While the developed world is beginning to show signs of economic improvement, there are still fractures within the global economy that pose significant spillover risks to many markets around the world. One of note is the strain on emerging and frontier market economies as they deal with the challenges of Covid-19.
Because these countries typically have a harder time attracting foreign funding—especially during economic downturns—the combination of declining export revenue from shutdowns and quarantines, as well as soaring costs associated with keeping workforces healthy, has created financial holes so large that many lower-income economies will need IMF assistance just to remain solvent.
The problem, though, is not that these countries will experience funding crises, it’s that the IMF has failed to prepare for this reality in an expeditious manner, or in scale. The IMF is usually pretty good at predicting the size of economic downturns, raising the necessary funding to address them, and quickly distributing those funds to countries in need, but its largely dropped the ball on forecasting the impact of Covid-19 and seems to have no plan for adjusting its capital strategy as new information on struggling member countries becomes available.
In early April, the IMF knew a global downturn was imminent. It forecasted how each of its members would be affected and raised new funding to meet predicted needs. But those forecasts pale in comparison to what is actually required to restore developing economies to steady growth paths. Colombia and Peru have seen unemployment rates double; Honduras has experienced a total collapse in exports; and double digit corrections are expected by most of South America and its neighboring islands. Put simply: the developing world has never faced such overwhelming challenges, and despite such alarming data, the IMF is acting as though current financing arrangements are sufficient to cover its members’ needs. This simply isn’t the case.
As of March, the IMF had special drawing rights (SDRs) totaling 978 billion—477 billion in quotas; 182 billion in new arrangements to borrow; 434 billion in bilateral borrowing arrangements—an equivalent of $1 trillion US dollars available to lend to its member countries. Now given challenges faced by poorer economies, it is more than probable this amount will be depleted, as revenues and cost continue to diverge. What’s alarming, though, is that there is actually a nefarious strategy behind such lackluster funding.
The IMF could borrow any amount needed to address the current crisis by simply increasing member quotas or expanding its borrowing arrangements. But by raising SDRs to a paltry $1 trillion, the IMF is signaling to member countries that it plans on them bearing most of the adjustment costs associated with Covid-19—a decision that could have vast and long lasting implications on member economies. Those with persistent current account deficits will face sudden stops in financing or even capital flight, as investors search for safer assets. Countries that rely primarily on export revenue for public sector financing will find themselves with fewer customers and drowning in red ink, forcing more layoffs, and more contraction. This downward spiral, when left to its own devices, is quite painful and causes unbelievable human suffering. This is why the IMF exists in the first place: to ease the adjustment process of economic contractions.
But inadequate funding isn’t the only problem. More concerning is how the IMF has created an environment that dissuades leaders from seeking help when their economies are in distress. Rather than simply being an institution that provides low interest loans to countries in need—buying them time to get through a downturn—its leaders have become more interested in reforming member economies in the manner they see fit, imposing austerity measures at every turn and implementing structural reforms that only increase the likelihood of further IMF assistance down the road. It would be like if a bank loaned a company money on the condition the company appoint the banker CFO. Then the banker made sure the company could never pay back the loan, but also never default. That’s IMF assistance in the 21st Century. The conditions have become so intrusive that some leaders have chosen to default rather than seek assistance from the IMF. It shouldn’t be this way.
If the IMF is going to be the real international lender of last resort, it’s high time it acted like it. If it is to serve the needs of the developing-world when they can’t fund themselves and foreign investors seek safer developed-world assets, then it should raise the requisite funds and distribute those funds with few strings attached. There is no reason why the IMF can’t get its members through Covid-19 without imposing unnecessary austerity on weakened economies and needless pain on millions of people.