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The IMF and eastern Europe

Into the breach
Oct 27th 2008
From Economist.com


The IMF helps eastern Europe’s two most vulnerable economies. Will it stop the rot?

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SIX months ago it all looked so different. The countries of eastern Europe were the poster-children of economic reform: having privatised, deregulated and stabilised after the collapse of communism, they seemed on a clear path leading to convergence with the richer half of the continent.

That picture was always a bit optimistic. Now it looks wildly out of date. A noxious cocktail of public foreign debt, heavy private borrowing in foreign currencies, big current-account deficits, lax public-spending controls and wobbly governments (different in each country but all potentially lethal in conditions of collapsing investor confidence) has sent policymakers scurrying to talk to the ultimate financial backstop: the International Monetary Fund.

This weekend, the IMF reached broad agreement on big bail-out packages for both Hungary and Ukraine. On October 22nd Hungary had raised its interest rate to an economy-crunching 11.5% (up from 8.5%) in the hope of halting steep falls in its currency, the forint. Fortuitously, the Hungarian markets then closed for a two-day break, followed by the weekend.

Over the weekend, as the hours ticked closer to the moment of the Hungarian markets’ reopening, the IMF was scrambling to gain agreement from the European Union, countries such as Germany, Austria and Italy, and other international lenders such as the World Bank, to support the bail-out. That task was hindered by Europe’s leaders' absence at an international EU-China summit in Beijing.



The rule in such panicky conditions is “the more the better”. The bail-out needs to be big enough to reassure lenders that they can roll over existing Hungarian debt. If not, the economy faces meltdown. Late on Sunday, time ran out to present the plan in full. Instead, the IMF issued a statement endorsing the Hungarian authorities’ planned stabilisation measures. “The policies Hungary envisages justify an exceptional level of access to Fund resources,” said the IMF’s managing director, Dominique Strauss-Kahn. On Monday, the European Bank for Reconstruction and Development issued a statement supporting the IMF plan. It could play an important role in recapitalising Hungary’s banks. Earlier this month the European Central Bank took the extraordinary step of issuing a €5 billion ($6.7 billion) credit line to Hungary’s central bank (Hungary is not in the euro zone). More may be in store.

The central feature of the plan is reform of public finances. But the room for manoeuvre is limited. Hungary’s growth is already feeble—likely to be only 2% this year. The government had already reined in spending and lifted taxes, and became highly unpopular as a result. More of the same risks plunging the country into recession. But without tough measures, international lenders may just walk away.

The early verdict from the market was sceptical: shares plunged by a further 10% when the market opened on Monday. That adds urgency to the need to finalise the deal. Those involved hope to have it ready by Wednesday. Politics is playing a big role. America sees Hungary as a strictly European problem, but has been pushing the IMF to provide more generous and immediate help for the other stricken economy, Ukraine.

Riven by political disputes, Ukraine is vulnerable in a crisis to its cash-rich neighbour, Russia. The Fund said on Sunday that it had agreed a $16.5 billion two-year loan to Ukraine, although it is unclear how the country, which lacks a government and is facing its third parliamentary election in three years, is in any position to adopt the tough economic policies needed to restore confidence.

A statement by the Fund said that it was moving “expeditiously” and that the programme would focus on “essential upfront measures”. It did not stipulate what these might be. A joint central bank and finance ministry statement mentioned a balanced budget and legislative moves to support the banking system. Parliament, normally fractious and deadlocked, is due to meet on Tuesday. Outsiders will be watching closely.