Politics marks problems with IMF bailouts

By Mark Egan

WASHINGTON (Reuters): Every economic plan comes with a set of basic assumptions, the most common being ceteris paribus, or all other things will be equal.

But if the International Monetary Fund (IMF) can draw one lesson from the current set of economic problems in Turkey and Argentina, it's that all other things are rarely equal, especially when it comes to politics.

Late last year the Washington-based global lender came to the rescue of both Turkey and Argentina.

A floundering banking sector in Turkey threatened to derail the entire economy, and required an US$11.4 billion IMF lending program. In Argentina, financial markets lost confidence that the government could enact much-needed reforms and the country, loaded with debt, faced a massive financing gap. Once again the IMF stepped in, leading a $40 billion rescue package.

In both cases, it took just a couple of months for all those billions of dollars to seem insufficient. Now the IMF is being forced to urgently revamp those bailout programs.

The common denominator in both cases was politics -- coalition governments ruling with a shaky hand rather than an iron fist. In both Turkey and Argentina, political developments took just weeks to undermine the IMF's programs.

Turkey is now hoping for even more money, Argentina too looks like it might need additional cash.

"What they need is a benevolent dictator ... they really need a strong leader," said Sung Won Sohn, chief economist at Wells Fargo Bank.

"They have very weak coalition governments and that's one of the reasons why they can't bite the bullet," he said, adding that a painful debt rescheduling was needed in both cases.

Politics played another role in both rescue packages, Sohn said. In Turkey's case, NATO membership and a border with Iraq ensured support for the package, he said. And he likened the IMF's help for Argentina to that of a father constantly bailing out a errant, spendthrift son.

Morris Goldstein of the Institute for International Economics believes the two crises had another common thread: in each circumstance, the fund should have pushed harder for more fundamental changes.

"The IMF has done a decent job, but they needed to be firmer," Goldstein said.

"In the Argentina case they will ultimately need a change in the currency regime and maybe a debt rescheduling. And in Turkey they should have gone much harder on the banking system, and they too may need some debt rescheduling," he added.

The IMF could potentially have withheld cash as leverage to push for more fundamental reforms. But with the political will in both countries relatively weak and crises brewing, that was never really a viable option.

In the case of Turkey, IMF officials would have liked to see the country adopt a floating currency regime, but Turkey was not ready or willing to act until a second crisis in February forced it to float the beleaguered Turkish lira.

In the case of Argentina, many economists believe the currency regime there -- a currency board which ties the peso to the U.S. dollar -- as ultimately doomed. But with the architect of that regime, Domingo Cavallo, appointed as the third economy minister there this year, any change in the currency board arrangement seems unlikely.

Indeed, Cavallo has vowed to keep the set-up for "years."

Because the peso is tied to the U.S. dollar, the South American nation has few weapons with which to attack the recession, effectively leaving monetary policy to the U.S. Federal Reserve. That leaves authorities in Buenos Aires tinkering with fiscal policy to try and improve matters.

"In the end, Argentina would be better off with a Brazil-or Mexico-type managed floating regime with inflation targeting that would allow them to use monetary policy quite substantially to dig them out of recession," Goldstein said.

Whatever the ultimate solution is, Sohn believes that the IMF goes too easy on almost all of its borrowers.

"The problem is that countries make promises to the IMF, they violate them, they renegotiate, and then the IMF gives them more money and that goes on, and on, and on," Sohn said.

"If we let countries experience more pain, that would likely coalesce some political consensus among themselves."

But the problem the IMF faces when difficult and painful changes are needed is highlighted by reforms currently underway at the lender.

This week, the IMF said it would attach fewer conditions to the loans it makes to allow countries more freedom in setting their own economic policies. The policy shift is aimed at deflecting criticism that the fund foists ill-suited policies on developing nations without taking account of the will of the people or the domestic political situation.

Against that backdrop, the Washington-based lender can hardly demand countries change their currency regime or reschedule their debt. Instead, they would prefer the borrowing nation to discover the best course of action on its own.

But, as has been shown in Turkey's case, those realizations often come late and at a cost. Turkey's lira is worth a third less than it was when the currency floated in February and the banking sector will require billions of dollars to fix.

Next week, Turkey's new economics superminister, Kemal Dervis, will do the rounds in Washington, cap in hand, hoping to generate fresh funds to help his embattled economy.

"What will be interesting is to see if Turkey asks for addition money and whether it gets it, particularly from the IMF and the U.S. Treasury," Goldstein said. "This is really the first test case for the Treasury on what their policy is going to be on bailouts."

While a number of officials at the U.S. Treasury have hinted that they might like a more streamlined IMF with fewer bailouts, that sentiment has yet to be put to the test.