By Reza Moghadam, Director - Strategy, Policy, and Review Department, IMF
Though the recent global crisis started in the advanced economies, most emerging markets came under pressure; it seemed that no country, especially those most interconnected, was immune from tremendous economic strain. Now, as the crisis abates, there is an emerging consensus that something needs to be done. A better safety net is needed to enable countries with good policies to insure against bad outcomes, especially when they are innocent bystanders caught up in a financial turmoil. [Click all images to enlarge.]
Last week, the IMF took another step toward meeting this need by enhancing its country insurance facilities. Following on from earlier reforms, the IMF Executive Board decided to extend the safety net to a broader set of countries with sound policies and economic fundamentals, making our contingent financial support more tailored to our members’ needs and circumstances. A new staff paper (pdf) and supplement (pdf) describe the main elements of these reforms.
The decisions taken by our Board—the rationale for which I wrote about earlier this year—were significant for two sets of countries. For countries with very strong policies and economic fundamentals, these reforms have made our flagship insurance option—the Flexible Credit Line (FCL)— even more attractive. And, for countries with some moderate vulnerabilities, the IMF now offers a new form of contingent protection through a new Precautionary Credit Line (PCL).
Flexible Credit Line
So far, three countries have made use of the FCL: Mexico, Colombia, and Poland. Put in place last year during the depths of the crisis, all three FCLs have been renewed, with senior officials in these countries noting the role played by the FCL in soothing market sentiment and providing them with “policy space” to take countercyclical measures.
Experience with the FCL—as well as extensive discussions across the broader Fund membership—suggested that this credit line for our strongest performers could be even more effective if we made it more flexible (“reserve-like”). Thus, we have made two principal changes. First, an FCL can be longer—up to two years, with a country’s policy strength reviewed after a year—providing an increased measure of predictability. Second, we have removed the implicit cap on its size, allowing it to be determined by the amount of insurance that a member actually needs.
Precautionary Credit Line
Despite making immense strides in improving their policy frameworks, many countries still have moderate residual weaknesses in, among others, fiscal and financial areas, with some susceptible to linkages to foreign banks. In the most turbulent times during the crisis, these countries ended up lacking contingent protection. The FCL was not an available option, given its high qualification bar. While a Stand-by Arrangement was available in a precautionary form—including with high access as a result of earlier reforms—this traditional crisis-resolution instrument was not used much for crisis-prevention purposes by these countries, identifying a gap in our ability to serve our member countries.
Thus, the PCL was born, designed to fill exactly this gap for members with sound policies. The PCL’s rigorous qualification process is intended to give a “seal of approval” regarding policy strengths in most areas, while also identifying residual vulnerability. Limited ex post conditions are then used to address such vulnerability, thus providing contingent financing as well as credibility to the authorities’ policies. Given the sound policies of qualified members, a PCL provides a large amount of up-front access to financing: as much as 500 percent of a country’s IMF quota could be available during the first year of the PCL, with up to a total of 1000 percent of quota available after a year.
A Global Financial Safety Net
Good policies and frameworks—endorsed with FCLs and PCLs—are certainly the first line of defense. However, as history and the recent crisis have shown, there are times when localized events trigger panic among investors, setting off chain reactions across markets and countries irrespective of fundamentals. The intensity of investor withdrawal during the recent crisis surpassed most expectations, with normalcy returning slowly and only after many forceful measures were taken by the global community, including the leaders of the Group of Twenty industrialized and emerging market economies.
Given this experience, what more can the Fund and the international community do? For our part, the Fund’s member countries have asked its staff to explore options for overlapping layers of protection for the global economy. Reform of the Fund’s lending facilities is but one layer. We are also working on establishing synergies in terms of lending and surveillance with key regional financing arrangements, and are consulting with various stakeholders. We are also considering a Global Stabilization Mechanism, a framework that would allow proactive provision of financing during a systemic crisis to stem contagion.
Our Executive Board has had a preliminary discussion and, building on this, we will be developing these ideas further in the months ahead.