There have been impassioned calls from many world leaders in recent days for the IMF to boost its power to extend finance to the world’s poorest countries with an expansion of fund members’ special drawing rights, which form part of their international reserve assets.
The goal is to help low-income countries boost health and other fiscal spending as coronavirus spreads. Under the IMF’s allocation mechanism, many of the poorest nations, with the smallest reserves, would see the largest proportionate increase in spending power, although the largest absolute increases would go to bigger countries.
The IMF Executive Board and the G20 have announced large, though probably insufficient, packages of debt relief. They have also indicated that they would like to explore proposals to increase allocations of SDRs.
However, the US has the IMF voting power to veto this initiative unilaterally, and “for now” it says it is against any general allocation of new SDRs, reportedly because it does not want to give China and Iran access to unconditional extra reserves.
The IMF has only ever issued one sizeable chunk of additional SDRs. That was in 2009 when Gordon Brown, then UK prime minister, persuaded other world leaders to sanction an astonishing $1tn injection into the global economy, including $250bn of additional SDRs, during the financial crisis.
One flaw then, and now, is that new reserves are allocated according to members’ quotas — or shares in the IMF. A great deal of the benefit in 2009 went to advanced economies that didn’t need help in accessing markets or financing fiscal deficits. If the same system was used now, only 40 per cent of the total would be given to the emerging economies. That is not good enough.
To overcome that problem we should revive a proposal from George Soros. He suggested in 2009 that advanced economies voluntarily transfer part or all of their new SDR holdings to low-income nations with greater need. There was little interest at the time, in this new form of international financial aid. In any new allocation of SDRs, this idea should be reintroduced. Even the US has hinted that it may be willing to consider similar proposals.
I was an external adviser to Mr Brown in 2009 and I remember that there was much excitement that the IMF’s new-found ability to increase the supply of SDRs, often labelled “paper gold”, would boost global demand and help the worst-hit economies. This was the original dream of Maynard Keynes, who invented the basic concept of the SDR, which he called “Bancor”, in 1940.
Did it work?
The expansion in global liquidity definitely helped to transform risk sentiment in financial markets. There had been a huge exodus of capital from the emerging markets into the dollar, greatly exacerbating the global financial shock. Because the new SDRs enabled emerging countries to acquire more dollars via the IMF, instead of in the open market, the summit helped to turn sentiment in the foreign exchange and other markets in the right direction.
The peak of the stampede into the dollar in 2009 coincided almost exactly with the summit. In the coronavirus crash, the capital flight from emerging economies has been three times as large as it was then, and a dose of the same medicine would be very timely.
Furthermore, many low-income economies did use their SDRs to acquire liquidity, with 21 of the most needy countries cashing in 75 per cent of their allocations. Fears that the increase in liquidity would lead to much higher inflation or cancellation of necessary adjustment programmes proved misplaced.
However, there were some disappointments. The size of the SDR issue had little effect on global growth in the following few years. One reason was that the entire allocation amounted to less than 1 per cent of the value of global trade in 2009.
Mr Brown, along with economist Lawrence Summers, returned to the fray last week, calling for a new issue of SDRs worth well over $1tn. This would be commensurate with the scale needed to handle the current crisis in the emerging world. But US Treasury secretary Steven Mnuchin needs congressional approval to permit any SDR allocation above $649bn, and he does not seem inclined to support even that amount.
An important opportunity for a major breakthrough was missed at the IMF and World Bank spring meetings last week,but given the scale of the crisis facing low-income countries this year, the subject is far from closed.
Source: This note is based on material which appeared in an article by Gavyn Davies published in the Financial Times on 19 April 2020.
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