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Info Service on Finance and Development (Jun21/03) Special Drawing Rights: Saving the global economy and bolstering recovery in pandemic times – Critical views on recycling mechanisms, funds and vehicles – By Bhumika Muchhala and Christopher Hope (1) In the wake of the liquidity and fiscal crisis across developing countries generated by the global pandemic, the role of Special Drawing Rights (SDRs) – an international reserve asset issued by the International Monetary Fund (IMF) – has been an important part of the debate on economic recovery. Developed countries account for nearly 80% of all fiscal efforts, while many low-income countries (LICs) have cut spending or have directed more funds to repaying creditors than they have to their own health sectors. In the 15 months since the onset of the pandemic in March 2020, multilateral efforts have not sufficiently accelerated comprehensive efforts to respond to the multiple dimensions of health and economic crises in developing countries, particularly through financing and provision of immediate liquidity. The unequal distribution of vaccines and emergence of new variants of the virus threaten to prolong the crisis, with developing countries continuing to bear the brunt of the exacerbation of poverty and inequality, including extreme poverty. Progress toward the Sustainable Development Goals by 2030 is effectively derailed, with many developing countries set back by years or decades in the achievement of these goals. In this context, there has been ample discussion of the possible role of SDRs in responding to the crisis. It now appears that later this year the IMF will allocate countries with SDRs worth a combined US$650 billion. But there remains much debate as to precisely how SDRs can support the pandemic response and recovery, how SDRs can be directed to those countries most in need, and what kind of institutions could be set up to utilise SDRs in the pandemic response. With these questions in mind, a group of 16 civil society organizations organized a webinar titled, ‘SDRs: Saving the global economy and bolstering recovery in pandemic times’ on 21 May. Opening remarks were made by Cardinal K.A. Peter Turkson (Prefect, Dicastery for Promoting Integral Human Development). Speakers were Vera Songwe (Executive Secretary, Economic Commission for Africa); Jose Antonio Ocampo (Former Finance Minister and Central Bank Board Member of Colombia); Daouda Sembene (Distinguished Non-Resident Fellow, Center for Global Development, and Former IMF Executive Director for a group of African Countries); Ana Corbacho (Assistant Director, Strategy, Policy and Review Department, IMF); Esteban Perez Caldentey (Chief, Financing for Development Unit, Economic Commission for Latin America and the Caribbean); and Jayati Ghosh (Professor of Economics, University of Massachusetts Amherst). The following presents a summary of the key themes discussed during the event. A recording of the discussion is available here. The purpose of SDRs Global reserve funds in the form of IMF SDRs are a vital tool to provide swift and unconditional support to the global response without increasing debt. Civil society organizations and experts have called for a new allocation of US$3 trillion in SDRs. Earlier this year the IMF membership conveyed broad support for an allocation of US$650 billion in SDRs and will consider a formal proposal in June, while the issuance will likely occur in August. Of this amount, low-income countries would receive US$21 billion – crucial relief, but not close to the $450 billion financing needs identified by the IMF to step up pandemic response and accelerate growth. Developing countries would receive US$230 billion, short of IMF estimates that last year placed emerging economies’ financing needs at US$2.5 trillion. During the 21 May event Ocampo said that the most positive aspect of SDRs is that they are essentially foreign exchange reserves for developing countries, providing them with international liquidity. In light of the very limited international cooperation on debt and liquidity that has taken place, SDRs are constructive for pandemic response and recovery in developing countries. Corbacho of the IMF clarified that SDRs will boost international reserves, and this is of vital importance as an insurance mechanism in times of crisis. Expanding reserve assets also strengthens global financial resilience and confidence by sending a powerful signal of macroeconomic stability. She outlined the immediate uses of SDRs in developing countries, which include building up reserve buffers, providing financial backstops and freeing up financial liquidity for urgent balance of payment needs. Corbacho added that the creation of additional liquidity can occur either by the addition of SDRs to reserves freeing up other foreign currency reserves or by countries converting their SDRs for hard currency. When countries convert their SDRs for currency, they are required to pay an interest rate to the IMF. Given that the normative interest rate is at a record low of 0.05%, using SDRs is currently very affordable. If, or rather, when, rich countries start to normalize and unwind their expansionary policies, interest rates may rise, which countries should bear in mind. Sembene said that if well-calibrated and timely, SDRs can provide useful liquidity, but that historically SDRs have not played this role. Mechanisms to recycle and transfer SDRs must be designed to maximize impact and use. While the immediate priority for developing countries is vaccine access and purchase, there are other priorities that should not be forgotten, such as debt sustainability and climate change. Governments across the South need financial resources to bolster economic recovery, counter wealth- and income-inequality and tackle rising poverty. Recycling rich country SDRs The core inequity in SDR allocation is that they are distributed according to IMF quotas, or financial contribution shares, rather than need. As a result, over 60% of SDRs go to a handful of wealthy countries, while developing countries with the greatest need receive the least. In response, IMF membership asked the institution to explore mechanisms for rich members to voluntarily transfer SDRs to vulnerable countries. Different stakeholders have proposed a number of, not mutually exclusive, forms for such mechanisms, for instance: contributing to the IMF Poverty Reduction and Growth Trust facility, financing expanded debt relief through the Catastrophe Containment and Relief Trust, strengthening the financial capacity of multilateral or regional financial institutions, and creating new vehicles – such as the Liquidity and Sustainability Facility, vaccine financing vehicles or the Covid-19 Economic Relief Fund. The key question is how can the design of SDR recycling mechanisms maximize positive impacts for all countries that need support, while avoiding harm? According to Perez Caldentey of ECLAC, recycling SDRs needs to proactively include middle-income countries (MICs). Despite being home to more than 75% of the global population, a majority of the world’s poor and accounting for almost 96% of the external debt of all developing countries (excluding China and India), MICs have so far not been granted access to G20 debt relief. Reallocation, he stressed, should also be used as a way to boost the lending capacity of regional financial institutions and regional banks, such as the FLAR and the Eastern Caribbean Central Bank, among others. Ocampo emphasized that SDRs should be lent to low and middle-income countries without conditionality and with attention to how exactly to spend the SDRs. For Corbacho at the IMF, the central question leading up to the August (2021) issuance is how SDR recycling mechanisms can supplement and meet global reserve needs. The IMF requires broad support from its members, she stressed, as the process of reallocation can only be made effective once the IMF’s Executive Board approves. Donating SDRs Civil society organisations and many other policymakers and academics have stressed the importance of maintaining the inherently benign properties of SDRs of being non-debt creating and unconditional. The best way to maintain these properties would be direct donations of SDRs from rich countries to developing countries. However, Ocampo warned that such donations are not easy, as the donating country will have to pay interest to the Fund. As a long-term approach to overcome this hurdle, Ocampo proposed this interest to be paid out of the general IMF, though he acknowledged that this would be unlikely to occur for this allocation. Corbacho reiterated the point, noting that the interest costs would be permanently incurred by the donor country. That is why it makes more sense for rich member countries to on-lend their SDRs, rather than donate them. On the other hand, Ghosh countered that for G7 countries the budgetary implications of paying this interest are minor. As such, the issue is convincing rich country governments to agree to donations. On-lending SDRs The
IMF is reportedly considering its Poverty Reduction and Growth Trust
(PRGT) lending facility as a central SDR recycling mechanism. Many
civil society advocates have concerns over PRGT loans, many of which
were mentioned by speakers. The PRGT facility is currently accessible
to only LICs and should be made accessible to all developing countries
in need. Ghosh noted that while IMF leadership and management have made statements that Covid-19 financing should be non-conditional, this point has not yet been incorporated into the Fund’s lending facilities. Many civil society advocates are also against the conditionality within PRGT loans, typically oriented toward fiscal consolidation in the medium to long term. They also stress that PRGT loans would exacerbate already high levels of debt distress, may be double counted as ODA rather than additional to existing aid commitments and requires a more appropriate accountability mechanism. Vaccine funds Songwe emphasized that the priority for the African continent is vaccine access and distribution. As such, as well as supplementing the PRGT, SDRs should be on-lent to create a fund for vaccines. While the first priority is to get more countries and companies to produce vaccines, after production the problem for developing countries will be vaccine affordability. Ghosh stated that SDRs should be specifically recycled into the World Health Organization’s Access to Covid-19 Tools (ACT) Accelerator, which addresses diagnostics supplies, personal protection equipment and medical needs, among other areas. Corbacho reiterated that ultimately it is up to IMF member countries how they will employ unused SDRs. Channeling SDRs for specific purposes such as vaccines and climate change, either through another trust or through Special Purpose Vehicles (SPVs), will need willing creditors as well as satisfying certain criteria, such as the additionality and complementarity of new trusts to existing IMF tools. A fund outside of the IMF Sembene said that while the IMF is important it is not the only institution and process by which SDRs can be recycled. Should there be a role for multilateral development banks (MDBs) and mechanisms within these institutions that can leverage SDR resources for use over the long term? He noted that an SDR recycling mechanism that should be on the table is on-lending via SPVs that are not yet prescribed holders of SDRs. This would require a decision from the IMF to designate new prescribed holders of SDRs. Sembene also stressed that one key area that SDR recycling conversations may not be focusing as much on is the role of SDRs in reducing debt burdens across the developing world. Liquidity and Sustainability Facility There was debate within the panel on the value of using SDRs to contribute to a Liquidity and Sustainability Facility (LSF) for Africa, which has been proposed by UNECA. The LSF . The LSF would mobilise private finance for the Sustainable Development Goals (SDGs) through mechanisms such as SDG Covid-19 bonds (see ECA, 2020). According to the ECA, the LSF would be financed by official development assistance, multilateral development banks, and/or by the central banks of members of the Organisation for Economic Co-operation and Development (OECD). The LSF is a response to the African context of sovereign debt, where countries often have to pay higher interest rates than non-African countries with similar macroeconomic fundamentals (often called the ‘African premium’), in that the facility hopes to reshape misperceptions about credit risk for African sovereigns. As Vera Songwe of ECA previously mentioned in a June 2020 Financial Times article, “Africa needs its own repo market, […] that would attract a new class of investors while shaving off the higher borrowing costs that African nations face because of age-old stubbornly sticky perceptions that they are especially risky.” The LSF “modelled on existing market-based and commonly used facilities in Europe and the US […] would help cut borrowing costs for African governments by providing incentives for the private sector to increase their portfolio investments on the continent.” Ghosh had concerns over these types of facilities for Africa. She noted that whilst it is good to leverage existing resources for additional finance, the design of the LSF meant that it was pro-cyclical, dependent on market behaviour, and would lead to a loss of domestic monetary and fiscal policy. Ghosh pointed to the experience of middle-income countries in Asia, who had opened up to bond markets over recent decades and have experienced net losses. Songwe responded that the LSF was not pro-cyclical and that its role was in correcting market distortions. The LSF is necessary because Africa has not yet deepened its capital markets, meaning that it presently has to borrow at high rates. The LSF would mobilise private finance for the Sustainable Development Goals (SDGs) through mechanisms such as SDG Covid-19 bonds (see ECA, 2020). According to the ECA, the LSF would be financed by official development assistance, multilateral development banks, and/or by the central banks of members of the Organisation for Economic Co-operation and Development (OECD). The LSF is a response to the African context of sovereign debt, where countries often have to pay higher interest rates than non-African countries with similar macroeconomic fundamentals (often called the ‘African premium’), in that the facility hopes to reshape misperceptions about credit risk for African sovereigns. As Vera Songwe of ECA previously mentioned in a June 2020 Financial Times article, “Africa needs its own repo market, […] that would attract a new class of investors while shaving off the higher borrowing costs that African nations face because of age-old stubbornly sticky perceptions that they are especially risky.” The LSF “modelled on existing market-based and commonly used facilities in Europe and the US […] would help cut borrowing costs for African governments by providing incentives for the private sector to increase their portfolio investments on the continent.” Long-term reforms to maximise the benefits of SDRs An underlying current during the event were voices calling for a more ambitious reformulation of how SDRs can be used to support developing countries. Ocampo identified three long-term solutions. First, eliminating the dual accounting of SDRs – counting as both assets and liabilities – within the IMF’s SDR account and its general resources account. In this way, SDRs that have been issued but have not been used by states can be used by the IMF to finance its products. This was the most important potential reform. Second was changing the distribution formula for IMF quotas so that the need for foreign reserves is taken into account. This would lead to more SDRs being allocated to low- and middle-income countries. And third, allowing for the private use of SDRs. While these options can move the needle forward for SDRs to achieve their purpose in assisting countries in need, all of them require changes in the IMF’s Articles of Agreement, which currently constrains the above options. In a similar vein, Ghosh argued that there should be automatic mechanisms within the IMF that keep issuing SDRs over time and that we need to think of reasonable ways of reallocating SDRs to support global public goods. Today we are talking about the pandemic, in the future it will be climate change. We need cross-border public trusts to ensure some degree of economic resilience, but they cannot be based on the on-lending IMF facilities which are necessarily conditional. We are all thinking within the constraints of what is possible right now, but ultimately this is no time for business as usual, and we have to rethink and step outside this box, if we are to do anything for the massive challenges the global economy is facing today.+ (1) Bhumika Muchala is Third World Network’s Senior Policy Researcher for finance and development. Christopher Hope is a Policy Officer at Bretton Woods Project.
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