The IMF staff state that the purpose of the global financial safety net is ‘to provide countries with insurance against crises, financing when shocks hit, 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 narrowly as a framework to provide unconditional liquidity support to countries that are ‘innocent bystanders’, receiving spillovers from economic and financial crises in other countries or that are exposed to the fickle vicissitudes of global financial markets.

This narrow view of the global financial safety net is specious. No country is truly an innocent bystander. Countries only exhibit different degrees of vulnerability to foreign or domestic crises. The task of national policymakers is to manage the trade-off between excessive risk and excessive caution in their pre-crisis policies. When they get the trade-off wrong in the face of a foreign shock, domestic shock or both, their policy choices are at fault.

Failure does not mean that countries should not have access to the global financial safety net, as narrowly defined. The principal questions are how far a country falls before it is rescued and what the associated conditions for rescue should be.

The IMF must be at the centre of the global financial safety net in the provision of temporary financial assistance because it is the only institution that is empowered to provide a financial and an economic policy backstop to financial assistance provided by central banks if that assistance proves inadequate because a country’s ex-ante policies were not up to the test of the shock. To play this role the IMF must be accepted as the final arbiter of whether a country needs to adjust its policies in the face of a shock and must also have adequate resources to help cushion the shock.

Unfortunately, neither countries potentially in need of temporary external financial assistance nor potential major creditor countries currently embrace this role for the IMF. Countries looking for what they see as liquidity assistance reject the idea that their policies may need adjustment in the face of changed global economic conditions. They are looking for financial assistance with no policy strings attached. Potential creditor central banks prefer to rely on bilateral ad hoc mechanisms over which they have more control.

And to make things worse, the IMF’s ability to play its vital role as a financial backstop is under threat. Today, the IMF’s financial resources are US$1.4 trillion consisting of US$700 billion in quota resources and about US$700 billion in potential borrowing from the New Arrangements to Borrow (US$265 billion) and bilateral borrowing arrangements (US$450 billion) that expire in 2020.

Observers hoping that the United States will not withdraw from the New Arrangements to Borrow or will support an increase in IMF quotas large enough at least to replace the expiring bilateral borrowing arrangements are likely to be disappointed. US support for IMF lending is likely to be increasingly and overtly politicised, complicating the IMF’s role at the centre of the global financial safety net.

Even if adequate IMF financial resources were assured, a consensus on how to manage them as part of the global financial safety net as a liquidity support mechanism has not been established. At present, moral hazard concerns prevent the fund from having the financial resources to support a global financial safety net on the scale sufficient to cover all eventualities. Consequently, the IMF must turn to the major central banks because that is where the (high-powered) money is.

Many mechanisms have been proposed that in principle could meet the needs of the major central banks and induce them to be lenders of first resort in the global financial safety net. With respect to a policy backstop, two approaches dominate the current debate.

The first is an ex-ante procedure in which the IMF finds that a country’s policies are sufficiently strong for it to be eligible for an IMF flexible credit line that it could use to repay the central banks. The second is a commitment by the drawing country that if it cannot repay the central bank or central banks within a set time period of, say one year, the country would ask for an IMF adjustment program. The two mechanisms should be combined.

Neither Asia nor the global financial safety net is prepared for the next crisis in the region. The IMF is likely to lack sufficient financial resources to backstop the global financial safety net as a short-term liquidity facility. Asian countries are not prepared to accept the potential need for a policy backstop from the IMF if a country receives temporary liquidity support from central banks inside or outside the region. Consequently, the major central banks are not prepared to commit to be a first line of defence.

Edwin M Truman is Nonresident Senior Fellow 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’.