Cultivating Global Financial Cooperation
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- Authors: BARRY EICHENGREEN
- Published: September 1, 2020
Crisis impact and key statistics
- The COVID-19 pandemic is described as "the mother of all stress tests" for the global economy, with severe financial effects preceding the virus’s physical arrival in many developing countries.
- Between February and April, more than $100 billion in financial capital flowed out of emerging and frontier markets.
- That outflow was "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.
- Central banks that adopted a formal inflation-targeting framework were able to cut interest rates by 40 to 50 basis points more than non-inflation-targeting counterparts through the first five months of 2020.
- The IMF received more than 100 calls for emergency funding in the first half of 2020.
- The IMF’s overall lending capacity is limited to $1 trillion.
- Pandemic bonds’ payout conditions were satisfied only 132 days into the outbreak and after more than 2 million cases were identified worldwide.
- In April 2020 the IMF provided debt service relief for an initial six months to 29 low-income countries.
Dollar dominance and global liquidity
- The global economy—and emerging market economies in particular—relies heavily on the dollar for international liquidity.
- The dollar is involved in 85 percent of foreign exchange transactions worldwide.
- The international interbank market runs heavily on dollars; bonds marketed to foreign investors are disproportionately denominated in dollars; the dollar is the dominant vehicle for trade invoicing and settlement.
- Central banks and governments have accumulated dollar reserves as a shield against sudden liquidity shortages.
- The US Federal Reserve provided dollar swaps and Treasury bond repurchase facilities for foreign central banks and purchased a wide range of fixed-income assets, flooding markets with liquidity and bringing credit spreads back to precrisis levels.
- The Fed’s actions helped capital flow back to emerging markets because the Fed did not buy emerging market debt.
- Concerns noted:
- The Fed provided swaps only to a selection of countries; selection criteria were not transparent.
- There is no guarantee a similar Fed response would occur in future crises.
- Suggestions exist to delegate swap decisions to an impartial arbiter such as the IMF, but central banks are not IMF members and governments are reluctant to cede control over central bank balance sheets.
IMF and World Bank responses and limitations
- The IMF created the Short-term Liquidity Line and enhanced access to existing facilities, including some that allow lending without a full-fledged program.
- The IMF’s resources were preserved via renegotiation of multilateral and bilateral borrowing arrangements, including the New Arrangements to Borrow, but quota increases have not produced results.
- There has not been requisite agreement of a supermajority of countries on a new allocation of Special Drawing Rights (SDRs).
- The COVID-19 crisis highlights incomplete reform of IMF governance in the context of the General Review of Quotas and incomplete enhancements to the international role of the SDR.
- World Bank pandemic bonds:
- Designed in 2017 as insurance against health-related shocks but "overengineered."
- Documentation complexity meant neither investors nor governments fully understood terms.
- Trigger conditions were stringent and ill-suited to poor countries’ limited case-identification capacity.
- Pandemic bonds triggered many simultaneous payouts in a global pandemic, wiping out investors’ stakes.
- The World Bank abandoned plans for another pandemic-related issue in 2020.
- The concept of financial insurance for pandemics is considered sound but requires a satisfactory structure, simplified design, and larger subsidy elements from donors.
Debt challenges and restructuring
- Commodity prices and global trade collapses create challenges servicing debt.
- IMF provided debt service relief in April 2020 for an initial six months to 29 low-income countries and urged suspension of repayments from bilateral and private creditors.
- The G20 issued the "G20 Action Plan" supporting these ideas.
- Collective action problems:
- Official bilateral creditors face incentives issues if others do not participate; agreeing creditors may end up shouldering the burden.
- The Paris Club has historically addressed official creditor coordination since the 1950s; however:
- China is not a member, despite being the source of more official bilateral poor-country debt covered by the G20 initiative than all other creditor countries combined.
- China agreed to match Paris Club terms but ambiguous coverage remains for state banks and state-owned companies.
- Lack of clear accounting for how much poor-country governments owe to the Chinese official sector complicates restructuring.
- Private debt restructuring was organized through the Institute of International Finance (IIF), which:
- Cautioned that restructuring could jeopardize market access and emphasized fiduciary duties to investors.
- Faced problems with conflicting contractual terms (Argentina example) and holdout creditors.
- There is "no sense that the existing ad hoc machinery had the capacity to deal with a flood of cases."
- The absence of an international facility or standard procedure to handle a wave of restructurings was highlighted.
Policy agenda and recommendations
Findings and diagnostics:
- Resilience begins with institution and resource building at home: fiscal space and anchored inflation expectations enable supportive policy.
- Emerging markets have shown improved capacity to implement supportive monetary, fiscal, and financial policies.
- International arrangements remain inadequate: dollar reliance persists, IMF resources and governance reforms are incomplete, pandemic insurance instruments underperform, and debt-restructuring mechanisms are insufficient.
Recommended reforms and policy options:
- Increase IMF resources and consider greater use of existing programs and lending facilities to provide dollars to emerging markets.
- Pursue a new allocation of SDRs (noting lack of consensus to date).
- Streamline design of pandemic insurance instruments, increase donor subsidy elements, and simplify documentation to make instruments attractive to governments and investors.
- Update the Paris Club to reflect 21st-century creditor realities, including clearer engagement with China and other major creditors.
- Have official institutions take a larger role in negotiations over restructuring private debt:
- Set standards for negotiations and encourage regulatory agencies to require institutional investor adherence to those standards.
- Require provisions in loan contracts (single-limb aggregation clauses) that encourage rapid restructuring during global crises.
- Consider prohibiting trading of bonds that lack these provisions.
- If these measures fail, stronger proposals (for example, some form of international bankruptcy court for sovereigns) may reemerge.
Cultivating Global Financial Cooperation — BARRY EICHENGREEN, F&D, September 2020
Content in this bundle
- Cultivating Global Financial Cooperation – IMF F&D
- Cultivar la cooperación financiera mundial ● Finanzas y Desarrollo ● Septiembre de 2020
- Cultiver la coopération financière mondiale