Is the IMF ready for the next emerging market debt crisis?

It is said that financially troubled emerging market economies approach the International Monetary Fund (IMF) for its conditional loans with as much enthusiasm as a patient visits his oncologist. 

This explains why over the past two years the pandemic-devastated emerging market economies borrowed relatively little from the IMF. With the world awash with liquidity as a result of massive Federal Reserve and European Central Bank money printing, why should they have submitted themselves to IMF conditionality when they could finance themselves so easily in the international capital market?

With the Federal Reserve now on the cusp of a credit tightening cycle to get the U.S. inflation genie back into the bottle, all of this is about to change for the emerging market economies. In a more challenging international liquidity and world economic environment, they will need very large-scale IMF financing to cover their deficits and to repay their creditors. 

A key question in 2022 will be whether the IMF will be adequately financed and whether it will have learned from its past unfortunate large-scale lending programs to Argentina and Greece to effectively play its lender of last resort role to the emerging markets.

The main reason to believe that the international borrowing environment will soon sour is that the world’s major central banks will have to start raising interest rates in earnest to curb inflation. This is especially the case considering that interest rates have been allowed to become so negative in inflation-adjusted terms. With consumer price inflation in the United States now running at some 7 percent and with policy rates at close to their zero bound, the Fed will need to do a lot of heavy lifting to get a handle on inflation.

If the Fed indeed has to raise interest rates this year more than the three times that it is currently anticipating, one must expect a strong reversal of capital away from the emerging market economies as has occurred on so many previous Fed tightening cycles. The emerging market economies might also find that they will have to cope with lower international commodity prices and more difficult export markets if the Fed interest rate hikes derail the global economic recovery by bursting today’s “everything” asset price and credit market bubbles.

Still amid the pandemic, emerging market public finances appear to be particularly vulnerable to a souring of the world economic and financial market environment.

This likely means that the emerging market economies will soon face strong balance of payment pressure as both domestic and foreign investors question these countries’ public finances and send their money abroad. That in turn will likely cause many countries to come knocking at the IMF’s doors for large bailout loans as they are spurned by the international capital market.

A serious problem for the IMF is that the renewed demand for its large-scale support will becoming at the same time that the IMF will be having trouble in getting repaid by Argentina, recipient of the IMF’s largest loan on record. That in turn is bound to raise questions about the IMF’s claim that it does not put U.S. taxpayers’ money at risk as well as about the IMF’s lack of success in its previous large-scale loan programs with countries like Argentina and Greece.

If the IMF is to receive the necessary financial support from its membership to effectively carry out effectively its role as the world economy’s lender of last resort, it will need to provide assurances that it will avoid repeating the mistakes of its earlier large-scale lending programs. In particular, it will need to explain how it will ensure that there will be adequate controls to prevent its money from being used to finance capital flight or to bailout private creditors where the country might have a solvency as opposed to a liquidity problem.

Especially now that the emerging market economies account for around half of the world economy, one has to hope that the IMF can mend its ways in a manner that reassures its main shareholders. For if ever the world will need the IMF to help manage a global emerging market debt crisis, it is likely to be in the coming global liquidity tightening cycle.

Desmond Lachman is a senior fellow at the American Enterprise Institute. He was formerly a deputy director in the International Monetary Fund’s Policy Development and Review Department and the chief emerging market economic strategist at Salomon Smith Barney.