Is the world’s financial firefighter ready?
The world needs to prepare for a series of financial crises across emerging and developing economies. The writing is already on the wall, with Ghana, Pakistan, Bangladesh and Sri Lanka currently queuing at the IMF door.
Rich countries must now equip the International Monetary Fund – the world’s leading financial firefighter – to prevent and manage the spread of crises. They can start by making sure the fund has the resources to stop low-income economies from adopting neighbor-begging policies that destroy other countries’ livelihoods and threaten political and economic stability.
With the US dollar strengthening and global growth slowing, many governments of poor countries already seriously overwhelmed by the coronavirus, and food and energy crises sparked by the Russian war in Ukraine, must contend with currency devaluations and rising borrowing costs.
Support from China is waning as the country’s new political priorities, non-proliferation policies, a faltering property market, demographic pressures and structural reforms cause its economy to grow at its slowest rate in four decades.
To make matters worse, foreign investors are withdrawing money from emerging markets at a record pace. As a result, many of these countries are burning the foreign exchange reserves they had carefully amassed after previous crises.
Major economies must now take several practical steps. During the 2008-2009 global financial crisis, for example, G-20 leaders agreed to create a “trillion-dollar international monetary fund” that would have the means to slow and contain the spread of the crisis. This included allowing the IMF to borrow from a group of willing countries, as well as increasing the fund’s capital to SDR 477 billion ($621 billion).
The IMF has additional lines of defense. In January 2021, the New Borrowing Arrangements Scheme, according to which 38 countries agreed to lend to the Fund if needed, doubled in size, and it was extended until 2025. The IMF also has bilateral borrowing agreements, which are currently being extended. is being negotiated.
Moreover, in August 2021, states agreed to a general allocation of $650 billion for Special Drawing Rights, the Special Drawing Rights, the largest in the fund’s history. The aim of this allocation was to enhance the resilience and stability of the global economy and help vulnerable economies that were struggling to deal with the coronavirus crisis. But since the SDR is distributed according to IMF quotas to countries, which are highly dependent on their GDP, the effect of the measure was limited.
The need for the IMF to play a central role in managing a global crisis is one of the few areas on which the G-20 countries may agree.
In previous financial crises, the IMF has played a key role in helping to maintain a minimum level of confidence, thus reducing the costs of crisis containment and management. Given volatile markets, fleeing investors, and financially exhausted governments, there is a strong case for strengthening the IMF once again.
First of all, the G20 countries should commit to doubling the core capital of the International Monetary Fund. This means a twofold increase in each country’s contribution – which is proportional to the size of its economy. Such negotiations have been difficult in the past, because fast-growing economies will insist on gaining larger stakes in the IMF, as Japan, Saudi Arabia and China have done over the years. The far-reaching reforms of 2010 included fundamental changes, and although geopolitical tensions have escalated further since then, these changes have paved the way for a further increase now.
The need for the IMF to play a central role in managing a global crisis is one of the few areas on which the G-20 countries may agree. They should do so soon, because ratification and implementation of any new set of quotas will take time – five years, in the case of the 2010 agreement.
The second most urgent step is for the IMF to strengthen its borrowing arrangements with wealthier countries through the above-mentioned NAB and bilateral agreements. Middle East energy producers, for example, are set to receive up to $1.3 trillion in additional oil revenue over the next four years, and will gain quiet leverage by agreeing to increase their lending to the International Monetary Fund.
A third possibility is either selling some of the IMF’s gold holdings, or countries agreeing to another year’s allocation of SDRs. But, again, the bulk of SDR issuance goes to the largest economies (which have mostly chosen not to redistribute them to needy countries). Moreover, there are limits to countries’ willingness to exchange their hard currency reserves for SDRs.
The least debated and most controversial option would be for the richer countries that do not borrow from the IMF to reduce the amount that the Fund pays in return for giving them credit. In 2020, the IMF spent SDR 546 million on reserve tranche compensation for members, and another SDR 90 million on interest expense. This is set to increase now, as both the credit owed to the IMF and the interest rate on the SDR rise.
Finally, the IMF, like its sister institution, the World Bank, can tap into the capital markets — something it hasn’t done before. The World Bank’s International Bank for Reconstruction and Development provides loans to low- and middle-income countries by borrowing four to five times its market capital. Even the International Development Association, the Bank’s concessional instrument for the poorest countries, relies on capital markets to maximize its financing, albeit on a much smaller scale.
Both IBRD and IDA have AAA credit ratings, enabling them to reduce the cost of capital. Their experience, as well as that of other multilateral borrowers, indicates that the IMF can issue AAA-rated debt and leverage equity, as well as its track record of not reporting any credit loss over its 78-year history.
The powerful countries of the IMF, especially the G-20, have to think seriously about what is at stake. Like the wildfires that broke out in the northern hemisphere this summer, financial crises spread quickly. Managing it effectively will require equipping the IMF early with well-placed reserves and fire retardants.
• Neger Woods, Dean of the Blavatnik School of Government, University of Oxford.
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