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
IMFs 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 IMFs 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 Indias 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
Neither China nor Brazil has yet bought any IMF notes, but
in Chinas 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
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 Chinas holdings of the IMF
bond would help give it greater saying and influence in the
Joseph Stiglitz, Nobel laureate and former World Bank chief
economist, says that the IMFs 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. Thats 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 IMFs current or prospective liquidity was
regarded as inadequate. It points to the oil facilities in
197475, the supplementary financing facility in
197981, and the enlarged access policy of 198186 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
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 worlds 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.