The quick view
- Recent violent protests have highlighted how fiscal austerity measures associated with IMF programmes can spark social unrest and risk creating adverse economic outcomes
- The pain of austerity has seen relatively market-friendly, pragmatic governments in countries such as Argentina meet an early demise at the polls, forcing the IMF to work with populist parties
- In its latest self-assessment, the IMF appears to be weighing up a more holistic approach – with less focus on the fiscal and more on the structural, social and political
- This would be a positive development for emerging market debt investors and it affects how they should assess EM economies.
The IMF’s fiscal focus
The IMF’s approach to helping get emerging market economies on a sustainable path has a heavy focus on fiscal austerity. Unsurprising, then, that people often say in jest that the initials stand for ‘It’s Mostly Fiscal’.
Fiscal belt-tightening can prove painful and unpopular. That much is hardly news to the IMF, which has ‘a difficult balancing act’ practically written into its job description. But a combination of recent events may have created cause for a shift in focus.
Recent violent protests in countries such as Ecuador have shone a glaring spotlight on the political pain and economic disruption austerity measures can cause. In Argentina, ‘reform fatigue’ – whereby the population becomes sick of taking the painful pill of cut-backs with the promise of brighter economic horizons – ultimately resulted in the ruling political regime losing power. A regime that had been making reasonable economic progress under the country’s IMF programme (as we wrote here), to the benefit of the country’s economic future and investors’ portfolios. Both are now facing an uncertain future.
The IMF is now having to work with newly elected populist governments in Argentina and Tunisia to find ways of squaring the circle of achieving necessary reform by politically acceptable means. Furthermore, in countries such as Ecuador, Jordan, Sri Lanka and Pakistan, we believe the fiscal targets set out by the IMF are going to prove difficult to meet.
Big picture policies
This year’s seminar hosted by the IMF at the IMF/World Bank annual meetings in Washington D.C. had a slightly more innovative feel to it than usual. A candid assessment of both successes and failures led it to conclude the following:
- It needs to take into account more fully the local political backdrop and focus more on social safety nets
- It should partner more often with other groups, such as the World Bank, to expand its focus from fiscal adjustment to more holistic solutions
- It must work with individual countries to ensure that it is the creditor government – and not the IMF – that fully owns the reforms and gets the population’s buy-in.
A more holistic approach could see the IMF's focus lessening on short-term fiscal targets and moving towards the implementation of significant structural reforms that lay the platform for future growth and sustainability.
These reforms could take various shapes, such as increasing labour market flexibility; phasing in pension age increases; and improving the availability of education to poorer parts of society – strengthening the workforce while also reducing inequality.
The IMF’s handling of the recent protests in Ecuador points to a more holistic approach in action. There, it agreed with the government that removing fuel subsidies had been a step too far for the population and other means would need to be found to right the economy.
What does this mean for investors in EM debt?
Broadly, investors should be encouraged by the prospect of a more patient IMF. But with a more holistic approach from the IMF, investors will need to take an equally broad view – one that goes beyond a simple debt-sustainability analysis. Finding the potential winners will be less about short-term fiscal gains and more about achieving long-term structural and social progress. Less tangible and more nuanced.
Looking through this wider lens is exactly what our team of specialists already does. Currently, we see interesting potential in countries such as Ukraine. The Ukrainian government is really owning the reform agenda and, while progress under the IMF programme may have been slower than hoped, it is still very much on track.
Emerging market: These markets carry a higher risk of financial loss than more developed markets as they may have less developed legal, political, economic or other systems.
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