Buying the bond

04/10/2009 | Phil Thornton

Brazil, Russia, India and China have agreed in principle to buy IMF bonds – in a canny move that gives them sway over reform of the institution, while allowing diversification away from the US dollar

After the catastrophic damage that complex financial instruments have wreaked on the global economy, one could be forgiven for thinking that a new promissory note is the last thing the world needs.

But the plan by the IMF to issue innovative bonds to the official sector as part of its multi-billion dollar refinancing programme has struck a positive note.

The IMF decided to offer the sale of paper in its own currency, the Special Drawing Rights (SDR), after the G-20 London Summit decided on an immediate increase in the IMF’s resources of $250 billion to replenish its coffers after it emerged as the lender of last resort for sovereign nations across the world.

While advanced economies have pledged to inject new capital in the IMF, many large emerging economies expressed an interest in contributing in a different way, by purchasing bonds issued by the Fund for government buyers.

On September 2, China made history by becoming the first country in the IMF’s history to sign an official agreement to buy up to SDR32 billion (around $50 billion) in IMF notes. This was followed three days later with India’s commitment to invest up to the equivalent of $10 billion in IMF notes. Brazil and Russia earlier this year pledged to buy up to $10 billion each.

Neither China nor Brazil has yet bought any IMF notes, but in China’s case the agreement would be activated as and when the Fund required additional resources.

The significance of the arrangement is not why the IMF is issuing bonds – it needs the capital – but why the Bric (Brazil, Russia, India and China) countries are happy in theory at least to buy them.


Eswar Prasad, a senior fellow at the Brookings Institution in Washington, says the Brics do not want to provide permanent new capital until they see “real progress” on governance reforms. “Emerging markets are able to restrict their additional financial support to a limited period,” he says. “This would enable them to maintain pressure for eventual reforms that would give them greater representation at the IMF in exchange for providing more permanent contributions.”

At the time of the agreement, Zeng Gang, director of the Department of the Banking Industry of the China Institute of Finance and Banking, said that China’s holdings of the IMF bond would help give it greater saying and influence in the IMF.

Joseph Stiglitz, Nobel laureate and former World Bank chief economist, says that the IMF’s decision to issue short-term bonds as a way of raising money was an admission that it could not expect big emerging economies to inject permanent funds without knowing how much share of the voting quota they would receive under the reform process.

He says that the previous IMF administrations had used the historic model for funding the IMF as “justification” for the out-of-date way that emerging economies were represented. He said that by offering bonds, the IMF was “moving away from that financing model but keeping the bad governance. That’s problematic”.

Although Asia has almost $4 trillion in currency reserves, the combined voting rights of Japan, China and India in the IMF are less than that of the US, the largest deficit country, and less than the combined quota of France, Germany and the UK.

The IMF plays down this aspect, saying that borrowing has always been an important temporary supplement to quota resources in the past, and has been considered appropriate at times when the IMF’s current or prospective liquidity was regarded as inadequate. It points to the oil facilities in 1974–75, the supplementary financing facility in 1979–81, and the enlarged access policy of 1981–86 as examples from history.

“The notes are a new form of IMF borrowing, but the Fund has borrowed when the time and size of a general quota increase was uncertain, and to finance the operations of newly-established facilities,” a spokesman says.

Borrowing peaked in the mid-1980s, but played its most important role in relation to the size of the IMF in the late 1970s when borrowing financed over 60% of IMF credit, and represented almost 30% of total quotas.


There is a second advantage for emerging economies to these bonds. Buying the notes will allow surplus-rich emerging economies to diversify their investment away from dollar-denominated bonds. Rather than increasing their exposure yet further to US dollars, by investing in SDRs, they are buying into a mixture of the dollar, sterling and the Japanese yen.

SDRs are based on four currencies, with the dollar providing 44% of the weight with 34% in euros and 11% in yen and sterling. Beijing will use yuan rather than dollars as and when it takes up its bond purchase option.

The IMF points out that the sums involved in its bond issuance are modest compared with other markets. “The US Treasury market is the deepest government security market by all measurements,” a spokesman says.

China holds an estimated $2.13 trillion in foreign exchange reserves, the world’s largest stockpile, and economists reckon that about two-thirds are invested in dollar-denominated assets. Both Russia and China had publicly floated the idea of using a new currency or basket of currencies as a reserve system to replace the dollar.

“This illustrates the problem that many countries feel of where to put their reserves,” says Stiglitz.

The UN Commission on Reforms of the International and Monetary Systems, which Stiglitz chaired, called for the creation of a global reserve system based on the SDR. “This issue highlights the need for a new global reserve system to replace the dollar-based system,” he says. “It is peculiar that we still have this dollar system when we are so globalized.”

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