The global spread of financial crises over recent decades—and their contagious effects—has had the G20 look with renewed attention to increasing the resilience of the international monetary system. As private capital movements have become the fundamental determinants of the global financial system, the absence of a sustainable mechanism for managing liquidity shocks and ensuring international financial stability has become more apparent.
In the short term, the external spillovers from national monetary policies in the advanced countries, especially the prospects and timing of the Federal Reserve’s further lift-off, adds to existing concerns. The ongoing regulatory reforms—and their potential impact on retrenchment in markets—have also increased financial uncertainties.
The central question is whether an international lender of last resort is needed to mirror the growing role of domestic central banks that have functioned as domestic lenders of last resort, and whether the International Monetary Fund (IMF) can play this role more effectively.
The reality is that today’s global and regional financial arrangements are not big enough to deal with potential shocks. In the recent crisis, the Federal Reserve effectively became a dollar lender of last resort, but this role cannot be sustained. As a result, the international liquidity safety net has fragmented, given rising financial globalisation, and many countries have chosen to self-insure inefficiently through external surpluses and the accumulation of international reserves.
There are many aspects to this issue but, among them, one vital question is whether the IMF has access to sufficient resources to potentially play such a role. Thus far, the periodic reliance on quota increases and bilateral borrowings has fallen far short of keeping the size of the IMF relative to the size of the global economy as it was in 1945. Can the IMF be equipped with a full-fledged monetary asset instrument to deal with changing global liquidity and systemic crises?
It helps that the IMF has been discussing a road map for strengthening the international monetary system and, more recently, whether SDR could play a broader role in helping its smooth functioning.
Indeed, SDR was originally envisaged in the IMF’s Articles of Agreement to be the principal reserve asset in the international monetary system.[1] However, the constraints on its creation and use—such as requiring an 85% majority in the Executive Board and allocated only in proportion to member quota holdings—have kept it from playing such a role. For example, between 1981 and 2009, no further SDR allocations were made. Thus, its stock has remained a fraction of global reserves, even after the one big allocation in 2009 after the onset of the global financial crisis.
Although SDR is not used in private markets, recently, there has been some interest in denominating financial instruments in SDRs to reduce the foreign exchange and interest rate risk relative to single currency instruments.
To restore the potential of SDR and move away from the reliance on a national currency (the dollar) as the main reserve currency, the IMF would need to have the power to use it much more flexibly, allowing the SDR to be traded directly with central banks that issue reserve currencies. Over time, the development of a private SDR market should be encouraged. Among the initial steps that would need to be taken to move in this direction are:
- Fundamentally reforming the present regime of allocations, which consists of providing supplementary SDRs to countries less in need of them than others. The challenge is to empower the IMF to issue SDRs, as required, in a declared crisis situation, to be used to help countries in need, thereby moving away from periodic allocations on a pre-defined basis and on the basis of quotas.
- Giving the SDR much more visibility in the operations of the IMF and other institutions in the official sector, thereby building its potential to become competitive with other internationally used currencies. For example, it can be used by all international financial institutions as a unit of account for financial statements, economic statistics, and the pricing of transactions.
How does one move in this direction? It would need to be carefully sequenced, and complemented by giving the IMF a stronger governance framework. This is especially important, given the historic rise of emerging markets, and the growing likelihood that tomorrow’s major financial players—official and private—will come from those very emerging markets. In this context, it helps that the SDR basket is being broadened by the addition of the Renminbi.
The IMF would also need to be assigned monitoring responsibility over movements in capital account balances in the manner in which it exerts it over current account balances; this will need an amendment to the IMF’s Article of Agreement. Moral hazard concerns from giving the IMF more of the role of an international lender of last resort will require a strengthened mandate for effective surveillance.
It will take time to build the necessary global consensus along these lines. To move in this direction, international public opinion needs to become much more aware of the ongoing risks of instability inherent in the current system, leading possibly to a new, large-scale crisis, and then of the need for a new global mechanism properly equipped to prevent it or to face it in credible fashion.
In the current climate, it would be highly desirable for the G20 to take this initiative forward and convene a new Bretton Woods II conference, mandated to propose the needed changes in the Articles of Agreement of the IMF. This would well complement the extensive financial reforms that have been led by the G20 after the financial crisis.
Anoop Singh is Distinguished Fellow, Geoeconomics Studies at Gateway House: Indian Council on Global Relations.
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References
[1] The SDR is not a currency, but a potential claim on the holdings of freely usable currencies of participants in the SDR Department (currently all IMF members). It was launched on January 1, 1970, and is allocated according to quotas. Allocations are not targeted based on need or any other consideration, but aim to supplement existing reserve assets.
Obstfeld, Maurice. ‘The SDR as an International Reserve Asset : What Future ?’ International Growth Centre, March 2011. <http://eml.berkeley.edu/~obstfeld/SDR_Obstfeld.pdf>
Fischer, Stanley. 1999. “On the Need for an International Lender of Last Resort.” Journal of Economic Perspectives,13(4): 85-104.
IMF, The Role of the SDR—Initial Considerations, July 2016, <http://www.imf.org/external/np/pp/eng/2016/072416.pdf>
IMF, Strengthening the International Monetary System, A StockTaking, March 2016. <http://www.imf.org/external/np/pp/eng/2016/022216b.pdf>