Caribbean Development Bank Receives Credit Rating Downgrade

Sources:  

Antigua Observer: Caribbean Development Bank loses top-rated ‘AAA’ status – S&P

Caribarena Antigua: CDB Downgrade Effects Unlikely

CBS News: S&P affirms reduced U.S. credit rating

Reuters: Banks need work implementing risk management

Reuters: S&P cuts Caribbean Development Bank to 'AA+'

Reuters: S&P report says Caribbean debt is on the rise

Stabroek News: Caribbean struggling with debt

In the wake of the recent global financial crisis, many countries and banks are seeing a decline in their credit rating.  The Caribbean Development Bank (CDB) is no exception. Both American credit rating agencies, Moody’s and Standard & Poor’s (S&P),  recently downgraded the CDB from the top rating (AAA) to the second best rating (AA1 for Moody’s, AA+ for S&P). Both credit rating agencies attribute the decline in ratings due to the weakness in CDB’s risk management as well as rising national debt among the Caribbean nations, who are all CDB’s customers. Despite the decline in credit rating, S&P is optimistic that CDB can recover its credit rating. S&P contributes its optimism to the strong relationship CDB has with its Caribbean customers and its strong capitalization—the sum of a bank’s invested cash.

Risk management includes supervising, regulating, and avoiding investment risks. For a bank, risk management is often associated with avoiding bad debt, but also includes ensuring general financial stability. Much of the financial crisis of 2008 and 2009 is credited to poor risk management by financial institutions.

Both Moody’s and S&P justify the downgrade of the CDB due to weaknesses in the Bank’s risk management that led to  reduced liquidity—a bank’s cash on hand—and a low number of borrowers. To avoid financial risk, a bank will have a high level of liquidity and a wide range of borrowers. A bank must maintain sufficient liquidity to pay its obligations when they come due, and thus lower liquidity increases risk of not having enough cash to meet the bank’s obligations. Also, a wide range of borrowers is beneficial because it reduces the impact of a single borrower’s default as revenue continues to come in from the many other borrowers. Last year, the CDB saw its liquidity significantly reduced; in the past, the CDB has held enough liquidity to pay 200% of its debt coming due in 1 year or less, but last year it only have enough liquidity to pay for 143%. In addition, five countries account for 63% of the CDB’s loans. Because many of these Caribbean countries have been facing rising credit vulnerabilities, the CDB’s concentration of borrowers has increased its exposure to financial risk.

Another reason for the CDB’s credit downgrade is the rising credit vulnerability in the region, which is a result of high levels of public debt among Caribbean countries and slow regional economic growth. Among Caribbean countries, net public-sector debt—the amount of government debt minus its cash on hand—increased to 57% of regional gross domestic product (GDP) in 2011, up from 37% in just 2008. On an individual basis, some Caribbean countries have debt burdens of 100% of their GDP or more—a high debt burden is often associated with reduced economic growth.

Despite the poor regional economic outlook and downgrade of the CDB, S&P provided the CDB with a positive and stable short-term year outlook. This outlook is based on its strong relationship with the member countries who borrow from the CDP, as well as its strong capitalization. In addition, the CDB is responding to the downgrades by evaluating and implementing improvements in its risk management, which S&P specifically said would help improve the CDB’s rating in the future. However, the CDB has not stated the specific improvements it will make to its risk management.

While the CDB’s downgrade is a difficult setback, it is largely a reflection of the current financial difficulties worldwide. For example, S&P recently affirmed downgrading the United States’ credit rating, which is equal to the downgrade it gave the CDB. However, the outlook for the CDB is stable and positive, and it hopes to reaffirm that positive outlook by fixing its current weakness in risk management.

HSBC Announces $100 Million Global Water Development Project

Sources:
Devex: HSBC to Invest in Developing World’s Water Sector
Devex: Water: The Means to End Poverty
Environmental Finance: HSBC Makes $100m Water, Sanitation Donation
HSBC: HSBC Invests $100m in Water Projects to Improve Lives and Boost Economic Development
Market Watch: Importance of River Basins in Driving Global Growth to Rocket: Top Ten Basins' GDP Set to Exceed That of USA, Japan and Germany Combined by 2050
Reuters: River Basins Critical for Emerging Markets: Report
WHO: Generating Economic Benefits with Improving Water Resources Management and Services

Based on a recent study by Frontier Economics, which demonstrates the economic importance of river basins, HSBC (Hong Kong and Shanghai Banking Corporation), a U.K.-based multinational financing and banking services firm, announced a $100 million project to improve water access and protect water sources in developing countries throughout the world. To accomplish its plan, HSBC is partnering with the World Wildlife Fund (WWF), WaterAid, and Earthwatch. The program will provide economic as well as social and environmental benefits for the countries involved, which span across Asia, Africa, and South America.

HSBC based its plan on a study it had commissioned on water resources in developing countries. The study demonstrated the importance of ten of the world’s most populous river basins, stating that, by 2050, economic development in these ten river basins is expected to produce a quarter of the global gross domestic product (GDP). The increase in GDP comes from an increase in water infrastructure, an increase in health among a nation’s workforce, and an increase in irrigable and traversable water (water that can be used for irrigation and for transportation)—all of which increase a nation’s productivity. The ten rivers in the study are the Ganges (India and Bangladesh), the Yangtze (China), the Indus (Pakistan), the Nile (Sudan, South Sudan, and Egypt), the Huang He (China), the Huai He (China), the Niger (Western Africa), the Hai (China), the Krishna (India) and the Danube (Southeastern Europe). Without significant investment in improving water management, the study found that most of these river basins will be facing water scarcity, thus undercutting their productivity. Reduced productivity would in turn hurt the growth of the developing countries these river basins support.

To prevent future water scarcity in these at-risk river basins, HSBC is implementing its $100 million water development program. Each one of its partners in the project will perform a specific task. WWF will help farmers and fishers implement more efficient water-use practices in Asia, East Africa, and South America. WaterAid will aid in improve sanitation and hygiene in Bangladesh, India, Nepal, Pakistan, Nigeria and Ghana by improving access to safe water. Finally, Earthwatch will address and monitor urban water management issues in twenty cities worldwide by setting up research projects with local conservation groups.

The projects will contribute to economic development in the target countries as studies have shown a direct correlation between increased access to safe water and sanitation and economic growth. By providing universal access to safe water and sanitation, a country can increase its GDP by 15%. The increase in GDP arises from the positive effects that safe water and sanitation have on the health of the country’s workforce and the amount of irrigable and traversable water— all of which, as mentioned above, helps increase a country’s productivity. In fact, the Frontier Economics river study demonstrated that besides improving health and the environment, on average each $1 spent on improving water infrastructure could provide a $5 economic return on the investment or more. Because of this, Frontier Economics believes that loans offered to some African countries to provide universal access to safe water could be paid back in as quickly as three years.

With its $100 million water improvement project, HSBC seeks to take action on opportunities for economic growth in the some of the world’s most populous river basins. Not only will the project increase economic development in the targeted countries, but it will also improve understanding for better practices among similar development projects as HSBC plans to share the findings with the international development community.

Oil-Importing Countries in the Middle East and North Africa Face Continued Financial Challenges

Sources:
Arab News: IMF's economic outlook for MENAP shows growth despite historic transitions
The Daily Star (Lebanon): Experts call for joint action to assist Arab states in need
IMF: Arab Oil Importers Under Strain
IMF: Anchoring Stability to Sustain Higher and Better Growth
IMF: Middle East and North Africa: Historic Transitions under Strain
The Nation (Pakistan): IMF expects high oil prices in 2012

In the Middle East and North Africa (MENA), countries which import oil faced reduced growth last year and projected financial challenges in the future. According to the International Monetary Fund (IMF), growth in the oil-importing MENA countries fell from 4.3% of gross domestic product (GDP) in 2010 to 2.2% in 2011. GDP is the total value of goods and services produced in a country during a year.

The slowed growth came in the form of a reduction in tourism and private investment in local businesses, both of which are sources of employment and revenue. The main cause of reduced tourism was the political unrest in the region as many nations faced either regime changes or significant political changes. Political unrest creates safety concerns, which in turn reduces tourism. It also reduces private foreign investment because the political instability creates a situation in which it is uncertain whether investors will see a return, or profit, from their investment.

Another cause of the reduction of tourism and private investment is the European financial crisis. Europe is a major source of tourism and investment for many MENA countries because of its close proximity to the region. However, Europeans have less money to spend elsewhere on tourism and investments because of domestic financial problems resulting from the European sovereign debt crisis.

While many MENA countries are seeing a return to political stability, the IMF points to continued challenges to economic growth for these oil-importing countries. First, the IMF expects oil prices to continue to rise in 2012, which would increase the amount of money flowing out of the country, making it more expensive to cover the costs of continued oil consumption. Second, Syria is still facing significant political turmoil, affecting the regional economy through continued decreased in tourism and private investment mentioned previously.

To aid in recovery, the IMF asserts that ensuring adequate financing is key. The IMF estimates that oil-importing MENA countries will need $50 billion in 2012 to keep their economies functional during times of political unrest. While the IMF is providing some assistance, the IMF and other experts call for international and regional donors to participate as well. The IMF says that infusions of investment funds will aid in meeting short-term needs and establishing greater long-term stability in the form of job growth and modernizing infrastructure.

Thus, though oil-importing MENA countries are currently facing financial challenges resulting from political unrest in the region and financial instability in Europe, the IMF expects that increased investment assistance will encourage future economic growth.

Germany Supports Increase in Funds to Combat the Debt Crisis Contagion

Sources:
Chicago Tribune: Merkel Signals Readiness to Compromise on Firewall
Nine News Australia: Merkel Gives Ground on Higher Firewall
San Fransisco Chronicle: Merkel Backs Firewall Increase for First Time Amid Spanish Concerns
WSJ: Euro Zone Raises Ceiling on its 'Firewall'

To limit the spread of the negative effects of a potential default in Greece, Portugal, or Ireland, European leadership has created a permanent rescue fund named the European Stability Mechanism (“ESM”) with a maximum value of €500 billion that will come into effect in July 2012. A current temporary fund with the same goal, the European Financial Stability Facility (“ESFS”), has already disbursed €200 billion and has €240 billion in unused capacity.

Having the necessary funds to combat default is vitally important because one country’s default can create a domino effect that causes enormous problems in other countries. This spread of economic harm based on one country’s default is called “contagion.” A simplified example of this problem is as follows. Suppose that country A (“A”), which is barely able to make its debt payments, holds €100 billion in debt from country B (“B”) and receives annual interest payments of €6 billion on that debt from B. A also owes €5 billion in interest payments each year to a number of other countries. If B defaults, A will no longer receive its €6 billion in interest payments that it counts on to be able to meet its own obligations. In this simplified example, the default of B could force A to default. Additionally, a default in one country could cause panic throughout Europe, leading banks to greatly reduce the amount of money they are willing to lend. Both of these problems could be devastating to the world economy.

Germany, one of the most economically powerful countries in the EU, previously believed that funds to combat the debt crisis contagion should be limited to the €500 billion maximum of the ESM. However, on March 26, in response to concerns that the economies of Spain and Portugal are in serious economic danger and pressure from the IMF and the governments of top global economies, Germany agreed that €500 billion may not be sufficient to combat the debt crisis contagion. Germany then agreed with other Eurozone members that the ESM and ESFS could run in parallel. Germany’s new position is that the permanent ESM will remain capped at €500 billion, but the €200 billion already distributed by the ESFS will not be included in that total, giving the Eurozone a total of €700 billion to combat the debt crisis. The increased availability of funds will allow countries nearing default to meet their current debt obligations, which will give these countries the additional time needed to implement economic changes that will allow them to meet future debt obligations.

On Friday, March 30, 2012, Eurozone finance ministers agreed to increase the bailout limit to €700 billion, but many in the euro-zone are concerned that it will not be enough. For example, the European Commission (the EU’s executive arm) argued that the ESM needs €940 billion to adequately contain the crisis. Germany however, believes that €700 billion is sufficient and was successful in defeating those lobbying for an even higher debt ceiling. The option chosen by the finance ministers still must be ratified by the 17 euro-zone member parliaments.

Extreme Poverty Falls, Even Amid Economic Recession

Sources:
Boston Globe: Economic Downturn did not Harm Efforts at Reducing Extreme Poverty in Developing World
Business Standard: Extreme Poverty Drops Worldwide
World Bank: World Bank Sees Progress Against Extreme Poverty, But Flags Vulnerabilities

A new World Bank report finds that the number of people living in extreme poverty—defined as living on less than $1.25 a day—in the developing world has fallen every year between 2005 and 2008, the most recent year where complete data is available. Additionally, according to preliminary data from 2010, the recent global economic recession, which many experts thought would lead to an increase in extreme poverty, instead has only slowed the rate of reduction.

Global attempts at reducing extreme poverty have been notable. In 1981, 1.94 billion people in the developing world lived below $1.25 per day. However, by 2008 that number dropped to 1.29 billion, a reduction of over 600 million people. Poverty reduction has been so rapid that the United Nations Millennium Development Goal of cutting extreme poverty in half from its 1990 level has already been achieved, well before the 2015 deadline.

Progress has been especially dramatic in East Asia. In 1981, the region was the poorest in the world, with approximately 77% of the population living in extreme poverty. By 2008, the percentage had dropped to only 14%. In South Asia, the percentage of people living in extreme poverty dropped from 61% to 36% between 1981 and 2008. In Latin American and the Caribbean, the population living in extreme poverty remained relatively constant at 12% between 1981 and 2002. However, since 2002, extreme poverty has been declining rapidly. In 2005 extreme poverty fell to 9% and by 2008 the number had fallen further to 6%.

Sub-Saharan Africa is the region of the world that has made the least progress since data collection began in 1981. In 1981, 51% of Sub-Saharan Africa lived in extreme poverty, but that percentage rose to 59% in 1993. Some progress has since been made, as the percentage of people in extreme poverty fell from 56% to 52% between 2002 and 2005. In 2008, the population living in extreme poverty was 48%—the first time in the region’s history that less than half of the population was not living in extreme poverty.

Despite the significant reduction in poverty, the World Bank believes additional progress needs to be made. At the current rate of progress, over one billion people will still live in extreme poverty by 2015. Additionally, while many people have escaped extreme poverty, these people remain extremely poor by middle- and high-income country standards. For example, many of those who have escaped extreme poverty now live on less than $2 a day, as evidenced by another recent study showing there has been only a 5% reduction in the number of people living on less than $2 a day between 1981 and 2008 (from 2.59 to 2.47 billion in 1981 and 2008 respectively). This data suggests that while 600 million people have escaped extreme poverty between 1981 and 2008, many of those people remain in dire financial positions. In total, 22% of the developing world still lives in extreme poverty and 43% lives on less than $2 a day. The World Bank hopes that the current trends will continue and world poverty will continue to decline.

Portugal Meets Economic Targets

Sources:
FT: Portugal Announces More Austerity Measures
International Workers Association: About the Austerity Measures and the Last General Strike
Washington Post: International Lenders Say Portugal is Making Good Progress on Implementing Bailout Program
WSJ: Portugal Bailout Seen on Track

The European sovereign debt crisis has affected almost every corner of the globe and resulted in economic problems for many European countries. In 2010, Portugal adopted a set of austerity measures (spending cuts and tax increases) to combat its own debt problems and hopefully avoid the need for a future bailout. Unfortunately, these austerity measures were insufficient, due to the country’s large debt and slowing economy, and a bailout was necessary. The three major credit rating agencies also downgraded Portuguese debt to junk status, signaling that the ratings agencies lost confidence in Portugal’s ability to pay its debt. The rating agencies’ negative views on Portugal spread to investors, resulting in Portugal being required to pay a much higher interest rates to borrow money (higher risk makes an investor demand a higher interest rate because the increased interest income will offset the higher possibility of loss). Because Portugal was forced to pay higher interest rates on its debt, the country had difficulty making its debt payments and moved very close to default.

To fight off default, eight months ago Portugal agreed to a €78 billion ($104.5 billion) bailout with the IMF. To receive bailout funds Portugal must meet economic benchmarks and implement additional austerity measures. Thus far, Portugal has received €34.2 billion ($45 billion) of the bailout. Before the IMF disburses the next portion of the bailout, it must first complete an analysis of the country’s economic position to determine if additional austerity measures are required. The IMF recently completed its analysis and decided that the country is on track to meet the bailout’s economic benchmarks, meaning Portugal does not need to take further action now to receive the next €14.6 billion ($20 billion) of bailout funds.

Portugal’s austerity measures have included labor market reforms aimed at making it easier to hire and fire workers, along with numerous cuts to the public sector including requiring state employees to work additional hours without additional pay, eliminating some paid holidays, and forfeiting bonuses worth more than one month’s pay. The combination of these measures reduced public sector wages by an estimated 20% in 2011 as compared to 2010. Outside the labor markets, the austerity measures have also included a 25% increase in the cost of using public transportation and an increase in the value-added (sales) tax.

Based, in part, on the above austerity measures, Portugal has successfully reduced its deficit-to-GDP (gross domestic product) ratio. In 2010, the ratio was 9.8%—well above the Eurozone maximum of 3%. While exact numbers are not yet available, Portuguese officials believe the ratio will be approximately 5% in 2011—below the 5.9% target set by the IMF. The reduction in the deficit is one of the main positive factors in the IMF’s report.

Even though Portugal will likely meet IMF benchmarks, its economy is not strong. Financial experts project the country will end 2012 with an economic contraction of 3.3%—down from a previous forecast of 2.8%—and currently has an unemployment rate of 14%, which experts project will peak at 14.5% later this year. However, the IMF believes the country’s economic problems will subside in 2013 thanks to increased private investment (leading to the creation of new jobs) and increased exports (increased demand creates a need for more workers to meet that demand).

The IMF’s report is a good sign for the European Union (EU), as it shows that Portugal’s economy is moving forward. However, Portugal is still in the midst of an economic recession and may face future debt problems. If Portugal continues to meet its economic targets, it may avoid the need for a second bailout and additional austerity measures, which will hopefully lead to a faster recovery for the country.

G-20 Officials Meet in Mexico and Postpone Decision to Increase Aid to Europe

Sources:
CBC News: G20 Fails to Reach Europe Debt Deal
Council of the Americas: Feb. 25-26: G20 Finance Ministers Meet in Mexico’s Capital, Discuss EU Crisis
FT: China and Japan Unite on IMF Resources
NYT: G-20 Meeting Focuses on Euro Firewall Fund
Reuters: Mexico Hopeful of G20 Promise on IMF Resources
WSJ: G-20 Defers Move on Aid for Europe

On February 25 and 26, the Group of Twenty (G-20) finance ministers and central bankers, representing twenty major world economies, met in Mexico. They mainly discussed whether to increase the lending capacity of Europe’s rescue funds by combining the European Financial Stability Facility (EFSF) and the European Stability Mechanism (ESM). Uniting the EFSF and ESM would create a $1 trillion firewall to help support struggling European economies like Spain and Italy. The EFSF is a temporary bailout fund Eurozone countries created to address the sovereign debt crisis, and the ESM will replace the EFSF when it takes effect in July 2012 as a permanent bailout fund to provide relief for EU countries in financial crises. G-20 officials also debated whether to increase the IMF’s lending capacity by $500 billion to approximately $1 trillion to provide additional protection for countries facing the effects of global financial instability.

Commentators have remarked on the irony of Mexico serving as Chair of the G-20 for 2012. Three decades after the Latin American debt crisis during which Mexico defaulted on its debt obligations, Mexico’s economy is characterized by “low debt, well-managed fiscal accounts and an inflation rate that is under control.” As Mexican President Felipe Calderón opened the summit, he emphasized Mexico’s unique position to contribute to the European crisis’ resolution considering its own recovery from crisis to emerge as a stable and growing economy. Mexico proposed that the G-20 agree to a simultaneous increase of the European bailout funds and IMF resources. Mexico argued that an increase of both funds is necessary to achieve a large enough firewall to help countries in crisis and stop the debt crisis from continuing to spread.

Contrary to Mexico’s wishes, however, G-20 officials postponed their discussion of an expanded European bailout fund to the next G-20 meeting of finance ministers and central bankers in April because of a lack of consensus on the issue. Germany does not agree that the European bailout fund should be increased, and since it would serve as the major financial contributor, an increase in the bailout fund will not occur without its agreement. Germany’s resistance stems from a belief that increasing the size of the bailout fund would mean that countries like Spain and Italy will not follow through on implementing structural changes. If additional money becomes available to help these countries during the crisis, they will be less likely to institute reforms and impose austerity measures that burden their citizens.

G-20 officials also postponed a discussion of whether to increase IMF resources. To many of these officials, expansion of IMF resources should be contingent on whether Europe’s bailout fund is increased. The United States and Canada have refused to increase their contribution to the IMF without Germany first agreeing to increase Europe’s bailout fund. They hope that if Europe’s bailout fund is substantially increased, an increase of IMF resources will prove unnecessary. China and Japan have also expressed their unwillingness to contribute additional money to the IMF unless European countries first expand their bailout fund. They argue that if the European bailout fund is not increased, an increase in IMF resources cannot cover the gap in funding necessary to stop the Eurozone crisis from spreading to other economies around the world.

Africa Losing Billions in Potential Trade Earnings

Sources:
Economic Times: Africa Losing Out Billions in Trade: World Bank
Herald Sun: Africa Losing Out Billions in Trade
World Bank: Africa Loses Billions in Potential Trade Earnings, Falls Short of Vast Promise in Cross-Border Business―New World Bank Report

A new World Bank report explains how African countries are losing out on billions of dollars in potential trade earnings due to high trading barriers between African countries. Currently, it is easier for African countries to trade with the rest of the world than within the continent. To remedy this situation, many African leaders are calling for an African free trade agreement by 2017.

The African free trade agreement is particularly important because of the global economic slowdown, especially the European sovereign debt crisis. The European debt crisis alone is projected to reduce Africa’s growth rate by 1.3% in 2012 due to the decreased demand for African goods within Europe. Despite Europe’s pessimistic outlook, the World Bank report finds room for significant economic growth in the trade of food, basic manufactured items (leather, wood, paper, etc.), and services between African countries. Only 10% of African economic revenues come from regional trade, as compared to North America where 40% of trade occurs with regional partners, and 63% for Western Europe. The report finds that an African free trade agreement would create larger markets for African goods, increase economic diversification (a larger market to sell goods will allow producers to diversify into many different types of goods, including goods that were not economically possible in a smaller region due to a lack of available consumers), reduced production costs (increased opportunities to take advantage of a specific region’s ability to produce a good at a lower cost than other regions, and then export that good throughout Africa), improve productivity (when specific goods can be produced in very large amounts and exported throughout Africa, producers are able to specialize in that item and increase the efficiency of its production), and reduce poverty (reduced unemployment and increased growth are associated with increased trade).

Current trade restrictions are especially difficult on poor traders, many of whom are women. Many women whom engage in cross-border trade deal with violence, threats, corruption, and sexual harassment. For example, one female egg trader who lives in the Congo but buys her eggs in Rawanda has to bribe custom officials with eggs, often forcing her to give away thirty eggs on each trip. Because an African free trade agreement would focus on reducing governmental corruption, it could reduce or eliminate the need for such cross-border bribes along with reducing other costs.

To unlock the advantages of free trade, the World Bank has recognized the need for African countries to pursue changes in three areas. First, countries need to improve cross-border trade by limiting the number of border agents, reducing corruption among the remaining border agents, and increasing cross-border technologies (such as cross-border mobile banking). Second, countries should remove non-tariff barriers to trade, which would include lifting restrictions on goods based on where they come from, removing import and export bans, and ending costly import and licensing procedures. For example, one African grocery chain spends approximately $20,000 per week on permits required to distribute meat, milk, fruits, and vegetables purchased in other countries. Finally, countries need to reform immigration policies that significantly limit the ability to travel and work throughout Africa, harming the flow of information and reducing investment in the service industry due to the lack of skilled workers to fill a specific service oriented position in certain regions.

To support regional integration the World Bank has increased its investment specifically pertaining to economic integration within Africa from a total of $2.1 billion in 2008 to $4.2 billion in July 2011, and expects total investment to increase to $5.7 billion by July 2012. Such investments have focused on increasing trade by improving infrastructure, implementing new immigration procedures, and eliminating the trade barriers listed in above. The World Bank believes increased continent-wide economic integration will ultimately reduce unemployment and poverty, and increase most African’s standard of living.

The IFC Invests $9.7 Million in Tunisia

Sources:

Canada Newswire: IFC Invests in Candax Energy, Supporting Economic Development in Tunisia
IFC: IFC Organization; Summary of Proposed Investment
NASDAQ: World Bank Group Member, IFC, C$9.8 Million in Candax Energy
Scandinavian Oil & Gas Magazine: Candax Signs Investment Agreement for $11 Million Private Placement

The International Financial Corporation (IFC), a member of the World Bank Group, agreed this week to invest $9.8 million Canadian dollars ($9.7 million U.S. dollars) in Candax Energy to help the country expand its operations in Tunisia. In addition to the IFC investment, certain Candax’s directors and senior management will personally invest approximately two million U.S. dollars into the project. The investment is intended to help Candax increase its oil production in Tunisia while strengthening the local communities and protecting the environment.

The IFC is the largest global development institution focused exclusively on the private sector, with U.S.$68 billion in assets as of 2011. The IFC’s investment in Tunisia is intended to advance Candax’s facilities in the country, especially those in the Robbana oil fields. Candax currently produces 320 barrels of oil per day in Tunisia, but production is projected to increase to 700 per day by the end of 2012 with the proposed investment. The increased production will produce benefits for Tunisian citizens. The oil fields in question are considered marginal, meaning that the amount of easily accessible oil is relatively low and without the proposed investments, extraction at these fields would soon decline significantly, possibly leading to their complete abandonment within the next few years. Candax also hopes the investment will result in the future creation of managerial and oil development positions that will be staffed by Tunisian citizens. However, at the current time, the amount and exact nature of the managerial and development positions are unclear.

Additionally, the IFC will help Candax implement policies and programs intended to minimize the project’s harm to the environment, such as developing methods to safely dispose of water contaminated during oil extraction. Additional IFC funds will be used to create a public consultation and disclosure plan intended to gather input and warn the local community of any potential harms. The investment will also serve to reassure the international community that Tunisia is a safe place to invest, especially considering the instability surrounding the political revolution that started in 2010 and the unknown policies of the recently elected democratic government.

In 2010, the GDP per capita in Tunisia was $9,400 U.S. (as opposed to $47,200 in the United States) and the unemployment rate was 13%. The Candax expansion will hopefully result in both increased economic activity, which will result in increased per capita GDP and reduced unemployment. IFC’s other projects in Tunisia also further these goals by improving the country’s infrastructure and education system, and increasing the availability of credit to start small businesses. The IFC believes the recent investment in Candax, along with its other current projects, will improve the lives of Tunisian citizens.

Hungary on Brink of Default

Sources:
ISRIA: Hungary - Fellegi Started Negotiations with IMF
MarketWatch: Hungary Won't be Last to Make Bondholders Pay
WSJ: Hungary, IMF meet on Loan Conditions
WSJ: Hungarian Forint Strengthens; Euro Falls Below HUF309
Trading Economics: Government Bond Yields - 10 Year Notes - List by Country

Hungary, a country with a total population of 10 million and a GDP of less than $200 million, is not normally the focus of international investors due to its relatively small size. However, Hungary is running out of money and may, within the next few weeks, be the first country in Europe to default as a result of the sovereign debt crisis. A Hungarian default by itself would not likely be catastrophic, due to the country’s relatively small economy, but it could be a precursor to additional European defaults.

Hungary is currently facing default due to a number of factors. Before the recent financial collapse, Hungary’s government and citizens used the availability of cheap credit to grow the economy at unsustainable levels, but after the recent credit crunch the country was unable to obtain the credit necessary to continue fueling that growth. Additionally, many Hungarian citizens incurred significant amounts of debt, most notably on personal mortgages, that many can no longer afford and are unable to refinance. When the Hungarian economy slowed, the country’s debt became a large burden. For example, Hungary’s personal and corporate incomes fell, which lowered government tax revenues and decreased Hungary’s ability to pay its debts. Also, with lower personal incomes, Hungarians had to spend a larger portion of their income on mortgage payments, leaving less income for other purchases, thus lowering consumption and economic growth further. In response to these economic issues, rating agencies have reduced the country’s bond rating to junk status (as a result, the country’s ten-year bond yields are around 10%—as compared to 1.85% in Germany, 3.37% in France, and 1.96% in the United States) and the Hungarian stock market has suffered greatly.

International financial markets want the IMF to step in with a loan of approximately €20 billion, which is enough for Hungary to meet its current debt obligations while the country’s economy recovers. Without IMF assistance Hungary will likely default on its loans, resulting in losses for Hungarian debt holders. The IMF loan would prevent a default, which would assure international investors recover their investments. However, recent talks have broken down based on disagreements about the independence of the Hungarian Central Bank from the Hungarian government and the implementation of austerity measures.

Based on these disagreements, the prime minister of Hungary may decide that a deal with the IMF is not the best option and the country could instead default on its financial obligations. This belief is based, in part, on a comparison of Greece and Iceland. Greece accepted IMF assistance and saw its economy shrink by 5% in one year. Iceland entered a financial crisis in 2008, did not accept IMF assistance, and instead defaulted on certain obligations. While this resulted in a shrinking economy from 2008-2010, the economy is now growing. While defaulting may be a good decision for Hungary, investors are worried that Hungary’s example will lead other countries to reach the same conclusion. Investors fear this outcome because when a country decides to default it will result in debt holders receiving less than the full value of their original investment. Investor confidence in the region would decline, which would negatively affect the amount of money invested and increase countries’ borrowing costs, both of which would harm the European economy. Even though a Hungarian default is possible, most believe Hungary and IMF will reach an agreement.

The IMF’s Assessment of the Chinese Financial Sector

Sources:
Bloomberg: IMF Sees 'Buildup' of China Bank Risk Needing More Oversight
Hindustan Times: China's Financial System Vulnerable, Warns IMF
The Independent: IMF Alert on Banks Adds to Fears About Dangers in China
Irish Times: IMF Warns China Must Relax Grip on Banks and Rates
NYT: IMF Warns China on State Control of Banking
Xinhau Net: IMF Reports on China's Financial System "Generally Objective": PCOB

The International Monetary Fund (IMF) recently completed its inaugural evaluation of the Chinese financial sector as part of the IMF’s periodic look at the twenty-five most important economies in the world. While the report found that China’s financial sector is sound, it also noted several vulnerabilities that need to be addressed and reforms that need to occur.

The report identified many things the Chinese financial sector is doing well, including a trend towards policies the IMF favors. Among these strengths is the Chinese Government’s trend away from state-controlled economic decisions towards a regime where market forces have a greater effect on the economy’s direction. The IMF also applauded China’s increased legal regulation and additional safeguards placed on the financial market, such as interest and exchange rate reforms. Despite the positive movements, the IMF warned that additional regulations are still required.

Chief among IMF concerns is the lack of risk management and regulation in the financial sector, which makes the country vulnerable to asset bubbles, especially within the housing market. Adding to this problem is the artificially low interest rate set by the Chinese Government through the People’s Bank of China. The artificially low interest rates have resulted in increased loans to Chinese citizens giving them more access to money. The increased availability of capital has increased consumer demand, which leads to higher prices in many markets, especially the housing market. This bubble will likely burst when interest rates for consumer loans increase because fewer people will be able to afford the higher loan payments associated with higher interest. Demand for houses will then decrease based on a reduction of potential buyers, and ultimately the price of houses will fall. The IMF is also concerned that extending credit to Chinese consumers will result in loans to less credit-worthy individuals who have a higher chance of default.

The Chinese financial sector also suffers from “shadow banking,” which is unregulated and lightly supervised distributions of capital that occur outside the formal financial market. These transactions, which the Chinese Government cannot adequately track or tax, can lead to financially risky investment decisions that the Government is not aware of and, therefore, cannot prevent or later correct. China also needs to improve its financial accounting oversight system to recognize and proactively stop accounting scandals. Finally, the IMF is concerned that China’s banking system favors state-owned companies over private and foreign corporations by giving Chinese companies easier access to capital—often at lower interest rates. The sum of the above problems has led to inefficiencies in the Chinese financial market.

According to the IMF, China should address these issues by first increasing privatization of the banking system, which the IMF believes will allow the financial sector to react to market trends faster and make more efficient capital allocation decisions. China is likely to retain more state control than the IMF would prefer, however, as state control is the basis of the Chinese financial model. This belief is furthered by China’s relatively successful past operation of state-run companies.

China’s response to the IMF report stated that it believes the report is objective and generally positive, but that the suggested timelines and priorities of certain projects do not reflect the reality of the Chinese economy. As China’s economy continues to move forward, many investors and countries will be following whether China implements the IMF’s recommendations.

The Italian Debt Crisis and the International Monetary Fund

Sources:
Reuters: Analysis: Losing Credibility, EU Seeks IMF's Embrace
Traders Magazine: G20 Summit Roundup
WSJ: UPDATE: UK: G-20 Withheld IMF Commitments, Want Euro-Zone Action

As the European sovereign debt crisis continues to worsen and many countries and investors are questioning the EU leadership’s ability to remedy the crisis, many investors are looking to the International Monetary Fund (“IMF”) to help stabilize and restore market confidence in the region. Market confidence is of upmost importance because the market’s perception of the troubled economies (Italy, for example) will significantly affect the interest rates the countries have to pay on bonds. In the case of Italy, market confidence is of extreme importance because Italy may be able to pay its debts if it is able to receive bonds at low interest rates, but if market confidence falls and Italy appears more risky investors will demand a higher risk premium on their investment in Italian bonds, which will increase Italy’s cost to borrow money and may cause the country to default.

Italy, the third-largest economy in the EU and eighth-largest in the world, is the most recent EU member to find itself in financial trouble. Because of the importance of market confidence in Italy, EU leadership recently forced the country to accept tighter oversight of the country’s economy from the IMF and European Central Bank (ECB). While the EU hoped the move would increase market confidence, some investors believe the move shows that the EU cannot maintain market confidence without outside assistance.

A large factor in market confidence is the ability and willingness of the IMF to offer a bailout to Italy, and potentially the entire EU, if the need arises. At a recent G-20 Summit in France on November 3rd and 4th, the group discussed potentially increasing the IMF’s funding to make a European bailout more plausible. However, before the G-20 will commit to additional funding it first wants to see the EU take more internal actions to control their debt. The G-20 also has specific concerns about the EU’s political structure, which makes quick or firm action almost impossible. Some developing countries that are also members of the G-20 (Brazil, China, and India) stated that they are willing to increase IMF funding if the EU can first show that it has adequate leadership, a clear vision, and the ability to respond to problems rapidly.

While at the current time it seems unlikely that the IMF will make a large loan to the EU, and will instead be involved in more intense economic monitoring, the EU is hoping the IMF’s presence will increase market confidence. However, if EU leadership cannot take concrete steps to confront the growing debt problem and market confidence continues to deteriorate, it may be necessary for the IMF and ECB to play a much more direct role to avert an economic collapse.

The World Bank and Others Suspend Funding to Malawi

Sources:
CIA World Fact Book: Malawi Country Profile
Maravi Post: World Bank to Malawi: Put Your House in Order
Nyasa Times: World Bank Tells Malawi: Address Concerns to Get Aid
Reuters: Malawi Donors to Continue Withholding Aid: Paper
The Star: Malawi Abandons Tobacco for Crop Diversification, Food Security

Malawi, a small, landlocked country in southeastern Africa, currently has one of the fastest growing economies in Africa. Despite the strong growth, Malawi is still struggling with economic and political issues associated with being an underdeveloped country. Adding to these problems is the recent decision of the World Bank and a large number of other donors to withhold $500 million in aid until certain political and economic concerns are addressed. The funding issues are particularly sensitive due to recent economic problems.

Among the political policy concerns that lenders want Malawi to address are threats to media freedom, overall poor governance, deteriorating human rights, and the government’s handling of anti-government demonstrations where twenty protestors were killed. In addition to political concerns, the World Bank is concerned about an economic policy calling for the adherence to a zero-deficit budget, meaning that the country’s spending is higher than its revenues. Many economists believe running a deficit can help reverse an economic downturn. In times of financial hardship demand for goods decreases, which reduces sales and, therefore, profits, which leads to job and wage cuts, which further reduces demand. Governments, in some instances, can reverse this cycle by spending money to increase demand. To do so, however, the government may have to borrow money, and, thus, run a deficit.

If the Malawi Government addresses the above political and economic concerns, budgetary funding from the international community will resume. The funding is especially important given the country’s current economic problems. Tobacco accounts for 70% of the country’s export revenue, but a combination of the global economic recession, overproduction, and anti-tobacco campaigns have reduced its global demand and price, putting deflationary pressure on the Malawian currency. A currency’s value is affected by many factors, one of which is the number of individuals who need to purchase a currency to pay for goods purchased from that country. With the demand and price of tobacco declining, fewer people are buying tobacco from Malawi, which means fewer people need to purchase Malawian currency. This reduced demand leads to a decline in the exchange rate.

The International Monetary Fund (IMF) recognized that the decreased demand for Malawian goods has lead to its currency being overvalued because its value has remained the same even though demand has fallen due to the government’s use of a fixed exchange rate system. During the summer of 2011, the IMF suggested that the exchange rate should be lowered to encourage foreign investment (a cheaper currency means lower costs for foreigners) and align the Malawian exchange rate with what it would be if determined by the free market. The Malawi government followed the IMF’s suggestion and devalued their currency by approximately 10%. Because the Malawian currency is now worth less on the international market, the cost of importing food and oil has increased, which has lead to hardship for many of the country’s citizens, and made the need for international aid especially pressing.

Three Multilateral Financial Institutions Will Collaborate to Loan Money to Help Fund the First Private Wind Farm in Pakistan

Sources:
Associated Press of Pakistan: IFC Supports Landmark Wind Power Project in Pakistan
Bloomerg: Zorul Gets $111 Million Loan for Pakistan Wind-Power Project
Business Recorder: ADB Boosts Pakistan's Wind Power Capacity

The International Finance Corp (IFC), the Asian Development Bank (ADB), and the ECO Trade and Development Bank (ECO) are providing loans of $38.1 million, $36.8 million, and $20 million, respectively, to a company named Zorlu Enerji Electrik Uretim (Zorlu) to expand its wind power generation plant in the Sindh province of Pakistan, near the border with India. Zorlu will use the funding to install additional wind turbines and increase the facility’s electricity capacity from 6 megawatts (MW) to 56.4 MW. The Zorlu project will be the first internationally financed wind power facility in Pakistan and one of the first two wind power projects to operate commercially in Pakistan.

Zorlu’s total cost for the wind expansion project is $147 million. In addition to the amounts supplies by the ADB, ITC, and ECO, Zorlu will supply $35.9 million and Pakistani bank Habib will loan the remaining $16.2 million.

Increased wind power generation is important in Pakistan because the country’s demand for electricity has increased by 40% over the last five years while production has been unable to keep up. Pakistan’s lack of electricity has resulted in brownouts (the partial loss of electricity) in all major urban centers, electricity rationing, and early closing times for businesses, all of which undermine the country’s economy. To combat these problems, the Pakistani government is pushing to expand its energy resources, which includes increasing wind power generation.

The wind project will also help reduce Pakistan’s reliance on imported fossil fuel for the majority of its energy needs, which is very costly and leaves the country vulnerable to changes in global price. The ADB believes that Zorlu’s additional wind output will provide Pakistan with much needed electricity while also increasing the country’s energy security and lowering its reliance on fossil fuels. The IFC hopes that its investment in the Zorlu project will stimulate other international investors to invest in wind power within Pakistan which will stimulate and strengthen the Pakistani economy.

The World Bank Increases Short and Long-Term Aid to the Horn of Africa to Fight Drought and Famine

Sources:
Reuters: UPDATE 2-World Bank Boosts Horn of Africa Aid to $1.88bln
WSJ: World Bank Boosts Aid to Horn of Africa
All Africa: UN Increases Funding for Drought-Hit Africa
Al-Jazeera: Africa's Drought: Is Weather or War to Blame?

The World Bank is increasing funding from $500 million to $1.88 billion to help the more than thirteen million people suffering from the worst drought to hit the Horn of Africa in fifty years. United Nations (UN) officials have called the situation the worst current humanitarian crisis in the world. Most of the aid will go to individuals in Somalia, Kenya, Ethiopia, Eritrea, Djibouti, and Uganda. The stated goal of the aid is to alleviate current pain while putting the region on a path towards sustainable living.

The main reasons for the severe famine are twofold: weather and war. Regarding weather, the region has had two consecutive growing seasons without any rain, which has lead to a devastating decrease in crop production and the death of livestock. In addition to the severe weather, the region is subject to violent militant groups that often destroy crops or do not allow international food aid into the parts of some countries, exasperating the problem.

The World Bank will begin distributing the $1.88 billion by handing out $288 million in 2012 and $384 million in 2013-14 based on needs assessments completed by World Bank experts. The remaining $1.2 billion will be distributed after 2014 to bolster the region’s future drought resistance. The long-term aid will be used to create a system to communicate the early warning signs of future droughts to those who may be affected. The aid will also provide additional support to local farmers with the aim of increasing the geographic diversity of crops and education about new farming techniques that are more resistant to drought. The long-term aid will also help countries increase their emergency food reserves.

While the World Bank’s aid will help, the UN has stated that the countries need an additional $700 million for the last three months of the current year alone. The UN estimates that the countries will need $2.4 billion to meet the needs of the 13 million people the drought is affecting. International donations have totaled $1.4 billion, which leaves a $1 billion remaining funding gap.

Cyprus Could be the Next Casualty of the European Sovereign Debt Crisis

Sources:
AP: IMF: Cyprus Growth Flat in 2011, to Shrink in 2012
Financial Mirror: IMF Sees Negative Growth for Cyprus; "Time is Up for Fiscal Measures"
FT: Cyprus Governor Warns of Emergency After Blast
FT: Mediterranean Gas Reserves Tension Flares
Fumagusta Gazette: Fule Stresses Cyprus' Right for Drilling
Reuters: IMF Says Cyprus Must Act Fast to Avoid Crisis

The International Monetary Fund (IMF) recently urged that Cyprus move forward with austerity measures if it hopes to avoid a debt crisis—and accompanying bailout—similar to the ones that have engulfed Greece, Ireland, and Portugal in recent years.

After spending eleven days studying the Cypriot economy, the IMF projected that Cyprus’s economy will not grow for the remainder of 2011 and will shrink slightly in 2012. The IMF also predicted that Cyprus’s fiscal deficit will swell to 7% in 2011, although it should decrease to 4% in 2012. These projections are less optimistic than those of the Cypriot government, which projected 1.5% growth and a 2.3% deficit in 2012.

Cyprus is an island nation in the Mediterranean Sea with a population of one million people and a €17 billion ($23 billion) economy. Aside from its ongoing fiscal deficit, Cyprus has encountered two additional financial difficulties this year. On July 11, a power station explosion caused an estimated €2 billion ($2.7 billion) in damages. Later that month, credit agencies downgraded the country’s bond rating due to Cyprus’s banks’ heavy exposure to Greek debt—a country going through its own debt crisis. The downgrade pushed interest rates on Cypriot bonds up as investors demand a higher yield (interest rate) to compensate them for the higher risk they are taking in purchasing Cypriot bonds. The IMF also recommends Cyprus conduct “stress tests” on its banks to determine whether they have sufficient capital (cash) on hand to cover any losses that would result from various adverse economic scenarios. These tests would give Cyprus a better understanding of the future financial difficulties it may face and would enable the country to prepare accordingly.

Despite Cyprus’s gloomy outlook, there are some positive signs. Cyprus is in the process of finalizing a €2.5 billion ($3.4 billion) loan from Russia at an interest rate of 4.5%, which is much lower than the current rate Cyprus can borrow at on the international bond markets. The loan will allow Cyprus to pay down some of its existing—and higher interest—debt. Furthermore, the discovery of large natural gas deposits in the Mediterranean provides hope for a boost in Cyprus’s economy. However, ongoing disputes with Turkey about Cyprus’s rights to the natural gas threaten to put a halt to drilling efforts.

The IMF cautions that these positive developments should not weaken the government’s resolve to push through austerity measures. Among the IMF’s recommendations for spending cuts are to mandate public sector employees to contribute to their pensions, freezing public sector wages and the cost of living allowance on public pensions, and raising the value-added tax. In line with the IMF’s recommendations, the finance minister’s 2012 draft budget includes a 1,100 person reduction in public sector employment, a €220 million ($299 million) reduction in social spending, and an increase in the value-added tax from 15% to 17%. The finance minister will present this budget to the parliament in mid-October, but given opposing political parties’ opposition, it is unclear whether the budget will pass.

Cyprus may not be the largest or most important economy in the European Union, but unless it takes steps to reduce its growing debt, it may be the next country in need of a bailout.

The International Monetary Fund Reduces the Economic Forecast for Europe and the United States

Sources:

Detroit Free Press: IMF Sharply Downgrades Outlook for U.S., Europe
Guardian: IMF wants Europe to get its Finger out and US Politicians Should Behave like Adults
The Jerusalem Post: IMF to Europe: Get Your Act Together

The International Monetary Fund (IMF) recently warned that the world economy has entered a dangerous phase and that national governments need to take strong actions to improve the world economic outlook. The IMF has significantly downgraded the financial outlook for both the United States and Europe through 2012. The IMF forecasts that the U.S. economy will grow by 1.5% in 2011 and 1.8% in 2012, as compared to its prior projections of 2.5% and 2.7% respectively. For the seventeen countries that use the Euro as their currency (the Eurozone), the IMF has forecasted economic growth of 1.6% in 2011 and 1.1% in 2012, which are reductions from prior forecasts of 2% and 1.7% respectively.

Within the United States, the IMF believes a sharp drop in the stock market and political indecision surrounding the government’s deficit reduction plan has created uncertainty. This uncertainty has caused consumers and corporations to save their money instead of spending or reinvesting, which slows economic growth. These and other factors have contributed to an annualized growth rate of .7% in the first half of 2011, which is well below even the revised IMF forecast.

The pessimistic forecast for the Eurozone centers on the sovereign debt crisis. The IMF is concerned that some Eurozone countries will not sufficiently control their debt, which may lead to destabilization within the region. When banks, consumers, and companies are unsure about their economic future, they are less likely to lend money, make long-term investments, or make discretionary purchases, and will instead save excess cash. Reduced lending, investment, and spending leads to lower economic growth, and, therefore, lower revenues for governments to use in paying their debts. The IMF has criticized European leadership for not moving quickly enough to remedy the uncertainty surrounding the debt crisis.

To combat slowing economic growth, the IMF suggests that European central banks and the United States Federal Reserve Bank continue searching for ways to lower borrowing costs, which would hopefully spur increased spending and investment. The IMF also suggests that the United States and European governments spend money to stimulate economic activity instead of reducing spending to lower budget deficits.

Building South Asia’s Infrastructure

Sources:
ADB: Innovative Fund to Pave Way for Infrastructure Boom
Asia One: ASEAN Launches $650m Fund to Build Infrastructure
Bernama: ASEAN Infrastructure Fund Set to Pave Way for Infrastructure Boom
Brunei Times: US$500m Infrastructure Fund for ASEAN Launched
Business World: ASEAN Infrastructure Fund Seen Fueling Regional Boom

The Association of Southeast Asian Nations (ASEAN), made up of Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, the Philippines, Singapore, Thailand, and Vietnam, launched a $500 million fund on September 24, 2011 to finance infrastructure projects that will better interconnect the region and improve access between the region and surrounding countries with larger economies. The Asian Development Bank (ADB), the Manila-based regional financial institution, will oversee the fund.

The ASEAN countries created the fund after observing that China, a country with which they have tenuous political relations, has been looking to exert more influence over them by increasing its investment in the region. As a result, the ASEAN countries have agreed that they need to invest more within the region to avoid becoming overly reliant on China’s money. They also believe that the region’s lack of highways, railroads, and an efficient electric grid is inhibiting economic growth by increasing production costs.

The ADB will administer the fund and be responsible for choosing and overseeing all of the projects that receive money from the fund. The ADB will select projects based on evaluations of their potential economic and social impact. Initially, member country contributions will make up 70% of the funds, and the ADB will contribute the remaining 30%. The fund will lend about $4 billion total through 2020, but the ADB projects that the countries will need a combined $60 billion for infrastructure projects over the next decade. The fund will serve as way for the ASEAN countries to effectively use the region’s $700 billion in foreign currency reserves. The countries also hope the fund will entice much-needed private investors who have been reluctant to invest in infrastructure projects in these countries because of the perceived high risk of long-term infrastructure transactions.

If successful, this co-venture between ASEAN and the ADB will encourage major economic development in the Southeast Asia. Improving infrastructure will reduce production and transportation costs, which should lead to increased trade and revenue. In addition, the infrastructure will improve the lives of millions of people in the region by increasing access to water and electricity.

Portugal Expected To Receive €3.98 Billion Disbursement from IMF

Sources:
BBC: Portugal Bail-out
CBS Money Watch: Portugal to get More Bail Out Funds
ECB: Statement by the European Commission, ECB and IMF on the first review mission to Portugal
IMF: IMF Completes First Review Under an EFF with Portugal
IMF: Executive Board Approves an €26 Billion Extended Arrangement for Portugal

On September 12, the Executive Board of the International Monetary Fund (IMF) completed the first review of Portugal’s performance under a three year, €78 billion, bailout agreement reached earlier this year. The successful completion of the review allows Portugal to immediately receive a €3.98 billion disbursement from the bailout fund, bringing total disbursements under the agreement to €10.43 billion.

One of the main reasons for Portugal’s financial trouble is that the country’s economy has not grown fast-enough to keep up with the government’s spending. As a result, the government has had to take on a great deal of debt to continue providing the services its citizens have come to expect. As the financial crisis worsened, interest rates on Portuguese bonds increased due to investors’ fears that Portugal was taking on too much debt, which made it more expensive for Portugal to continue borrowing money. Eventually, interest rates increased so much that Portugal needed external financial support to pay its debts—a bailout.

Under the bailout agreement, approved on May 20, 2011, the IMF and other European countries agreed to lend Portugal €78 billion on the condition that it make specific dramatic economic reforms within the next year and a half to address the country’s debt. The reforms, which include forcing banks to increase cash reserves and reducing government payroll costs, are meant to improve competitiveness and put Portugal’s economy on a path toward sustainable growth. In its first review of the country’s austerity program, the IMF stated that the country is on track to meet its fiscal target of reducing the budget deficit to 3% of gross domestic product (GDP) by 2013. The IMF also expects economic growth and inflation to remain in line with its conditions.

The review committee noted that Portuguese banks have been successful in increasing their capital (cash) reserves to meet the new capital adequacy requirements, and that the Portuguese government has made progress in strengthening its supervisory and regulatory framework over the financial sector. Nevertheless, the success of the IMF program is greatly dependent on the government’s ability to address another one of Portugal’s main problems—lack of competitiveness—by opening the economy to competition. To do so, the government has so far eliminated the special rights (shares) it holds in private companies to reduce government involvement in the private sector, which helps level the economic playing field. While the reforms appear promising so far, Portugal still faces more difficulties. The review committee made it clear that Portugal has not yet done enough to ensure the future stability of its debt.

IMF Lowers its Prediction for Debt-ridden Ireland's Economic Growth

Sources:
Belfast Telegraph: Noonan Plays Down Budget Fears
Bloomberg: IMF to Cut Irish Growth Forecasts as Outlook Worsens for Trading Partners
The Independent: Enda Kenny Elected Taoiseach
Irish Times: IMF Says Irish Economy to Grow
Reuters UK: IMF Cuts Irish Outlook, Urges More Asset Sales
WSJ: IMF Urges Flexibility for Ireland

Although the International Monetary Fund (IMF) forecasts Ireland’s economy to grow in 2011 for the first time in three years, it lowered its prediction for Ireland’s 2011 growth from 0.6% to 0.4%, and 2012 growth from 1.9% to 1.5%. This unwelcome news is due, in part, to the weakening economies of Ireland’s main trading partners (the Eurozone countries, United States, and United Kingdom), but also to fears that Ireland may suffer negative side effects if Greece has to restructure its debt.

The IMF has been monitoring Ireland since November 2010, when a banking crisis compelled Ireland to ask the IMF and the European Union (EU) for assistance. In exchange for an €85 billion ($114 billion) bailout, Ireland agreed to recapitalize its banks and introduce government austerity measures (a mix of spending cuts and higher taxes). These measures were aimed at reducing Ireland’s budget deficit to less than 3% of gross domestic product (GDP) by 2015.

There have been significant political and economic changes in Ireland since the EU/IMF bailout. In a March 2011 election, Prime Minister Brian Cowen of the Fianna Fail party lost his position to a coalition government led by Enda Kenny of the Fine Gael party. Prime Minister Kenny has continued Ireland’s austerity programs and the IMF reports that Ireland is on target to meet the fund’s 2011 deficit target of 10.5% of GDP. In July, Ireland’s progress in implementing austerity measures led Eurozone leaders to cut the interest rate Ireland pays on its bailout loans. Furthermore, Ireland has seen a rise in its exports (and, therefore, its export revenue), although the IMF cautions the increased exports could be temporary due to recent declines in new export orders.

Even with lower deficits, higher growth rates, and increased exports, the IMF warns that Ireland and the Eurozone still need to do more to restore investors’ confidence in Ireland. The IMF suggests Ireland consider selling €5 billion in assets to raise more funds (potentially the country’s stakes in the airline Aer Lingus and several energy firms), and recommends that Eurozone leaders consider making the European Financial Stabilization Fund (EFSF) more flexible to address future financial risks.

Despite the IMF’s and Eurozone’s attempts to rescue Ireland from its debt crisis, Ireland’s low economic growth and large, persisting deficit are still daunting problems. Finance Minister Michael Noonan recently admitted that future deficit-reductions may require “rather difficult policy decisions.” For a Prime Minister attempting to fix a struggling economy while promising no new taxes or cuts to social welfare programs, these will be difficult policy decisions indeed.