Towards the Marginalization of Multilateral Crisis Finance? The Global Financial Safety Net and COVID-19

On the eve of the COVID-19 crisis, the global financial safety net (GFSN) boasted more liquidity resources than at any other point in history. As the global economy entered into free fall due to the economic effects of the pandemic and efforts to stop the spread of COVID-19, both casual observers and experts were convinced that policymakers had a broader range of institutions to draw on for international liquidity support than during the global financial crisis of 2008-09. Yet, the increased resources of additional and reformed multilateral institutions for emergency liquidity have so far been surprisingly underutilized during the COVID-19 pandemic.

According to recently updated estimates from the Global Financial Safety Net Tracker, a new interactive database compiled by the Institute for Latin American Studies at Freie Universität Berlin and the Boston University Global Development Policy Center, in 2018, the financing available from the GFSN had reached at least $3.5 trillion, or 4 percent of global GDP.

Today, the IMF with its current $1 trillion lending volume is by far not the only actor to provide emergency liquidity. Further to the IMF, several regional financial arrangements (RFAs) have been set up to provide crisis finance between neighboring countries or peers. Further, bilateral currency swaps between central banks of substantial volume have become an essential element of the GFSN landscape. While the level of support is larger than just a few decades ago, it is still less than 1 percent of total financial assets.

A new policy brief  by Laurissa Mühlich, Barbara Fritz and William Kring shares the latest analysis of the GFSN coverage and explores the utilization of the GFSN during the COVID-19 pandemic. The authors find that newly created and reformed multilateral institutions on the global and the regional level – the IMF and the RFAs – have so far lent only a small share of their available lending capacity in reaction to the COVID-19 shock. While the RFAs have disbursed about $3.8 billion to member countries, the IMF has lent about $108 billion, i.e. around 10 percent of its lending capacity. At the same time, the third element of the GFSN, bilateral swap arrangements between central banks has provided much larger volumes of crisis finance liquidity, with about $1.75 trillion accessible in bilateral central bank currency swaps as of March 2021. These swaps are offered by a wide range of central banks, predominantly the US Federal Reserve and the People’s Bank of China.

So far, the authors observe that the amount of liquidity provision provided by bilateral currency swaps to prevent or backstop a financial crisis has outpaced that of multilateral institutions by far. Voluminous as they may be, bilateral swaps lack the predictability and transparency of multilateral lending and are not provided at a level playing field, but rather on the interests of economically powerful countries.

The authors also highlight three key lessons on the potential marginalization of the once fundamental multilateral elements of the GFSN.

First, despite pledges of rapid and abundant responses of liquidity from the IMF and the RFAs, these institutions have seen little use throughout the crisis. This could potentially be the calm before the storm: at the time of writing, many emerging market and developing economies have not lost access to capital markets due to a high market liquidity overall. This could change as debt levels continue to surge and if demand for liquidity resources grows, poorer countries and regions less covered by the GFSN will struggle to find the crisis financing needed.

Second, while RFAs and the IMF are multilateral institutions, the extent to which swaps have outpaced multilateral liquidity provision throughout the crisis raises questions about countries’ confidence in the capacity of these institutions to adequately respond to crises. Further, it raises the specter of national interests increasingly influencing the global crisis finance regime. While it is certainly premature to draw any conclusions about the GFSN, the authors suggest there may be increasing geostrategic considerations behind this vast volume of bilateral liquidity support, which might be described as ‘liquidity diplomacy.’ However, it is still too early to tell if bilateral currency swaps between central banks could crowd out multilateral liquidity provision by the IMF and RFAs.

Finally, the most important lesson that the GFSN Tracker suggests according to the authors is that multilateral institutions need to become more attractive to member countries to prevent their marginalization. Maintaining choice and competition in the system is important to encourage better service delivery and enhance the bargaining power of governments regarding programs to return nations to stability and sustainability. At the same time, inequalities in access to and availability of short-term financing point to the uncoordinated status quo of the GFSN. Most importantly, uncoordinated surveillance and lending entails the risk of mistakenly categorizing a solvency crisis as a liquidity crisis.

In addition to the initial signs of cooperation between the IMF and RFAs, such efforts need to be systematically widened in scope to swiftly prepare for the next potential crisis after COVID-19. Additionally, reform is needed to IMF conditionality to regain utilization as a flexible, predictive and adequately conditioned crisis response mechanism besides regional and bilateral ones. In addition, safeguards must be put in place to ensure the RFAs not only benefit from collaboration with the IMF, but also maintain their autonomy and independence that is so highly valued by their member constituencies.