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    Is it necessary to sign an agreement with the IMF?

    Fatih Özatay, PhD14 June 2009 - Okunma Sayısı: 1095


    Current state of affairs in Latvia proposes solid grounds for those who consider not signing an agreement with the IMF and who recommend us not to sign an agreement with the IMF. Foreign currency denominated debts of banking, corporate and household sectors have reached unprecedented levels. Public budget performs badly. Latvian Treasury tried to sell t-bills to finance budget deficit last week; but failed. The auction did not receive sufficient demand. The country implements fixed exchange rate regime; Latvian currency unit lat is pegged to euro and is allowed to float within a very narrow interval (minus-plus 1 percent). These circumstances put lat under the pressure of a significant devaluation. The interesting thing is; Latvia has a stand-by agreement with the IMF. That is, all of these happen despite the presence of an IMF agreement. In short, Latvia is in a condition we are quite familiar with from the pre-2001 crisis period.

    IMF is criticized for not offering Latvia the correct solutions: It is questioned why the economic program implemented in the context of the stand-by agreement was not launched after ensuring depreciation. On Friday news said that both the EU and the IMF will extend additional credits to Latvia. Despite this, it is deemed impossible to safeguard the current exchange rate regime. Most optimistic estimation says that the lat will be allowed to float between plus-minus 15 percent interval rather than plus-minus 10 percent interval. Nonetheless, as we have learned from the crises experiences of Turkey, what is meant to happen will happen also given that there exists a risk perception that lead to receiving no offers at the Treasury auction.

    The moral of the study is that signing an agreement with the IMF is not sufficient to solve the problems. It can also be said that it is not at all a necessity provided that the indispensible prerequisite to solve the problems is met. The said prerequisite is to implement the correct economic program. But if you respond "What is this 'correct' economic program you talk about, you are completely right.

    That correct program is: to provide a fiscal stimulus that will surge domestic demand to limit the intensive contraction we are faced with; when doing this, to prove everyone that the budget balance, which is already highly deteriorated, will not get beyond the control; to construct a framework about the medium term fiscal rule; to make sure that the policies to stimulate domestic demand will are directed to the lowest-income groups; to implement the credit guarantee system that will reduce the risk perception of banking sector; to design systems that will substitute for the tightened foreign credit channels for a certain period of time; to this end, to involve the central bank into the picture and implement a credit guarantee system as well for foreign currency denominated credits.

    You have been reading the details of these measures frequently since October. A part of these series of measures was implemented with the latest measure package. Nonetheless, I have been repeating them for a reason:

    First, the measures already implemented or to be implemented will stimulate domestic demand permanently only if you can make the framework concerning the medium term fiscal discipline credible and reliable. Otherwise, domestic demand will appear like it goes up, the market will rally slightly; but after a while due to the upward trend in the budget deficit risk premiums scale up, confidence in the economy goes down and unemployment rate remains at the high level it once reached. So, does the medium term fiscal discipline promise become credible?

    Second, to attain a higher pace of growth and investment you need to use foreign resources until domestic savings reach a higher level. Can you sustain this alone?

    If your answer to these questions are 'yes', you do not need to sign an agreement with the IMF. But if your answer is 'I doubt it', the solution is not unconditionally relying upon the IMF. You need IMF, but you must not sign an agreement with the IMF under the framework of a standard IMF program. The agreement you will sign must ensure medium term fiscal discipline and simultaneously allow steps that will reduce unemployment that already reached high levels. To repeat; the mentioned steps might convey the impression that fiscal discipline is given up in the short term. On short, we have a quite hard task to accomplish.


    This commentary was published in Radikal daily on 14.06.2009