Is the global financial firefighter well prepared?

The world needs to prepare for a cascade of financial crises in emerging and developing economies. The signs are already evident, with Ghana, Pakistan, Bangladeshi Y Sri Lanka queuing outside the International Monetary Fund. Today the richest countries must equip the IMF, the main financial firefighter on the planet, to prevent and manage the spread of crises. They could start by making sure the organization has the funds it needs to prevent lower-income economies from adopting “beggar-thy-neighbor” policies that end up destroying other countries’ livelihoods and threatening political and economic stability.

As the US dollar strengthens and global growth slows, several governments of poor countries that were already struggling due to Covid-19 and the food and energy crises caused by Russia’s war in Ukraine, must now face the depreciation of their currencies and the increase in debt costs. Nor can you count on the support of China, when its economy grows slowest in four decadesdue to its new political priorities, its Covid zero measures, its ailing real estate market, demographic pressures and structural reforms.

To make matters worse, foreign investors are withdrawing their funds in emerging countries at a pace that sets a historical record. As a result, several of these countries are turning to foreign currency reserves they had carefully accumulated after past crises.

“As the US dollar strengthens and global growth slows, several governments of poor countries that were already struggling (…) must face the depreciation of their currencies and the increase in debt costs”

Large economies should be taking several practical steps. For example, during the global financial crisis of 2008-09, the leaders of the G20 agreed create a “trillion dollar IMF” with the ability to reduce and contain the spread of the crisis. That meant letting the IMF borrow from a group of countries willing to lend it funds, as well as increasing its capital to 477,000 million special drawing rights (SDR), or $621 billion.

The IMF has additional lines of defense. In January 2021, your New Arrangements to Borrow (NAB) program, under which 38 countries they have agreed to lend to the IMF if needed, doubled in size and extended to 2025. In addition, the IMF has established bilateral loan agreements, the extent of which is currently being negotiated.

Furthermore, in August 2021 the countries agreed on a general allocation of $650 billion in SDRs, the largest in the Fund’s history. Its purpose was to strengthen the resilience and stability of the global economy, and help vulnerable economies that were struggling to overcome the Covid-19 crisis. However, since the SDRs are distributed according to the countries’ quotas in the IMF, which depend largely on their GDP, the impact of the measure has been rather limited.

In past financial crises, the IMF has played a key role in helping to maintain a minimum level of confidence, thereby reducing the costs of containing and managing crises. Given the current landscape of volatile markets, investors withdrawing their funds, and financially overburdened governments, there is a good case for reinforcing the IMF’s advocacy capacity.

To begin with, the G20 countries should commit to double the main capital of the IMF, which means doubling the contribution of each country (which is proportional to the size of its economy). Such negotiations have proven difficult in the past, as fast-growing economies will insist on higher quotas (influence) in the IMF, as Japan, Saudi Arabia, and China have done over the years. The sweeping reforms of 2010 brought about substantial changes, and while geopolitical tensions have increased since then, they were changes that paved the way for another surge now.

One of the few areas that the G20 countries will agree on is the need for the IMF to play a central role in managing a global crisis. They should do it soon, because ratifying and implementing a new set of quotas will take time (five years, in the case of the 2010 agreement).

A second and more immediate step would be for the IMF to improve its credit arrangements with richer countries through the aforementioned bilateral agreements and the NAB. For example, the energy-producing countries of the Middle East will receive up to $1.3 trillion in additional oil revenue over the next four years and, if they agree to increase their loans to the IMF, they can earn a silent advantage.

“A more controversial and much less talked about option is for the richer countries that are not debtors to the IMF to reduce the amount that the IMF pays them for their debt to them.”

A third possibility is to sell part of the gold reserves from the IMF, or for countries to accept another general allocation of SDRs. But again, most of the SDR issuance goes to the largest economies (which, for the most part, have preferred not to redistribute them to countries in need). Furthermore, there are limits to the willingness of countries to exchange their hard currency reserves for SDRs.

A more controversial and much less talked about option is for richer countries that are not debtors to the IMF to reduce the amount that the IMF pays them for their debt to them. In 2020, the IMF allocated 546 million SDR to remuneration of posts in the reserve tranche of its members, and another 90 million SDRs in interest, amounts that will increase as the interest rate on SDRs rises and credits pending payment by the IMF.

Finally, the IMF, like the World Bank, its sister institution, could tap into capital markets, something it has never done before. The World Bank’s International Bank for Reconstruction and Development (IBRD) provides loans to low- to middle-income countries, and raises those funds by borrowing 4-5 times its own capital from the markets. Even the International Development Association (IDA), the Bank’s concessional financing vehicle 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, allowing them to minimize their cost of capital. Their experience, along with that of other multilateral creditors, suggests that the IMF could issue AAA-rated debt and leverage its own funds, taking advantage of its history of never having failed in its 78-year history.

The powerful countries that are part of the IMF, especially those that are also in the G20, must seriously consider what is at stake. Like the wildfires that raged across the northern hemisphere this summer, financial crises spread fast. To deal with them effectively, it will be necessary to provide the IMF with well-positioned reserves and firewalls in advance.

© Project Syndicate, 2022. www.project-syndicate.org