Yellen should act quickly to assist financially stricken countries

Maurice Obstfeld (PIIE) and Edwin M. Truman (Mossavar-Rahmani Center for Business and Government at Harvard's Kennedy School)

January 27, 2021 12:00 PM
Image credit: 
REUTERS/Manaure Quintero

The global economic meltdown caused by the COVID-19 pandemic has plunged many countries into potential external financial crises through no fault of their own. The Trump administration prevented the International Monetary Fund (IMF) from deploying one of its key tools—called special drawing rights (SDR)—to help countries in distress. Fortunately, Treasury Secretary Janet Yellen can act quickly to remove this blockade.

Such a move would extend the Biden administration's commitment to revive US multilateral cooperation by rejoining the Paris climate accord and the World Health Organization. The United States can reverse course on global financial cooperation as well by supporting an allocation of $650 billion in SDR. This action would help countries fight the pandemic and aid global economic recovery, to the benefit of the United States as well as the rest of the world.

The United States must approve any SDR allocation because an 85 percent weighted majority vote of the IMF executive board is required, and the US voting share is 16.51 percent of the total. Because of its voting power, the United States can and has blocked proposals to allocate SDR for almost a year. Under US law, the Treasury secretary can endorse an SDR allocation without the approval of Congress so long as the amount of the SDR allocation the United States would receive does not exceed the US quota in the IMF ($119.7 billion) and the secretary notifies Congress 90 days in advance. The Treasury secretary thus could consent to an SDR allocation of, say, $650 billion (of which the United States would receive $113.4 billion) without seeking explicit congressional approval. This aspect has the major benefit that the SDR allocation can be authorized quickly—if only the United States would allow the IMF to act. If Secretary Yellen were to notify Congress on February 1 that she intended to vote for an SDR allocation at the IMF, the allocation could be on the books by mid-May.

Critics of using the SDR tool argue that it is a blunt instrument, not designed to help the most troubled countries, rewards bad actors, and risks turning the IMF into a kind of global central bank. These criticisms are misguided.

Arguments for an SDR allocation

The SDR supplements reserve assets of IMF member countries. It is not itself a currency, and its value is based on a basket of international currencies. SDR are allocated to members in proportion to their IMF quota shares—a zero-cost way of adding to members' international reserves. A member uses SDR by transferring them to another member in return for foreign currency.1 (See footnote 1 for a more technical explanation.)

An allocation of $650 billion in SDR would signal the collective determination of countries to act together in the current crisis and add 5.5 percent to countries' international reserve holdings on average. It would provide financing to countries with growing current account deficits and/or reduced capital inflows resulting from reduced export earnings and domestic demand.

The SDR lifeline would enable countries to increase their imports of badly needed medical supplies and provide a costless insurance policy for the global economy. These benefits would also boost US economic recovery by reviving exports of important sectors such as agriculture and tourism.

As we noted earlier, unlike most other large, fresh initiatives to help financially stricken countries, an SDR allocation can be implemented quickly. If Secretary Yellen removes the blockade, a decision by the IMF executive board, for example, in February to allocate $650 billion of SDR can be implemented by May.

Flawed arguments against an SDR allocation

Because SDR are allocated to all IMF members, including richer members, in proportion to their quotas, critics argue that countries that need help would benefit little from the allocation. But 40 percent ($260 billion) of a $650 billion allocation would go to emerging-market and developing economies; some of them, such as Argentina and South Africa, could benefit from the boost in their reserves. Total IMF net disbursements to all members from regular programs from March to December 2020 were only $52.5 billion plus about $1 billion in special grants to low-income members to help defray repayments to the Fund. Four and a half percent ($29.2 billion) of a $650 billion SDR allocation would go to low-income countries that are eligible to borrow from the World Bank's International Development Association (IDA). This amount would exceed average annual IDA disbursements during the past three years ($17.8 billion) by more than 60 percent and also exceed IMF disbursements to them from March to December 2020 by almost $20 billion.

For most countries with adequate reserves or not subject to near-term external financial pressures, the boost to their available international liquidity would be small. Countries with more than adequate reserves could lend their SDR to the IMF or to other countries—another potential benefit to less wealthy IMF members in distress.

Some critics also argue that SDR are wasteful because they are allocated to all IMF members, regardless of immediate need—and that actions should be focused exclusively on countries in distress. But such targeted aid would require a cumbersome process of budgetary outlays by an array of bilateral lenders. In fact, SDR are very well targeted. Only countries that need them use them. Countries receiving an SDR allocation receive equal amounts of assets and liabilities, with no immediate net transfer of financial resources. Countries that do not use their SDR neither gain nor lose.

Critics also fear that the SDR allocation would be available to Iran, Russia, Syria, Venezuela, and other outcasts. But all broad-based assistance programs, including US COVID-19 relief efforts, are bound to benefit some domestic bad actors, which is not a sufficient reason to oppose the program. In any case, SDR holdings of Iran and Syria currently exceed their allocations, and Russia's SDR holdings are only 14 percent less than its allocations. Venezuela has largely spent its previous SDR allocations.

Another traditional argument against an SDR allocation is that it would contribute to inflation, allegedly because countries would spend their newly acquired SDR. In the current downturn, such spending is not likely to contribute to global inflation, and most economists would welcome any resulting increase in inflation (or avoidance of deflation). A related argument is about "moral hazard," suggesting that helping countries would tempt them to undertake foolishly expansionary policies. That argument seems grotesquely irrelevant at a time when so many countries are struggling to support their economies.

A further criticism holds that countries wishing to convert their allocations into hard currencies would turn to the United States and impose a cost on US taxpayers, increasing US Treasury debt in the hands of the public. In fact, US taxpayers may make a profit on US net holdings of SDR when the US government's short-term borrowing rate is less than the SDR interest rate that it would earn. That is not the case today because the short-term interest rates of three of the other currencies in the SDR basket are negative. But the SDR interest rate is 4 basis points (that is, 0.04 percentage point) below the short-term Treasury bill rate (0.09 percent), and demands on the US Treasury to purchase SDR redemptions are likely to be small. Several factors underlie this prediction. For many countries, additional SDR allocations are important not because they are used but because they could be used, enabling countries to avoid more contractionary policies. In addition, countries looking to exchange SDR into hard currencies approach other countries beside the United States. As of the end of 2020, US SDR holdings were only 4 percent more than its total allocations. Ten other advanced economies had positive net holdings, and those countries accounted for more than two-thirds of the combined net positive holdings of the group. China's holdings exceeded its allocations by 14 percent.

Voicing Trump administration concerns, former Treasury secretary Steven Mnuchin warned that an SDR allocation risked turning the IMF into the "equivalent of a central bank" as a source of global emergency liquidity. The SDR is not a global money, however, and the IMF cannot create money. The Fund has never fulfilled the original vision for the IMF proposed by the economist John Maynard Keynes in the 1940s, giving the IMF such powers. A $650 billion SDR allocation would not do that either. Rather, it would reduce the pressure on the US Federal Reserve to be the world's central bank—a role it reassumed in spring 2020 by expanding access to liquidity swap arrangements and is under pressure to expand further.

In conclusion, with the coronavirus pandemic still raging, prompt action on an SDR allocation would support a broad-based global economic recovery, without which the US recovery will be slower and weaker. US support for an SDR allocation now also would signal that the United States wants to resume a leading role in international economic and financial cooperation.

Edwin M. Truman was nonresident senior fellow at the Peterson Institute for International Economics until December 2020. He is a senior fellow of the Mossavar-Rahmani Center for Business and Government at Harvard's Kennedy School.

Note

1. The IMF established its SDR facility in 1969 to supplement other reserve assets of member countries. The SDR tracks a basket of international currencies comprising the US dollar, Japanese yen, euro, pound sterling, and Chinese renminbi. When the IMF issues SDR, members receive them in proportion to their IMF quota subscriptions. Members cannot directly make international payments using SDR—because the SDR is not itself a currency—but they can transfer SDR to another IMF member for the equivalent in a convertible or hard currency, for example, US dollars or euros. When an IMF member receives SDR, it receives a claim on the IMF but also incurs an equal liability to the IMF. It, therefore, pays or receives interest on the difference between its total SDR holdings and its cumulative allocations—which will differ whenever a country (on net) has used some of its SDR to acquire hard currency or has accepted SDR from other members in exchange for hard currency. The current interest rate is at its minimum, 0.05 percent.

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