(By Daniel Bradlow and Kevin P. Gallagher)
On July 9, the International Monetary Fund’s executive board agreed to inject the equivalent of $650 billion in Special Drawing Rights — IMF’s unique reserve asset — into the world economy.
The most significant multilateral financial effort in decades, this historic decision should help states maintain liquidity and gain fiscal space to battle the pandemic while mounting a green and inclusive recovery.
To work truly though, the allocation must be done in a way that optimizes the access of low- and middle-income countries to these reserve assets both now and into the future.
This will be the largest SDR allocation IMF has ever made. It will more than double the total amount of SDRs that IMF has issued since the creation of SDR in 1969 and will increase the current level of global foreign exchange reserves by about 5%. How it is implemented will influence the future evolution of international public finance.
To maximize the use of SDRs in the COVID-19 era, three problems must be addressed.
First, the majority of SDRs will flow to countries that will not need or use them. IMF is legally bound to allocate new issuances of SDRs among its members according to their quotas rather than according to financial need. Because high-income countries have the largest quotas, they will receive most of the allocation — approximately $390 billion, or 60% of the total allocation — even though they do not need additional reserves.
LMICs who most need new resources will not receive enough to overcome the shock that the COVID-19 pandemic has inflicted on their economies and citizens, let alone address their other daunting social, economic, and environmental challenges.
Second, the international community needs to build an effective SDR reallocation mechanism. In recognition of this problem, the G-20 has charged IMF with advancing options for recycling SDRs to those countries that need them most.
Third, while the creation of $650 billion in SDRs is unprecedented, it is not enough. The United Nations has estimated emerging markets and LMICs will require upward of $2.5 trillion to restore liquidity and gain the fiscal space for a proper recovery. Civil society groups estimate that they may need at least $3 trillion.
History offers an important warning regarding these problems. When SDRs were being created, LMICs advocated for establishing a link between SDRs and development, so that those countries most in need of additional resources would be able to use a more than proportionate share of all SDR allocations to fund their development.
Several proposals were made about how to structure the link — ranging from requirements for high-income countries to make donations to the International Development Association, the World Bank agency that lends to low-income countries, to direct allocation of SDRs to development agencies.
The international community should acknowledge that, despite its historical significance, the $650 billion allocation of SDRs does not fully meet the needs of LMICs.
Unfortunately, there was no agreement on the best approach. The high-income countries exploited the divisions among the proponents and defeated efforts to create an SDR-development linkage.
There is a risk of this history repeating. SDRs can be used in many potential ways: to support the liquidity needs of LMICs countries; to fund vaccines and other COVID-19-related expenses; to address climate change and other environmental risks, or to promote the 2030 Sustainable Development Goals.
There are also several different ways to implement the recycling effort.
One option is to utilize IMF’s Poverty Reduction and Growth Trust, which IMF currently uses to provide concessional financing to low-income counties. There is precedent in that PRGT has been supported by SDRs in the past and has experience financing operations in low-income countries in difficulty.
But IMF support for low-income countries often comes with problematic conditionalities such as tax increases and cuts in social expenditures. IMF itself appears to be on the brink of proposing a new trust, which would address climate change — the Resilience and Sustainability Trust. A third option, which has also been used in the past, is to allow each high-income country to decide for itself how to reallocate its SDRs to help LMICs.
The international community should use this historic opportunity to establish an innovative strategy for recycling SDRs to LMICs. A necessary first step is to incorporate the 15 entities, besides IMF and its member states, that are authorized holders of SDRs into the reallocation process. These entities include four supranational central banks, three regional monetary authorities, and eight development institutions.
They should be invited to collaborate with each other to establish dedicated mechanisms to hold and distribute SDRs among the relevant states in ways that ensure the SDRs are used in compliance with the following five operating and governance principles:
- Reallocated SDRs are made available to all LMICs who can demonstrate that they need additional liquidity, regardless of their income level.
- High-income countries do not use the reallocations as an excuse to reduce their current aid commitments.
- Reallocations do not result in the receiving countries incurring any financial costs beyond what is required by the SDR rules.
- Neither IMF and the other authorized holders nor the reallocating countries attach any additional conditions to the use of the reallocated SDRs other than those arising from the current SDR rules.
- Decision-making procedures and operational policies and practices of the mechanism should be transparent, and, as appropriate, should provide opportunities for accountability to and participation by all their stakeholders.
Finally, the international community should acknowledge that, despite its historical significance, the $650 billion allocations of SDRs does not fully meet the needs of LMICs. Consequently, it should agree that IMF will make further SDR allocations, for example, every year for the next three to five years. These new allocations should be coupled with recycling mechanisms in compliance with the above principles.
The human, ecological, and economic health of the planet may depend on it.