Since the outbreak of the Coronavirus, developing countries have been exposed to massive withdrawals of capital flows. In this post, I unpack the financial challenges these countries are facing and consider what role the Special Drawing Rights (SDRs) of the IMF can play in easing the burden.
According to the calculations by the Institute for International Finance (IIF), investors withdrew almost $80 billion over recent weeks from emerging markets (Wheatley 2020). During periods of crisis, investors ‘fly to safety’ by selling risky assets and purchasing safe assets such as US Dollars and the US Treasury Securities. As international investors flee to dollars amidst the financial turmoil caused by the Coronavirus, there is an acute concern that low and middle-income countries will be short of dollars. Furthermore, the scale of the withdrawal suggests that these countries will face great difficulty in raising funds for their sovereign debt payments. Besides governments, firms based in developing countries are also expected to face difficulties in raising foreign currency-denominated debt in international capital markets. Meeting this growing demand requires a global lender of last resort that can provide dollars on request. Within the existing global financial order, the Fed and the IMF are two major organizations that are capable of meeting this demand.
The Fed can provide dollar liquidity through swap lines, which allows global central banks access to dollars in exchange for their own currency with the promise that the principal, as well as the interest, will be paid later. When engaging in a swap operation, the Fed provides dollars to the recipient central bank for an equivalent amount of their currency at a given market exchange rate. After a certain period, the two central banks resell to each other their respective currencies at the initial exchange rate. The recipient central bank provides the dollars to financial institutions in its jurisdictions at the same maturity and rate. This way, swap lines provide dollar liquidity to recipient countries’ central bank and financial institutions (Bahaj and Reis 2018).
To meet the rising demand for the US Dollars, the Fed has recently extended its dollar swap lines. However, despite the extension, the scope of this operation is still minimal as it includes 14 countries, out of which only two of them (Brazil and Mexico) are emerging economies (three if we count South Korea as an emerging market).
The IMF’s emergency loans are another option for countries facing financial difficulties. According to Kristalina Georgieva, the managing director of the IMF, 103 countries have already approached the IMF for emergency financing (Georgieva 2020). Besides deploying new emergency lending facilities, the IMF, together with the World Bank and the G-20 countries, has agreed to a debt standstill for the 76 poorest countries. Even though introduction of new channels to disburse funding and the temporary debt relief are positive developments, it does not fully address the dire financing needs of many nations. For instance, economic historian, Adam Tooze, notes that the needs of low-income countries are small in economic terms as they owe just over $150 billion in public debt. However, the emerging markets owe about $7.69 trillion, of which $484 billion is long-term bonds held by private investors, $2 trillion is long-term debts owed to banks, and $2.1 trillion is short-term borrowing (Tooze 2020).
In the context of the urgent liquidity needs of developing countries and the insufficiency of other responses to address this gap, there have been several calls, from academics, policy makers and politicians, for a major issuance of SDRs to address the financial fallout caused by the Coronavirus Crisis.
The recent proposals to issue SDRs in response to the Coronavirus crisis
SDRs are interest-bearing international reserve assets that can be held by the IMF, its member countries, and designated official entities known as the prescribed holders. The IMF holds the authority to create unconditional liquidity through general SDR allocations to all its members in proportion to their quotas at the IMF, which reflect their relative economic standing in the global economy. Through SDR allocations, the Fund provides its every member with on-demand access to freely usable currencies. Members can exchange these SDRs to meet their Balance of Payments needs or to adjust the composition of their reserves. Although the SDR market generally functions on a voluntary basis, in the event that there are not enough voluntary buyers, the IMF can designate members with a strong balance of payment position to provide freely usable currency in exchange for SDRs (IMF SDR Factsheet).
One of the proposals for a new SDR allocation came from Kevin P. Gallagher, Jose Ocampo, and Ulrich Volz. This proposal called the IMF to agree to an allocation of the equivalent of at least $500 billion as part of the global response to the Coronavirus crisis. Larry Summers, former US Treasury Secretary, and Gordon Brown, former British Prime Minister, similarly called for an SDR allocation of over $1 trillion.
Besides academics and policymakers, several political leaders including Abiy Ahmed, the prime minister of Ethiopia, Cyril Ramaphosa, the president of South Africa, French President Emmanuel Macron and German Chancellor Angela Merkel urged the IMF to allocate additional SDRs to provide additional liquidity that can be used for the procurement of basic commodities and essential medical supplies (Politi 2020).
Even though the use of SDRs is not necessarily less costly for low income countries than borrowing directly from the IMF, SDRs have the advantage of being unconditional, which allows countries to avoid following IMF programs (Gallagher et al. 2020). SDRs would also be more preferable to the Fed’s swap lines because only few countries have swap lines with the Fed, and the choice of countries that are included in swap lines often reflect the strategic national interest of the US (Adler and Arauz 2020). As David Adler and Andres Arauz, the former knowledge minister of Ecuador, puts it “Swap lines are the ventilators, allowing governments to keep their economies—and their citizens—alive. The Federal Reserve is the doctor, deciding which ailing patients it will choose to save from the mortal symptoms of economic crisis.”
In theory, SDRs can allow developing countries that are in a dire financial situation to cover for basic services, such as hospital care or medical supplies, without relying on the political will of the US. However, journalistic reports suggest that the Trump administration does not want a new SDR issuance given that two enemies of the Trump administration, namely Iran and Venezuela, would benefit from a new allocation (Tooze 2020). SDR allocations require an 85 percent vote of all members, and with its 16.51 percent voting share, an approval by the US is necessary for a new SDR allocation to take place (Truman 2020). Therefore, the resistance by the US to SDR proposals make the prospects of a partial financial relief for developing countries depend again on the political will of the US.
If it is approved, close to two-fifths of the new SDR allocation would go to emerging and developing countries, which will be the primary users of SDRs. Given that about three-fifths of the SDRs will go to the advanced economies, some critics, including the US Treasury, find the proposals for a new SDR allocation as ill-targeted. However, what the critiques miss out is that advanced economies will not have to use the SDRs if they do not need to, and the two-fifths of the SDR allocation can still provide great help to some developing nations.
An increase in SDR allocations is particularly needed for countries like Colombia, Turkey and South Africa who are left out from standstill agreements and the Fed’s swap arrangements. Besides, countries that do not have access to other sources of Global Financial Safety Net, which, as Mühlic et al. (2020) shows, include many countries in Sub Saharan Africa and Latin America, can be beneficiaries of a new SDR allocation. Even though an allocation of about $500 billion or $1 trillion may not be sufficient to fully address the financing gaps faced by emerging markets, it would nonetheless be an important step in the right direction.
Adler, David, and Andres Arauz. 2020. “It’s Time to End the Fed’s ‘Monetary Triage’ | The Nation.” Accessed April 21, 2020. https://www.thenation.com/article/economy/economy-fed-imf/.
Bahaj, Saleem, and Ricardo Reis. 2018. “Central Bank Swap Lines.” VoxEU.Org (blog). September 25, 2018. https://voxeu.org/article/central-bank-swap-lines.
Brown, Gordon. 2020. “Debt Relief Is the Most Effective Pandemic Aid | by Gordon Brown & Lawrence H. Summers.” Project Syndicate. April 15, 2020. https://www.project-syndicate.org/commentary/debt-relief-most-effective-covid19-assistance-by-gordon-brown-and-lawrence-h-summers-2020-04.
Gallagher, Kevin P., José Antonio Ocampo, and Ulrich Volz. 2020. “IMF Special Drawing Rights: A Key Tool for Attacking a COVID-19 Financial Fallout in Developing Countries.” Brookings (blog). March 26, 2020. https://www.brookings.edu/blog/future-development/2020/03/26/imf-special-drawing-rights-a-key-tool-for-attacking-a-covid-19-financial-fallout-in-developing-countries/.
Georgieva, Kristalina. 2020. “A Global Crisis Like No Other Needs a Global Response Like No Other.” IMF Blog (blog). Accessed April 21, 2020. https://blogs.imf.org/2020/04/20/a-global-crisis-like-no-other-needs-a-global-response-like-no-other/.
IMF, SDR Factsheet. n.d. “Special Drawing Right (SDR).” IMF. Accessed April 16, 2020. https://www.imf.org/en/About/Factsheets/Sheets/2016/08/01/14/51/Special-Drawing-Right-SDR.
Mühlich, Laurissa, Barbara Fritz, William N Kring, and Kevin P Gallagher. 2020. “The Global Financial Safety Net Tracker: Lessons for the COVID-19 Crisis from a New Interactive Dataset,” 11.
Politi, James. 2020. “US Holds off on IMF Plan to Boost Emerging Economies’ Finances.” April 15, 2020. https://www.ft.com/content/9cb75566-bfd2-4f25-81f7-55780ebdaa3d.
Tooze, Adam. 2020. “The IMF Was Organizing a Global Pandemic Bailout—Until the Trump Administration Stopped It.” Accessed April 21, 2020. https://foreignpolicy.com/2020/04/17/global-pandemic-bailout-imf-world-bank-meetings-america-sdrs/.
Truman, Edwin M. 2020. “The G20 Missed an Opportunity to Expand Financial Resources for Vulnerable Countries.” PIIE. April 16, 2020. https://www.piie.com/blogs/realtime-economic-issues-watch/g20-missed-opportunity-expand-financial-resources-vulnerable.
Wheatley, Jonathan. 2020. “Surging Dollar, Coronavirus and Oil Slump Hit Emerging Economies.” March 19, 2020. https://www.ft.com/content/69fc6e2a-69d3-11ea-a3c9-1fe6fedcca75.
Esra Ugurlu is a Ph.D. student at the University of Massachusetts, Amherst. Her research explores the effects of credit expansions on economic growth in developing countries. She tweets at @cicikalecki.
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