World needs stronger financial safety net

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By Gao Haihong and Kevin P. Gallagher | China Daily | Updated: 2020-11-19 07:48


At the virtual G20 Summit in Riyadh, Saudi Arabia, on Saturday and Sunday, the leaders of the participating countries are expected to discuss the unprecedented challenge brought by the COVID-19 pandemic and the economic recession it has caused. One of the key issues they must address is how to secure global financial stability by bolstering the global financial safety net, which comprises the layered financial support from various resources.

International financial markets became very volatile in March and April. Uncertainties caused due to the interruption of economic activity triggered massive capital flight to safe-haven assets. Subsequently, US dollar-funding costs, an indicator of liquidity condition, increased sharply, leading to an immediate shortage of dollar liquidity. Emerging economies, too, experienced a sudden reversal of capital flow and depreciation of their currencies, which accentuated their external debt burdens.

In response to the shocks, the US Federal Reserve acted swiftly to lower the funding cost for its unlimited dollar swap lines with five other central banks. The Fed also set up new temporary swap lines with nine other central banks, broadening the access to the dollar liquidity market. Under Managing Director Kristalina Georgieva and responding to the demand of most member economies in the multilateral system, the International Monetary Fund initially called for a new, large allocation of Special Drawing Rights to help alleviate the problem.

While those proposals have been rebuffed, the IMF quickly activated the resources it had at hand. From March to November, the IMF made $250 billion funding available for its members, 40 percent of which were provided through its emergency mechanisms. Such funding supported 82 members on Rapid Credit Facility and Rapid Financing Instrument, and 26 on the Catastrophe Containment and Relief Trust, a new facility designed for low-income member economies.

Besides, the G20 held emergency meetings calling for corrective responses, and worked with the World Bank and the IMF to launch the Debt Service Suspension Initiative for suspension of debt service payment for the least-developed countries.

Those actions highlighted the importance of a well functioning global financial safety net to protect global financial stability in times of crises. However, the persistent fragility of the global financial system will prolong an uneven recovery from the pandemic, and the global financial safety net will require further expansion in order to mitigate the effects of and facilitate the recovery from this crisis.

The IMF is one of the most important international financial institutions safeguarding global financial stability, and promoting policy coordination among its 189 member economies. In her recent statement, Georgieva has expressed the urgent need for a "big bazooka" for the IMF's financial capacity. Currently the total funding resources at the IMF amount to $1 trillion, half of which consists of just temporary arrangements, namely, "new arrangements to borrow" and bilateral borrowing arrangements which require renewals and cannot be adequately relied upon moving forward.

The core half comes from quota-based funding contributed by the member economies. The size of the quotas can be adjusted but only in regular "quota reviews", and the next round of general quota review of the IMF will not be complete until 2023.

There is a clear gap between the IMF's lending capacity and its financing needs. The IMF and United Nations Conference on Trade and Development both say that $2.5 trillion financing is needed in emerging markets and developing countries-much more than the $1 trillion the IMF has at its disposal. Such a demand is particularly pressing from countries that have insufficient foreign exchange reserves for self-issuance, limited access to central banks' swap lines, and are not covered by any regional financial arrangements.

And for the poor countries that have suffered severe economic damage and have high debts, the need for financial assistance is enormous and urgent. The expansion of the Catastrophe Containment and Relief Trust that allows poorer countries to not pay their debt during the crisis is welcome but insufficient. Many emerging markets and developing economies are using 30-70 percent of government revenue to service external debt. They, too, need more external assistance through liquidity and debt relief. One immediate way of expanding the IMF's resources is for its member economies to agree to a new allocation of the Special Drawing Rights. A new SDR allocation, like the successful SDR increase after the global financial crisis in 2008, could enlarge the IMF's firepower instantly.

In the face of the pandemic, policy reactions may differ from country to country. However, financial instability and economic downturn will cause worldwide repercussions. The pandemic has caused widespread human and economic suffering. But it has also created an opportunity to renew and strengthen global cooperation. The G20 was created as a central forum to address these issues a decade ago, and is poised to rise again to harness coordination in a way that will help the world to contain the virus and mount economic recovery.

Gao Haihong is a senior fellow at the Institute for World Economics and Politics, Chinese Academy of Social Sciences, China; and Kevin P. Gallagher is a professor at and director of the Global Development Policy Center, Pardee School of Global Studies, Boston University, USA.

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