## ADEQUACY OF THE GFSN—CONSIDERATIONS FOR FUND TOOLKIT REFORM (pp121917-adequacyofthegfsn)

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### Executive summary — growing demand for liquidity and evolving risks
- Global environment:
  - Period of protracted uncertainty with frequent episodes of volatility.
  - Intensified demand for liquidity, in particular from emerging markets (EMs) facing a build-up of vulnerabilities and depleted fiscal buffers.
- Market and policy developments:
  - Six reserve currency-issuing central banks in 2013 put existing bilateral swap lines onto a standing basis to “support financial stability by reducing uncertainties among market participants as to whether and when these arrangements would be renewed”.
  - Failure of covered interest parity across major foreign currency markets since the onset of the GFC, as measured by large FX swap spreads.
- Structural and conjunctural drivers:
  - Greater EM integration and financial interconnectedness; larger EM cross-border liabilities increasing foreign-currency liquidity shock risk.
  - Persistently weak global growth since the GFC, legacy high private and sovereign debt, hysteresis, China’s economic transition, persistently low commodity prices, and monetary policy divergence in reserve currency countries.
  - Declined fiscal buffers in many countries following the GFC.
- Nature and magnitude of recent liquidity events:
  - EMs increasingly at the receiving end of “global” liquidity events (European debt crisis, “taper talk”, China market correction).
  - For a group of 19 large EMs, EPFR-reported net portfolio outflows during the three months following the taper talk totaled around US$30 billion; those associated with the Chinese market correction and RMB devaluation in the second half of 2015 were around US$55 billion.
  - EPFR flows generally represent around one-fifth to one-quarter of BOP-reported portfolio flows (coverage limited).
  - A high-frequency indicator shows around 80 percent of disorderly market conditions in EMs since the GFC occurred during global liquidity events, with up to two-thirds of EMs experiencing high stress during each episode.
- Consequences of frequent small events:
  - Even limited outflows can have significant and persistent financial consequences; repeated episodes have eroded buffers and increased vulnerabilities in EMs (e.g., increases in EM corporate leverage and currency mismatches; rising public debt percentiles).

### GFSN evolution, structure, and current gaps
- GFSN components and objectives:
  - Comprises international reserves, central bank bilateral swap arrangements (BSAs), regional financing arrangements (RFAs), Fund and other IFI resources, and market-based instruments.
  - Three main objectives: (i) crisis prevention mechanisms; (ii) supply financing when crises hit; and (iii) incentivize sound macroeconomic policies.
- Expansion since the GFC:
  - Network of BSAs expanded sharply during the crisis and continues to evolve; new RFAs established and existing RFAs augmented (examples: ESM, EFSD; AMF, CMIM, FLAR, CRA).
  - Fund instruments introduced: Flexible Credit Line (FCL), Precautionary Liquidity Line (PLL).
  - Global stock of foreign exchange reserves grew to around US$12 trillion by end-2015, “well in excess of what would be warranted by the Fund’s ARA metrics.”
- Key gaps and uneven coverage:
  - BSAs outside the small standing network among reserve currency issuers largely transitory; most allowed to expire.
  - Many countries have limited or no coverage from new/strengthened RFAs.
  - Precautionary support in some RFAs often linked to a parallel Fund-supported program and remains largely untested.
  - Use of the Fund’s reformed toolkit is uneven; new precautionary instruments used by a limited number of countries.
  - Some countries, including systemic and gatekeeper EMs, lack adequate access to predictable and reliable resources for the entire duration of potential shocks.
- Coordination weaknesses:
  - Coordination mechanisms across GFSN layers underdeveloped; tapping multiple layers simultaneously is largely untested.
- Diagnostic assessment (criteria and summary):
  - Assessment criteria: Predictability, Speed, Reliability, Cost (financial and political), Policies.
  - Main finding: Nearly all GFSN elements score poorly on Cost and Policies; reliability weaknesses notable. Only the Fund has an established macroeconomic policy framework; elements provide insufficient reliability for prolonged crises.

### Fund lending toolkit: usage patterns, limitations, and trade-offs
- Toolkit evolution and features:
  - Shifted to a more flexible framework addressing all types of BOP problems.
  - Instruments tailored to members’ fundamentals and policies; financing options depend on shock size, persistence, nature, and policy strength.
  - Flexibility yields high predictability of crisis prevention/resolution support and near-universal membership access, but creates instrument overlap and potential signal confusion.
- Recent reforms and milestones:
  - 2009 overhaul eliminated CFF and SRF; created FCL.
  - 2010–2011 refinements: FCL duration extended to 12/24 months; implicit cap of 1000 percent of quota removed; PCL introduced in 2010 (replaced by PLL in 2011); PLL introduced six-month liquidity window (unused to date).
  - 2011 RFI established for emergency assistance (outright purchases; low access limits; no Fund-supported program required).
  - 2014 clarified FCL and PLL qualification criteria to enhance transparency and predictability.
- Selected facility features (preserved):
  - Stand-By Arrangement (1952): duration 6–36 month arrangement; No cap.
  - Flexible Credit Line (2009): duration 12/24 month arrangement; No preset limit; No ex post conditionality; annual reviews for 2-year FCL.
  - Rapid Financing Instrument (2011): outright purchase 37.5% of quota; 75% of quota cumulative.
  - Precautionary and Liquidity Line (2011): 6 month Liquidity Window with 125% per arrangement; 250% cumulative; 12–24 month arrangement with 250% first year; 500% cumulative.
- Actual use and limitations (2009–16):
  - RFI: used four times since mid-2014.
  - FCL: 17 arrangements in total, but concentrated—repeated use by only three members at high access levels.
  - PLL (and predecessor PCL): very limited—two countries accounting for a total of four arrangements, all at mid- to high-access levels.
  - Six-month liquidity window: not used to date.
  - SBA used precautionarily by 10 members in 14 arrangements, mostly low- to mid-access.
- Key limitations identified:
  - Lack of a standing liquidity backstop like central bank BSAs limits availability of support over prolonged shocks.
  - Stigma: resorting to Fund financing still carries a high political cost for some members.
  - No standing instrument that can be re-used and automatically replenished; once an arrangement is fully drawn, resources are depleted and not automatically replenished.
  - Perceptions of judgement and facility tiering limit predictability despite sharpened qualification criteria.

### Proposed enhancements to the Fund toolkit — new liquidity instrument (rationale and design)
- Rationale:
  - Address unmet demand for timely, predictable, and stigma-reducing liquidity support for members with strong fundamentals facing temporary liquidity shocks.
  - Incorporate lessons from past initiatives (STFF, CCL, SLF): need for predictability, reliable prequalification, and avoidance of excessive safeguards that reduce usability.
- Core objectives for a new instrument:
  - Improve reliability; reduce stigma; provide standing, revolving liquidity support with streamlined prequalification and no ex post conditionality for members with strong policies and fundamentals.
- Proposed design features and safeguards:
  - Early repurchase expectations to encourage use only for temporary (typically self-correcting) BOP needs; relatively short repayment term (e.g., one year) to manage Fund liquidity risks and preserve revolving nature.
  - Annual re-qualification based on assessment at the time of the Article IV consultations; failure to implement appropriate policies would cause qualification to lapse at the next annual assessment.
  - Limited access so the backstop covers small- to medium-sized shocks; illustrative cap discussed: 145 percent of quota (the current normal annual access limit).
  - Revolving credit features: enable repeated purchases and repurchases under a single arrangement and across arrangements, shifting from access in terms of flows to access in terms of stocks; reconstituted access rights within arrangement duration to improve reliability and efficient use of Fund resources.
  - Prequalification and opt-in: periodic prequalification (e.g., with Article IV consultations) to improve predictability and eliminate stigma associated with requesting an arrangement.
  - Qualification criteria could be more parsimonious than for the FCL and PLL while ensuring strong fundamentals and a policy track record.
- Qualification framework and exclusions:
  - Proposed parsimonious qualification (three criteria): (i) a sustainable external position and market access, including adequate reserve coverage, sustainable external debt, and no significant exchange rate misalignment; (ii) sound public finances, indicated by a sustainable public debt position with high probability; (iii) no actual BOP need at approval.
  - Exclusionary conditions: (i) bank solvency problems that pose an immediate threat of a systemic banking crisis; (ii) ineffective financial sector supervision; (iii) insufficient data transparency and integrity.
  - Safeguards include prequalification, early repurchase expectations, lower access than FCL/PLL, annual reassessment, and Board review clause if resource demands exceed a specified threshold.
- Financial resource implications and illustrative need:
  - For a group of 21 large EMs during recent episodes of short-term volatility, an EM-wide short-term volatility shock would imply total liquidity requirements of around US$90 billion, which is equivalent to the largest existing FCL arrangement.
  - Operational cautions: the Fund would not be called upon for the full amount as countries would be expected to use reserves; the backstop implies a direct, semi-permanent call on Fund resources and could have second-round effects on Fund liquidity and the Financial Transactions Plan (FTP).
- Coherence considerations with existing instruments:
  - FCL would remain as the exceptional-access counterpart for extreme shocks/tail events, with an exit expectation.
  - Significant overlap between eligibility for the new backstop and the PLL suggests the forthcoming review could consider whether to retain the PLL.
  - SBA would remain the Fund’s workhorse for members not meeting ex-ante qualification criteria and for those facing actual BOP needs.

### Policy monitoring instrument and PSI experience — rationale, findings, and proposals
- Coordination and signaling rationale:
  - Many countries need to access multiple GFSN elements; a Fund policy monitoring instrument could facilitate allocation of global resources, reduce moral hazard, and catalyze financing from other GFSN layers.
  - Fund assessments can provide credible policy signaling to donors, RFAs, and private investors; Fund engagement without financing can still serve a signaling/catalyzing role.
- Past experience and trade-offs:
  - Risks: becoming a “rating agency”; difficulty sending explicit negative signals; credibility concerns if no Fund financing; risk of misinterpretation if standards differ from UCT.
  - Need for careful communication strategy and credible standards.
- Gaps in current tools:
  - Surveillance (Article IV) lacks a clear standard and frequency to serve as a broad signaling device.
  - Assessment letters and staff-monitored programs offer ad hoc assessments but lack Board endorsement or broad publication.
  - Precautionary arrangements provide signals but are not available to members with no prospective need to draw and the PSI is limited to a subset of PRGT-eligible countries.
- Experience with the Policy Support Instrument (PSI):
  - Introduced in 2005 for PRGT-eligible LICs that do not need Fund financial assistance.
  - Since introduction, seven countries used the PSI; 18 PSIs approved in Cape Verde (2), Mozambique (3), Nigeria (1), Rwanda (2), Senegal (3), Tanzania (3), Uganda (4).
  - Donor survey results: all respondents agreed or strongly agreed that the PSI delivers clear and timely signals; 60 percent indicated PSI signals played an important role in aid allocation decisions.
  - Program performance: PSI users consolidated economic stability; structural benchmark implementation inconsistent and weakening; quantitative targets generally met.
- Key findings and design issues with the PSI:
  - PSI programs have less conditionality relative to comparators; PSI users typically have a higher fiscal deficit driven by higher public investment.
  - PSI signaling may be less sharp recently; governance issues have affected some PSI users despite broadly fine macro performance.
  - Design issues: fixed review schedule pressures completion of reviews; qualification criteria create an on/off signal; PSI focus on macroeconomics may insufficiently signal governance weaknesses.
- Proposed characteristics for a new monitoring instrument:
  - Avoid qualification criteria to permit access for all countries; value derives from policy dialogue and monitoring rather than binary access.
  - Require UCT-quality policies to provide a transparent and consistent standard.
  - Use review-based monitoring of conditionality to provide a clearer signal on program performance and reduce stigma; emphasize staff and Board assessment over small deviations from targets.
  - Adopt a more flexible review schedule to limit pressure to complete reviews while maintaining regular updates.
  - Enable accelerated access to Fund resources if needed, subject to existing lending policies.
- Institutional considerations:
  - To streamline the toolkit, the new instrument could replace the PSI, perhaps after a trial period to help the Board decide whether the PSI is rendered obsolete.

### Implementation path and next steps
- Directors’ views would guide staff to return with subsequent papers laying out specific and detailed proposals for reforming the GRA lending toolkit.
- Separate forthcoming paper will assess aspects of the concessional lending toolkit.
- Document date: September 30, 2016.

*Source: ADEQUACY OF THE GFSN—CONSIDERATIONS FOR FUND TOOLKIT REFORM, EXECUTIVE SUMMARY*

### EXECUTIVE SUMMARY

### EXECUTIVE SUMMARY

### Growing demand for liquidity and evolving risks
- The global economy is experiencing a period of protracted uncertainty, marked by frequent episodes of volatility.
- Demand for liquidity has intensified, in particular from emerging markets, which are experiencing a build-up of vulnerabilities and the depletion of their fiscal buffers.
- Market and policy developments:
  - Six reserve currency-issuing central banks in 2013 put existing bilateral swap lines onto a standing basis to “support financial stability by reducing uncertainties among market participants as to whether and when these arrangements would be renewed”.
  - Market signals include the failure of covered interest parity across major foreign currency markets since the onset of the GFC, as measured by large FX swap spreads.
- Structural and conjunctural drivers:
  - Greater EM integration and financial interconnectedness; larger EM cross-border liabilities increasing foreign-currency liquidity shock risk.
  - Persistently weak global growth since the GFC, legacy high private and sovereign debt, hysteresis, China’s economic transition, persistently low commodity prices, and monetary policy divergence in reserve currency countries.
  - Fiscal buffers have declined in many countries in the wake of the GFC, implying policymakers will likely face tighter and more volatile global financial conditions for some time to come.
- Nature of recent liquidity events:
  - EMs are increasingly at the receiving end of “global” liquidity events (e.g., European debt crisis, the “taper talk” episode, China market correction).
  - For a group of 19 large EMs, EPFR-reported net portfolio outflows during the three months following the taper talk totaled around US$30 billion, while those associated with the Chinese market correction and RMB devaluation in the second half of 2015 were around US$55 billion.
  - EPFR coverage is limited; EPFR flows generally represent around one-fifth to one-quarter of BOP-reported portfolio flows.
  - A new high-frequency indicator shows around 80 percent of disorderly market conditions in EMs since the GFC occurred during global liquidity events, with up to two-thirds of EMs experiencing high stress during each episode.
- Despite generally limited capital outflows in recent episodes, frequent small and short-lived liquidity events can have significant and persistent financial consequences; repeated buffeting has led to eroding buffers and increasing vulnerabilities in EMs (e.g., increases in EM corporate leverage and currency mismatches; rising public debt percentiles).

### GFSN evolution and current gaps
- The GFSN comprises international reserves, central bank bilateral swap arrangements (BSAs), regional financing arrangements (RFAs), Fund and other IFI resources, and market-based instruments, with three main objectives: (i) provide crisis prevention mechanisms; (ii) supply financing when crises hit; and (iii) incentivize sound macroeconomic policies.
- The GFSN has expanded and undergone important reforms since the GFC, but significant gaps in the architecture remain.
- The enhanced GFSN meets only partially the higher demand for liquidity.
- The IMFC and G20 have called on the Fund to further strengthen the safety net and revisit the Fund’s lending toolkit to:
  - strengthen the Fund’s approach to helping members manage volatility and uncertainty—including through financial assistance on a precautionary basis; and,
  - develop non-financial instruments, such as a policy monitoring instrument covering emerging market countries (EMs) and advanced economies (AEs).

### Fund lending toolkit: usage issues, stigma, and design considerations
- Despite a major overhaul of the Fund’s lending instruments available for precautionary financing, only a modest number of countries have used them.
- Key limitations identified:
  - Lack of access to a liquidity backstop for members with strong policies—similar to the standing BSAs among central banks—limits availability of Fund support over the whole duration of a shock during protracted periods of global uncertainty.
  - The need to resort to Fund financing still carries a high political cost (stigma) for some members.
- Design tradeoffs to consider in reform:
  - Reducing stigma vs. containing moral hazard.
  - Safeguarding Fund resources while expanding predictability and availability of timely safety net resources.

### Proposed enhancements to the Fund toolkit
- Consideration could be given to revisiting the existing toolkit and introducing new instruments.
- Potential enhancements highlighted:
  - Establishing a new facility for precautionary financing that would provide a “standing” liquidity backstop to members with strong fundamentals and policies for use when hit by liquidity shocks.
  - Adjusting the existing toolkit to maintain cohesion across instruments.
- A Fund policy monitoring instrument could improve cohesion of the global safety net:
  - As the GFSN has expanded and become more multi-layered, improved cooperation across different layers is needed to unlock financing and signal commitment to reforms.
  - Creating a policy monitoring instrument that is available to all Fund members could help improve cooperation and policy signaling.

### Next steps and process
- In light of Directors’ views on these points, staff could come back with subsequent papers that lay out specific and detailed proposals for reforming the lending toolkit.
- While these papers focus on the GRA lending toolkit, a separate forthcoming paper will assess some aspects of the concessional lending toolkit.
- Document date: September 30, 2016.

*Source: ADEQUACY OF THE GFSN—CONSIDERATIONS FOR FUND TOOLKIT REFORM, EXECUTIVE SUMMARY*

### 11. Partly reflecting the increased demand for liquidity, the GFSN has expanded and

### 11. Partly reflecting the increased demand for liquidity, the GFSN has expanded and

### Expansion and multi-layering of the GFSN
- Network of BSAs among central banks expanded sharply during the crisis and continues to evolve.
- New RFAs established and existing RFAs augmented:
  - Examples of new RFAs: European Stability Mechanism (ESM), Eurasian Fund for Stabilization and Development (EFSD).
  - Augmented RFAs and instruments: Arab Monetary Fund (AMF), Chiang Mai Initiative Multilateralization (CMIM), Latin American Reserve Fund (FLAR), BRICs Contingent Reserve Arrangement (CRA).
- Fund enhancements:
  - New Fund instruments for precautionary/crisis prevention: Flexible Credit Line (FCL), Precautionary Liquidity Line (PLL).
- Self-insurance remains dominant:
  - Global stock of foreign exchange reserves grew to around US$12 trillion by end-2015, “well in excess of what would be warranted by the Fund’s ARA metrics.”

### Uneven coverage and gaps in the GFSN
- BSAs outside the small standing network among reserve currency‑issuers were largely transitory:
  - Most were allowed to expire; prospects for reestablishment are uncertain.
- Many countries have limited or no coverage from new/strengthened RFAs.
- Precautionary support in some RFAs (BRICs CRA, CMIM, ESM) is often:
  - Linked to a parallel Fund-supported program.
  - Largely untested in practice.
- Use of the Fund’s reformed lending toolkit is uneven:
  - New instruments available for precautionary financing have been used by a limited number of countries.
- Consequence:
  - Some countries, including systemic and gatekeeper EMs, lack adequate access to predictable and reliable resources for the entire duration of potential shocks.

### Coordination across GFSN layers
- Coordination mechanisms are underdeveloped despite potential need to tap multiple layers simultaneously.
- Challenges:
  - Ensuring timely provision of resources and coherent policy advice becomes more difficult as more elements are involved.
  - Coordination is largely untested; the Fund has limited experience working with some RFAs.

### Diagnosis of the current GFSN (Box 1): assessment framework and key shortcomings
- Assessment criteria for GFSN elements:
  - Predictability, Speed, Reliability, Cost (financial and political), Policies.
- Color/score legend used:
  - Red (0) = Limited/insufficient for predictability, speed, reliability, and policies, and high for cost;
  - Yellow (1) = Some;
  - Green (2) = Extensive/adequate for predictability, speed, reliability, and policies, and low for cost.
- Main findings:
  - Nearly all GFSN elements score poorly on Cost (financial and political) and Policies; reliability weaknesses also notable.
  - Most elements have significant financial costs (e.g., reserves) or stigma-related political costs (e.g., the Fund, and to a lesser extent RFAs).
  - Only the Fund has an established macroeconomic policy framework; RFAs’ policy requirements vary and can be politically influenced.
  - All elements provide insufficient reliability for prolonged crises, offering limited coverage over protracted periods of global uncertainty.
- Borrower-group specific assessment (summary of scores as presented):
  - Reserve currency AEs: Predictability 2 1 1 1 2 (table formatting preserved in source).
  - Other AEs: Predictability 2 1 1 1 2.
  - Systemic and gatekeeper EMs: Predictability 2 1 1 0 1.
  - Other EMs/DCs: Predictability 2 1 1 1 2.
  - (Full characteristic-level scores in source for Reserves, Swaps, IMF, RFAs, Hedging.)

### Inefficiencies and moral hazard concerns
- Individual layers are economically and politically costly:
  - Large reserve buffers imply high opportunity costs for individual countries.
  - Excessive reserve accumulation can have negative global externalities, undermine international monetary system resilience, and reduce global demand.
- High political costs (stigma) remain a barrier to Fund and, to a lesser extent, RFA support.
- Lack of adequate global policy incentives:
  - Only the Fund provides a regularly and transparently reviewed macroeconomic policy framework.
  - Risk of facility shopping and moral hazard exists given uneven incentives and coverage.

### Fund role and reform priorities
- The Fund can begin reforms unilaterally to address a few key gaps even though full remediation requires concerted cross‑layer effort.
- Paper focus: identifying key gaps and possible actions to address them.

### The Fund’s GRA lending toolkit: design, reforms, and trade-offs
- Post-crisis shift:
  - From special facilities for specific BOP problems to a more flexible framework addressing all types of BOP problems.
- Current toolkit features:
  - Instruments tailored to strength of members’ fundamentals and policies; coverage of a wide range of access needs including potential BOP needs.
  - Financing options depend on size, persistence, nature of shock, and policy strength.
- Benefits of flexibility:
  - High predictability of crisis prevention and resolution support.
  - Nearly universal membership access with varying access limits and requirements.
- Costs of flexibility:
  - Instrument overlap reduces clarity of signals when members seek Fund support.
  - SBA’s association with actual financing/adjustment may deter members seeking purely precautionary arrangements.

### Recent IMF toolkit reforms (Box 2): milestones preserved in source
- 2009 overhaul eliminated CFF and SRF; created FCL.
- SBA and EFF retained; SBA reformed to allow high access arrangements across BOP situations.
- 2010–2011 refinements:
  - FCL duration extended to allow two-year arrangements; implicit cap of 1000 percent of quota removed.
  - PCL introduced in 2010 (replaced by PLL in 2011); PLL usable for actual and potential BOP needs; introduced six-month liquidity window (unused to date).
  - 2014 clarified FCL and PLL qualification criteria to enhance transparency and predictability.
  - RFI established in 2011 for emergency assistance; outright purchases, low access limits, no Fund-supported program required.

### Tabled GRA facility features (selected highlights preserved)
- Stand-By Arrangement (1952):
  - All actual, prospective or potential; short- to medium-term; duration 6–36 month arrangement; No cap. Exceptional Access criteria apply beyond normal access.
- Flexible Credit Line (2009):
  - All actual, prospective or potential; criteria: very strong ex ante macroeconomic fundamentals, economic policy framework, and policy track record; duration 12/24 month arrangement; No preset limit; No ex post conditionality (only ex-ante qualification); annual reviews for 2-year FCL.
- Rapid Financing Instrument (2011):
  - Actual, Urgent; outright purchases; Outright purchase 37.5% of quota; 75% of quota cumulative; No Fund-supported program; no ex post conditionality or reviews but PAs possible.
- Precautionary and Liquidity Line (2011):
  - All actual, prospective or potential; 6 month arrangement (Liquidity Window) with 125% per arrangement; 250% cumulative (latter due to exogenous shock heightened stress); 12–24 month arrangement with 250% first year upon approval; 500% cumulative.

### Actual use of the Fund toolkit and limitations
- Usage patterns (2009–16):
  - Extensive use for actual financing: many SBA and EFF arrangements since 2009.
  - RFI: used four times since mid-2014.
  - FCL: 17 arrangements in total, but concentrated—repeated use by only three members at high access levels.
  - PLL (and predecessor PCL): very limited—two countries accounting for total of four arrangements, all at mid- to high-access levels.
  - Six-month liquidity window: not used to date.
  - SBA used precautionarily by 10 members in 14 arrangements (including joint SBA-SCFs), mostly low- to mid-access.
- Gaps and limitations highlighted:
  - Reliability:
    - Fund arrangements, once approved and on-track, are reliable but subject to periodic reviews; exit expectations in FCL and PLL may pressure users.
    - No standing type instrument akin to BSAs that can be re-used and automatically replenished; once an arrangement is fully drawn, resources are depleted and not automatically replenished (even after early repurchases).
    - Reserves and BSAs can be reused frequently to manage liquidity during extended volatility.
  - Cost (stigma):
    - Fund financing has very low financial cost but often significant political costs (“stigma”), deterring members from requesting support, especially precautionary support.
    - Special design features of FCL and PLL reduce stigma benefits to a small portion of membership.
    - Tiering of facilities may generate stigma and perceptions of hierarchy (e.g., PLL seen as a “second-class FCL”; HAPA viewed as inferior).
  - Predictability:
    - Despite being a Fund strength, transparency and predictability of FCL and PLL limited by perception that qualification decisions involve considerable judgement.
    - Qualification criteria were sharpened in 2014; too early to determine if concerns are fully resolved.

*Source: Adequacy of the Global Financial Safety Net, IMF Policy Paper, March 2016.*

### 20. In Spring 2016, the IMFC called for the Fund to explore ways to help members manage

### ADEQUACY OF THE GFSN—CONSIDERATIONS FOR FUND TOOLKIT REFORM

### Background and policy calls
- In Spring 2016, the IMFC called for the Fund to explore ways to help members manage volatility and uncertainty, including through precautionary financial assistance.
- The international community has called for a stronger IMF role in global liquidity provision, including through rapid liquidity instruments to deal with capital flow volatility.
- Proposals for a policy monitoring instrument were last considered at the time of the 2009 reforms; low-access arrangements have been used to signal policy strength and for precautionary purposes since then.
- The expansion and evolution of the GFSN, particularly RFAs, have created new demands for a versatile instrument to facilitate coordination and catalyze support across GFSN layers.

### Sources and forms of Fund stigma (Box 3)
- Stigma is multi-faceted and can deter members from engaging the Fund:
  - Economic stigma: a request for a Fund program can be viewed by markets as a sign of weakness and prompt capital outflow.
  - Conditionality stigma: conditionality can create a sense of intrusiveness and lack of ownership.
  - Political stigma: persistently negative image among opinion leaders, NGOs and the public can discourage engagement.
- Design features contributing to stigma:
  - Facility tiering: qualification criteria that limit availability of facilities can cast aspersions on those excluded (e.g., PLL viewed as a “second-class FCL”; HAPA viewed as inferior to both).
  - Exit stigma: exit from a precautionary arrangement due to no longer meeting qualification criteria can provoke negative market reaction.
- Potential approaches to reduce stigma without weakening effectiveness:
  - Offer financial instruments clearly for precautionary purposes only (users have no need for adjustment financing).
  - Wider use of prequalification based on sound policies to signal that a Fund program for crisis prevention is a signal of strength and avoid ex post conditionality.
  - Make policy-monitoring support (without financing) more widely available to the membership, based on periodic reviews rather than “hard” conditionality.

### Overview of reform options (Section V)
- The Fund’s toolkit was revamped recently with instruments for quicker access and streamlined ex-post conditionality, and the Policy Support Instrument (PSI) exists for policy monitoring.
- Qualification criteria restrict benefits to limited membership segments; design could be recalibrated to better suit members’ needs.
- Possible reform paths include revisiting existing instruments and introducing new instruments—each with distinct costs and benefits.

### A new liquidity instrument: rationale and past lessons
- Historical context:
  - Idea dates to at least 1972 (possible Fund financing of short-term capital movements); subsequent proposals after 1990s capital account crises.
  - Earlier initiatives (STFF in 1994, CCL, SLF) either failed to be adopted or attracted little interest.
- Key lessons from CCL and SLF experience:
  - Fund support needs to be sufficiently predictable and reliable to attract demand.
  - Excessive safeguards (e.g., activation review, unclear eligibility application, temporary backstops) reduce predictability and reliability and worsen stigma.
  - Timing matters: demand can be strong during crises but fade as conditions normalize.
- Despite lessons incorporated into FCL and PLL, demand remains modest; stigma over approaching the Fund and risk of not qualifying persists.
- The 6-month PLL reduced stigma from ex-post conditionality but was limited by restrictions on repeat use.

### Reform alternatives to enhance liquidity support (paragraph 26)
- Revisiting the existing toolkit for crisis prevention:
  - Revisit qualification criteria and duration terms to allow more members precautionary access that covers anticipated volatility.
  - Explore allowing members to opt in to an arrangement rather than “request” one to reduce stigma.
  - Consider revolving access features for FCL and PLL to reconstitute access as repurchases are made.
- Use of SDRs for liquidity provision:
  - Pooling and on-lending SDRs, possibly via a separate funding department or carving out General Resources for traditional lending, would require a change to the Articles of Agreement.
- Designing a new instrument:
  - Wipe the slate clean to define a fresh purpose that better promotes and creates incentives for implementing and maintaining good policies.
  - Consider revisiting the need for existing instruments to avoid proliferation.

### Design features proposed for a new liquidity instrument
- Core objectives: improve reliability; reduce stigma; provide standing, revolving liquidity support with streamlined prequalification and no ex post conditionality for members with strong policies and fundamentals.
- Safeguards to mitigate moral hazard and protect Fund resources:
  - Early repurchase expectations to encourage use only for temporary (typically self-correcting) BOP needs; setting a relatively short term for repayment (e.g., one year) to manage Fund liquidity risks and preserve revolving nature.
  - Annual re-qualification based on assessment at the time of the Article IV consultations to mitigate moral hazard and incentivize sound policies; failure to implement appropriate policies would cause qualification to lapse at the next annual assessment.
  - Limited access so the backstop covers liquidity needs likely to arise under relatively small-scale, short-term volatility; for example, cap access at 145 percent of quota—the current normal annual access limit.
- Revolving credit features:
  - Enable repeated purchases and repurchases under a single arrangement and across arrangements, shifting from access in terms of flows to access in terms of stocks.
  - Reconstituted access rights within the duration of an arrangement would improve reliability and efficient use of Fund resources.
- Prequalification and opt-in:
  - Periodic prequalification (e.g., in conjunction with Article IV consultations) to improve predictability and eliminate stigma associated with requesting an arrangement.
  - Qualification criteria could be more parsimonious than for the FCL and PLL while still ensuring strong fundamentals and a track record of implementing policies.

### Coherence of the toolkit and implications for existing instruments
- If a liquidity backstop for small- to medium-sized shocks is established:
  - The FCL would be envisaged as the exceptional-access counterpart for temporary backstops against extreme shocks/tail events, with an exit expectation.
  - Significant overlap between eligibility for the new liquidity backstop and the PLL—and PLL’s lack of take-up and tiering issues—means the forthcoming review could consider whether to retain the PLL.
- The SBA would remain the Fund’s workhorse instrument for members not meeting ex-ante qualification criteria and for those facing actual balance of payments needs.

### Empirical context and access limits (Figure 8 note)
- Figure 8 compares normal access limits versus large net portfolio outflows:
  - Bars represent peak quarterly outflows in the period from 2006 to 2016.
  - Labels include “Largest 3-mo portfolio outflows”, “5th percentile 3-mo portfolio outflows”, “Normal Annual Access Limit”, “Reserve Currency BSAs”, and country examples such as Australia, Czech Rep., Denmark, Iceland, Israel, Korea, New Zealand, Norway, Singapore, Brazil, Bolivia, Bulgaria, Chile, China, Colombia, Guatemala, Hungary, India, Indonesia, Kazakhstan, Malaysia, Mexico, Peru, Philippines, Poland, Romania, Russia, South Africa, Thailand, Turkey, Uruguay.
  - Units shown: Billion USD.
  - Note that one illustrative access cap discussed is 145 percent of quota (the current normal annual access limit).

### Qualification criteria (Box 4)
- The new instrument would retain pre-qualification but aim for a more parsimonious set of criteria that remain adequate to assure appropriate policy response to shocks.
- FCL/PLL frameworks:
  - Core assessment: member’s policies, fundamentals and institutional policy frameworks are very strong (‘generally sound’ in the case of the PLL).
  - FCL qualification: based on nine qualification criteria.
  - PLL qualification: grouped into five areas.
  - Disqualifying conditions include any of: (i) sustained inability to access international capital markets; (ii) need for large policy adjustments (unless credibly set in train); (iii) a public debt position that is not sustainable with high probability; (iv) widespread bank insolvencies.
  - Eligible members should be assessed to have very strong or sound institutional policy frameworks for the FCL and the PLL, respectively.
- The prospective new liquidity instrument would seek predictable and transparent qualification while ensuring strong fundamentals and safeguarding Fund resources.

*Source: ADEQUACY OF THE GFSN—CONSIDERATIONS FOR FUND TOOLKIT REFORM (excerpt).*

### 2. A capital account position dominated by private flows

### 2. A capital account position dominated by private flows

### Qualification framework for a new instrument
- Existing checklist elements cited:
  - 3. A track record of steady sovereign access to capital markets at favorable terms
  - 4. A reserve position which remains relatively comfortable
  - II. Fiscal policy 5. Sound public finances and a sustainable public debt position
  - III. Monetary policy 6. Low and stable inflation, in the context of a sound monetary and exchange rate policy framework
  - IV. Financial sector soundness/supervision 7. A sound financial system and the absence of solvency problems that may threaten systemic stability
  - 8. Effective financial sector supervision
  - V. Data adequacy 9. Data transparency and integrity
- Proposed parsimonious qualification for a new instrument (three criteria):
  - (i) a sustainable external position and market access, including adequate reserve coverage, sustainable external debt, and no significant exchange rate misalignment
  - (ii) sound public finances, as indicated by a sustainable public debt position with high probability
  - (iii) no actual BOP need at approval
- Exclusionary conditions (arrangement would not be approved for a member facing):
  - (i) bank solvency problems that pose an immediate threat of a systemic banking crisis
  - (ii) ineffective financial sector supervision
  - (iii) insufficient data transparency and integrity
- Safeguards and design features to protect Fund resources:
  - Prequalification
  - Early repurchase expectations
  - Lower access than the FCL or PLL
  - Annual reassessment of qualification
  - Clause for Board review if resource demands exceed a specified threshold

### Financial resources and a potential liquidity backstop
- Estimated illustrative liquidity needs:
  - For a group of 21 large EMs during recent episodes of short-term volatility, an EM-wide short-term volatility shock would imply total liquidity requirements of around US$90 billion, which is equivalent to the largest existing FCL arrangement.
- Operational notes and cautions:
  - Net outflows for the group during recent episodes were manageable relative to normal access limits for many countries, although such limits generally fell short of reserve-currency BSAs for those countries that could avail of them.
  - In such situations, the Fund would not be called upon for the full amount, as countries would be expected to partly cover the needs with reserves.
  - The backstop would have an impact on the Fund’s liquidity position: it would imply a direct, semi-permanent call on Fund resources and could have important second-round effects on Fund liquidity by removing members from the Fund’s Financial Transactions Plan (FTP) if they draw under the facility to meet emerging actual BOP needs.
  - Potential consequences for FTP members: potential drawings would tie up part of reserves (at least for non-reserve currency issuers), resulting in lower returns.
  - As an additional safeguard, the instrument could include a clause whereby the policy is subject to a Board review if the resource demands exceed a specified threshold.

### Rationale for a new policy monitoring instrument
- Coordination need:
  - With many countries needing to access several elements of the global safety net (GFSN) to fully cover financing needs, better coordination is essential as global resources have become increasingly decentralized and coordination has lagged behind.
- Roles for a credible Fund policy monitoring instrument:
  - Facilitate a more efficient allocation of global resources and help reduce moral hazard by incentivizing stronger policies and reducing facility shopping.
  - Assist members that do not wish to tap Fund resources but are seeking financing from other sources (RFAs, other IFIs, or private investors).
- Situations where closer Fund cooperation without Fund financial resources is beneficial:
  - Catalyzing financing from other GFSN layers:
    - RFAs have increased capacity but many continue to request Fund involvement; some RFAs have partially outsourced assessment roles to the Fund (e.g., CMIM and BRICS CRA).
    - A structured collaboration could replace assessment letters where a more in-depth Board-endorsed assessment and monitoring may be needed.
  - Signaling commitment to a policy reform agenda:
    - New or non-member governments may want to signal commitments to a new policy agenda and demonstrate a “break from the past.”
    - Fund engagement without resources but with upper credit tranche (UCT) level conditionality could fulfill the signaling role of a Fund arrangement.
- Rationale for Fund suitability:
  - The Fund may have better information than other official agencies and some private agents through special access to policymakers and institutional knowledge.
  - Authorities may view the Fund as a desirable channel to demonstrate commitment; Fund engagement through a financing arrangement signals access to—or ability to mobilize—additional resources.

### Past Fund experience and design trade-offs for signaling mechanisms
- Key issues from historical experience:
  - Risk of becoming a “rating agency”:
    - Tension between informing creditors (catalyzing role) and leaving markets to their own judgment; concern about weakening market discipline and certifying borrowers.
    - As financial markets have matured and information availability has increased, there may be fewer grounds for concern that private creditors would rely excessively on the Fund’s judgment.
  - Difficulty in sending explicit negative signals:
    - Reluctance to send explicit negative signals for fear of damaging relationships with authorities and affecting their access to financing.
    - Blunt on/off mechanisms intensify this issue; a multi-dimensional assessment with UCT-equivalent conditionality could mitigate it.
  - Credibility without Fund financing:
    - Lack of a commitment of Fund financial resources could weaken the signal since the Fund has no financial stake; alternatively, absence of financing pressure might make the Fund a more impartial assessor.
  - Risk of misinterpretation if standards are not UCT:
    - UCT is well-known; any other standard could be misinterpreted as equivalent, risking undermining UCT-quality program perceptions.
  - Tension between on/off signals and multi-dimensional assessments:
    - On/off signals (e.g., review completed or delayed) can cause overemphasis on presence of an arrangement rather than review content; a clear communication strategy is needed to emphasize overall assessment.

### Policy monitoring tools in the current Fund toolkit and gaps
- Surveillance (Article IV consultations):
  - Provides policy advice and periodic assessments (typically once a year) but does not provide a clear standard against which policies are assessed.
  - In some cases, more frequent monitoring is warranted but not possible under current Article IV framework.
- Assessment letters and staff-monitored programs (SMPs):
  - Assessment letters:
    - Produced in response to requests when an up-to-date Board assessment is not readily available.
    - Should provide a clear and candid assessment of macroeconomic conditions and policies, but do not assess policies against any prescribed standard and are generally not published.
  - Staff-monitored programs:
    - Enable program-type engagement to build track record in anticipation of eventual Fund-supported program, but are not used for signaling and do not entail Board endorsement.
- Arrangements used on a precautionary basis and the Policy Support Instrument (PSI):
  - Precautionary arrangements (e.g., SCF arrangement or SBA) can provide closer monitoring and a clear signal but are not available for members with no present, potential, or prospective need to draw on Fund resources (e.g., substantial market access or other official financing).
  - The PSI:
    - Available to a subset of PRGT-eligible countries that have no present or prospective BOP need, do not require significant macroeconomic adjustment, and have sufficient institutional and policy quality.
    - Helps design, implement and monitor policies and provides a Board-endorsed signal to donors and investors.
    - No comparable form of support is available to the large majority of Fund members who are not PSI-eligible.

### Experience with the Policy Support Instrument (PSI)
- Purpose and coverage:
  - Introduced in 2005 for PRGT-eligible LICs that do not need Fund financial assistance but have achieved macroeconomic stability and basic structural reforms.
  - Aims: promote close policy dialogue, help consolidate macroeconomic stability, pursue advanced structural reforms, provide regular assessments, and deliver signals for donors/creditors/public.
- Usage to date:
  - Since introduction, the PSI has been used by seven countries.
  - A total of 18 PSIs have been approved to date in the following countries:
    - Cape Verde (2)
    - Mozambique (3)
    - Nigeria (1)
    - Rwanda (2)
    - Senegal (3)
    - Tanzania (3)
    - Uganda (4)
- Concurrent use with Fund financial arrangements:
  - Limited: only three countries requested an SCF during PSI use (Tanzania 2012, Mozambique 2015, and Rwanda 2016).
- Donor perspectives and survey results:
  - Official creditors and donors value PSI signals and use them in aid allocation decisions.
  - In a recent staff survey of donors in PSI countries:
    - All respondents agreed or strongly agreed that the PSI delivers clear and timely signals on the strength of country policies.
    - Sixty percent of respondents indicated that, to varying degrees, the PSI signals have played an important role in their aid allocation decisions, particularly in assessing countries’ commitment to sound macroeconomic policies and management.
  - Donors appreciate collaboration with the Fund through the PSI as complementary to donors’ sectoral work.
  - Past surveys showed donors found the PSI more useful than a surveillance-only relationship for aid decisions.
- Program performance under the PSI:
  - PSI users have consolidated economic stability.
  - Evidence of sustained improvements in implementation of structural reform is limited:
    - Quantitative program targets are generally met.
    - Structural benchmark performance is inconsistent and weakening over successive PSIs.
    - Potential drivers: difficulty implementing second-generation reforms; fixed review schedule under the PSI lacking flexibility to meet targets with a delay.
- Comparative performance:
  - Overall, program performance with the PSI is not weakened by the absence of Fund financing when compared with similar PRGT-eligible countries using Fund financial facilities.

*Source: pp121917-adequacyofthegfsn - 2. A capital account position dominated by private flows*

### Box 5. Experience with the Policy Support Instrument (PSI) (concluded)

### Box 5. Experience with the Policy Support Instrument (PSI) (concluded)

### Key findings on PSI users and conditionality
- PSI programs have less conditionality relative to comparator countries and other PRGT-eligible countries.  
- PSI users typically have a higher fiscal deficit compared with comparable PRGT-eligible countries, in part explained by the scaling-up of investment.  
- While the macroeconomic performance of PSI users and their comparators is generally similar (reflecting the selection criteria for the comparators), PSI users have higher fiscal deficits and public investment levels.  
- A regression analysis indicates that the difference in fiscal deficit is driven essentially by higher investment by PSI users. Once investment is accounted for, being a PSI user per se is no longer associated with higher fiscal deficits.  
- The quality of signaling from the PSI may have been somewhat less sharp in recent years. Governance issues (corruption and large non-transparent off-budget spending) have affected some PSI users even though their macroeconomic performance has been broadly fine. Because PSI performance assessment is mostly focused on macroeconomic issues, reviews could be completed in circumstances where donors have withheld financial support due to governance issues.  
- The fixed review schedule under the PSI could put pressure for completion of reviews to the detriment of performance: in ten years, the only case where a review under the PSI was not completed is that of Uganda in 2011.

### Identified design issues with the PSI
- Fixed review schedule can create time pressure and potentially encourage completion of reviews despite weak implementation.  
- Qualification criteria for the PSI create an on/off signal that may restrict access and contribute to stigma.  
- The PSI’s focus on macroeconomic assessment may provide insufficient signaling on governance or non-macroeconomic weaknesses.  

### Proposed characteristics for a new monitoring instrument
- Avoid qualification criteria, to permit access for all countries.  
  - Rationale: Fund policy monitoring should be available broadly; establishing qualification criteria would unnecessarily restrict access for some countries, result in additional tiering in the membership, and possibly further contribute to stigma. The instrument’s value would derive from policy dialogue and monitoring provided by ongoing reviews rather than a binary access signal.
- Require UCT-quality policies, to provide a transparent and consistent standard.  
  - Rationale: The UCT quality of policies is a clearly established standard applicable in programs with Fund financing. Maintaining this standard would be important in a new instrument that could be used to unlock financing from other GFSN components.
- Use review-based monitoring of conditionality to provide a clear signal on program performance and reduce stigma.  
  - Rationale: Review-based monitoring of quantitative and structural reform conditionality would explicitly recognize that program reviews provide the context for a more robust and “real-time” assessment of program implementation. Quantitative targets and structural reforms would remain central to program design but monitoring would be modified so countries would not need a formal waiver if a particular target is missed. Emphasis would be placed on the staff and Board assessment as the bottom-line appraisal of whether policies are on track to meet objectives rather than on small deviations from specific targets.
- A more flexible review schedule to limit pressure to complete reviews but maintain regular updates on program performance.  
  - Rationale: Committing to a fixed review schedule (e.g. every six months) ensures regular information but can result in pressure to complete reviews to avoid sending an overly negative signal. A limited time buffer around reviews would enable extra time if there are delays in implementation while avoiding prolonged periods without updates.
- Enable accelerated access to Fund-resources if needed.  
  - Rationale: As under the PSI, if the monitoring program is on-track this could expedite access to Fund financing in the event of a member’s balance of payments need, subject to existing lending policies.

### Institutional considerations
- To maintain a streamlined toolkit, consideration could be given for the new instrument to replace the PSI. The proposed monitoring instrument would enable a broader set of countries to engage more closely with the Fund. If introduced, it could replace the PSI, perhaps after a trial period that would help the Board decide whether the new instrument has rendered the PSI obsolete.

*Box 5. Experience with the Policy Support Instrument (PSI) (concluded).*

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_Source: https://www.imf.org/-/media/files/publications/pp/2017/pp121917-adequacyofthegfsn.pdf_