changes that are posing significant risks to the international monetary system. While the global financial safety net (GFSN) has expanded, it has also become more decentralized, and has critical gaps. The IMF has been working to strengthen the safety net by introducing new instruments and operational measures to enhance cohesion within the net, but more remains to be done.
By Chad Steinberg, Alina Iancu, Michael Perks
The challenges of a multipolar and interconnected world
Over the past few decades, the global economy has experienced major structural shifts, perhaps none more dramatic than the sustained growth of emerging market countries (EMs). Today, EMs account for about 60 percent of the global GDP (in purchasing power parity terms), up from about 40 percent two decades ago. They are also integrated more deeply into global financial markets, with capital flows to EMs increasing more than 25-fold since 1980.
Source: IMF staff estimates.
While capital flows have contributed to strong growth and job creation, they have also generated tensions and risks in the form of spillovers. In recent years, EMs have increasingly been on the receiving end of global liquidity shocks—for example, the European debt crisis, the “taper tantrum” and the China market correction—with up to two-thirds of large EMs experiencing high stress during each of these events.
Source: IMF staff estimates.
1/ The indicator covers 22 large EMs and is compiled based on 23 financial market indicators, aggregated by principal components.
EMs have managed to emerge from recent liquidity events relatively unscathed, but they may prove more susceptible to future shocks. This is because, although the capital outflows associated with these events have tended to be relatively small and short-lived, the repeated buffeting has taken its toll: fiscal buffers have been depleted while vulnerabilities, such as high corporate leverage and currency mismatches, have emerged.
An expanded and more decentralized global financial safety net (GFSN)
A strong GFSN is at the core of an effective international monetary system, alongside prudent country policies, robust surveillance and effective global cooperation. It must serve three key functions: provide insurance to help prevent crises; supply financing if crises materialize; and incentivize sound policies.
The current GFSN has four main layers: countries’ own reserves; bilateral swap arrangements (BSAs); regional financing arrangements (RFAs); and the IMF. All these layers have expanded significantly over the last two decades. Reserves have increased five-fold and continue to dominate the safety net. At the IMF, members have made available substantial additional borrowed funds since the global financial crisis (GFC) and, more recently, quota resources have doubled. However, the BSAs and RFAs have seen the most dramatic expansion, effectively leading to a more decentralized safety net.
Sources: Bank of England; Central Bank websites; RFA annual reports; and IMF staff estimates.
1/ Unlimited swap arrangements are estimated based on known past usage or, if undrawn, on average past maximum drawings of the remaining central bank members in the network. Two-way arrangements are only counted once.
2/ Limited-value swap lines include all arrangements with an explicit value limit and exclude all CMIM arrangements, which are included under RFAs. Two-way arrangements are only counted once.
3/ Based on explicit lending capacity/limit where available, committed resources, or estimated lending capacity based on country access limits and paid-in capital.
Today, BSAs are largely contained in two separate networks: unlimited permanent swaps between the central banks of the reserve currency-issuing countries; and an extensive network of swaps from China to a range of other countries, worth around $500 billion, to support trade and investment. Most of the swaps extended by reserve-currency issuing countries to other advanced economies and EMs during the GFC have expired.
The expansion of RFAs since the GFC has been no less striking. New RFAs have been established—notably the permanent European Stability Mechanism for crisis resolution within the Euro Area (€500 billion) and the BRICs’ multilateral Contingent Reserve Arrangement ($100 billion). The resources of existing RFAs have also increased significantly—for example, the Chiang Mai Initiative was multilateralized (CMIM) and doubled in size to US$240 billion, effective from 2014.
How does the current GFSN measure up to the challenges of a multipolar and interconnected world?
In March 2016, the Fund conducted a comprehensive examination of the GFSN, including an assessment of each layer and the system as a whole, based on five criteria—predictability (availability) of resources,speedof disbursement of resources, reliabilityof resources throughout the shock period, cost(financial and political stigma) of resources, and incentivesfor sound policies. The safety net currently available to several relevant country groups was then assessed based on the same five criteria.
Source: IMF staff estimates.
Red = Limited/insufficientfor predictability, speed, reliability, and policies, and highfor cost; Orange = Some; Green = Extensive/adequatefor predictability, speed, reliability, and policies, and lowfor cost.
This analysis identified some important shortcomings. It showed that coverage remains uneven, as the safety net serves well the reserve-currency issuing countries, but all other groups of countries, including key EMs, lack adequate access to funding or would need multiple layers of GFSN support, raising serious coordination challenges. While the decentralization into complementary layers could one day strengthen the GFSN, the new RFAs and BSAs have never been drawn upon and are thus currently untested.
At the same time, most layers lack adequate policy incentives, meaning that the overall system may not be sufficiently supportive of robust policies. This raises the risk of crises and encourages “facility shopping,” whereby financing is used to defer necessary policy adjustments. The analysis also showed that the GFSN can still be too costly, both for the borrower and the broader international community. Some layers have high financial costs, like countries’ own reserves, while others are politically costly due to stigma, in the case of the Fund and, to some extent, the RFAs. The overaccumulation of reserves is not only costly for the country itself, but also inefficient from a global perspective.
Filling the gaps
The Fund plays a central role in the GFSN through both its policy advice and its ability to provide financing. Our work in the past two years has focused on strengthening the GFSN in two ways: (i) improving the Fund’s own toolkit to better meet the needs of the membership; and (ii) solidifying the links among the GFSN layers, particularly between the Fund and the RFAs.
Proposing a new (swap-like) IMF instrument
With heightened global uncertainty and growing demand for liquidity support, we developed a proposal for a new Short-term Liquidity Swap (SLS) facility. The SLS proposal aimed to provide members that have very strong policies with a predictable and renewable backstop against potential, short-term, moderate capital flow volatility. This proposal was specifically envisaged for (but not restricted to) EMs, many of which are insufficiently covered by the current global safety net.
The proposal included several innovative features. Just like a central bank swap, countries would be able to draw down and pay back credit repeatedly, within the approved access level, to reflect the frequent nature of the shocks envisaged to address. While individual arrangements would be approved for a 12-month period, there would be no “exit expectations” or limits on the number of successor arrangements for a country as long as it continued to qualify. This would improve the reliability of support for users. It also allowed for the IMF to extend an “offer” to the qualifying member or make a “simultaneous offer” to several qualifying members to help minimize the first-mover problems and help kick-start the use of the facility.
The IMF’s Executive Board did not establish the SLS at this time. There was broad consensus that it could serve as a blueprint for such a facility in the future, should there be sufficient demand and support from the membership.
Solidifying links between the GFSN layers
The IMF has pursued several initiatives aimed at increasing the overall cohesion of the GFSN and strengthening the policy content of the various layers. A new instrument without financing—the Policy Coordination Instrument (PCI)—has been created to help countries unlock financing from different layers of the GFSN, particularly RFAs. The PCI also helps members demonstrate a commitment to a reform agenda, as a vehicle for policy dialogue. By providing monitoring and Board endorsement of member policies, which are required to meet the same standards as under a standard IMF loan, the PCI can also help strengthen policy incentives. The first PCI arrangement was approved for Seychelles in December last year, and several other countries have also expressed interest.
In parallel, the IMF has been working on improving collaboration with RFAs by setting out operational principles and a framework for engagement. These operational principles are based on lessons derived from past IMF-RFA co-lending and a simulated joint program test-runs with CMIM, as well as productive bilateral discussions with several major RFAs. Key issues include the protocols for designing a joint program and information-sharing that take into account the mandates and technical expertise of the RFAs and the IMF. Modalities for improved collaboration and engagement on surveillance and capacity development are also considered.
The GFSN will no doubt continue to evolve as economic and financial conditions change. The IMF will continue to support these developments with a view to enhancing coherence across the various layers and strengthening the policies underpinning the GFSN. Having developed the SLS blueprint, the IMF is now better placed to react swiftly if, for example, monetary policy normalization in advanced economies generates further capital flow volatility and renewed demand for global liquidity. The ongoing dialogue between the RFAs and the IMF and the work on enhancing this collaboration should also help exploit synergies between GFSN layers and ensure a more cohesive overall system.
“Adequacy of the Global Financial Safety Net—Review of the Flexible Credit Line and Precautionary and Liquidity Line, and Proposals for Toolkit Reform—Revised Proposals,” International Monetary Fund Policy Paper, December 2017.
“Adequacy of the Global Financial Safety Net—Review of the Flexible Credit Line and Precautionary and Liquidity Line, and Proposals for Toolkit Reform,” International Monetary Fund Policy Paper, December 2017.
“Adequacy of the Global Financial Safety Net—Considerations for Fund Toolkit Reform,” International Monetary Fund Policy Paper, December 2017.
“Adequacy of the GFSN—Proposal for a New Policy Coordination Instrument,” International Monetary Fund Policy Paper, July 2017.
“Collaboration Between Regional Financing Arrangements and the IMF,” International Monetary Fund Policy Paper, July 2017.
“Adequacy of the Global Financial Safety Net,” International Monetary Fund Policy Paper, March 2016.
“Strengthening the International Monetary System—A Stocktaking,” International Monetary Fund Policy Paper, March 2016.