Table of Contents
What is the argument of Strom Thacker?
Why do countries default?
What happens if a nation defaults on its debt?
IMF’s effectiveness
Michael Tomz’s theory can be argued both positively and negatively. If a bank or bondholder bases the reputation of a particular country on its external and internal image as well as additional market factors such global market factors then many countries will be regarded negatively.
Iraq, for example, has consistently been ranked as the most vilified country in the country RepTrak annual reports.
RepTrak is an annual report that takes into account the self-image and external perception of each country as well as global market factors.
Below is the 2017 and 2015 Reputation Report.
Iraq’s civil war and the decline in oil prices have all had a negative impact on its economy. The economy of Iraq was seriously affected. Iraq’s economy was badly affected.
Orders worth 6.6 billion US dollars were placed for the purchase of 1 billion US dollar bonds. These bonds will mature by 2023. These bonds were all guaranteed at 100% by the United States Government.
The yield is actually lower than what the original pricing expectation was.
It appears that bondholders didn’t consider the reputation of these countries when buying bonds. This could be because Iraq’s oil industry is a major player, and oil exports are increasing slowly as a result.
Iraq may not have the reputation that would allow it to repay, but its oil sector is a valuable resource for other countries.
Greece is the second country. In 2016, the economy of Greece grew by only 0.01%. The European Union and International Monetary Fund have also provided multiple bailouts to this country.
Greece is still below average in Europe and the world. The 2008 financial crises had a major impact on Greece’s economy. The unemployment rate in Greece is still high.
They sold three billion euro five-year government bonds in 2017 despite Greece having the worst credit ratings in the world and being the only nation to fail to repay the International Monetary fund.
Investors were turned away because the demand for debt was 6.5 millions euro higher than the amount of the loan.
Argentina is the third nation in this row. In 2017, Argentina borrowed 2.75 Billion USD of 100 Year Bonds at an 8% yield in June 2017. This was despite a long history of defaults.
Since 1816, Argentina defaulted eight times on its sovereign debt. Argentina made the largest default in history on bonds worth USD 100 billion back in 2001.
In looking at these 3 countries, investors and commercial banks as well as private bondholders can all agree that reputation or repayment history did not seem to matter. All these bond sales would have been possible if they had. The fact that some of these examples also include reputation-based borrowing is noteworthy.
It has been reported that countries are not able to borrow enough money by issuing bonds.
The demand for US bonds at an auction held in March 2018 was not as high as expected. The auction was for USD 21 billion. Bond traders retreated from lending in America after the federal reserve raised interest rates and increased the deficit.
The rise in yields has caused even China to fail in an auction of bonds in June 2015.
German bonds auctions failed in 2011, as the lowest bidders were drawn. In the 10-year auction it sold US$ 4,92 billion from 6 billion Euro. The average return was 1.98%.
These failed auctions of bonds have occurred despite the reputation of the country borrowing the money. This is due to the instability of its economy.
The Argument of Strom ThackerThe International Monetary Fund, established in 1945, is an institution that has the primary goal of monitoring and maintaining international monetary systems. Many countries have experienced great economic changes. It has stabilized and fostered world economies.
The IMF may claim that it follows universalistic criteria for a loan agreement, but in reality the IMF is influenced by the individual government’s decisions.
Storm Thacker’s claim is hard to refute, since the United States has a significant influence on IMF lending decision.
IMF funding is provided by its members. United States has 17.46% with voting power of 16.52%.
The IMF’s decision-making structure gives the United States more power than other members.
United States officials in May 2009 urged the IMF not to grant a 1.9billion USD loan for Sri Lanka because the country did not have the capacity to carry out strategic reforms.
Donald Trump’s administration pressed the IMF to refrain from participating in Greek bailouts. A bill was introduced to urge the Trump administration not to participate in any more IMF bailouts for Greece. The bill required the US also to oppose larger IMF Reforms until Greece pays off all its IMF debts.
IMF staff sent to Athens a team of negotiators to meet with the government. But IMF was in a very hardline position and refused any commitments due to US influence.
It appears that the United States exerts influence over IMF.
Why do countries default? When a government borrows money and is unable to repay it, countries may default on external debt. Defaults are possible for many reasons. In certain cases, the default could be caused by a missed loan payment.
Global capital flows are important in determining a country’s ability to pay its debt. In times of prosperity, countries will borrow money from institutions or financial centers that promise a high return. Every situation is like a coin. Positive environments are not liable for the actions of countries. A simple failure of a bank can stop the trade in a whole country. A country’s debt can be defaulted on if there is a crisis in its capital flow cycle.
Argentina, Greece and Russia are among the countries that have defaulted on their debts in recent years.
In 1994, the Peso crisis led to Mexico’s default on its foreign loans. Mexico’s national debt was paid by the Mexican government buying US Dollars at a devalued rate of peso. Mexico was rescued by a USD 80 million multi-country loan.
In 2001, Argentina defaulted a USD132 billion loan. This amount was one-seventh the total borrowed money by the Third World at that time.
This move was made after economic and political uncertainty led to a devaluation of the Argentinian currency. The Argentinian Government froze bank accounts and only allowed people to withdraw a small amount of money each week. Argentina borrowed from the IMF to pay off debts, but this only led to a larger depression.
During global financial collapse in 2008, Iceland defaulted US$ 85 billion on its debts abroad. Later, the Central Bank of Iceland tried to bail out three of Iceland’s largest lenders but ended up going bankrupt itself. Iceland’s currency value plummeted. Iceland had to be saved from economic collapse by the IMF and severe restrictions on the movement of money outside the country.
Various crises led to the default of countries on their debts.
What will happen when a country defaults?Undoubtedly, a debt is a burden for a government but what will happen when a country does not pay back its debt? The results are worse.
Bondholders may suffer more damage if a government defaults on their debt. This will affect pension reserves and large investors.
If the borrower defaults, they will lose their access to international financial markets. In addition, the government won’t have access to international capital markets if it defaults. The country will be forced to either eliminate its public deficit or to create the money necessary to cover it. The country will have a hard time paying off its debts and bonds, and it is unlikely that anyone will lend another loan.
In a default situation, not only the government but also private companies are prevented from obtaining foreign funding.
Defaulting on external loans means that the government’s economy will be closed. The government must rely solely on itself.
The Central Bank will be under pressure to create more money, which in turn will cause inflation. When a country is heavily dependent on external financing, its government will also run out of cash.
Lack of confidence will lead to the next horrible outcome, which is a devaluation of currency by that government. But it won’t affect the economy directly as this will lead to major exporters exporting and importing more, narrowing the trade surplus.
Indirectly, the value of government assets like buildings will be reduced. These buildings will become affordable and accessible to everyone, even to outsiders.
The aftermath of a defaulted debt is extremely bad, and recovery will take several years.
Why is the International Monetary Fund treated preferentially?
International Monetary Fund is a lender last resort, assisting countries in financial crisis. IMF loans are usually issued in dollars or euros.
The example below illustrates how IMF is like a last-resort lender.
Country A is developing with an economy that relies on natural resources. Its exports are high-priced and valuable. Country A was therefore able get a bank loan to finance long-term investments. The government spends 20% of this borrowed money, and 40% of its revenue is derived from export.
In the end, exports are not as good because these high-valued products have lost some of their value due to unforeseen circumstances. The government revenue dropped by 20% as a result.
Second, Country A’s currency had been bought for years to purchase their exports. Now that exports have performed poorly, the currency’s value has decreased relative to dollar and euro. Indirectly, the country A is forced to spend its local currency more to pay off its external loans. The A government already has lower revenues, but it now must spend more money on debt service.
The trade deficit is likely to increase. The A Government must now look for ways to improve. It may default on external loans. The worst is yet to come. The country will lose foreign direct investment, which will eventually damage its reputation. Yes. They’ll ask the International Monetary Fund for help.
International monetary Fund was established to deal with such problems. IMF will provide loans multiple times to a country that has requested assistance. This is done under strict agreements and conditions. It will restructure Country A’s Debts. IMF has the ability to convince lenders of a certain debt amount. It will also create plans for stabilizing and strengthening the devalued currency and economy of affected countries.
Summary – It seems that countries are not willing to hurt their relationship with International Monetary Fund. This includes delaying repayment, defaulting IMF loans, or refusing to comply with IMF’s conditions. IMF gets special treatment because countries do not want a poor reputation as the lender of last recourse. They turn to IMF when they are in a financial crisis and no one else is willing to loan them money. IMF provides assistance even if the country has a bad reputation and a poor performance in economic terms. No one will treat someone who is willing to lend you money, no matter what your situation may be.
Since its founding in 1945, IMF carried out many projects. It has also provided many services. The effectiveness of the programmes can vary. IMF is a great institution for most countries to help them get through a crisis. IMF is also criticized for its failures.
IMF primarily has three functions. It conducts a basic checkup on the health of member economies, which is known as surveillance. The IMF also provides training and technical support, as well as lending to member nations in times trouble.
The IMF can provide advice and loans for countries that are facing economic crises or wish to avoid them. Sometimes, a country’s reserves are not enough to ensure a stable economy. It could be a result of internal or outside problems. If a country is in a financial crisis, it could be because of weakened financial systems or because they are buying more services and financial products from other countries. It can also be a crisis if the economy isn’t growing fast enough. It can cause a crisis if foreign investors start to withdraw their money. Spending money inefficiently can cause a crisis. IMF loans can ease adjustment and restore confidence. IMF members can request a loan, regardless of their income level. They are available in a variety of sizes and cost less than any other source. The loans are customized to fit specific needs. When a government requests a grant, the IMF collaborates with that country to design an effective and flexible reform program to enable the country’s own recovery. Recovery often means making tough choices. For the loan’s effectiveness, the country must have the right policies in place and address the problems which caused the crisis.
IMF provides loans to countries that meet certain strict criteria in terms of the country’s economic policies. They tell the government that they should spend less, raise taxes, and charge higher rates of interest in order to improve the country. These economic policies sometimes make things worse.
Greece is a good example of a failed story. The currency of Greece was the drachma until 2001, which is 3000 years old. 1832 Greece gained independence and reintroduced the drachma. In 2001, however, Greek became a member of the Eurozone. They began to use the Euro. Although the euro was great for trade, it had some problems. 19 countries using a single currency created problems. The European Central Bank was in charge of Greece’s money policy and how much they could print. Greece’s fiscal and monetary policy was controlled primarily by the Greek government. Greece and Eurozone were supposed follow fiscal rules. The Greek government, starting in the mid-1990s has been presenting deficits as well as debts which were significantly lower than what they were. In 2009 the newly elected Greek government announced 13.9% for the whole year. These numbers were not accurate in some years. Greece’s wage cost rose significantly after joining Eurozone. Their debt was too high to begin with and they also had an enormous problem of tax evasion. In 2008, the U.S. economic recession spread globally. Greece was particularly affected as its main industries, tourism and shipping, were both struggling after the recession.
An IMF loan has greater benefits. It can encourage other lenders and creditor to provide funding and send a signal to investors that the country is safe to invest. This will help rebuild the foreign exchange reserves of the country, as well as boost the confidence in its currency and economy.
