Italy’s door now, with as much as half of the $600 billion (the Euro $440 billion) European Financial Stability Facility war chest already committed, implies at least $300 billion has to come from somewhere. It’s too late for the Europeans to do it themselves, even if they could. The IMF now needs to be the senior partner, rekindling its old strengths and glory, bringing the combination of serious money and the credibility of its reform –based programs that the markets want. The money part of that recipe amounts in our view to $250 billion right now, and another $250 billion that could be available to commit over the next 12 months.
Second the world’s poorest, low-income countries – mostly in Africa – that in bad times rely almost entirely on grants and soft loans from the multilaterals. Whether Europe collapses or lurches along for another 12 months or joins the United States in a prolonged period of deleveraging and stagnation, the low-income countries will be hit. They need access to at least 2 percent of their GDP to provide short-term trade financing in the event of a credit panic and to help them offset the costs of even a temporary downturn in remittances and trade –including revenue losses so they can pay teachers and health workers and maintain nutrition and other poverty programs.
A new IMF paper says they could need additional financing of as much as $27 billion in 2012 in the event of a sharp downturn in the global economy (over and above current aid transfers of about $120 billion). That is in fact about 2 percent of their current GDP of about $1.5 trillion. The IMF could probably provide $5 billion of that additional money – enough for any short term infusion in the case of a market panic, including by using some of its profits on recent gold sales. That could be critical if the traditional donors reduce transfers in 2012 because of their domestic budget pressures. The MDBs frontloaded their grants and lending to these countries in 2009 and 2010; their soft-money coffers now await approval in the United States and other legislatures of a critical new round of cash.
The bottom line: the critical resources for the poorest countries are probably there, but it’s hard to be optimistic they will be forthcoming. The amount of money is tiny compared to the billions Europe needs. But the traditional donors may not maintain current aid spending, and the MDBs would have to take a risk they dislike – a new round of frontloading that they fear mortgages their future.
Third, the middle-income countries –Argentina, Colombia, Egypt, Ethiopia, India, Indonesia, Mexico, Pakistan, Peru, Nigeria, South Africa and more – remain vulnerable to global systemic shock and are home to millions of the world’s extreme poor ($1.25 per day). Excluding the BRICs, these countries make up more than 25 percent of the developing world population and more than 10 percent of world GDP. To build market confidence in those countries after 2008, the IMF created a flexible credit line that can be accessed quickly for countries with adequate macroeconomic policies; it is now getting ready to approve a simultaneous precautionary credit line to help countries hit by systemic shocks. Eligible countries for these instruments could need access to about $250 billion from the IMF in the event of a serious collapse in Europe. (That is about 2 percent of the GDP of all the middle-income economies, including China and India, of about $13 trillion).
Where will the money come from? The big and quick money has to come from the IMF. For Europe and the emerging markets our numbers above imply the IMF needs about $750 billion. What the IMF has on hand now is closer to $300 billion at most – because among other things of its recent commitments to Ireland, Greece and Portugal. For the worst case scenario – helping to rescue Europe and protecting the rest of the world from a slow-growth aftermath, it needs another $450 billion of usable resources. It also has income from its recent highly profitable sales of gold that could add to its war chest – but that income is also its best source of quickly available funds to make the grants and low-interest loans to its poorest countries members that have the highest bank for the buck in terms of minimizing the sharp and often irreversible increases in poverty of past crises.
What about the multilateral banks? In 2009-10 the IMF World Bank made loans to the middle-income countries of about $70 billion, almost $25 billion more than the pre-2009 level; the Asian, African and Inter-American Development Banks similarly upped their lending. Now all four big banks await their members’ approvals of new capital infusions, without which they cannot return to their high levels of 2009-2010 without mortgaging the post-2013 period. For the World Bank the agreed recapitalization is the first in over two decades; for the Inter-American Bank and Asian banks the first in more than 15 years. While they await new capital, they can increase their lending – adding perhaps among them all $50 billion a year in 2012 and 2013. Even that will require a kind of risk-taking (e.g. a modest increase in their leverage, now close to one) that their traditionally minded members will find awkward; and greatly increased flexibility on the part of their bureaucracies.
We have not dealt here with what we will call a comprehensive financing package for the short and the medium term – beyond 2012. We plan to do that in a forthcoming note. A global recession in 2012 would not be likely to yield to a return to healthy growth in 2013 or even 2014. On the contrary, the signs are already emerging that the devotion to deleveraging in Europe and the United States is beginning to take its toll on demand-driven growth in the major emerging markets. Nor would recession-inspired increases in financing for the developing world address the more serious long-term capital needs of these countries.
Moreover even if the current recapitalizations come fast enough to build resilience in the short term, will they be enough to support the huge infrastructure demands of the developing world in the next decade – in clean energy alone estimated at more than $48 billion a year (see more here)? It is those investments in China, India, Brazil, and across Africa that are critical if the world is to find a low-enough carbon growth path to avoid a slowly unfolding but increasingly likely climate catastrophe.
In short, the money is not there now – though the amounts needed are in fact manageable. In a global economy of $40 trillion, $500 billion is available. As Arvind argued last week, it is time for the leadership of our international financial institutions to make a deal with China and the other emerging markets. It is not just Christine Lagarde but Robert Zoellick of the World Bank (and his counterparts at the regional banks) who should be fussing and corralling and persuading and convening. As part of this effort to avoid a global financial crisis, they should be making the deals on changes in influence, votes, and leadership that the development community has long advocated (see here and here). Are they?