Is the world’s financial firefighter ready?
G20 countries should commit to doubling the core capital of the IMF.. (Shutterstock) The world must prepare for a cascade of financial crises in emerging and developing economies. The writing is already on the wall, with Ghana, Pakistan, Bangladesh and Sri Lanka currently queuing at the door of the International Monetary Fund. Richer countries must now equip the IMF – the global financial firefighter – to prevent and manage the spread of crises. They could start by ensuring that the Fund has the resources to stop lower-income economies from adopting beggar-the-neighbor policies that destroy other countries’ livelihoods and threaten political and economic stability. As the US dollar strengthens and global growth slows, many poor country governments already strained by COVID-19 and the food and energy crises sparked by Russia’s war in Ukraine now have to deal with currency devaluation and the rising cost of borrowing. And support from China is waning as the country’s new policy priorities, zero-covid-19 policies, distressed housing market, demographic pressures and structural reforms cause its economy to grow at its slowest pace in four decades. Adding fuel to the fire, foreign investors are pulling capital out of emerging markets at a record pace. As a result, many of these countries are burning through the foreign exchange reserves they had carefully built up after previous crises. Major economies should now take several practical steps. During the global financial crisis of 2008-09, for example, G20 leaders agreed to create a “trillion-dollar IMF” that would have the means to slow and contain the spread of the crisis. This included letting the IMF 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 Arrangements to Borrow program, under which 38 countries agreed to lend to the Fund if needed, doubled in size and was extended until 2025. The IMF also has bilateral loan agreements, the extension of which is on currently under negotiation. In addition, countries agreed in August 2021 to a general allocation of $650 billion in Special Drawing Rights, SDRs, the largest in the Fund’s history. The allocation was intended to strengthen the resilience and stability of the global economy and help vulnerable economies struggling to cope with the COVID-19 crisis. But because the SDRs are allocated according to countries’ IMF quotas, which depend heavily on their GDP, the impact 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 G20 countries are likely to agree.
Ngaire Woods In previous financial crises, the IMF played a key role in maintaining a minimum level of confidence, thereby reducing the cost of crisis containment and management. Given the volatile markets, fleeing investors and fiscal governments, there is a strong case for the IMF’s firepower to be stepped up again. For starters, G20 countries should commit to doubling the core capital of the IMF. This means doubling 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 getting bigger quotas at the IMF, as Japan, Saudi Arabia and China have done over the years. The far-reaching reforms of 2010 included substantial changes, and although geopolitical tensions have increased further since then, these changes have paved the way for further escalation now. The need for the IMF to play a central role in managing a global crisis is one of the few areas on which G20 countries are likely to agree. They should do so soon, because any new quota package will take time to ratify and implement – five years, in the case of the 2010 deal. A second, more immediate step would be for the IMF to strengthen its lending arrangements with richer countries through the aforementioned NABs and bilateral agreements. Middle Eastern 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 IMF. A third possibility is either to sell off some of the IMF’s gold reserves, or for countries to agree on another general SDR allocation. But, again, most SDR issuance goes to the largest economies (which have mostly chosen not to redistribute them to countries in need). Furthermore, there are limits to countries’ willingness to exchange their hard currency reserves for SDRs. A much less discussed and more controversial option would be for richer countries that do not borrow from the IMF to reduce the amount the Fund pays them to provide credit. In 2020, the IMF spent SDR 546 million on the remuneration of members’ reserve positions and another SDR 90 million on interest expenses. This is now set to increase as both outstanding IMF credits and the SDR rate increase. Finally, the IMF, like its sister institution, the World Bank, would be able to tap into the capital markets – something it had never done before. The World Bank’s International Bank for Reconstruction and Development provides loans to low- to middle-income countries by borrowing four to five times its market equity. Even the International Development Association, 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, which allows them to minimize their cost of capital. Their experience, as well as that of other multilateral borrowers, suggests that the IMF could issue AAA-rated debt and leverage its own capital, as well as its track record of never reporting a credit loss in its 78-year history. The strong IMF countries, especially the G20, must now seriously consider what is at stake. Like the wildfires that ravaged the northern hemisphere this summer, financial crises spread quickly. Their effective management will require adequate equipment of the IMF in time with well-positioned reserves and firefighters. • Ngaire Woods is dean of the Blavatnik School of Government at the University of Oxford. Disclaimer: The views expressed by the authors in this section are their own and do not necessarily reflect the views of Arab News
