By Justin Yifu Lin and Yan Wang
The global economy is facing polycrisis: increasing climate change, Russia’s war in Ukraine and capital flight from emerging markets and developing countries, leading to declines in their foreign exchange reserves, local currency depreciation and difficulties to repay dollar denominated loans.
A recent book by Leonce Ndikumana and James K. Boyce found that between 1970-2018, the African continent lost $2 trillion to capital flight. The authors tracked the sources, the channels and destinations of capital flight, revealing that it is not unrelated to the premature capital account liberalization and the weak global governance system around tracking the flows of trade mis-invoicing, money laundering, tax evasion and illicit financial transactions, which African countries frequently struggle to track.
Given this situation, policymakers and development practitioners must ask tough questions. First, who should be held accountable for the consequences of these misleading policies? Washington-based Bretton Woods Institutions, namely the International Monetary Fund (IMF) and the World Bank, have the responsibility and ability to inject liquidity at times of foreign exchange and financial crisis. However, World Bank lending has not kept up with economic growth since 2017. In fact, it declined in fiscal year 2022, and the IMF has not done much better, as shown in Figure 1. This should be unacceptable to the shareholders of the IMF and the World Bank.
Figure 1: Net Disbursement in the World Bank’s International Development Association (IDA) and the IMF’s Poverty Reduction and Growth Trust (PRGT)
Given this decline in FY2022 net lending, which runs counter to the expectations of shareholders, the rationale for these financial institutions to stay out of the current debt relief effort has significantly weakened.
Second, what can be done to stem capital flight? In our view, three steps are necessary.
First, the IMF released in a staff paper in 2010 and updated its Institutional View in 2022 to say that its past advice on capital account liberalization was misleading, and at times of crises, countries can legitimately use “capital flow management tools.” So far, few countries have done so, despite the fact that they are suffering massive capital outflows and currency depreciation, exacerbating debt distress in some (though not all) low-income countries. We suggest that countries in debt distress may consider using these capital flow management tools.
Second, we support capital increase and quota reform in the World Bank and the IMF. We support the suggestion by Larry Summers that “the Bank’s shareholders insist on a financial vision that will result in $2 trillion in lending over the 2024-34 decade.” The IMF should rapidly increase their unconditional lending to the least developed countries utilizing Special Drawing Rights (SDRs) which were contributed to the new Resilience and Sustainability Trust (RST) facilities by China and other countries. Third, the World Bank, with its mission of reducing global poverty, should participate in the current round of debt restructuring by taking the lead with innovative approaches, such as debt to “Brady-like” bond swaps, debt-to-nature swaps, debt-to-climate swaps and asset-based refinancing. Emerging and developing countries can then follow their models and learn from their experiences.
Justin Yifu Lin is former Chief Economist of the World Bank and the Director of the Institute of New Structural Economics at Peking University.
Yan Wang is Senior Academic Researcher at the Boston University Global Development Policy Center.