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Analysis
Plenty brewing behind the scenes at IMF meetings

Plenty brewing behind the scenes at IMF meetings

‘Business as normal’ as Greek default nears 

by David Marsh

Mon 20 Apr 2015

The most dramatic feature of the weekend spring meetings of the World Bank and International Monetary Fund in Washington was the absence of drama. There are plenty of possible disturbances in the world economy – expectations of possible tumult from a rise in US interest rates (whenever that happens), the slowdown in the Chinese economy and the likelihood of a Greek default on European Central Bank and IMF loans – but little of this was aired in any meaningful way during three days of meetings in the US capital.

Central bankers and finance ministers have perhaps grown tired – and embarrassed – about talking or thinking about these issues. In the principal policy discussion body, the International Monetary and Financial Committee, the question of a Greek default was not mentioned once. Apart from a grandstanding performance on Thursday, Yanis Varoufakis, the barnstorming Greek finance minister, failed to make any impact – in contrast to the headline showings of several of his predecessors in previous years.

Beneath the surface, there are several indications of key turning points. Here are six key issues investors should focus on.

  1. The semi-official view is that a Greek default will be more or less a non-event. The view from euro area policy-makers is that Greece is close to defaulting on its loans to the senior creditors, the IMF and European Central Bank. This step would be associated with exchange controls and some kind of Greek parallel currency that would co-exist with the euro.
  2. The hope is that Greece can carry on within the euro with little contagion to the rest of the single currency bloc. The chances of that happening without a major upset are probably below 50%. We will see if the relatively sanguine view holds. The best way to test whether the fire walls in monetary union really are effective may well be to allow a fire to start – and do everything necessary to prevent a conflagration.
  3.  If Greek unrest breaks out, the euro will continue to trade weaker and funds will flow into German government securities. The contractionary effect of the stronger dollar would delay a US interest rate rise – even though many on the capital markets and even within vulnerable emerging market economies (Brazil, Turkey, South Africa) would rather that the Fed simply gets the rate hike out of the way. Still firmer German Bund rates would make still more difficult the Bundesbank’s task of finding enough securities to purchase at acceptable prices to fulfil its ECB quantitative easing quota
  4. Despite the ‘business as normal’ view propagated by officials, there are abundant trigger points for a correction of stretched equity and bond market valuations. The ‘consensus trade’ based on operators going long on equities and short on bonds, and the accompanying ECB action that has allowed bond prices to stay buoyant in many jurisdictions, may be facing the sternest of reality tests.
  5. China is showing the rest of the world that it understands what it means to be a major creditor nation. China’s steady progress in winning sufficient support from the US and other leading countries to get its renminbi accepted within the Special Drawing Right, its refusal thus far to decouple from the strong dollar and assurances of further liberalisation of Chinese financial and investment markets are all indications that Beijing takes its responsibilities seriously. The People’s Bank of China cut in reserve requirements shows that the firm renminbi provides adequate cover for sensible domestic easing measures.
  6. Christine Lagarde, the IMF managing director, presided over the meetings with aplomb: deftness without depth. Many emerging market economies are broadly aware that they have a chance of securing the post and wrenching it away from the Europeans when her mandate expires next year, but there is no clear-cut mechanism for finding a replacement. Lagarde’s chance of securing a renewal must be around 60%. The next few months will be crucial in assessing whether the rest of the world is serious in wishing regime change at the IMF. Since Lagarde as a former French finance minister was partly responsible for the impasse over Greek debts, her ability to survive into a second term may be closely linked to the outcome of the Greek crisis as it unfolds in coming weeks.
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