Australia G20, Reinveinting Bretton Woods Committee
Conference-Reviving growth and building resilience in the global economy, Washington, D.C. 9 April 2014
Ousmène Jacques Mandeng, Global Institutional Relations Group, Prudential Investment Management
The IMF was widely applauded for being the only entity capable of putting together at short notice a sizeable financial support package for Ukraine. It is indeed the very strength of the IMF. Yet, the IMF merely lends by borrowing money. The IMF moves international liquidity around but for all practical reasons cannot create international liquidity. Ukraine thus serves as a good reminder that the IMF remains highly constrained in supporting countries in distress. To remedy this sustainably the IMF should not principally look at its own resources to be able to offer more countries more financial support actual and contingent, as has been normally the case in the past, but rather based on one of its main purposes prioritise broadening the usability and convertibility of currencies in international financial transactions. This would address one of the key causes of emerging markets distress rather than the remedy.
Countries need international liquidity or so-called freely usable currencies or reserve assets to conduct international trade and financial transactions. That’s because most international transactions—payment for a Korean car by a Chinese importer; repayment to Sweden of an external loan by Brazil—are conducted in dollars and also in euros and a few other currencies. If countries do not have access to such reserve assets they risk not being able to meet their external obligations. Most countries cannot create international liquidity. Here lies of course the original idea for establishing the IMF.
When the Federal Reserve announced in October of last year that it converted the temporary bilateral liquidity swap arrangements—providing dollars in exchange of other currencies—with the central banks of Canada, the Euro area, Japan, Switzerland and the United Kingdom into standing arrangements, it caused a tremor among emerging markets’ policy makers. Unlike the IMF, the Fed can create international liquidity. The standing arrangements granted to only a small group of central banks exacerbates the asymmetry in access to international liquidity and risks causing increasing monetary fragmentation of the international economy.
The IMF operates like a credit union based on an exchange of reserve assets for non-reserve assets. Each country—member country of the IMF—maintains a quota—de facto countries’ subscriptions to the IMF—that determines the maximum financial commitment to the IMF. The IMF extends financing temporarily by providing reserve assets to the borrowing country from reserve asset subscriptions of other countries that have sufficiently strong external positions in exchange of the borrowing country’s non-reserve assets. Countries whose reserve assets are being used—currently 51 countries participate in the so-called financial transaction plan—receive a claim on the IMF but may withdraw their funds unconditionally at short notice. Hence, the IMF does not change the total amount of reserve assets or international liquidity.
The IMF can mobilise additional resources through its borrowing arrangements and issuance of its own reserve assets so called Special Drawing rights (SDRs) but those also remain contingent on countries’ ability to extend reserve assets.
Countries have of course amassed significant amounts of reserve assets representing about US$12,000 billion (IMF). Yet reserves are highly unevenly distributed, with China, Japan, Russia and Saudi Arabia representing more than half of the total, and many countries remain reluctant to deploy them or lend them out. Fear of intervening suggests that many central banks feel they would want many more reserves to be comfortable.
The IMF announced towards end-March a staff level agreement with Ukraine on US$14-18 billion. The implications of the way the IMF lends are thus broadly as follows. It will ask, for the simple sake of argument to borrow from Russia, being one country in the financial transaction plan, in proportion to Russia’s IMF quota, reserve assets. Since the rouble is not a reserve asset, Russia would have to provide for example dollars. To do so it would sell part of its foreign exchange reserves, for example U.S. treasury bills and notes. Similarly, if Russia were to provide resources through the borrowing arrangements, it would have to sell foreign exchange reserves.
If the IMF wanted to support a large country at a scale proportional to Ukraine’s, it would not get very far. At end-February, it had a residual lending capacity of about US$420 billion. If in addition it wanted to offer meaningfully a safety net of more contingent facilities—today only three countries representing US$113 billion of IMF commitments alone benefit from its flexible credit line—it would require many more resources.
IMF Managing Directors have repeatedly called for strengthening the IMF’s resources. Yet, the IMF is unlikely to ever receive sufficient resources to make a meaningful difference. To support orderly international monetary conditions credibly and predictably, the key is to create more of a level playing field for international liquidity. The IMF needs to build on a key ambition of its original purpose that was to assist in the establishment of a multilateral system of payments for current transactions and in the elimination of foreign exchange restrictions; during the 1950s the IMF’s major achievement was helping making the main European currencies convertible. This now needs to be expanded for financial transactions for key emerging markets currencies.
Unless countries can use their own currencies to address international liquidity shortfalls, the international economy will remain unduly dependent on a very small set of countries’ able to issue reserve assets. The decision by the Fed to divide the international economy into haves and have-nots has made broadening the set of currencies freely usable in international financial transactions all the more urgent.