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Oct 30, 2008 | 10:06 GMT

Global Finance: The Course of the Crisis and the IMF's Abilities

The International Monetary Fund (IMF), World Bank and European Union announced Oct. 29 that they have coordinated to give Hungary a bailout loan in the midst of the global financial crisis. The course of the crisis warrants a closer look, as does the IMF's ability to cope with it.
The International Monetary Fund (IMF), World Bank and European Union announced a combined $25.5 billion bailout plan for the former Soviet satellite state — and now EU member — Hungary on Oct. 29. The sheer size of the project warrants not simply a closer look at the crisis as it builds in Europe, but at the rough road map that is shaping up globally — along with the IMF's ability to deal with it. So far, the bulk of the serious damage from the crisis is confined to Europe, largely because it is in this region where the worst of the crisis has hit. Unlike the United States, which faces "only" a liquidity crisis, and Northeast Asia, which is anticipating "only" an export crunch, Europe faces simultaneously a liquidity crisis, an export crunch and a banking crisis. Additionally, states such as Iceland and Hungary were also deeply enmeshed in the yen and Swiss franc carry trade. The result is a perfect storm of factors that are making the weaker states in the vicinity of Europe the most threatened. The fact that Pakistan is among the first states in the IMF queue is testament to how weak Pakistan is, not to how exposed it is. The Oct. 29 combined IMF/EU/World Bank package for Hungary is an attempt to nip the problem in the bud and build a firewall around the European Union's most vulnerable economy. In this we anticipate failure, not because the plan is a bad one, but because the other problems at hand are simply too severe and embedded for one package — no matter how large — in one country to fix. Before this is all over, we would be very surprised if Estonia, Latvia, Lithuania, Croatia, Serbia, Romania and Bulgaria were not all forced to turn to the IMF directly. It is even possible, albeit less likely, that Austria, Sweden, Italy and Greece will require assistance. (click image to enlarge) Just to the east of Europe, the economically nondiversified and perennially unstable state of Ukraine is already facing crisis due to proximity. Here we see geopolitics more than raw economics playing a role in the loan package. Russia is making a sustained bid to purge Western influence from Ukraine — now a key buffer state between Russia and Europe. Russia has in its toolbox a mix of military, energy, political and economic tools to do this. But it has found itself in a bit of a cash crunch. It is not that Russia is poor (far from it) but that the Kremlin realizes it needs its financial resources at home. That is providing the West with an opportunity to use the IMF as a wedge in Ukraine. It is not perhaps the best tool, all things considered — Russia influences most of Ukraine's political factions — but it is all the West has available. Similarly, neighbor Belarus' request for IMF assistance is simply an effort by President Aleksandr Lukashenko to get some maneuvering room in relation to an overpowering Moscow. Lukashenko must be getting desperate as he now is, in order to please the IMF board, promising the same economic reforms that he has flatly rejected for the entirety of his 14-year reign. Regardless, as Europe's problems deepen, we fully expect Ukraine to be joined in the IMF queue by Georgia and Turkey, both of whom are heavily dependent upon trade with Europe (and after its war with Russia in August, we are a little surprised that the IMF is not lending money to Georgia already). We would find it very odd, however, for Russia to seek any IMF assistance. Regardless of how severe liquidity problems become, the government's reserve accounts should allow the Kremlin to hold off the worst. Russia is using the crisis to transform itself back into a state-centered economic system. (And even in the worst-case scenario, the current Russian government would rather be force-fed glass by vengeful Chechens than even consider submitting to the IMF.) The next phase of the crisis will break in East Asia. As we mentioned before, Asia is anticipating an export crunch as recessionary United States and Europe reduce their purchases of Asian exports. Japan's growth likely has already turned negative, and the Chinese are concerned — although not yet terrified — that there will be knock-on effects throughout their entire system as the investment-driven boom of the last 30 years slows and unwinds. Yet both Japan and China boast robust financial reserves that they will use to stave off the worst that this blossoming global recession can offer. Both will have problems — dire problems — and their mitigation efforts may well breed more. For example, STRATFOR fully expects Japanese and Chinese crisis management to inject deflation into the global mix. But neither will be turning to the IMF for help. The two Asian giants are simply too flush with cash, and too large. The same cannot be said for Southeast Asia, however. Here economies are often a hybrid of Northeast Asia's capital-rich financial system and a more Anglo-European capital-scarce system. As a consequence, they will not get hit as hard as the West on the liquidity front, nor as hard as East Asia on the export front — but they will still get hit by both. Therefore, we expect several states in this region to be forced to look for help, and in the order we now present them: Vietnam, where the liquidity problems are hitting hardest in the region; the Philippines and Indonesia, both of which skate the edge even in the best of times; and Thailand, where political instability is complicating any and all attempts to head off economic dislocations. However, there is no guarantee that these states will be seeking help from the IMF. The East Asians have recently agreed to create an $80 billion facility to supplement — or more accurately, intended to replace — the role of the IMF in their region. The details are not merely sketchy but actually still under negotiation, but the idea is to have an Asian system to oversee Asian problems. The facility will probably not be ready for prime time before the crisis smashes into East Asia — the first money is not supposed to be available until June. But for the first time ever, an alternative to the IMF may (and we emphasize "may") be forming. Finally, there is everyone else, and here is where things could get truly dicey. At the end of the day, the Europeans and East Asians have broadly functional and somewhat diversified economies. But countries beyond these regions are much more fragile as a rule. With the exceptions of Brazil, Mexico and South Africa, there are no countries in Latin America and Africa that gain a significant portion of their income from anything but commodity exports, and even those three countries are not exactly models of sound economic management. All — including these three — are extraordinarily dependent upon imported capital and heavily vulnerable to swings in commodity prices. With oil down by more than half and with nickel down by 80 percent in just the past three months, the precipice for all of them is very close. Luckily, the IMF is flush with cash. The global economic boom of the last seven years has allowed most of its wards to pay off their debt in full. Even if every cent of the loans currently under negotiation are used — that's $41.3 billion — the IMF would still have roughly $215 billion left to throw at additional problems. All in all, that's a hefty amount of water for the fire that is building, and political support from the West and Japan for shoving more resources to the IMF is rising by the day. Which, of course, does not necessarily mean that it will be enough. It is a very big world in a very big interconnected crisis, and there is only so much any one organization can do.
Global Finance: The Course of the Crisis and the IMF's Abilities

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