As the crisis evolves, capital will flow out of emerging countries. The IMF’s new facility may help with short term shocks. It is also a useful step towards risk pooling and away from self-insurance with large currency reserves and should thus help reduce global imbalances in the long run.
The crisis is rapidly collecting victims, most notably among the world’s poor nations. What started as a credit crunch in the US has triggered a collapse in world trade, murky protectionism, mass lay-offs, lower remittances from migrant workers, lower foreign aid, and a reversal of capital flows to developing nations. For once, these nations’ problems are not of their own making.
If this were an oil spill instead of a financial crisis, we’d know who should pay for the damage caused by gross negligence in the regulation of financial markets. Grave failings in internal governance of G7 nations – especially the US and UK – set the stage for this crisis, so they are the ones that should pay for the clean-up.
While cash transfers are out of the question, the G20 could decide on two types of policies that would help the innocent bystanders.
- First, G7 nations should make the political sacrifices necessary to eschew protectionism – both the old-fashioned and newer, murkier forms.
- Second, the IMF needs to be ready for a major slowdown of capital inflows in many emerging countries, as banks deleverage by repatriating funds, foreign direct investment is dropping, bond issuances and syndicated loans are dwindling.
As Guillermo Calvo urges, international financial institutions must be quickly endowed with considerably more firepower to help emerging economies through the deleveraging period.
I’ve had my say on the trade side in Baldwin and Evenett 2009. Here, I’ll focus on the capital flow side of what the G7 “crisis culprits” should do to help clean up the mess they created.
New IMF tools
Since the crisis began, recipient countries have given the IMF the cold shoulder. As Michael Pomerleano writes, “the fund’s $100 billion lending program announced in October 2008 hasn’t attracted a single borrower among the countries targeted: Mexico, Peru, Chile, Brazil, Singapore, South Korea, Taiwan, and perhaps Poland”. But emerging market and developing countries around the world are facing increasing difficulties, as external financing dries up, exports drop sharply, and commodity prices fall. As the crisis becomes more prolonged, a growing number of countries will find their room for policy manoeuvre increasingly limited. Large-scale financing from the IMF can cushion the economic and social costs of these shocks and even avert full-blown crises.
Out of a sense of guilt and responsibility (“the IMF is in search of a role and a happier reputation” as the Economist puts it) for its past failings, the new management at the IMF is looking to play a role in helping emerging countries cope with this global crisis. This is a two-step process. The IMF needs more lending power. But, as the Economist puts it, the IMF must now stimulate demand by appearing more attractive to borrowers. Emerging nations need loans but apparently they do not want to hear from the IMF yet. To counter this, the IMF also needs to change its rules so that well governed nations can view IMF borrowing as a reliable and usable source of emergency funding to help them through this unexpected crisis.
It seems progress is being made. As part of the clean-up effort that the culprits owe the world, the IMF Board has approved a major overhaul to the Fund’s lending framework by:
- Modernising IMF conditionality,
- Introducing a new flexible credit line,
- Enhancing the flexibility of the Fund’s regular stand-by lending arrangement,
- Doubling access limits,
- Adapting its cost structures for high-access and precautionary lending, and
- Eliminating facilities that were seldom used.
In addition, the IMF is seeking to sharply increase both its non-concessional and concessional lending resources, which would enable it to meet expanded financing requirements in the crisis. Reforms of concessional lending instruments for low-income members are also in train.
According to the information available online, the IMF aims to ensure that conditions linked to IMF loan disbursements are tailored to borrowers’ conditions. With luck, this will reduce many emerging nations’ resistance to IMF cash. In particular, the IMF has introduced a new credit line – the Flexible Credit Line – for countries that came into the crisis with strong fundamentals.
The Fund seems to also be rethinking its concessional lending facilities to poor nations, providing a window for short-term and emergency financing.
Time to pay up
The crisis seems far from over – and I believe there is a significant risk that this crisis will spark a round of classic balance-of-payments crises among developing and emerging economies. If this happens, the IMF is going to need more capital. Japan has already stepped up to the plate with an additional $100 billion – even though Japan is not one of the crisis culprits. The EU has committed €75 billion. The US should do its bit, as the irresponsible governance of US financial markets is in large part responsible for the oil spill that is now washing up on foreign shores.
As with an oil spill, the clean-up costs of this crises should be borne up by the culprits. The IMF’s strategy is a step in the direction of pooling insurance and thus reducing the need for each emerging market to self-insure via a big stack of reserves. But rebuilding a reputation takes time, and emerging economies will knock on the IMF’s door only as a very last resort.