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Who Will Come to the Rescue? The Inadequacies of the Global Financial Safety Net and Its Impact on Developing Countries

File image of the headquarter building of the People's Bank of China in Beijing. AFP

By Marina Zucker-Marques and William N. Kring

In an era marked by ‘higher-for-longer’ interest rates and restricted access to international financial markets, access to emergency liquidity financing is essential for emerging markets and developing economies (EMDEs) to weather economic and climate shocks. Sufficient and rapid sources of emergency financing are key to ensuring liquidity crises do not escalate into full-blown solvency crises.

Yet, the current Global Financial Safety Net (GFSN) – the emergency liquidity financing provided by the International Monetary Fund (IMF), regional financial arrangements, and currency swap agreements – is deeply flawed and asymmetric. While the United Kingdom, Japan, Canada, Switzerland, and Euro area economies are over-insured and have access to unlimited and unconditional swap lines from the U.S. Federal Reserve, other developing economies are only marginally insured, and at least 80 countries have to rely solely on IMF for crisis finance, which is often accompanied by austerity programs.

Through the provision of currency swaps and the establishment of RFAs, China is helping to fill the void left by the West and its institutions by providing crisis finance to EMDEs that would otherwise have no other viable options. However, China alone cannot fulfill the world’s crisis finance needs. Rather, the IMF, as the anchor of the GFSN, must be reformed to enable the institution can truly provide equitable support across the global financial system.

Unfortunately, IMF reform in all its dimensions has been disappointing for developing countries to date.

Scholars from the Freie Universitat Berlin, the Boston University Global Development Policy Center, and the United Nations Conference on Trade and Development have been tracking the availability of GFSN resources in the Global Financial Safety Net Tracker. Recently released data through July 2023 shows that, of the $1 trillion in active currency swaps, over $400 billion is provided by the People’s Bank of China (PBOC). Several EMDEs are benefiting from this liquidity finance, including Pakistan, Egypt, and Indonesia. Earlier this year, a swap agreement with the PBOC allowed Argentina to draw $2.7 billion to bridge its IMF program. Additionally, China has contributed to several RFAs, including $41 billion to the Contingent Reserve Arrangement and $76 billion through the Chiang Mai Initiative Multilateralization.

While the financial vulnerability of countries like Argentina made the extension of Chinese swap maturities an imperative, it is important to remember that swaps are fundamentally short-term emergency credit lines. They are not vehicles for long-term investment. Essentially, swaps function more like insurance, activated only under unstable external conditions, and should not be conflated with other development finance instruments. Additionally, as countries can extend their central bank swap agreements, IMF loan payments can also be extended. Such extensions do not alter the fundamental nature of IMF lending as part of the GFSN; the same is true for central bank swap agreements. These distinctions are key to understanding the difference between longer-run development finance and short-term liquidity finance.

Along with other EMDEs, China has long called for reforming the governance of the international financial system, in particular, at the IMF. The IMF serves as the crucial anchor of the GFSN, but its effectiveness is hampered by a myriad of factors. Critically, the conditions attached to its loan programs often impose austerity measures and exacerbate inequality without consistently promoting stability and growth. Furthermore, the countries most impacted by IMF policies hold minimal influence within the IMF’s decision-making process due to its ranked quota system. Compounding these issues is the fact that IMF funding does not adequately meet the escalating external financial needs of developing countries, creating a significant gap in global economic stability.

Unfortunately, IMF reform in all its dimensions has been disappointing for developing countries to date. With the exception of the 2010 IMF Quota and Governance Reforms, progress towards realigning quotas at the IMF and increasing permanent, quota-based resources has been non-existent. This week, the IMF Board of Governors will vote on the Executive Board proposal to increase IMF quotas by 50 percent. While scholars and policymakers have long called for a significant increase in IMF resources, the current proposal includes two disappointing details: IMF quotas will be allocated to member countries in proportion to their current quotas and will replace more temporary sources of IMF lending capacity, which means there will not be a net increase of funding for the Fund.

It is important to note that Chinese swaps – like swaps from other countries – have been criticized over a lack of transparency and higher costs than some alternative components of the GFSN. Additionally, while Chinese swaps augment the GFSN with much-needed support, they are not a silver bullet for resolving the GFSN’s asymmetries. Rather, that will require reform at the IMF, including revamping its policy conditions, expediting fund disbursements and expanding the overall availability of financial resources.

Vulnerable EMDEs need the IMF to step up and truly serve as the global lender of last resort and to do that, they must initiate deep reform of their lending terms, programs, and governance by increasing the volume of credit available for low- and middle-income countries, eliminating pro-cyclical austerity measures and overhauling conditionality policies.

Moreover, considering the increasing complexity of the GFSN, the IMF can take the role of coordinating its different layers to ensure all countries have fair and equitable access to GFSN resources.

To reform the international financial system to be more equitable and inclusive, reform must first start with the governance that oversees that system. That work begins with the IMF.

Marina Zucker-Marques is a Post-doctoral Researcher with the Centre for Sustainable Finance at SOAS, University of London. Follow her on X: @MarinaZucker.

William N. Kring is the Executive Director of the Boston University Global Development Policy Center. Follow him on X: @WilliamNKring.

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