Friday, December 2, 2011

Can the ECB and IMF save Italy?

The markets have been reacting this morning to the news of a joint ECB and IMF plan to save the eurozone. According to Bloomberg:
A European proposal to channel central bank loans through the International Monetary Fund may deliver as much as 200 billion euros ($270 billion) to fight the debt crisis, two people familiar with the negotiations said.

Here's how the plan would work:
Under the proposal, national central banks would recycle funds through the IMF, potentially to underwrite precautionary lending programs for Italy or Spain, the two countries judged to be the most vulnerable now, the people said.

“We’re looking for a maximum reinforcement with the IMF and the central bank,” Belgian Finance Ministers Didier Reynders told reporters Nov. 30.
I was hopeful that such a plan might work, but recently STRATFOR (subscription required) poured cold water on the idea of an IMF rescue of Italy [emphasis added]:
The IMF normally operates by a tranche-and-reform model. The bailout money is provided in chunks, and each chunk is given only after specific defined and monitored reforms are implemented. This grants the IMF leverage over the state in question to ensure that the agreed-upon reforms are not only crafted, but implemented and stuck with for the duration. Otherwise the ward is cut off, as Belarus has recently been.

Italy’s problem is more than just simply needing cash. Italy isn’t just facing an immediate funding crunch like most IMF wards. It has a preexisting debt stock that’s about 120 percent of GDP — it’s unserviceable, and Italy faces billions in maturing debt that must be refinanced on a monthly, and sometimes even a weekly, basis — 300 billion in refinancing needs in the first half of 2012 alone.

Were the Fund to become involved, it would have to intervene regularly in the bond markets to keep Italian yields down. Such proactive activity is not only not within the existing skill sets of IMF staff, it would deny the Fund the leverage over Rome that it needs to make the reforms stick.
Bruce Krasting, in response to the now denied rumor of the IMF rescue of Italy, wrote that the credit markets might not react well to such an outcome:
In the real world of global finance the reality is that any country that is forced to accept an IMF bailout is also blocked from issuing debt in the public markets. IMF (or other supranational debt) is ALWAYS senior to other indebtedness of the country. That’s just the way it works. When Italy borrows money from the IMF it automatically subordinates the existing creditors. Lenders hate this. They will vote with their feet and take a pass at Italian new debt issuance for a long time to come. Once the process starts, it will not end. There will be a snow ball of other creditors. That's exactly what happened in the 80's when Mexico failed; within a year two dozen other countries were forced to their debt knees. (I had a front row seat.)

There are no doubt many versions of the Grand Plans. If a resolution to the eurozone crisis was easy and relatively painless, it would have been done by now.

The devil is in the details.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

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