Resetting the Global Financial Safety Net for the COVID-19 Recovery

Due to the COVID-19 pandemic, the year 2020 saw the sharpest economic downturn since the Great Depression. In 2021, the world economy is showing signs of a broad, albeit uneven recovery. The existing gaps of vaccination rollouts, economic fundamentals, and varying monetary and fiscal responses in different countries pose challenges in the areas of financial stability and solid growth worldwide. In particular, many emerging markets and developing countries that are lacking policy options in coping with uncertainty and spillover effects from advanced economies are desperate for liquidity support.

In a new policy brief published by T20 Italy’s International Finance Task Force, Kevin Gallagher, William Kring and co-authors propose to reset the Global Financial Safety Net (GFSN) designated to provide financial assistance for countries in need in the following aspects: (1) boost the use of the International Monetary Fund’s (IMF) Special Drawing Rights (SDRs), (2) update the IMF’s financing arrangements; (3) broaden the coverage and enhance the role of Regional Financial Arrangements; (4) coordinate national policies to mitigate negative effects of spillovers; and (5) align the GFSN with the 2030 Sustainable Development Goals (SDGs) and the Paris Climate Agreement.

Recommendations:

• On SDRs:
  • The agreement to issue $650 billion dollars in SDRs is a significant advance in reinforcing the GFSN to manage the ongoing crisis. Close to two-fifths of the new SDRs would boost the reserves of developing countries.
  • Beyond crisis management, it is essential to reform the SDRs by:
    • Eliminating dual IMF accounting,
    • Increasing the share of developing countries in the allocation.
• On the IMF’s financing arrangements:
  • The IMF should:
    • Consider a framework for a central bank-financed multilateral swap mechanism,
    • Reform the access limits and surcharge policy,
    • Increase the accessibility of emergency credit lines, as they provide rapid approval and no conditionality.
• On Regional Financial Arrangements (RFAs):
  • The constraints on the fiscal use of financing facilities and efficiency within the RFAs may have been a deterrent to their use by member countries.
  • The Chiang Mai Initiative Multilateralization has now institutionalized the use of member countries’ local currencies in addition to the US dollar for funding, and increased the portion that is de-linked from the IMF supported program from 30 percent to 40 percent of each member’s maximum arrangement amount.
  • Other steps should be considered as well, such as altering toolkits to complement the IMF, creating an integrated global economic surveillance framework and improving the Policy Coordination Instrument of the IMF.
• On domestic policy:
  • The central banks in G20 countries should set a regular schedule for communications to avoid sharp turns of market expectation caused by divergent policy moves.
  • To maintain financial stability, capital management policies ranging from macro-prudential measures to temporary capital controls are crucial.
• On achieving the SDGs and the Paris Climate Agreement:
  • The IMF and RFAs can play important roles in supporting climate-vulnerable countries in mitigating and managing climate-related macro-financial risks, leveraging opportunities from climate policies to boost growth, investment and resilience.
  • In particular, the IMF needs to integrate climate risk analysis into its surveillance activities, including Article IV consultations, as well as Financial Sector Assessment Program assessments and Debt Sustainability Framework analyses conducted with the World Bank.

In order to continue to respond to post-pandemic challenges and bolster a strong and sustainable recovery, the authors propose multiple avenues for the IMF to ensure that a GFSN is met at a national, regional and international level. The authors argue it is crucial that the IMF identify signs of financial fragility and provide sufficient support for the countries in need of liquidity to tackle the balance of payments problems and debt crises, as well as to manage the long-term challenges of climate change.