As Italian yields skyrocketed and stock markets tumbled, the worst nightmare since the euro area crisis began has come true. The fallout of one of the most-indebted nations in the world, with euro1.9 trillion ($2.6 trillion) of public debt, is impossible to handle through conventional instruments such as a joint program with the International Monetary Fund and the European Financial Stability Facility.
In 2012 alone, the Italian Treasury will have to rollover some euro286 billion (a bit less than $400 billion) of bonds coming to maturity, equivalent to the IMF’s current financial firepower and in excess of that of the EFSF.
The IMF’s Intensive Surveillance
The unprecedented request from a G-7 country for the IMF’s “intensive surveillance,” made by the outgoing Italian prime minister, Silvio Berlusconi, in the midst of the G-20 Summit last week, has had virtually no effect in improving the credibility gap facing the Italian authorities that have unduly delayed any serious action since the crisis began to escalate.
Italy would greatly benefit from the credibility provided by a third party like the IMF. Under intensive surveillance, the IMF would monitor—almost on a continuous basis—the implementation of an agreed reform program. Such a program will be an operational version of the stabilization plan that the Italian Parliament will have to approve by the end of the week.
The IMF’s contribution will be to establish the intermediate policy targets and their respective timeframe in close cooperation with the Italian authorities. But it will also highlight trade-offs, complementarities and risks among competing policy measures. An IMF team due to fly to Rome as early as next week has reportedly been put on hold until a new government will take office.
This intensive surveillance will feature quarterly validations by the IMF’s staff, who will formulate its own independent appraisal in a report to be discussed then by the IMF’s executive board, which presumably will then be made public. Mechanisms of this sort provide a better signal of commitment than the statutory surveillance that the IMF obligated to conduct typically on an annual cycle.
An IMF Lending Program
Yet, intensive surveillance is less binding than that of a full-fledged IMF lending program, which is typically thought of as the most binding—and, thus, most credible—device.
If some of the agreed policy measures are not fulfilled by the borrower in the context of an IMF’s lending program, the executive board can either waive them or withhold the disbursement of the remaining funds. In so doing, it offers a much clearer signal of where the country stands in terms of the implementation of the agreed reform agenda.
Moreover, as the IMF’s own resources are at stake, market participants would typically attach a greater weight to the IMF’s pronouncements, since the fund would be “putting its money where its mouth is.” In appraising program implementation, in fact, the executive board must safeguard the institution’s funds in fulfilling a crucial fiduciary role.
In light of the current political turmoil, there would be merit in exploring a financial arrangement with the IMF for the following reasons:
- It would provide a stronger backstop to the Italian authorities’ low credibility.
- It would insulate, to some extent, the implementation of the reform agenda from the country’s unstable political outlook.
- It would establish a reassuring framework for the ECB to step in by announcing potentially-large scale interventions, should market pressures not recede upon successful implementation of the program.
- By containing the Italian problem, the prospect of a systemic collapse of the euro area would hopefully subside.
The possibility that a new government in Italy with a short-term mandate could take office ahead of snap elections in the next few months provides a unique opportunity for the Italian authorities to securely anchor their own reform agenda by seizing the benefits of a full-fledged IMF program.