Why the IMF’s $650bn plan alone won’t save indebted countries

The Covid-19 pandemic has created divergences between countries of canyon proportions.  The richest economies, bolstered by fiscal and monetary stimulus measures and advanced in their vaccination campaigns, are on course for a faster recovery. But for some of the most vulnerable countries, saddled with debt and with limited resources or access to vaccines, the “R” word is harder to fathom.

Leading multilateral financial institutions, led by the IMF and the G20 group of large economies, have been grappling to find the best way to respond to the economic damage left behind by Covid, including the question of how to tackle the mounting debt burdens that many low and medium-income countries were struggling with before the pandemic.

The biggest of these plans involves creating a record $650 billion in new “Special Drawing Rights”, or SDRs, an international reserve asset that countries can effectively exchange against a hard currency and use to pay for Covid recovery efforts such as vaccines, or to pay down debt.

The proposal moved closer to being finalised after a meeting of the IMF’s executive board on Friday where members reportedly gave their unanimous approval. It still needs final consent from the board of governors, consisting of representatives of the IMF’s 190 member states, which the Fund’s managing director Kristalina Georgieva has said could happen in August.

But for UN development experts, the SDR allocations will fall short of what the poorest countries need to manage the crisis and have limited effect unless wealthier nations voluntarily redirect some of their allocations to them – a move that G7 member countries are considering.

“If we stick to a business-as-usual approach, the expected $650 billion SDR allocation might not prove to be as transformative as they should do because for most highly vulnerable developing countries, the share that is implied in the current allocation would far from cover [their needs],” said Achim Steiner, administrator of the UN Development Programme (UNDP), at a press conference last week.

Beyond providing much-needed short-term relief, the UNDP also argues that any plan to redirect funds should also consider how to help nations deal with long-term debt as well as development issues, such as tackling climate change.

What are Special Drawing Rights?

The SDR is an international reserve asset created by the IMF to boost member countries’ reserves and provide liquidity in a crisis. It is neither debt nor credit and can be exchanged against five currencies: the euro, US dollar, Japanese yen, Chinese Yuan and British pound. The borrower pays a low interest rate, currently set at 0.05 per cent.

SDRs are distributed according to each country’s share in the IMF, roughly equal to the size of their economies. This means that the lion’s share goes to high income nations, with the G7 countries alone receiving $283bn of the total. By contrast, the world’s 82 highly debt-vulnerable economies will receive just $54.bn – equivalent to 1.8 per cent of their total gross public debt stock this year, according to a UNDP policy brief released last week.

The proportion varies within the group.  For the Democratic Republic of the Congo, the SDR allocation, for example, would equal approximately 20 per cent of its total gross public debt. For Egypt, Eritrea, Kenya, Laos, Maldives, Sri Lanka, and Sudan, it would be not even one per cent.

According to a separate note by ratings agency S&P Global last week, the SDR allocation would be enough to restore the reserves of five of the 44 emerging market sovereigns rated B+ or below to adequate levels: Zambia, Jordan, El Salvador, Benin, and Togo. Another two sovereigns, the DRC and Suriname would see one of the measures they define reserve adequacy restored.

However, S&P says the IMF’s reserve boost would still fall nearly $200bn short of the amount needed to bring all remaining B+ or lower-rated countries back up to adequate levels.

A plan to channel SDRs to countries in need

The IMF is currently exploring ways in which wealthy countries could voluntarily transfer their excess reserves to poorer nations. At a recent G7 summit in Cornwall, the US and the other six nations said they were considering redirecting up to $100m of their allocated SDRs.

There are currently mechanisms in place, like the IMF’s Poverty Reduction and Growth Trust (PRGT), that are expected to play a key role in doing this. However, only 55 of the 82 highly debt vulnerable nations are eligible for it. All vulnerable developing economies should be able to benefit, says the UNDP.

The policy brief argues that alternatives such as setting up a new “resilience and sustainability fund”  – an idea that the IMF is working on and has gained support from members – could ensure that more countries are included and would allow funds to be channelled towards specific objectives, such as funding climate mitigation or adaptation measures.

Nine of the top 10 most climate-vulnerable countries in the world are highly debt-vulnerable.

“There's a very urgent need for countries to get their hands on cash to manage the crisis. That means, for instance, extending income support programmes to protect vulnerable populations who have lost incomes, or who are now dealing with rising food prices. It also deals with being able to order and purchase vaccines or invest in the infrastructure necessary to roll out vaccines which is also a huge bottleneck,” Lars Jensen, UNDP Senior Economist and author of the policy brief, told Geneva Solutions.

“But if we look beyond this very short term an urgent need of managing the health and socio-economic impact of the crisis, we argue in the brief that there's a big elephant in the room that needs to be addressed, and that is the debt situation.”

A paper published by UNDP earlier this year showed that already before the pandemic in 2019, 40 of the 82 highly debt-vulnerable developing countries had surpassed their threshold of gross debt that was deemed to be sustainable as a percentage of their  GDP.

Jensen added: “If we don't find a better and more effective way of dealing with this debt problem, development prospects for lots of developing economies will look very dim in the future. So that is something I believe this SDR location should also address.”