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Thursday, September 23, 1999 Published at 16:02 GMT 17:02 UK

Business: The Economy

The IMF vs. the private sector

Mr Camdessus says they are not encouraging default

The International Monetary Fund (IMF) is on a collision course with private lenders to developing countries.

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  • Usually the friend of the private sector, banks only lend money after a financial crisis once the IMF has agreed its strict loan conditions with a country in crisis.

    In return, the IMF generally insists that countries do not default on their loans to the private sector.

    But now, under fire for its handling of the Asian crisis, its approach is changing. It wants the private sector to share the costs of any future bail-outs.

    But private lenders, like banks and bondholders, say that forcing them to take part in any future rescues would cause private lending to dry up.

    Ecuador test case

    The tiny South American country of Ecuador is being seen as a test case for the new strategy.

    The IMF has agreed a $400m loan to Ecuador, despite the fact that the country has said it cannot pay its debts to private creditors, and suspended payments last month.

    [ image: Falling oil and banana prices hit Ecuadorians hard]
    Falling oil and banana prices hit Ecuadorians hard
    If Ecuador finally defaults on those debts next week, it will be the first time the International Monetary Fund has nodded its approval at a country's default.

    IMF managing director Michel Camdessus has denied they are encouraging the Latin American country to default.

    But this denial is unlikely to convince bankers, who believe that Ecuador is a test case for a new Fund policy, forcing them to renegotiate debts whether they want to or not.

    Its creditors fear that having taken losses when the so-called Brady bonds were first created in 1994, they may lose more money this time.

    Who's taking the blame?

    The IMF came under fire in the global financial crisis for being too quick to help the private sector.

    At the height of the Asian crisis, the IMF led a $57bn loan to South Korea in December 1997, which resulted in full repayment of creditors - although western banks had to extend the maturity of their debts. In total $190bn was paid out in loan bail-outs around the world.

    The justification for the bailout was that they needed to protect the global financial system from the shock of a country defaulting on its debt.

    [ image: The IMF bailed out Korea in 1997]
    The IMF bailed out Korea in 1997
    But many thought that the Asian crisis had its roots in reckless lending by the private sector.

    The use of taxpayers cash to bail out these lenders prompted concern that it would encourage reckless investments, as they had the security blanket of IMF help when the going got tough.

    This "moral hazard" argument has encouraged the IMF to seek ways to involve the private sector in any future rescue package.

    Banks' big losses

    Bankers and officials are united in agreeing that the private sector should pay for its own mistakes.

    But bankers say they already do pay for these mistakes and IMF proposals to "share the burden" are wide of the mark.

    [ image: Wall Street fears fresh demands from the IMF]
    Wall Street fears fresh demands from the IMF
    Equity investors, bondholders and private creditors absorbed losses to the order of $350bn in connection with the crises in Asia and Russia in 1997 and 1998.

    The IMF's problem is that the private sector has lent emerging economies $1.7 trillion over the past ten years. This compares to $350bn from official sources.

    If the private sector decides not to lend this cash - which has boosted growth in developing countries - it is not clear how the shortfall would be made up.

    Or else, private lenders could charge punishing rates of interest, effectively shutting some borrowers out of the market.

    Already, it looks like net lending to by banks and capital markets to emerging economies in 1999 is likely to be near zero, in contrast to a peak of $207bn in 1996.

    One of the loudest proponents of the private sector viewpoint has been the Institute of International Finance, which represents 300 financial institutions.

    In a letter to UK Chancellor Gordon Brown, chairman of the IMF committee, Mr Charles Dallara, managing director of the IIF, said:

    "Actions by officials to encourage and condone a default by Ecuador on its Brady bonds need to be avoided. Such action would add to market concerns and could have negative implications for other borrowers in emerging markets."

    Mr. Dallara and others in the private sector fear that the IMF are manoeuvring to force them to participate in all future rescue packages, when they insist that their involvement should be voluntary.

    Bond action

    So far, the IMF has said it wants private creditors to be involved from early on in any crisis.

    To this end, it suggests setting up creditor councils for discussions between debtors and creditors. Creating a formal contact between borrowers and private creditors may create a forum in which debt can be renegotiated.

    One IMF proposal is to have a collective action clause in bonds. This makes it easier to secure bondholder approval for debt negotiation, as at will allows agreement to be reached with a majority of bondholders.

    This so far has met with scepticism from bankers.

    "Mandatory approaches could send the wrong signal to borrowers and lenders and could label emerging market economies as second-class citizens when some are approaching high standards of creditworthiness," Mr Dallara writes.

    Given the impasse, this issue is likely to be on the IMF's agenda for some time to come.

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