HAKAN TAŞÇI

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HAKAN TAŞÇI
April 24, 2012, Tuesday

Who will save Europe? Back to multilateralism

Another busy week has ended in Washington, D.C. The semi-annual IMF and World Bank spring meetings were held in the shadow of European financial turmoil and the nightmare scenarios expected in the upcoming two years.

While markets are again obsessing over Spain’s poor economic growth prospects and higher bond yields together with Italy, the IMF seems to be cautiously optimistic over the crises. In 150 pages of the April 2012 financial stability report economists successfully (!!!) explain the source of the European crisis with 504 words in the report’s relevant section while talking extensively about the risks for the emerging economies and commodity prices. The world growth prospects for 2012 compared to last January report upgraded. However, the downgrade for Italian and Spanish economies will only deepen the concerns for a worse than expected year in Europe.

IMF Chief Christine Lagarde won the day by raising another 430 billion dollars of new funds for emergency lending thanks to the pledges of the G20 finance ministers. This helped her to double available funds despite the reluctance of the BRICS (Brazil, Russia, India, China and South Africa) countries. The US as well is reluctant to let more of its financial resources be used for the European economies insisting that since it is a European crisis, more domestic involvement is necessary. On the other side European big brothers would like to see more multilateralism and direct involvement of the world economies together with the emerging economies. They feel the IMF burden is necessary for quicker reforms and strong policies to get over the problems of the weakest links.

However, there is another side to the story, Europe has to turn over 6 percent share to emerging economies together with two seats on the board. Promises were made but nothing has been delivered so far. Turkey, as well, is in the race to change the power balance within the IMF by trying to create a new board position. No success so far. BRICS countries are active in this race and they were reluctant to announce a committed figure for Lagarde’s additional fund due to this undelivered promise. The United States has 16 percent of the vote while Europe has 34 percent say in IMF policy making. This reform to the IMF power balance is required in order for it to gain credibility as an international organization.

If one reads the economic outlook IMF announced during the week, it can easily be seen that commodity prices and the political risks surrounding oil resources are the main cautionary points in the report after debt-ridden Spain and Italy.

Potential problems in the Strait of Hormuz, the route that carries one fifth of the world’s oil supply, or somewhere else in oil producing countries or on transit routes, which could inflates oil prices will only dramatize the already weak global outlook. However, under normal conditions oil prices are expected to decline which will ease the reelection of Obama and burden of the oil importing countries like Turkey. In the case of the bad scenario, oil prices can jump another 30 percent according to IMF estimates, which would be a nightmare.

Another recommendation in the report was to continue with the accommodative monetary policy for the struggling economies which already has enormous problems on the debt front which would carry on fragilities to the upcoming years. Turkey is probably one of the unique emerging economies, which already started to implement innovative tight monetary policy to control the domestic credit boom and current account deficit. Spain is also a good example of this. If it does not further tighten its monetary policy but continue with the current policy, the southern European economy will have a budget deficit of around six percent of its gross domestic product (GDP), which is twice as much as outlined for European Union members in the Maastricht Agreement.

As the European Central Bank flooded 1.3 trillion dollars cheap liquidity into the banking system in order to give it a little breathing room but it won’t be long before further steps have to be taken.

The estimates are suggesting another trillion dollars fund is required for the upcoming year. More central bank intervention however will raise the inflationary pressures and increase the vulnerable countries’ risk premiums such as Spain, Italy and others. And as we are finishing this column, I have to note that I even did not have a chance to analyze the adverse affects of the unrest in the Middle East.

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