It is now difficult to imagine that only a year ago the IMF was going through an existential crisis. Almost all major borrowers had repaid their loans and some pundits were suggesting that the high level of precautionary FX reserves in the emerging markets would make the International Monetary Fund unnecessary as a lender of last resort. The global financial crisis has of course once again turned the Fund into an important and, in many cases, pivotal global liquidity provider. The financial shock has exposed financial vulnerabilities in a number of emerging markets. Over the past few months, the IMF has increased its loan commitments by more than USD 40 bn. Further loan agreements are ready for approval by the Fund Board or in negotiation currently being negotiated (Belarus, El Salvador, Latvia and, Serbia, Turkey) and other countries may yet be forced to request IMF financial support over the coming months. This raises the question whether the Fund will have sufficient resources to deal with the global financial crisis.
The massive increase in cross-border financial flows has no doubt made it more challenging for the Fund to counter capital account shocks. In 2002, net private capital flows to emerging markets amounted to USD 170 bn. Last year they reached a staggering USD 1,030 bn. Stripping out more stable FDI flows, net private capital flows exploded from an average of USD 10 bn in 1999-2002 to more than USD 550 bn last year. In gross terms, private cross-border flows also skyrocketed. Gross bank lending to emerging markets soared from USD 117 bn in 2000 to USD 455 bn in 2007, while gross bond issuance doubled from USD 69 bn to USD 142 bn over the same period. Net portfolio equity flows amounted to USD 145 bn in 2007, a ten-fold increase compared to 2000!
But have emerging markets not sharply reduced their financial vulnerabilities over the past few years? This is true for most of the larger, systemically important emerging markets, but is not true for the emerging markets universe as a whole. While emerging markets’ FX reserves have risen dramatically over the past few years, the accumulation has been concentrated in just a handful of countries. FX reserves surged by a staggering USD 1 tr in 2007, but the BRIC countries – and first and foremost China – accounted for over two-thirds of the increase. Emerging markets are also running an aggregate current account surplus, but according to the World Bank one in two registered a deficit in excess of 5% of GDP last year! Not all of these countries depend on private capital flows to finance their current account shortfalls, but many of them do. So the IMF will have its work cut out should the current decline in cross-border financial flows prove more permanent than expected. The longer the global crisis drags on, the greater will be the call on IMF financial resources.
The IMF’s lending capacity has improved in recent years following substantial loan repayments by countries such as Argentina and Brazil. As of September, its one-year forward commitment capacity (FCC) amounted to USD 200 bn, not including an additional USD 50 bn under the New and General Arrangements to Borrow (NAB/GAB). In 2002, the FCC stood at a mere USD 74 bn. Nonetheless, the IMF’s financial resources have seen only very modest growth compared to the staggering upturn in private-sector financial flows (e.g. USD 5.7 bn or 1.8% ad hoc quota increase in 2006). The last significant increment took place during the regular, quinquennial general quota review in 1998 when quotas were boosted by 45% (and the NAB was approved). (A second round of quota increases under the quota and voice reform process will, once approved by IMF members, lift quotas by a further 9.6%.)
The Fund’s new short-term liquidity facility (SLF) provides eligible member countries with access of to up to five times their subscribed quota. This means that in a scenario where four of the world’s six largest emerging markets (e.g. Brazil, India, Korea and Mexico) were to draw on the facility at the same time, the IMF’s lending capacity would decline by USD 100 bn overnight. The fact that loans drawn under the SLF are short-term is somewhat of a mitigating factor. We continue to believe that such a scenario is not very likely. But if the past few months have shown anything it is that almost anything is possible and that financial shocks have become more systemic in nature. If in such a scenario several other countries requested substantial stand-by arrangements (or access to the SLF), IMF resources could quickly become stretched.
Would such a scenario spell doom for the emerging markets? If our optimism about the larger emerging markets were misplaced and several of these countries ended up requiring large bail-out packages, several lines of defence would be available. Other multilateral and bilateral funding sources could be tapped in order to alleviate the pressure on the Fund’s lending capacity. Japan has already offered USD 100 bn. China may also be persuaded to provide additional financing. Being very dependent on trade and enjoying a solid financial position, China would have an interest in stabilising a badly shaken global financial system and pre-empting potential threats to the world trade system. Offering the Fund USD 100 bn in financing would not make a difference to China’s financial stability and politically it would give Beijing an opportunity to strengthen its role as an important stakeholder in the global financial and economic system. Beijing could probably be persuaded to provide funding in exchange for an increase in IMF voting rights. At the multilateral level, the World Bank and other regional development banks could provide additional funding to emerging markets and so could the EU, the US and Japan (and China) on a bilateral basis, either by way of loans or further central bank swap agreements (e.g. recent agreement on establishing/ augmenting currency swap facility between China, Japan and Korea).
In conclusion, even if a prolonged global crisis were to substantially reduce the Fund’s lending capacity and impair its lender-of-last-resort function, this would not necessarily spell doom and gloom for emerging markets. Our baseline scenario remains one where the larger emerging markets will manage to avoid tapping IMF financial support and in this scenario the Fund’s resources should be sufficient to cope with the financial problems that emerging markets are and will be facing over the next 12-24 months.