The financial crisis led governments to buy assets to help avert a collapse of the financial sector.
GLOBAL ECONOMIC CRISIS
This will take time, and it is certainly too early to withdraw some forms of support. But governments should have a well-defined strategy for, initially, managing the assets and risks they took on, and then gradually winding them down.
The IMF paper, “Crisis-Related Measures in the Financial System and Sovereign Balance Sheet Risks,” issued on September 15, provides a practical overview of the principles and actions governments need to consider in moving towards an eventual exit from financial sector support.
The study points out that, contrary to popular opinion, government support to the financial sector has so far had only a limited impact on fiscal deficits. Other stimulus measures have been far more important. But the interventions mean that governments’ risk exposures have risen sharply.
“Guarantees may be called, announced lending facilities may be used, loans may not be repaid, and assets may not retain their value,” the study says. This means that the ultimate cost of the interventions to the taxpayer will depend on what governments do from now on. Governments must strike a delicate balance between continuing to support the financial sector for as long as is needed and saving money by closing off access to the measures now available.
Broad approach
Since not only governments, but also central banks and other public sector institutions such as sovereign wealth funds, combined to support the financial sector, the risks facing the state must be confronted with a broad framework—the sovereign balance sheet. The authors call for strategic management of the assets and liabilities of all relevant components of the public sector, including the central bank and other public financial institutions, and of associated off-balance sheet risks, mainly the guarantees.
‘Now we’ve got to get from a statement of desired targets to spelling out the nuts and bolts of how to get there,’ said Adrienne Cheasty, Senior Advisor in the IMF’s Fiscal Affairs Department.
Ways of eventually unwinding the stimulus and disposing of assets taken over during the crisis are likely to be discussed by policymakers at the IMF-World Bank Annual Meetings in Istanbul in early October.
“I do think the time is right for policymakers to develop their exit strategies – because failure to clarify and formulate these plans will risk undermining confidence and the recovery process itself,” said Dominique Strauss-Kahn, Managing Director of the IMF, in the Sixth Annual Bundesbank Lecture in Berlin on September 4.
Plans boost credibility
The advantage of setting out how financial support will be managed and eventually unwound, and the communication of this to other policy makers and the financial markets, is the predictability it conveys to all actors in the process. The IMF paper breaks down the top priorities for managing central bank and government balance sheets.
For central banks, these include:
• Taking stock of new risks, and balance sheet mismatches, and revising management practices to take these into account.
• Shedding credit risk from direct lending to the private sector, either by shrinking the balance sheet or by transferring risky assets to the government, so that these can be managed as part of the budgetary process.
• Adjusting the terms of access to central bank lending and liquidity facilities as market conditions change, with the goal of protecting the central bank balance sheet.
For governments, priorities include:
• Clarifying the framework for managing assets, either through asset management companies or a decentralized approach.
• Setting out clear and transparent rules for participation in asset management—including for buying and selling, valuation, and operational autonomy.
• Insulating themselves from the cost of guarantees, by charging appropriate fees for guarantees to help set the right incentives, and making budget provisions to pay for these, .
• Considering debt refinancing to increase maturity where cost-effective.
• Maintaining a level playing field between institutions to ensure fair competition.
Manage expectations, disclose risks
Getting from a phase of large interventions and stimulus to an unwinding phase will require governments to be clear in deciding their deficit and debt targets, in order to establish timetables for returning to a more normal state of affairs, according to the study. The trajectory of deficits and debt over time will in turn define governments’ financing needs and inform the management of their assets and liabilities.
Given the high level of uncertainty, risk assessments will have to be a central part of the strategy.. They will need to take into account various potential costs and shocks as well as different assumptions about the prices and recovery rates for the assets.
“Sovereign balance-sheet-risk management allows for a comprehensive systemic risk management and better monitoring of the interconnections and transmission channels of sovereign risks,” said Udaibir Das, Chief of the Sovereign Assets and Liabilities Division in the IMF’s Monetary and Capital Markets Department. “This framework is, by construction, the most consistent operational approach for ensuring sovereign creditworthiness”
Accurate valuation of assets and liabilities is crucial for understanding the impact of the financial support on fiscal solvency, the IMF said. The paper discourages any aggressive deviation away from the use of mark-to-market accounting, which allows for price discovery through the “fair value” granted the asset in a liquid market. As a rule, it is better for governments to “know the worst” and use full information when making policy decisions, according to the study.
The IMF study also points out that transparency and accountability will be key to maintaining confidence. Several countries, including Australia, Brazil, Indonesia, Pakistan and others, publish full statements of fiscal risks, including all guarantees provided by the government and in some cases estimates of potential losses.
Plans for unwinding help preserve taxpayers’ money
The paper outlines a few key criteria for successfully reversing central bank and government interventions, such as:
• Selling-off assets in such a way to maximize the return for the taxpayer, and avoid guarantees being claimed.
• Preserving central bank independence by closing lending facilities and removing support for specific credit markets.
• Returning the central bank and the government to their core responsibilities for monetary policy and budgets respectively, and strengthening the regulatory framework.
• Restoring the role of the private sector in the financial system, with private investors bearing the risk and rewards for their action.
Policy coordination
Also critical to the global recovery will be policy coordination of the unwinding both within and across countries. The key purpose of international policy coordination will be to keep everyone informed and maintain confidence in the market, the IMF said.
The IMF study stressed that there is no one-size-fits-all approach for countries to divest themselves of the assets and liabilities acquired during the crisis, and there are a number of complex issues surrounding timing and sequencing. That said, some practical guidelines may help:
• Redundant or ineffective facilities can be closed first, though it is important to choose these carefully.
• A gradual approach is likely to be required, to test whether financial stabilization can be sustained without support, and to avoid abrupt valuation changes.
• Access to support should be made increasingly less attractive, and risks transferred to the private sector, by raising interest rates and guarantee fees over time.
• Past crises have shown that central to any plan is a clear communications strategy by the government outlining its intentions, which helps all players, including financial markets, know what to expect.
As part of its ongoing work to help governments and central banks tackle these issues, the IMF will host a high-level conference to discuss the complex policy implications of unwinding public interventions in the financial system. The meeting will be held on October 29 in Washington, D.C. and will include government and central bank officials, as well as academics and private sector participants.
A recent article in the September issue of the IMF’s Finance & Development magazine discussed a number of the related macro-policy issues surrounding global economic recovery.
Comments on this article should be sent to imfsurvey@imf.org
