By Kevin P. Gallagher
China is being criticized for stepping up its policy to provide liquidity financing in the form of loans and currency swaps for countries in distress for the wrong reasons. Providing such liquidity shows that China is capable of being a responsible global stakeholder as the Western-backed institutions, namely the International Monetary Fund (IMF), continue to fall short of appropriate responses to yet another crisis. That said, China should learn from history and play a more engaging role to ensure its liquidity finance is put to good use or China could lose even more of its hard-earned capital.
Developing countries have been battered by four waves of compounding crises in just three years. First of course was the COVID-19 crisis, then Russia’s war in Ukraine, followed by this summer’s severe climate shocks, and now the mishandled interest rate hikes to tame inflation in the advanced economies. Left to their own devices by the multilateral system, developing countries did all they could to protect their people during these times but have run out of fiscal space. This latest wave of capital flight has further depreciated currencies and ballooned debt levels. During the first two waves in 2020 and 2021, most countries went to private capital markets, despite the fact those loans were vastly more expensive than IMF loans. Now, they are running out of options.
No one wants to go to the IMF. The academic literature overwhelmingly shows that IMF programs favor the geopolitical allies of Western countries and conditions its loan packages on austerity programs that accentuate poverty and inequality and seldom return a country back to stability and growth. Such an approach stands in stark contrast to the Western approach, where the bipartisan consensus is that expansionary fiscal and monetary policy to grow out of a recession is the best course of action. Indeed, Western countries unleashed upwards of $13.4 trillion in fiscal support alone to recover from COVID-19, while countries that went to the IMF had to tighten their belts.
China has long been a critic of these IMF policies. Rather than the austerity that plagued the European response to the 2008 financial crisis, China mounted the largest and most effective expansionary stimulus package that not only helped China recover but also helped buoy much of the developing world. To be sure, China watched its East Asian neighbors crumble in the face of IMF programs in the 1990s. To protect themselves, East Asian countries have amassed large amounts of dollar reserves so they never have to go to the IMF again.
Many emerging markets and developing countries in Africa, South Asia, and Latin America are net importers of capital and do not have that option. Newly published research conducted by Rebecca Ray, William Kring, and myself affirms previous findings that IMF loans favor the geopolitical allies of Western governments by granting those allies less harsh austerity conditions—while imposing harsher conditions on Chinese allies. China is not only doing the right thing, it is protecting its own interests, as partners who get a harsh deal from the IMF will have less ability to pay back loans owed to China.
Can China provide a better alternative? James Sundquist has shown that China has become an important source of alternative liquidity than the IMF for quite some time. Stephen Kaplan’s new book shows that China’s liquidity loans have given Latin American countries more room to maneuver so they could recover and avoid the IMF as well. In 2008 after the IMF and the private sector had shut Ecuador out of private capital markets, China provided a liquidity loan that helped Ecuador return to the private capital markets much quicker than if they had undergone austerity measures.
However, the compounding crises developing countries are facing is far worse than over a decade ago when China first started this kind of financing. There is no guarantee that recipients of Chinese loans will implement effective, expansionary policies to put them on a better economic path and able to pay their creditors. In fact, there is increasing pressure for countries to take China’s dollars and turn around and pay back loans to the Paris Club, multilateral development banks, and private bondholders instead. Rather than giving handouts, China should engage in South-South cooperation (not North-South conditionality) to help recipient countries learn from China’s experience in formulating effective stimulus packages—while also ensuring seniority of Chinese loans that thus can’t be used to pay other creditors.
Without such cooperation, China may be gambling with these loans and the odds may be against them.
Kevin P. Gallagher is the Director of the Boston University Global Development Policy Center and a Professor of Global Development Policy at the Pardee School of Global Studies at Boston University. Follow him on Twitter: @KevinPGallagher.
