Paper gold is just the ticket for crisis-hit EM

24/02/2009 | Emerging Markets Editorial Team

The IMF’s currency of special drawing rights should be part of the solution for the global liquidity crisis

Emerging market governments and companies need to make huge bond and loan repayments this year, as well as finance trade and investment, but they’re unlikely to be able to do so without some form of help from institutions such as the International Monetary Fund. New allocations of ‘paper gold’ — the IMF’s currency of special drawing rights — could help, and help head off deflation on the way.

It’s now taken for granted that risk re-pricing and liquidity shortages have made it increasingly difficult for even well-managed emerging markets borrowers to access external financing. And, unlike their rich world counterparts, most emerging market central bankers are in no position to extend blank cheques across their economies without devastating effects on interest rates and exchange rates.

It’s clear that over the coming months, access to international finance could get tougher for many countries and lead to emerging economies facing simultaneous balance of payments crises on an unprecedented scale. What’s also clear is that the International Monetary Fund’s $250bn in resources (together with a recent $100bn pledge from Japan) is scarcely enough to stem the current run on emerging market assets. Even a small number of sovereign defaults could wreak havoc on an already strained global financial system.

This is not to say that authorities have so far failed to prop up economies in distress. On the contrary, the IMF has extended over $50bn of emergency credit to several cash-strapped emerging nations while approving a short-term financing facility for emerging economies with a good track record but difficulties accessing credit. Meanwhile the US Federal Reserve has approved bilateral currency swap agreements with more than a dozen foreign central banks to ensure their dollar liquidity.

But neither the Fed swap lines nor the new IMF lending facility have had many takers: no country wants to signal that they might be in trouble and running out of resources.

Any options?
Yet there is an alternative: the IMF could, if shareholders let it, create a vast new allocation of its international reserve currency, Special Drawing Rights (SDR) — ‘paper gold’ — that member countries can add to their reserves and use for payments requiring foreign exchange. In effect, it would be letting the IMF print money that would create global liquidity while allowing credit-starved emerging countries to increase their spending. Allocating more SDRs could be introduced swiftly and would have the advantage that it does not require the IMF to negotiate a programme for every country that needs financing — a generalised SDR allocation would give countries the cover without damaging their reputations.

The proposal may even have the sympathetic ear of the UK prime minister, Gordon Brown, who has reportedly acknowledged that he sees a new injection of SDRs as one quick and efficient way to recapitalise emerging market economies and their financial systems. The obvious problem with issuing new SDRs is that it’s inflationary. But with the spectre of deflation looming, that could be just what the doctor ordered.

The other catch is that SDRs are allocated on the basis of IMF quota shares — the distribution of which remains highly controversial, given a disproportionate weighting of shares towards rich countries at the expense of large emerging economies with a greater share of global GDP. Critics would argue that without an adequate system of global governance, ramping up SDRs would entrench such historical imbalances.

But the need for quick action vastly outweighs such concerns. Reforming global governance is a necessary project, but it will take more than another meeting of G20 leaders to get there. And with eastern Europe the first emerging region facing imminent economic and political meltdown, there is no time to waste. Let’s get more of the IMF currency on tap now.

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