Politics imperil IMF in Europe

Thursday 7th January 2010

At the height of the global crash, many governments promised painful belt tightening in return for IMF loans but selling these economic reforms to their electorates has proved tough.

That leaves countries facing standoffs with the fund, which could panic markets and leave governments without the cash for public salaries and sovereign debt payments.

"There were a lot of unrealistic expectations last year about how easily these reform packages would solve crises," said senior research fellow Vanessa Rossi at London-based think tank Chatham House.

"But like any debt renegotiation, it's going to be a difficult, messy process and they are going to get unstuck from time to time. It's going to last several years. You can't ignore the democratic process."

Iceland's economic aid package was thrown into doubt when its president rejected a bill to repay Britain and the Netherlands more than $5bn lost by savers after its banking sector imploded in 2008.

The "Icesave" bill is opposed by 70 percent of Icelanders who complain it leaves them bearing the cost of the banks' mistakes. But rejecting it could imperil EU membership efforts, financial support from fellow Nordic countries and an IMF lifeline. Ratings agencies downgraded Iceland after the move.

Forthcoming elections add complications
Almost all mainland Europe's most exposed economies - notably Ukraine, Latvia, Hungary - hold major elections in 2010, meaning short-term political ends will likely take priority over meeting IMF requirements.

Ukraine's IMF deal has been effectively suspended until after a January 17 presidential election which still may not end months of political paralysis and infighting that have blocked reforms.

Latvia's government pushed stringent budget and pension cuts through parliament only to have them overturned by the constitutional court, sending it back to the negotiating table with lenders.

Parliamentary elections later this year could strain or even fracture its ruling coalition, again endangering potentially both the deal and Latvia's currency peg, the failure of which would spook markets across Europe.

The latest disbursement of Romania's 20 billion euro IMF-led package was delayed last year ahead of elections, but the IMF says it is hopeful payments could resume after the new centrist coalition government 2010 budget bill goes through parliament.

Hungary's IMF deal remains on track, but could be upset by parliamentary polls due in April or May. Centre-right opposition party Fidesz, which wants to renegotiate with the EU and IMF and almost double the budget deficit, is tipped to win.

Country-specific political news has also become an increasing driver of foreign exchange and bond prices as emerging markets shift from the herd-like moves that characterised the initial crisis and then recovery to greater investor discrimination between countries.

"Multi-headed hydra"
If countries do not follow its prescriptions, the IMF will have to decide whether to walk away and risk letting them collapse and potentially default - which could spark a wider market rout - or become less stringent in its demands.

That in itself will likely come down to how the powers that dominate IMF board voting rights choose to play it. Many of these countries, such as Britain, are simultaneously facing demands from ratings agencies to make painful cuts themselves to square their ballooning budget deficits.

Troubled emerging economies will likely feel hard done by and may even band together if richer countries are slow to tackle their own debt but continue to lecture weaker states.

Latvia called the sharp response of some richer nations to Iceland's presidential blocking of the bill "exaggerated".

"Is this reaction due to the fact that Iceland is a small country?" said Latvian Foreign Minister Maris Riekstins. "It is difficult to imagine that similar comments would be heard if for example such a step had been taken by the French president."

And within the EU, Brussels could potentially face a tricky choice over whether to continue to support members if the IMF - usually regarded as the "bad cop" of the relationship - walks away from a shared bailout deal.

"Probably, these support packages will survive but there will be standoffs from time to time," said Rossi at Chatham House. "It will be like a multi-headed hydra. As soon as one head is cut off, trouble will rear up elsewhere."

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