Europe needs to follow a basic, but necessary, five-point action plan if it is to recover from the current financial crisis, says Arvind Virmani, International Monetary Fund (IMF) Executive Director, India.
Speaking on Wednesday in Ottawa, Virmani says the plan includes policy reform to get growth back on track, debt restructuring for insolvent countries such as Greece and Portugal, bank capitalization, IMF assistance and most importantly, help from the European Central Bank (ECB).
“This is now the problem [politicians] are struggling with,” Virmani said, noting that the ECB has a constitution by which it cannot act as a so-called lender of last resort. “What saved the day in the U.S. was two-fold: the Treasury provided the fiscal backstop and the Federal Reserve provided the unlimited liquidity necessary.”
“This is the sticking point – they are desperately looking for ways in which this can be done,” Virmani said. “It is my view that unless this happens, Europe cannot be saved.”
The ECB has been under pressure to buy bonds from insolvent countries. ECB president Mario Draghi has argued this violates the treaty that established the central bank in 1998.
Virmani admits there’s disagreement on the ECB liquidity issue. “Many people don’t agree with me, but I have challenged them to show me a way that it can be done. I am waiting for a response to that challenge.”
Unless the ECB constitution is modified, which appears unlikely, Virmani says, European leaders may look for more indirect ways of providing liquidity. “There’s been talk of the IMF setting up a special fund to which ECB and other national banks of the Euro area will contribute to provide liquidity to certain countries. The mechanism is not important but the fundamental concept is key.”
Virmani notes that no matter what decisions are taken, the IMF will have an important role to play given that the current crisis could affect other countries around the world, what the IMF calls innocent bystanders.
“The IMF has to be ready to provide liquidity to these innocent bystanders,” he says.
And Virmani admits the IMF wasn’t quick off the mark in terms of even recognizing the current crisis in Europe. “People didn’t believe that things could go wrong again. Two years ago, no one in the IMF was willing to accept that possibility that Greece was insolvent.”