IMF may need to 'print money' as crisis spreads

By Ambrose Evans-Pritchard
The Telegraph, London
Monday, October 27, 2008

http://www.telegraph.co.uk/finance/comment/ambroseevans_pritchard/326966...

The International Monetary Fund may soon lack the money to bail out an ever-growing list of countries crumbling across Eastern Europe, Latin America, Africa, and parts of Asia, raising concerns that it will have to tap taxpayers in Western countries for a capital infusion or resort to the nuclear option of printing its own money.

The fund is already close to committing a quarter of its $200 billion (L130 billion) reserve chest, with a loans to Iceland ($2 billion), Ukraine ($16.5 billion), and talks under way with Pakistan ($14.5 billion) and Hungary ($10 billion) as well as Belarus and Serbia.

Neil Schering, emerging market strategist at Capital Economics, said the IMF's work in the great arc of countries from the Baltic states to Turkey is only just beginning.

"When you tot up the countries across the region with external funding needs, you get to $500 billion or $600 billion very quickly, and that blows the IMF out of the water. The fund may soon have to start calling on the West for additional funds," he said.

Brad Setser, an expert on capital flows at the Council for Foreign Relations, said Russia, Mexico, Brazil, and India have together spent $75 billion of their reserves defending their currencies this month, and South Korea is grappling with a serious banking crisis.

"Right now the IMF is too small to meet the foreign currency liquidity needs of the larger emerging economies. We're in a dangerous situation and there is the risk of extreme moves in the markets, as we have seen with the Brazilian real. I hope policy-makers understand how serious this is," he said.

The IMF, led by Dominique Strauss-Kahn, has the power to raise money on the capital markets by issuing 'AAA' bonds under its own name. It has never resorted to this option, preferring to tap members states for deposits.

The nuclear option is to print money by issuing Special Drawing Rights, in effect acting as if it were the world's central bank. This was done briefly after the fall of the Soviet Union but has never been used as systematic tool of policy to head off a global financial crisis.

"The IMF can in theory create liquidity like a central bank," said an informed source. "There are a lot of ideas kicking around."

For now, Eastern Europe is the epicentre of the crisis. Lars Christensen, a strategist at Danske Bank, said the lighting speed and size of Ukraine's bailout suggest the IMF is worried about the geo-strategic risk in the Black Sea region, as well as the imminent risk a financial pandemic. "The IMF clearly fears a domino effect in Eastern Europe, where a collapse in one country automatically leads to a collapse in another," he said.

Mr Christensen said investor sentiment toward the region has reached the point of revulsion. The Budapest bourse plunged 10 percent yesterday despite the proximity of an IMF deal Meanwhile, Standard & Poor's issued a blitz of fresh warnings, downgrading Romania's debt to junk status, and axing the ratings of Poland, Latvia, Lithuania, and Croatia.

The agency said Romania was "vulnerable to a sudden-stop scenario where capital inflows dry up or even reverse," leaving the country unable to cover a current account deficit of 14 percent of GDP.

Romania's central bank has taken drastic steps to defend the leu, squeezing liquidity so violently that overnight rates shot up to 900 percent. But there are growing doubts whether this sort of shock therapy can obscure the fact that economic booms are now turning to bust across the region.

Merrill Lynch has advised to clients to take "short" positions against the leu. "The fundamental picture suggests that Romania may face a currency crisis in the near term, similar to what Hungary has gone through over the last week," it said. The bank also warned that Turkey and the Philippines are vulnerable.

Hungary was forced to raise interest rates last week by 3 percentage points to 11.5 percent to defend its currency peg in Europe's Exchange Rate Mechanism. Even Denmark has had to tighten by a half point, raising fears that every country on the fringes of the eurozone will have resort to a deflationary squeeze.

The root problem is that Eastern Europe and Russia have together borrowed $1,600 billion from foreign banks in euros and dollars to fund their catch-up growth spurt over the last five years, according to data from the Bank for International Settlements. These loans are now coming due at an alarming pace. Even rock-solid companies are having trouble rolling over debts.

Mr Schering said Turkey was likely to join the queue for bailouts very soon. "Their external liabilities have reached $186 billion, and a lot of this is short-term debt that has to be rolled over in coming months," he said.

Turkey's prime minister Recep Tayyip Erdogan said over the weekend that his country would not "darken its future by bowing to the wishes of the IMF," but it is unclear how long Ankara can maintain its defiant stand as capital flight drains reserves.

Pakistan -- now facing imminent bankruptcy -- has also raised political hackles, balking at IMF demands for deep cuts in military spending as a condition for a standby loan. Diplomats say it is unlikely that the West will let the nuclear-armed Islamic state slip into chaos.

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