## GLOBAL FINANCIAL COOPERATION

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**Canonical URL:** [GLOBAL FINANCIAL COOPERATION](https://www.imf.org/-/media/files/publications/fandd/article/2020/september/cultivating-global-financial-cooperation-eichengreen.pdf)

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Cultivating

### The COVID-19 shock and immediate financial effects
- The COVID-19 pandemic is described as "the mother of all stress tests" for the global economy, with severe financial effects even where full-blown health crises were averted.
- Between February and April, more than $100 billion in financial capital flowed out of emerging and frontier markets, "five times as much as in the first three months of the global financial crisis."
- The World Bank forecast that remittances would fall by an additional $100 billion in 2020, "four times as much as during that earlier crisis."
- Global trade was forecast to fall even faster than in 2009; commodity prices collapsed and emerging market and developing economy currencies weakened against the dollar.
- Governments responded with emergency spending packages; emerging market central banks cut interest rates and in some cases purchased securities.
- Central banks that adopted a formal inflation-targeting framework were able, "through the first five months of 2020," to cut interest rates by "40 to 50 basis points more" than non-inflation-targeting counterparts.
- Outcome: the predicted tidal wave of debt defaults, currency crashes, and system collapses "has not come to pass. At least not yet."

### Dollar dominance and the Federal Reserve response
- The dollar remains central: it is involved in "85 percent of foreign exchange transactions worldwide" and is the dominant vehicle for trade invoicing, settlement, and foreign-currency bonds.
- Countries can hold dollar reserves to shield against liquidity shortages; central banks and governments have increased dollar reserves in recent decades.
- The absence of severe dollar scarcity during the crisis owed largely to the US Federal Reserve's actions: dollar swaps and Treasury bond repurchase facilities for foreign central banks, plus large purchases of fixed-income assets that flooded markets with liquidity and compressed credit spreads.
- The Fed's asset purchases did not include many emerging market sovereign debts; this helped channel investor flows back into emerging markets after initial strain.
- Limitations and concerns:
  - The Fed provided swaps only to a selection of countries, and "the selection criteria were not transparent."
  - It is "not obvious that there will be an equally foresightful Federal Reserve Board to do the same in a future crisis."
  - Proposals have been made to delegate swap-extension decisions to an impartial arbiter such as the IMF, but central banks are not IMF members and governments are reluctant to cede balance-sheet control.

### IMF and World Bank roles and constraints
- IMF actions:
  - The IMF created the Short-term Liquidity Line and enhanced access to existing facilities, including instruments allowing lending without a full-fledged program.
  - In the first half of 2020, the IMF "received more than 100 calls for emergency funding."
  - The IMF's overall lending capacity is limited to "$1 trillion."
  - Shrinkage of IMF resources was averted by renegotiations of multilateral and bilateral borrowing arrangements, including the New Arrangements to Borrow.
  - Efforts to augment resources through quota increases have not produced results.
  - There has not been the requisite agreement of a supermajority of countries on a new allocation of Special Drawing Rights (SDRs).
  - Reforming IMF governance in the General Review of Quotas and enhancing the international role of the SDR remain incomplete.
- World Bank experience:
  - The World Bank issued pandemic bonds in 2017 in response to Ebola; these bonds paid out only after stringent triggers were met.
  - Payout triggers were satisfied only "132 days into the outbreak and after more than 2 million cases were identified worldwide."
  - National case reporting requirements disadvantaged poor countries, reducing the bonds' effectiveness; the bonds behaved unlike catastrophe bonds because pandemics trigger many simultaneous payouts, wiping out investor stakes.
  - The World Bank abandoned plans for another pandemic-related issue in 2020; the author concludes that "the notion of some form of financial insurance for pandemics is sound conceptually, but a satisfactory structure has yet to be found."
- Implication: the IMF could provide greater dollar liquidity if it had more resources; a new SDR allocation is a possibility but lacks consensus.

### Dealing with sovereign debt in the pandemic
- Debt-service relief actions:
  - In April 2020 the IMF provided debt service relief for an initial "six months" to "29 low-income countries" that were previous loan recipients.
  - Managing Director Kristalina Georgieva called on governments with bilateral loans to suspend repayments and on private sector creditors to do likewise; the G20 issued a declaration, the "G20 Action Plan," voicing support.
- Collective-action problems:
  - Official bilateral creditors face incentives not to suspend payments if others do not; unilateral suspensions impose costs on participating governments.
  - The Paris Club (creditor group chaired by a French Treasury official) has historically managed official debt issues since the 1950s, but China is not a member despite now being "the source of more official bilateral poor country debt covered by the G20 initiative than all other creditor countries combined."
  - China has agreed to match Paris Club debt relief terms, but clarity is lacking on whether this extends to loans by state banks and state-owned companies, and the total exposure is uncertain.
- Private debt and restructuring:
  - Negotiations with private creditors were largely organized by the Institute of International Finance (IIF); the IIF cautioned that restructuring could jeopardize market access and stressed fiduciary duties to clients.
  - Early Argentine bond renegotiations stalled over conflicting contractual terms and "the absence of a single standard for bond covenants," with holdout creditors further slowing progress.
  - There is no international facility or standard procedure to handle a wave of restructurings; the existing ad hoc machinery "had the capacity" shortfall.

### Policy agenda and recommendations
- Domestic resilience:
  - Resilience "starts with institution and resource building at home": fiscal space, anchored inflation expectations, and stronger monetary, fiscal, and financial institutions enabled many emerging markets to adopt supportive policies.
- International liquidity and IMF role:
  - Cross-border finance remains dollar-based; while change is possible, "little reason to think that it will change anytime soon."
  - The supply of dollars is national and depends on Federal Reserve policy; the IMF could be an alternative supplier if it had more resources and if there were agreement on measures such as an SDR allocation.
- Financial instruments for pandemics:
  - Using financial markets to insure against pandemics is conceptually sound; improvements include streamlining instrument design and increasing donor-provided subsidy elements to make them more attractive to governments and investors.
- Debt restructuring architecture:
  - Update the Paris Club to reflect 21st-century realities, including bringing key new creditors into the remit.
  - Official institutions should take a larger role in negotiations over restructuring private debt and set standards for such negotiations.
  - Regulatory agencies should be encouraged to mandate institutional investors’ adherence to negotiation standards.
  - Governments and regulators can require "single-limb aggregation clauses" in loan contracts to encourage rapid restructuring during global crises and can prohibit trading of bonds that lack these provisions.
  - If these measures fail, the possibility of a more heavy-handed approach—"some kind of international bankruptcy court for sovereigns"—may reemerge.

*Barry Eichengreen, "GLOBAL FINANCIAL COOPERATION — Cultivating" (Finance & Development, September 2020).*

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_Source: https://www.imf.org/-/media/files/publications/fandd/article/2020/september/cultivating-global-financial-cooperation-eichengreen.pdf_