The global financial safety net is incomplete
Author: Edwin M Truman, Peterson Institute for International Economics
Neither Asia nor the global financial safety net is ready for the next crisis in the region. There are three reasons for this. First, there is a lack of consensus on the goal of the global financial safety net and the place of the Chiang Mai Multilateralization Initiative (CMIM) within it. Second, threats to the resources of the International Monetary Fund (IMF) are emerging. Third, the key mechanisms needed to manage the global financial safety net have not been agreed.
Staff say the goal of the global financial safety net is to “provide countries with crisis insurance, shock financing and incentives for sound macroeconomic policies.” Many countries would not include the third element of this triad. They see the global financial safety net more closely as a framework for providing unconditional liquidity support to countries which are “innocent bystanders”, which receive the fallout from economic and financial crises in other countries, or which are exposed to vicissitudes. capricious world financial markets.
This narrow view of the global financial safety net is specious. No country is truly an innocent bystander. Countries have only different degrees of vulnerability to foreign or domestic crises. The task of national decision-makers is to manage the trade-off between excessive risk and excessive caution in their pre-crisis policies. When they make a bad compromise in the face of a foreign shock, a domestic shock or both, their political choices are at fault.
Failure does not mean that countries should not have access to the global financial safety net, as narrowly defined. The main questions are how far does a country fall before it is rescued and what should be the conditions associated with the rescue.
The IMF should be at the center of the global financial safety net in providing temporary financial assistance, as it is the only institution empowered to provide financial support and economic policy to financial assistance provided by central banks if this assistance is insufficient because a country’s ex ante policies were not up to the shock. To play this role, the IMF must be accepted as the final arbiter in determining whether a country should adjust its policies in the face of a shock and must also have adequate resources to help cushion the shock.
Unfortunately, neither the countries potentially in need of temporary external financial assistance nor the major potential creditor countries are currently assuming this role for the IMF. Countries in search of what they see as liquidity aid reject the idea that their policies might require adjustment in the face of changing global economic conditions. They are looking for financial aid without any political conditions. Potential creditor central banks prefer to rely on bilateral ad hoc mechanisms over which they have more control.
To make matters worse, the IMF’s ability to play its vital role of financial support is threatened. Today, the IMF’s financial resources stand at US $ 1.4 trillion, including US $ 700 billion in quotas and about US $ 700 billion in potential borrowing under the new borrowing arrangements ( US $ 265 billion) and bilateral borrowing agreements (US $ 450 billion) that expire in 2020.
Observers who hope that the United States does not withdraw from the new borrowing deals or that it supports an IMF quota increase large enough at least to replace expiring bilateral borrowing deals are likely to be disappointed. US support for IMF loans is likely to be increasingly and overtly politicized, complicating the IMF’s role at the center of the global financial safety net.
Even if adequate financial resources from the IMF were secured, consensus on how to manage them within the framework of the global financial safety net as a liquidity support mechanism was not established. Currently, moral hazard concerns prevent the fund from having the financial resources to support a global financial safety net on a scale sufficient to cover all eventualities. Therefore, the IMF has to look to the big central banks because that is where the (big power) money is.
Many mechanisms have been proposed that could in principle meet the needs of large central banks and lead them to be lenders of first resort in the global financial safety net. When it comes to a political safety net, two approaches dominate the current debate.
The first is an ex ante procedure in which the IMF finds that a country’s policies are strong enough for it to be eligible for a flexible IMF line of credit that it could use to repay central banks. The second is a commitment by the recipient country that if it cannot repay the central bank or central banks within a specified period of, say, a year, the country will request an adjustment program from the IMF. The two mechanisms must be combined.
Neither Asia nor the global financial safety net are prepared for the next crisis in the region. The IMF is unlikely to have sufficient financial resources to support the global financial safety net as a short-term liquidity facility. Asian countries are not prepared to accept the potential need for IMF political support if a country receives temporary liquidity support from central banks inside or outside the region. Therefore, the big central banks are not ready to commit to being a first line of defense.
Edwin M Truman is a Non-Resident Principal Investigator at the Peterson Institute for International Economics.
This article appeared in the most recent edition of East Asia Forum Quarterly, ‘Asian crisis, ready or not‘.