IMF: Divergent recoveries stem from divergent policies – I

New York, 20 Apr (Bhumika Muchhala) – The International Monetary Fund (IMF) is responding to urgent liquidity needs in developing countries but fails to ensure systemic debt solutions or recovery without austerity. At the virtual spring meetings of the IMF and World Bank with the finance ministry, central bank and private sector officials that took place on 5 to 11 April, the key message from the flagship World Economic Outlook publication is that recoveries are diverging dangerously across and within countries.
While developed countries, as well as China, are expected to experience rebounds in economic growth and trade, developing countries, and in particular low-income countries, “are expected to suffer greater scarring given their more limited policy space,” the report says.
This unequal recovery is rooted in the inequitable access to affordable vaccines, which the Group of 24 (G24) developing countries in the IMF has called “the most critical public good” in its communique.
While the IMF recognizes that vaccine equity is the central global dilemma, unlike the G24, it does not explicitly call for making vaccines publicly available through a temporary waiver of the TRIPS Agreement in the World Trade Organization in order to enable global mass production of affordable vaccines by developing countries.
Vaccine inequity means that while some countries will achieve widespread vaccinations as early as the summer of 2021, the poorest countries will be waiting until the end of 2022 or even later.
The IMF says countries need to work together to ensure universal vaccination by ramping up vaccine production and distribution, avoiding export controls, fully funding the COVAX facility on which many low-income countries rely for doses, and ensuring equitable global transfers of excess doses; but stops short of laying out how exactly the political will to take these critical actions will be generated.
Special Drawing Rights (SDRs), an international reserve asset which provides countries with liquidity, have been called for globally as an urgent response to the liquidity crunch afflicting developing countries since the outset of the pandemic in March 2020.
Over a year later, and after a change of the US administration, the Fund’s Executive Board finally agrees on an issuance of USD 650 billion of SDRs in the next several months, the amount permissible by US law without going through a time-consuming process in Congress.
SDRs are necessary to secure recovery for developing countries hardest hit by the crisis created by the pandemic, who face deep losses of revenue and tax income, as well as unemployment and a growing number of people falling from working middle-class into poverty or even extreme poverty.
Layered with debt distress and vulnerabilities and the risk of a normalization, or increase, of interest rates in advanced economies, developing countries, both middle- and low-income, are in a fragile situation and require urgent fiscal space to meet social protection financing and improve precarious health systems.
Civil society advocates highlight that while an SDR issuance is welcome, it falls short of the level of response needed for the current economic recession.
An allocation of $3 trillion means that only $1 trillion directly reaches the reserve buffers of developing countries.
Hundreds of civil society organizations have endorsed a letter calling on the IMF and G20 finance ministers to urgently support a new SDR allocation in the amount of $3 trillion, stating that a scale of $3 trillion is required to address the real needs of developing countries in a sustainable way.
In response to the global financial crisis in 2009, the international community responded to a crisis of much smaller scope and proportions with an allocation of $250 billion in SDRs.
This initiative had a significant role in restoring market confidence and supporting global recovery. Last year, even before the scale of this crisis was clear in late March 2020, IMF estimates placed emerging economies’ financing needs at $2.5 trillion.
Aside from the scale of issuance, the second issue is that SDRs are allocated in accordance with IMF quotas, or financial contribution shares, rather than real fiscal need.
This creates an inequity by which 67.44% of SDR allocations automatically accrue to rich countries, who need it the least. Perversely, the countries with the greatest need receive the least.
In order to recycle both existing and newly created SDRs from rich countries to all those that need it, the Fund is currently formulating mechanisms, with an emphasis on boosting the IMF’s lending capacity and new measures to enhance transparency and accountability in the use of SDRs.
Many developing countries as well as civil society advocates call for ensuring that such mechanisms benefit all countries in need.
This means not excluding any country a priori based on income, and instead taking into account factors of real fiscal need and vulnerabilities related to debt and climate change.
The Development Committee at the Spring Meetings issued a communique affirming that pandemic vulnerabilities and risks are arising in many countries, not just low-income.
The Civil Society Group on Financing for Development (FfD) stressed at the follow-up FfD forum, which took place virtually on 12 to 15 April, that the closer the recycling mechanism resembles the original properties of an SDR allocation, the more effectively they will contribute to a genuine economic and social recovery.
This means that SDR transfers from developed to developing countries should have low or zero conditionality and low or zero interest.
Essentially, the ideal recycling format allowing for the quickest deployment of urgently needed liquidity would be that of SDR donations from developed to developing countries.
The key task at hand is to activate SDRs from a reserve asset to actual fiscal support to respond to real domestic economic and health needs.
This could be facilitated by the use of SDRs in multilateral, regional or sub-regional development finance institutions to support grants and lending at concessional or below market rates.
Developing countries could subsequently create domestic fiscal space without jeopardizing debt sustainability.
Meanwhile, several funds to enhance liquidity have been proposed at UN and regional meetings by regional groups and some developing countries.
Costa Rica has proposed the Fund to Alleviate Covid-19 Economics, or FACE, as a vehicle for international solidarity and sustainable pandemic recovery toward achieving the 2030 SDGs.
It is envisaged as a fund of half a trillion dollars for one-off support, financed with 0.7% of the GDP of the world’s richest economies, those that account for 80% of global GDP, to be intermediated by one or several multilateral development banks, as long-term and fixed interest rate concessional loans to developing countries.
Recycling mechanisms for SDRs could be channelled through development-oriented financing vehicles like FACE and other such regional or global funds that expand fiscal space while avoiding the deepening of debt and conditionality biased toward fiscal contraction through reducing public expenditures, particularly during a time of economic recession and social challenges.
However, the OECD member countries with the greatest voting power in the Fund are leaning towards re-purposing rich country SDRs through concessional loan facilities, such as the Fund’s Poverty Reduction and Growth Trust (PRGT).
This reflects the reality of wealthy nations’ unwillingness to voluntarily offer unconditional liquidity as well as the Fund welcoming an opportunity to expand its lending role.
IMF Managing Director Kristalina Georgieva noted that roughly $20 billion of unused SDRs have already been reallocated to developing countries through concessional loans.
Two key challenges come with the SDR issuance resulting in the perpetuation of lending instruments. First, it will almost certainly discourage even the minority few rich countries willing to offer direct and unconditional SDR transfers to do so.
Second, loans are attached to the IMF’s characteristic fiscal contraction policies.
These include, for example, reducing public spending for social sectors by containing the wage bill through which public doctors, nurses and teachers are hired, as well as regressive tax measures, such as value-added taxes that disproportionately impact the poor and vulnerable, and women and children in particular.
The pandemic has demonstrated that accessible and affordable public services, especially in health, education and social protection, are indispensable to human survival.
This begs the question of whether the costs associated with IMF conditionality are a fair price to pay for the urgent need for fiscal liquidity.
In April 2020, over 500 organizations and individuals signed a petition calling on the IMF to put an end to its history of fiscal consolidation.
The state of debt distress across low-income countries repeatedly point to the lacuna of systemic debt solutions on the multilateral level.
IMF Managing Director Kristalina Georgieva confirmed that developing countries are in “a debt trap,” citing the IMF’s calculation that 56% of low-income countries are either at a high risk of debt distress or already in debt distress.
In response, Vera Songwe, Executive Secretary of the Economic Commission for Africa, said that, “It is not so much a debt trap. It is a poverty trap or doubling down of the poverty trap, with 170 million people worldwide falling into extreme poverty. And in the continent when people fall into poverty, they fall much further down and for much longer.”
According to a recent report by the European Network on Debt and Development, a debt pandemic is revealed where $194 billion have been transferred from developing countries to private, multilateral and bilateral creditors in 2020, and 58 countries experienced more revenue leaving their borders than coming in.
In 2020, external public debt service was larger than health care expenditure in at least 62 countries, and larger than education expenditure in at least 36 countries.
What this picture makes exceedingly clear is that it is not only the inequity of vaccine access that is constraining pandemic recovery for developing countries; it is also an unsustainable debt burden draining vital financial resources to invest in public services that protect the lives and livelihoods of local populations.
And yet the Group of 20 (G20), in its 7 April finance ministers’ and central bank governors’ meeting, issued a communique that merely repeated a 6-month extension of its Debt Services Suspension Initiative (DSSI) through the end of December 2021.
The DSSI defers debt liabilities but does not write them off, with the contractual rate of interest remaining in place once the five-year deferment period has ended.
Aside from not delivering genuine debt reduction, the DSSI also excludes middle-income countries.
In response, Dr. Aubrey Webson, Ambassador to the United Nations for the island nation of Antigua and Barbuda and Chair of the Alliance of Small Island States (AOSIS), pointed to the exclusion of middle-income countries from the G20’s debt suspension initiative: “More than half of the world’s small island states don’t even qualify for this debt relief, due to the arbitrary designation of our countries as “middle-income.” This is ludicrous in a year when our debt-to-GDP ratios are beyond maxed out and when even in the best of times, a hurricane can easily wipe out an entire year’s GDP in one fell swoop.”
Ambassador Webson emphasized that expansion and extension of the debt suspension initiative is an important first step, but what is needed is a “fairer, more inclusive system that will help us build resilience to the effects of climate change and achieve sustainable development.”
The G20’s communique also reaffirmed the “Common Framework for Debt Treatments” in order to address debt vulnerabilities on a case-by-case basis, promising to hold joint creditors’ negotiations in an open and transparent manner.
Alluding to the looming concern that without private creditor participation, debt relieved by bilateral creditors gets passed on to repayments for private creditors, the G20 stressed the importance of private participation in the Common Framework on terms at least as favourable, in line with the comparability of treatment principle.
G24 developing countries also emphasized the need for private creditor participation in the Common Framework in order to ensure fair and meaningful debt relief measures.
The IMF reinforced institutional support for the G20’s Common Framework, echoing the need for private creditor participation as “a critical factor to ensure adequate burden sharing.”
A balance between the twin priorities of timeliness and sufficiency of debt relief is stressed, in that “timeliness cannot come at the expense of … a debt treatment that is insufficient to durably address the needs of each country.”
Although the Common Framework is limited to adjusting the terms of sovereign debt, such as maturity periods, interest rates and standstills through rescheduling or re-profiling initiatives, the Fund still states that “this could enhance fiscal space, smooth consolidation, and help limit financing stress” in indebted countries.
In response to the penalizing behaviour of credit rating agencies, which have downgraded 11 countries in 2020, in many cases for requesting debt suspension from the G20’s DSSI, the IMF rationalized that making re-profiling options “better known could help moderate market and credit rating agency reactions,” as well as “avoid discouraging countries from seeking debt treatment” from the Common Framework.
However, this approach bypasses the need to better regulate credit rating agencies and hold them accountable on the basis of methodology, criterion and biases toward deregulation and austerity that are baked into agency business models.
Civil society advocates argue that the Common Framework deters a comprehensive approach, is tied to IMF lending programs and inadequately assessed debt sustainability indicators, and importantly, lets private creditors off the hook again.
Private creditors, who hold significant amounts of developing country debt, have repeatedly refused to participate in any debt relief initiative.
They claim that a fiduciary responsibility to protect their clients’ investments prevents full involvement.
Bondholders’ “chutzpah”, as pointed out by Daniela Gabor, professor of economics and macro-finance at UWE Bristol, is a direct outcome of the way G20 leaders and their central banks have “nurtured” private finance to become so powerful that they now find themselves unable to curtail its might.
Mohamed El-Erian, President of Queens’ College, Cambridge and Chief Economic Advisor at Allianz, said at a webinar during the Spring Meetings that the private sector has been happy to free-ride on the official sector, and this explains its support for SDR issuances.
The Paris Club process of case-by-case debt treatments is “not enough to overcome coordination problems in the private sector; the Paris Club needs to impose more of a stick for the private sector,” said El-Erian.
Private creditors are not the only ones getting a free ride. Multilateral lenders are also not required to participate in the G20’s Common Framework.
The World Bank, dominated by the US, Japan and European shareholders, is still not providing relief on its own loans, claiming the risk of downgrades to its triple A rated bonds jeopardizes the ability to raise funds in capital markets.
While the IMF is providing debt relief on some of its loans through its Catastrophe Containment and Relief Trust, this is being financed with external donor resources, which could be better used to support countries’ Covid-19 responses.
The G20 clarifies that a sovereign’s need for debt treatment, and the options made available for re-profiling, will be based on an IMF/World Bank Debt Sustainability Assessment and the participating official creditors’ collective assessment.
The G24 responded by saying, “realistic debt sustainability assessments are necessary to determine the depth of the financing needed.”
Civil society as well as the UN Conference on Trade and Development criticize the DSA for disregarding countries’ human rights obligations, climate commitments, gender equality and Sustainable Development Goals.
If integrated, the assessment of a country’s ability to repay its debts would reflect an understanding that public funds should prioritize domestic development needs before debt repayments.
An underlying feature of the Common Framework is that countries seeking debt re-profiling under it will be obligated to sign up to an IMF loan program.
This raises serious concerns about a decades-long history of attached conditions to contract public expenditure in social sectors, which disproportionately harm health and education services and would effectively stall pandemic recovery.
Meanwhile, the IMF’s Global Financial Stability Report has warned that rising US interest rates will draw capital from vulnerable countries, resulting in currency depreciation, financing shortfalls and increasing the cost of debt repayment, all leading to prolonged economic crisis.
This scenario is predicted as US Treasury bonds jumped to their highest level since January 2020.
The G24 has responded by calling on the IMF to accelerate discussions on a short-term liquidity line instrument to support developing countries’ efforts to deal with massive capital outflows.
The G20’s fragmented and piecemeal Common Framework ultimately cements a role for the G20 in the design of global debt architecture, sidelining longstanding calls for a comprehensive multilateral framework for debt crisis resolution under the auspices of the United Nations, which would restructure debt through a fair and transparent process in which all countries have an equal voice.
The debt pandemic growing today presents a critical opportunity to recreate the international debt architecture towards fairness, stability and sustainability through inclusive multilateralism. Unfortunately, this opportunity is being stalled in the interests of private, and some multilateral, creditors.
(Published in SUNS #9330 dated 21 April 2021)