While U.S. investors are debating whether the financial crisis is ending, the damage is still spreading in developing countries. Countries more remote from the meltdown’s epicenter, like those in sub-Saharan Africa, did not feel the pinch immediately, but are now facing big drops in foreign investment, crashes export income due to falling commodity prices, and decreased remittances from citizens working abroad, where their jobs are the most vulnerable to the crisis. The fragility of low-income countries’ economies means that the crisis is likely to last longer and hit them harder.
One of the reasons the crisis will be more intense in places like Africa is because governments there are not able to respond with the kinds of “stimulus packages” that the U.S. and European countries relied on. Most countries simply don’t have the capital liquidity to undertake such programs. Many have been forced to seek new loans from the International Monetary Fund (IMF), the multilateral institution that was laying off staff and desperately seeking a new mission before the crisis erupted but has now resumed its prominent role in many developing countries’ economies. The conditions attached to IMF programs — such as ultra-low inflation and deficit targets, layoffs, and cuts in public-sector wages, and elimination of subsidies — are the opposite of stimulus measures. Rather than pumping up their economies, IMF borrowers must shrink them, with potentially devastating consequences.
There is, however, one hopeful sign for developing countries coming from the IMF: nearly $100 billion in new resources is being made available to them at the end of this week with no conditions and minimal cost. This results from the decision made in April at the London Summit of 20 large economies that the IMF should issue a new general allocation of Special Drawing Rights (SDRs), a little-known “reserve asset” (sometimes called a “reserve currency” or “quasi-currency”). SDRs are created and backed purely by the consensus of the IMF’s member governments, which is to say virtually every government (with Cuba and North Korea being the only sizable exceptions), so they are essentially cost-free.
SDRs can be used by governments simply as reserves — they bolster a country’s savings, and thereby increase its creditworthiness and perceived stability. With greater reserves, a country can borrow more and on better terms, or free up existing hard currency reserves. SDRs, whose value is based on a basket of four major currencies (the U.S. dollar, the euro, the Japanese yen, and the U.K. pound sterling), can also be converted into cash through a system of swaps managed by the IMF. Countries pay fluctuating interest charges on converted SDRs until they are replenished.
But governments are otherwise free to use the cash realized from SDRs however they like: as reserves, or for development projects, stimulus packages, paying down debt, etc. Even though SDRs come from the IMF, they are not subject to its conditions. They’re probably the cheapest and easiest way developing countries can access hard currency resources without conditions, short of undirected grants (which are very rare). Indeed, with sufficient SDR resources, countries facing temporary crises could avoid having to borrow from the IMF.
This new “allocation” of SDRs called for by the G20 is the first since the early 1980s, so this is the first time in a generation that their use is really being debated. In June, at the United Nations Conference on the World Financial & Economic Crisis and Its Impact on Development, the U.S. government joined in the unanimous endorsement of a final statement which called for exploring the use of SDRs for development purposes. It then issued an “explanation,” saying that SDRs should only be used as a reserve instrument (a sentiment echoed by Canada), suggesting we’ll see debates over how developing countries deploy their SDRs. But once the SDRs are issued, the U.S. has no formal control over their use, nor does any international institution.
In London, the G20 called for an allocation of SDRs worth about $250 billion — a moderate injection of liquidity into the global economy. The IMF has now taken the formal steps to ratify the move, and the allocation will take place on August 28.
The problem is that most of the resources won’t reach the countries that actually need them. This will be a “general allocation” and general allocations are done on the basis of IMF quotas, which are determined by the size of countries’ economies. That means the wealthiest countries have the biggest quotas. The quotas, which also determine voting power within the IMF (thus maintaining power in the hands of the rich minority), break down roughly along a two-thirds/one-third split, with the developing world getting the short end, both in terms of votes and SDRs. This means that a general allocation of SDRs, ostensibly devised as a boost for developing countries, literally requires that the rich must get richer in order for the others to get a smaller additional portion. Of the $250 billion being allocated now, between $80 and $100 billion will go to developing countries (depending on which countries you define as “developing”); only about $11 billion — less than 5% of this newly issued money — will find its way to sub-Saharan Africa, the most vulnerable region.
Not only is the system unjust, it’s illogical. The United States, which gets the largest share, has little use for SDRs: The fees for converting SDRs mirror precisely the interest rates that the hard-currency source countries pay on their bond issues. It’s a good deal for developing countries, which would never be able to get such rates on hard currency on their own, but nonsensical for the issuers of hard currencies.
Civil society organizations have therefore been calling for additional SDR allocations — either at regular intervals, or automatically at times of crisis — which would be apportioned on the basis of need rather than quota. As already noted, creating SDRs costs nothing; the only solid basis for objections is the risk of inflation. But if the allocations are done at a moderate level, or only at times when more global liquidity is needed (i.e., when the risk of deflation outweighs that of inflation), this should be a small concern.
To address the imbalance in the current general allocation, there have been calls for creating a system that allows for, and encourages, the transfer of SDRs from rich countries to those who need them — something that several European countries have indicated they would consider. One problem is that the interest charges for the SDRs would remain with the donor country to which they were originally allocated — a serious disincentive to altruism. There were hopes that the IMF would address this issue in the guidelines for this allocation, but when they were issued in July the Fund stated only that “no proposal for the voluntary redistribution of SDRs has ever been put into effect” because it “has a real cost to the provider.”
Another important demand, then — not only to encourage transfers but to make SDRs a more useful resource generally — is that developing countries’ costs for converting SDRs, including transferred SDRs, be eliminated or subsidized through the use of other IMF resources (such as the sale of some of the IMF’s massive gold stocks). At the very least, the interest charges should be fixed, like fees, so that countries can predict the costs associated with using SDRs over time.
Another factor discouraging transfers is that some potential donor countries, including the United States, have accounting rules which count SDRs as assets — even though they have no cost (and, as we’ve seen, dubious usefulness for a country like the United States). Thus their transfer would have to be balanced by receipt of other assets. Just as the rules for provisional allocations by the United States to the IMF were adjusted recently (to “score” the allocation 5% of face value) to make the move more palatable to Congress, so too could the budgetary status of SDRs be easily changed. SDRs actually present even less risk than the $100 billion designated for the “New Arrangements to Borrow” (NAB), under which the United States is virtually guaranteed its money back. And unlike NAB funds, which can only be lent to middle-income countries at market rates, SDRs can be of enormous value to the low-income countries that most need assistance.
In recent weeks, it has emerged that the IMF will likely propose that wealthy countries transfer their SDRs — not to countries in need, but to the IMF itself, which would then loan the resources to low-income countries, with their usual slate of conditions. This would be an unfortunate way of converting SDRs from unconditioned, cheap resources to conditioned loans. The proposal would at allow donor governments to be seen as generous even as they increase the power of the IMF over developing country economies. If it goes forward, it seems likely that a way to deal with the issue of the costs associated with SDRs will be found; advocates should insist that any such method instead be applied to straightforward country-to-country transfers.
Because the United States is the IMF’s largest shareholder — it wields more than 16% of the Fund’s executive board’s voting power — and because major decisions, such as allowing special SDR allocations on the basis of need rather than quota, require an 85% super-majority board vote, the U.S. occupies a pivotal position. In practice, such decisions are validated once the U.S. Congress approves them. The July vote on the NAB funds also included approval of an amendment for the first-ever special SDR allocation — this one for the countries which had joined the IMF since the last allocation in 1981 (and thus including many of the East European countries being hit hard by the crisis). That provision had been approved by the IMF board in 1997; Congress waited 12 years to ratify it.
President Barack Obama and Congress should move quickly to approve new special SDR allocations and SDR transfers. With no cost to the United States, they would be providing developing countries with desperately-needed, unconditional resources they can use to combat the impacts of the global financial crisis, a catastrophe now being visited upon poor people in developing countries because of the actions, or inactions, of U.S. regulators and bankers.