Broda, C., and E. Levy-Yeyati, 2003, “Dollarization and the Lender of Last Resort,” in Dollarization: Debates and Policy Alternatives, ed. by E. Levy-Yeyati, and F. Sturzenegger, (Cambridge, Massachusetts: MIT Press).
Caballero, R., and S. Panageas, 2003, “Hedging Sudden Stops and Precautionary Recessions: A Quantitative Framework,” NBER Working Paper No. 9778 (Cambridge, Massachusetts: National Bureau of Economic Research).
Caballero, R., and S. Panageas, 2004, “Contingent Reserves Management: An Applied Framework,” NBER Working Paper No. 10786 (Cambridge, Massachusetts: National Bureau of Economic Research).
Cohen, D. and Portes, R., 2004, “Towards a Lender of First Resort,” CEPR Discussion Paper No. 4615 (London: Centre for Economic Policy Research).
Cole, H, and T. Kehoe, 1996, “A Self-fulfilling model of Mexico’s 1994-95 Debt Crisis,” Journal of International Economics, Vol. 41, pp. 309-30.
Cordella, T., and E. Levy Yeyati, 2003, “Bank Bailouts: Moral Hazard vs. Value Effect,” Journal of Financial Intermediation, Vol. 12, pp. 300-30.
Cordella, T., and E. Levy Yeyati, 2004, “Country Insurance,” IMF Working Paper No. 04/148 (Washington: International Monetary Fund).
Council on Foreign Relations Task Force, 1999, Safeguarding Prosperity in a Global Financial System: The Future International Financial Architecture (Washington: Institute for International Economics.
Diamond, D., and P. Dybvig, 1983. “Bank Runs, Deposit Insurance, and Liquidity,” Journal of Political Economy, Vol 3 No. 91, pp. 401-19.
Fischer, S., 1999, “On the Need for an International Lender of Last Resort,” paper delivered at the joint luncheon of the American Economic Association and the American Finance Association, New York, January 3, 1999.
Freixas, X., 1999, “Optimal Bail-Out, Conditionality and Constructive Ambiguity,” LSE Financial Market Group Discussion Paper No. 237 (London: London School of Economics).
Goodhart, C., and H. Huang, 1999, “A Model of Lender of Last Resort,” IMF Working Paper No. 99/39 (Washington: International Monetary Fund).
Goldstein, Morris, 2001, “IMF Structural Conditionality: How Much Is Too Much?” Institute for International Economics Working Paper No. 01-04 (Washington: Institute for International Economics).
Hausmann R., and A. Velasco, 2004, “The Causes of Financial Crises: Moral Failure Versus Market Failure,” available on line at: http://ksghome.harvard.edu/~avelasco/Files/Research/Causesof_Crises_Dec2004.pdf
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Zettelmeyer, J., 2000, “Can Official Crisis Lending be Counter-productive in the Short-Run?” Economic Notes, Vol. 29, pp. 13-29.
IMF Research Department and Universidad Torcuato di Tella, respectively. We are indebted to Eduardo Borensztein, Giovanni Dell’Ariccia, Enrica Detragiache, Haizou Huang, Jaewoo Lee, Eduardo Ley, Olivier Jeanne, Jun Il Kim, Paolo Mauro, Alessandro Prati, Raghuram Rajan, Arvind Subramanian, Angel Ubide, and Jeromin Zettelmeyer, as well as to participants in the IMF/RES Country Insurance Workshop for their constructive comments and suggestions. Naomi Griffin provided excellent research assistance.
Hausmann and Velasco (2004) present an updated survey of the debate on the nature of financial crisis.
For instance, according to Sturzenegger and Zettelmeyer (2004), although Pakistan was unable to pay the hefty 24 percent demanded by the market at the time of the debt exchange, it was able to pay (hence, was solvent at) a more reasonable 10 percent interest rate. In this case, the associated NPV haircut was merely the reflection of exceptionally high risk premia.
Our proposal builds on previous background internal analyses of ex ante conditionality and rules-based variants of the contingent credit lines conducted by IMF staff, including the Strategic Issues Division in the Research Department.
We come back to the definition of reasonable rates below. For the moment, it suffices to note that, in order to limit the use of the facility to exceptional cases (and following a standard lender of last resort practice), rates should be at a premium with respect to precrisis values.
These include the so-called statutory and market-based approaches, as represented by the sovereign debt restructuring mechanism (SDRM) proposal and the emphasis on the introduction of collective action clauses (CAC) in global bond contracts, respectively. See Roubini and Setser (2004) for a review.
In most private insurance contracts, a premium is charged to the insured to guarantee the financial viability of the insurer to cover the claims. There are, however, insurance contracts in which premiums are not specified ex ante, or are paid by the insurer (usually a government) out of a more general budget (e.g., disability insurance).
The traditional Bagehot view dictates that funds should be made available with certainty, at a penalty rate (relative to normal levels) to illiquid (but solvent) banks (see, Goodhart, 1995). It has to be noted, however, that liquidity assistance is typically collateralized by a well-defined list of eligible assets. On the other hand, although in principle bank supervisors should be able to assess ex ante the solvency of the bank, some authors argue that central banks should (and, in fact, do) make use of constructive ambiguity in situations in which the bank’s solvency may be at stake (see Goodhart and Huang, 1999, and Freixas, 1999; and Cordella and Levy Yeyati, 2003, for a critical view).
These proposals include, among others, Tobin taxes on foreign exchange transactions, and Chilean-style taxes on short-term capital inflows.
For an evaluation of the effectiveness of Malaysian capital controls as a crisis resolution instrument, see Kaplan and Rodrik (2001).
The longer the period in which capital controls are in place, the higher the likelihood that agents find ways to circumvent them.
Thus, it would have to pay an “annual fee” equivalent to the interest rate premium over the international risk-free rate. This rough estimation would not apply, however, if the country holds reserves in excess of the stock of public debt.
This requires that a significant fraction of fiscal revenues comes from commodity exports, either through direct ownership of the production facility or through export taxes. Caballero and Panageas’ argument for the use of copper futures in the case of Chile could be extended to Mexico (oil) or even Argentina (soybeans).
Unlike in a standard insurance contract, expected insurance outlays (and hence fair insurance costs) would be determined here by the amount of insurance purchased. Note that the standard assumption of an exogenously given probability of capital account reversals is at odds with their non-fundamental nature.
This is due to the fact that, if crises are purely of the self-fulfilling type, there is no fundamental risk, so that the availability of insurance eliminates its need.
The margin call also adds to this negative feedback. Note that although the insuring banks know that by hedging they increase the probability that the repo is activated, they face a coordination problem as the negative impact of their actions is diluted in the aggregate while the benefits from hedging accrue entirely to individual banks. Thus, the argument implicitly assumes that no individual bank will be willing or able to insure the country single-handedly.
The contract ultimately provided a meager US$1.77 billion (out of US$4.75 billion available at the beginning of 2001). Moreover, owing to the ongoing liquidity run, the decline in the price of the bonds used as collateral implied a reduction in the size of the line, which dropped to US$1.35 billion at the first 3-month renewal (generating a financing gap for the difference).
The IMF will lend to a country only if the IMF Executive Board approves a letter of intent in which the country lays down the steps that it is willing to undertake to redress the macroeconomic imbalances that created the balance of payments need. Disbursement, is conditional on the implementation of the policies agreed on in the letter of intent.
The reluctance to request a Fund program may also reflect a signaling problem: approaching the Fund may be perceived as a sign of hidden weakness, much in the same way as banks that come to the central bank’s liquidity window may be stigmatized by the market.
As reported in the news.
The basic rate of charge on Stand-by Arrangements (SBAs) is about 100 basis points (bps) over the risk-free rate. A surcharge of 100 bps is applied for credit over 200 percent of a country’s quota in the IMF, while programs over 300 percent of the quota command a surcharge of 200 bps. Higher surcharges are applied to funds drawn from the Supplemental Reserve Facility (SRF), starting from 300 bps and increasing by 50 bps after one year and each subsequent six months up to a maximum of 500 bps.
Henrique de Campos Meirelles, Governor of Brazil’s central bank, said at the 2004 IMF-World Bank annual meetings, “We would like to see a facility that prevents crises, particularly when they are caused by changes in market sentiment that have nothing to do with emerging markets in general” (Dow Jones Capital Markets Report, October 3, 2004).
IMF Press Release No. 99/14, April 25, 1999.
In the revision, initial monitoring arrangements were streamlined, mid-term reviews were simplified, and the rate of charge and the commitment fee were reduced. See IMF (2003) for a detailed discussion.
However, automaticity would not fully avoid the impact of changing fundamentals on borrowing costs, as countries get closer or further away from eligibility. We come back to this below.
While currency swaps between ASEAN countries date back to 1977, they were rarely used due to their small volumes. The CMI represented a substantial increase in the amounts involved.
Note that, while central banks typically do not impose conditions on access to a standing liquidity facility, eligibility criteria are implicit in the prudential requirements that banks have to comply with on a continuous basis and in the list of eligible assets that typically collateralize liquidity assistance.
Naturally, eligibility in the near future will still be influenced by sudden unexpected changes in economic conditions and will be subject to a degree of uncertainty in borderline cases. We will come back to this important point later on.
Note that the Maastricht criteria included conditions on both solvency and interest rate convergence, aimed at reducing the perception of an implicit regional LLR to mitigate free riding. The CIF, by contrast, is intended to play a LLR role, inducing interest rate convergence as a result.
It follows that, in order to be eligible, countries should be willing to provide detailed and reliable information on a few relevant variables on a continuous basis.
Debt maturity also deserves specific treatment; see below. Note that the data and the methodology used by the CIF to assess the eligibility criteria should be publicly disclosed. In this respect, it is crucial that the Special Data Dissemination Standard (SDDS) collect data on the currency and the maturity composition of public debt. At the moment, only very few countries provide such figures.
Nominal exchange rates were deflated, alternatively, by the wholesale price index (WPI), and the simple average of the CPI and the WPI, to proxy for the GDP deflator.
A related operational issue is the way in which international reserves (and off-balance-sheet items) should enter into the computation of debt ratios.
In principle, the CIF (particularly, its premium and size) could be more generous for countries that overcomply with the eligibility criteria (and thus, that are less likely to present a solvency issue in the future), thereby introducing further incentives for countries to reduce indebtedness or bring down fiscal deficits beyond what is required to be eligible.
Since we do not have data on the currency composition of foreign debt, we arbitrarily assumed that all domestic (foreign) debt is in pesos (dollars). In addition, since we do not have data on debt maturity, we ignore this criterion for the purpose of the exercise.
In addition, one could conjecture that the existence of the CIF may have helped Chile avoid the preventive monetary tightening in 1998-1999, in response to the Asian crisis.
The SRF offers one-year loans renewable for a subsequent one and a half years at a rising cost (50 bps increase every six months).
According to IMF (2001), in the overall fiscal balance “net lending/borrowing [is] adjusted through the rearrangements of transactions in assets and liabilities that are deemed to be for public policy purposes. Notably all proceeds under privatization […] would be included as financial item; and subsidies given in the form of loans would be recognized as an expense” (p. 53).
Needless to say, the country should be current on all its debt at the request date.
Countries that are already borrowing from the CIF but fear that they will not be eligible for renewal may preempt market reaction by entering into a precautionary IMF program.