Coronavirus chaos is the IMF’s biggest test ever
What the world needs most right now is a lender of last resort
Finance ministers and central-bank governors logging in for this week's virtual meetings of the International Monetary Fund and World Bank will say the right thing, promising to work together to confront the economic fallout of the coronavirus. The question is whether they will do the right thing and take concrete steps to allow the necessary cooperation and coordination.
Many countries have responded poorly to the pandemic and its economic consequences. The international response has been worse — not just hesitant and ill-planned, but almost invisible. One area of neglect is especially important, and goes to the core of the IMF's purpose: The world lacks an effective lender of last resort.
When a bank that's fundamentally sound faces a run on deposits, the country's central bank provides cash to meet the demand until confidence returns. The central bank's capacity to do this is unlimited, since it controls the supply of money. But suppose the currency that's needed to stop the run is foreign, not domestic. That complicates things.
Many low- and middle-income countries borrow in dollars or other foreign currencies. As the pandemic worsens and losses mount, capital will flee. The outflow in the past two months stands at $100 billion, more than three times bigger than in the corresponding period of the financial crisis. This is like a run on bank deposits — except that the central banks concerned can't provide the needed liquidity. The local damage could multiply and spread, as the effects are transmitted to foreign investors and trading partners.
All this has long been understood, and preventing crises like this is one of the IMF's main jobs. But its tools aren't good enough. Although cross-border flows of capital have surged in recent decades, the resources and arrangements that the IMF uses to handle the consequences haven't kept pace.
Nowadays the global system relies heavily on non-IMF forms of support. There are three. First, central banks set up bilateral swap-line arrangements — under which the US Federal Reserve, say, lends dollars to other central banks in exchange for their currency. (The partner central bank then lends the dollars to borrowers in need of dollar liquidity; in due course the Fed and its partners swap their currencies back.) Another approach is to set up a regional financing arrangement to act as a kind of mini-IMF (sometimes in collaboration with the actual IMF); the European Stability Mechanism is one such arrangement. And another is for individual governments to self-insure against a squeeze on liquidity by building up their foreign-currency reserves.
Though better than nothing, these elements of the so-called Global Financial Safety Net fall short.
Swap lines among the big central banks — the ones that issue reserve currencies like the dollar and the euro — are now routine, but arrangements for emerging economies are ad hoc and unreliable. Regional arrangements haven't worked well even for their members (think of the ESM's difficulties with Greece) and leave non-members unprotected. The distribution of reserves is patchy, with some countries having more than they need and others not enough. Self-insuring that way is also expensive and can contribute to global instability by promoting excessive current-account surpluses and savings gluts; and, when push comes to shove, countries are often reluctant to draw on their putative insurance and run down their reserves, because it signals they're in trouble.
With the global outlook deteriorating at a stunning rate, the big central banks have taken steps to protect themselves and each other — but this isn't helping smaller and poorer economies. The US, Europe and Japan won't be immune to a crash in the rest of the world. There's a compelling common interest in trying to cushion the blow.
Most of the IMF's $1 trillion lending capacity is untapped. That's unlikely to be sufficient, but it's a start. In the first instance the focus should be on maximum speed and flexibility in delivering available support to the countries that need it. This week governments should confirm that they'll provide any additional capacity that might be required. A new allocation of Special Drawing Rights, the IMF's proprietary currency, would help. And some governments will need outright debt relief, because they're not just illiquid but insolvent.
Beyond all this, the international financial plumbing needs work. A crucial overdue improvement would be a global system of central-bank swap lines under IMF supervision. Edwin Truman of the Peterson Institute for International Economics set out a plan for this reform after the crash. His idea was to replace the orthodox "constructive ambiguity" over swap lines with an institutionalized and predictable program. By pre-qualifying countries and making central banks plan ahead, this could deliver more support more quickly. Just knowing that the system was in place would help to stabilize capital markets, even if the arrangements didn't need to be used.
The idea is in the air again. IMF Managing Director Kristalina Georgieva says she's been discussing an "IMF-swap type facility." The details matter, though: The IMF by itself can't promise liquidity support at the required scale. That needs to come from actual central banks, preferably acting in coordination with the IMF. Truman's proposal made sense when he first suggested it in 2010. Ten years on, it would have been an excellent tool for dealing with part of the pandemic's economic fall-out — but nothing was done.
Add "lender of last resort" to the list of ways in which global integration has moved faster than the institutions needed to manage it. The costs of turning back the clock on integration would be enormous — as the world might be about to find out. The alternative is to get global policy-making up to speed, finally. The politicians who give the IMF its orders should make a start right now.
Disclaimer: This article first appeared on Bloomberg.com, and is published by special syndication arrangement.
