Any crisis on the scale of the Covid-19 outbreak is likely to provoke considerable debate on the extent to which fundamental institutions need to be transformed. As in many other fields, the Covid-19 pandemic has revealed existing weaknesses in the International Monetary System (IMS).
The financial cycle of the past decade has undoubtedly provided developed economies with an easy but precarious escape route from “secular stagnation”, while at the same time offering many emerging and developing countries the opportunity for growth through financial subsidies. This has perpetuated the use of an international key currency system (in this case the dollar), the limits of which are becoming increasingly clear today, in terms of meeting the financial needs related to global commons such as the climate, health or biodiversity.
A triple crisis for emerging countries
The countries involved, along with some of the world’s most vulnerable populations, have too often borne the social and ecological cost of this unbalanced dynamic (e.g. extractivism, multiple dependencies on coal, oil and gas). Emerging countries are now facing a triple crisis. Firstly, the downturn in the financial cycle, evidenced by the major decline in capital flows from emerging and developing countries, is creating a crisis in these countries far worse than the health crisis, which has often been better contained than in the United States or Europe.
The resulting decline in exchange rates in emerging and developing countries (between 5 and 25% drop against the dollar) makes access to foreign currencies more expensive, particularly the dollar and the euro, whether for imports or loan repayments in the domestic currency, and significantly increases the risk of defaults.
The almost 40% average drop in the price of raw materials, and of oil in particular, further reduces the capacity of these countries to operate with political autonomy in dealing with the outbreak.
Finally, the health crisis, to which the response has often been much faster and more effective than in many Western countries, could nevertheless cause considerable damage in countries that, until recently, have been forced to follow programs aimed at reducing public spending and services.
In view of this triple crisis, the current financial safety nets, or what is more generally known as the international monetary system, may prove to be somewhat ineffective.
Emergency facilities to restore dollar liquidity
To meet their most urgent foreign exchange needs, many countries have already requested IMF financing facilities, whether conditionalities apply or not. A number of emerging countries such as Algeria and Argentina, traumatized by recent experiences with such loans, may well postpone such a decision for as long as possible.
For its part, the United States, via its Federal Reserve (Fed), has deployed an arsenal of currency exchange lines, known as swap lines, intended for the central banks of “friendly” countries, with the aim of supplying these countries with dollars in direct exchange for their own currency. The two main emerging countries involved are Brazil and Mexico.
In addition to these swap lines, a “repo” facility has also been opened to allow more countries to exchange their US Treasury securities for dollars. Discussions have begun about the possibility of a currency swap line between the IMF and the Fed. Finally, an agreement was reached at the G20 to extend the deadlines for payment of interest on the debt of the poorest countries in 2020.
Systemic holes in the financial safety net
The financial safety net available to mitigate this triple crisis is limited by a number of shortcomings and inherent biases. For example, this is clear from certain conditionalities on IMF loans, in addition to emergency loans, based on so-called sound fundamental macroeconomic principles which effectively exclude many emerging countries. But it is also evident from the amounts of liquidity issued, with needs often largely underestimated in view of the challenges involved, and from the selection of beneficiaries using criteria based on hegemonic power, whether by direct selection in the case of Fed involvement (India, Turkey, Thailand and South Africa are currently excluded from being swap line beneficiaries), or indirect selection via the IMF’s quota system.
While the United Nations Conference on Trade and Development (UNCTAD) estimates the immediate needs of emerging and developing countries at $2,500 billion, the sum of the stimulus plans for these countries currently represents significantly less than the nearly $9 trillion raised in financial support globally.
In light of these system biases, the idea of using the IMF’s Special Drawing Rights (SDRs) was chosen from a number of proposals, as an additional solution that would allow emerging and developing countries to benefit from a free injection of foreign currency. The immediate challenge for these countries is to ensure they benefit from virtually free additional liquidity, which nonetheless will be limited according to their IMF quota share.
Consequently, if the IMF’s International Monetary and Financial Committee decides to allocate $1 trillion in new SDRs, as recommended by UNCTAD, emerging and developing countries will only receive about two fifths of this sum, or $200 billion. SDRs can now be created ex nihilo based on a ruling backed by 85% of IMF votes. However, the United States holds 16.5% of the IMF voting power and thus has the de facto right to veto such a decision. For the time being, the country has blocked any further injection of SDRs. Nevertheless, it has not ruled out issuing SDRs again in the future.
Why issue SDRs?
The wider use of SDRs to meet the current liquidity needs of developing and emerging countries, or even to establish the terms for the systematic creation of such SDRs in order to facilitate their endogenous development, would nevertheless be inadequate as a solution. The financial imbalances inherent to the key currency system create the conditions for structural vulnerability in emerging economies. This vulnerability prevents these countries from implementing long-term development strategies, while developed countries may end up with large deficits or may focus on export sectors with high added value.
As a result, there is an implicit hierarchy of economies within the key currency system, and this monetary/financial hierarchy also reflects an ecological hierarchy which has come to light during the crisis. Due to lower currency liquidity, developing and emerging countries are forced to offer higher interest rates or more attractive exchange rates to maintain an inflow of foreign capital.
This external pressure tends to drive these countries towards specializing in raw materials or energy products, as this is the best (or at least the quickest) way to obtain foreign currencies on the financial markets and thus attract capital with a view to achieving export-led growth. It is not, however, the best way to implement development strategies in line with the Sustainable Development Goals or the Paris Agreement.
A triple crisis with a common cause
Viewed from this perspective, the triple crisis that is affecting emerging and developing countries has a common cause which lies within the current international monetary system. While broader use of SDRs is an appealing idea in itself, ideally, a collective definition of SDR uses would be developed in parallel with their implementation. This is not a new concept.
Before the Second World War, in his “Treatise on Money” (1930), John Maynard Keynes had already put forward the idea of a fixed, but adjustable, exchange rate regime anchored to a price index of a basket of commodities, and thus materially linked to the real economy. It was believed that such a system would be much more stable than the highly procyclical gold standard that existed at the time. It would also have paved the way for more harmonized development of countries that were heavily dependent on these raw materials. J. M. Keynes returned in part to this approach prior to the Bretton Woods conference in 1942, when he proposed a system for storing raw materials, financed through Bancor, a conceptual ancestor of SDRs. Later in the 1960s, Kaldor continued to work on this theory.
SDRs to finance global commons
Stopping the use of oil and fossil fuels in all sectors of activity is a major challenge for the coming decade. However, it is difficult to imagine the end of the oil and extractivism industries with an international monetary system that is structurally reliant on perpetuating these activities to meet the requirements of foreign exchange reserves. Conversely, the reduction of greenhouse gas emissions and carbon neutrality are representative of a common goal to which the international community has already made a legal commitment.
In addition to meeting the immediate liquidity needs of emerging and developing countries, the challenge is to base the future issuance and use of SDRs on carbon neutrality, and to associate this with the refinancing and guarantee initiatives of national central banks and with the financing of development strategies of public financing and development banks. This can be achieved in a number of ways.
- The Network for Greening the Financial System (NGFS) is a vast network of central banks and financial supervisors, over which the Fed holds no jurisdiction, created to facilitate the implementation of the Paris Agreements and, in particular, to align financial flows with climate objectives. Its members could set the liquidity and guarantees supplied to financial stakeholders in response to the Covid-19 crisis by measuring the degree of alignment of the financial position and loans of said stakeholders with climate objectives. It would be fully within the mandate of the NGFS in terms of reducing the transitional and physical risks associated with climate change.
- Other forms of green swap lines could be established between members of the network and emerging and developing countries, by exchanging SDRs for foreign currency with countries committed to business recovery plans in line with climate and biodiversity objectives. The regular issuance of SDRs by the IMF would ensure the sustainability of these swaps. The networks of development banks with international mandates could provide the guarantee (under monitoring) for compliance of the funded projects with these environmental and social objectives.
- Countries could still lend their unused surplus SDRs to multilateral and bilateral development banks as part of financial support plans for COP21 (climate) and COP15 (biodiversity) objectives for the future. One of the institutions being financed is the Green Climate Fund, for which the use of SDRs has been under discussion internally at the IMF since as early as 2010. The Green Fund would provide loans to developing or emerging countries with the greatest need in terms of green technology transfer, based on priority rules.
- Finally, the IMF could gradually transform the quota system into a system for allocating SDRs according to the efforts made by countries to reduce their emissions, while taking into account the principle of common but differentiated responsibilities as per the United Nations Framework Convention on Climate Change, when evaluating these efforts. In this regard, a reform of the IMF statutes is clearly essential, as long as the current system of so-called budgetary use of SDRs requires the parliamentary approval of all countries.
There is no doubt that this current period offers a historic opportunity to address the issue of international liquidity and the increase in SDR issuance and use, at a time when all of the major stakeholders of the international monetary system would stand to benefit. The stakes are incredibly high, with the guarantee of access to foreign exchange facilities, in line with more endogenous modes of development for developing countries and a far more restrained approach to development from the entire international community.
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