Economics, Politics and Public Policy in East Asia and the Pacific
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 about the purpose of the global financial safety net and the place of the Chiang Mai Initiative Multilateralization (CMIM) within it. Second, threats to the resourcing of the International Monetary Fund (IMF) are emerging. Third, key mechanisms needed to manage the global financial safety net have not been agreed to.
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.
East Asia Forum welcomes comments, both for adding depth to analysis and for bringing up important new issues. Original comments adding insight and contributing to analysis are especially encouraged.
The editors retain the right to refuse and edit comments at any time.
Well, this is what happens when you get rid of all the government regulations that were created after the Great Depression due to business leaders and wealthy people being greedy. The IMF has never been the center global financial safety when you look at how they told the countries in the last few years, that they will help them out in return that the countries get rid of social and economic safety nets that were in place to protect the ordinary citizens. The IMF has been a safety net for the corporations and the wealthy folks.
KC
If the IMF is the “sole arbiter” of whether to rescue a country from financial distress, I suspect it is because no other institution has a similar capacity to assess the case for liquidity assistance. But surely the demands of democracy would imply that other voices are at least heard, and the final decision ought not be the exclusive preserve of technocrats?
Also, I would defend the need for other institutions to develop the capacity to assess the case for liquidity assistance. The IMF is not free from “Group think” and is often in practice beholden to the US and Europe. For so long as the IMF remains a partial institution, it is right that other countries seek to develop alternative solutions to an IMF led safety net. Of course, this is not easy and takes time.
Gunther Von Hoffman
Well, I don’t like it when the American bankers told the American government to bail them out in 2008 or they were going to let the economy crash. It is outrageous to reward business people for their failure when they knowingly made bad decisions that they would know destroy the economy both at home and around the world.
East Asia Forum welcomes comments, both for adding depth to analysis and for bringing up important new issues. Original comments adding insight and contributing to analysis are especially encouraged.
The editors retain the right to refuse and edit comments at any time.
Well, this is what happens when you get rid of all the government regulations that were created after the Great Depression due to business leaders and wealthy people being greedy. The IMF has never been the center global financial safety when you look at how they told the countries in the last few years, that they will help them out in return that the countries get rid of social and economic safety nets that were in place to protect the ordinary citizens. The IMF has been a safety net for the corporations and the wealthy folks.
If the IMF is the “sole arbiter” of whether to rescue a country from financial distress, I suspect it is because no other institution has a similar capacity to assess the case for liquidity assistance. But surely the demands of democracy would imply that other voices are at least heard, and the final decision ought not be the exclusive preserve of technocrats?
Also, I would defend the need for other institutions to develop the capacity to assess the case for liquidity assistance. The IMF is not free from “Group think” and is often in practice beholden to the US and Europe. For so long as the IMF remains a partial institution, it is right that other countries seek to develop alternative solutions to an IMF led safety net. Of course, this is not easy and takes time.
Well, I don’t like it when the American bankers told the American government to bail them out in 2008 or they were going to let the economy crash. It is outrageous to reward business people for their failure when they knowingly made bad decisions that they would know destroy the economy both at home and around the world.