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Friday, 23 October 2015

The Troika – Past and Future? A view from Washington

Alexandra Zeitz, St. Antony’s College, Oxford

Speaker: Russell Kincaid, PEFM Associate, Former senior IMF official
Chair: David Vines, Balliol College, Oxford

In late 2009, when the extent of Greece’s debt problems first became clear, there were no established rules for coordination between the IMF and the Eurozone institutions. While special mechanisms for surveillance of the Eurozone existed, there were no guidelines for lending to countries within the currency area, an event that was considered “extremely unlikely”.

And yet, over the course of the Eurozone crisis, four countries borrowed from the IMF (Cyprus, Greece, Ireland and Portugal). And with Greece’s future still uncertain, the Fund looks set to play a continued role in the Eurozone for the foreseeable future. In October 2015, Russell Kincaid, a former senior IMF official and current PEFM Associate, gave a rich and novel account of the cooperation and coordination among those three institutions that were at the forefront of stemming the crisis from 2009 onwards: the Troika.

Kincaid suggested that the groundwork for coordination among the IMF, the European Commission and the European Central Bank was laid during earlier programs in Hungary (2008), Latvia (2009) and Romania (2009). In these earlier programs, patterns appeared that would also characterize the later dynamics between the later institutions. While Kincaid stressed that the overall working relationship was smooth, the Latvian case does illustrate the disagreements that arose from the institution’s diverging objectives. The IMF concentrated its attention on the Latvian exchange rate, which it saw as “fundamentally misaligned”. The Fund saw the peg of the Latvian lats to the euro as unsustainable.

By contrast, the European Commission was willing to support Latvia’s exchange rate policy (a politically potent policy as Latvia was on its way to adopting the euro). Instead, the Commission was far more concerned with fiscal adjustment and made its lending conditional on sharp fiscal retrenchment, of which the IMF disapproved. In the end, the IMF made a smaller contribution to the Latvian program due to its disagreements with European conditions.

This experience proved telling for the later, much more intense cooperation among the Commission, the Fund and the ECB in the programs with Eurozone members. The interests of the institutions did not always align. Kincaid stressed that for joint lending to be successful, institutions have to apply the same conditions: a country can implement only one set of policies at a time.

The IMF’s priorities in a country program, according to Kincaid, are those policies that will restore stability and growth to that particular economy. The Commission, by contrast, representing the interests of the Eurogroup, sees policies in light of their possible precedent and consequences for the stability of the currency area as a whole. Yet what is best for an individual country may set an uncomfortable precedent or risk spillover to the rest of the Eurozone.

These diverging priorities raise the question: who was leading among the institutions? Kincaid claimed that as much as the press might describe the IMF as the junior partner in the relationship with the European institutions, staff within all three Troika bodies did not consider the IMF a lower-ranking partner.

In fact, the IMF enjoyed an important form of leverage in the negotiations. Of course, the European institutions had the most tangible bargaining chip, Eurozone membership. However, the IMF provided an important vote of credibility for the programs, a position that they could use to their negotiating advantage. The German Bundestag and other European parliaments used IMF approval as a measure of the soundness of assistance programs. Threatening not to participate in programs could therefore be a meaningful source of leverage, argues Kincaid.

Kincaid did not comment on what impact of the Fund’s participation in European assistance programs has been for its own credibility, or for its reputation as a reliable assessor of policies. Often this is the most important thing that the IMF contributes to agreements with countries facing crises, as its stamp of approval calms the anxiety of panicking markets. But in the European cases, the Fund was forced to compromise with European institutions who were often driven by political concerns about contagion and precedent, as in the failure to “burn the bondholders” in Ireland and bail-in senior bondholders.

The inclusion of the European Central Bank as a co-equal partner in the Troika often raised eyebrows. Technically the ECB was not a lender to the countries receiving assistance from the Commission and the IMF, and it was not formally imposing conditions. Indirectly, however, the ECB is often a major creditor, having purchased government debt in secondary markets and lent directly to the banking sector.

Conventionally in IMF programs, the central bank sits with a country’s finance ministry on one side of the negotiating table, facing the IMF. In the case of the Troika, the ECB was on the same side as the Fund and the Commission, helping to set conditions rather than being asked to comply with them. Some commentators have pointed out that this may have given undue weight to the interests of the currency area in the design of the programs. Kincaid did not take a position on this question of on which side the ECB should be placed.

He did insist however, that the ECB must be involved in the programs as a participant and not, as the European Parliament has requested, merely as a “silent observer”. Kincaid stressed that with the emergence of the Singe Supervisory Mechanism in which the ECB has become the sole supervisor of European banks, the ECB will continue to be central to any negotiations. The macroprudential tools available to the ECB also make it a potentially important partner in supporting any policies agreed.

Contemplating the long-term future of the IMF in Europe, Kincaid argued that the Fund will remain important as a “trusted advisor”. This is especially the case, he suggested, for bringing a global perspective to Europe. What happens for the Eurozone matters for the global economy, and the IMF may be able to point out the global implications of low growth and low inflation and advise alternative courses of action. Whether Europe will listen is another question.

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