As the financial crisis pulled the rug from under the emerging markets, analysts and policymakers alike began to question the adequacy of Fund resources. This worry was neither new nor surprising. For decades, private international capital flows had grown at a much faster rate than those of the IMF, rendering our institution too small to be able to deal with systemic crises.
As one country after another approached the Fund for financial assistance, it become clear that the international community needed to act decisively. Thus in April, the leaders of the G-20 industrial and emerging market countries, supported by the entire IMF membership, called for a tripling of the IMF’s lending resources from $250 billion to $750 billion. By early September, individual country pledges, including from many non-G20 countries, had reached the promised $500 billion in contingent resources that could be called by the Fund if needed.
In parallel, the Fund has been modernizing its lending and conditionality framework to deploy its resources more effectively. A key feature of the reform was to provide precautionary or contingent lending on an unprecedented scale and on unprecedented terms. The most important innovation for the emerging markets was the introduction in March of a new instrument: the Flexible Credit Line. This provides exceptionally high financial support with no policy conditions for members with a track record of very strong policies. This was a major breakthrough: strong performers were able to take out insurance with the Fund, and those taking up the offer—far from being “stigmatized—were rewarded by a positive market reaction (see charts).
Increasing our lending resources and reforming our lending facilities has undoubtedly helped immensely in stabilizing the financial markets. The significant boost in Fund resources, and our ability to deploy them in a contingent manner ahead of an actual payments crisis, convinced the markets that a safety net was in place to protect the global economy against even extreme outcomes. Since the crisis began, the IMF has committed $165 billion of its enlarged resources, i.e., about a quarter of its new lending capacity.
Will we still need the rest of the pledged resources even as the impact of the crisis wanes? The answer is an emphatic yes. It is too early to declare victory over the crisis. Many emerging market and developing countries are likely to remain vulnerable to unanticipated shocks and rollover risks for the foreseeable future. Some members with Fund programs also have deep intra- and inter-regional systemic links, such that the risk of spillovers remains high.
Need for warchest
More generally, the recent experience has demonstrated just how important it is to have large resources available at short notice to forestall major financial stress. The core argument is that crises can become globally synchronous and even lead to countries that normally have easy market access to borrow from the Fund.
Some academics have called for the Fund’s resources to be expanded even more, arguing that the availability of large resources would forestall the actual need for the IMF to intervene, and also prevent sudden stops in capital flows. For example, Simon Johnson has suggested that at least $1 trillion is needed, while Guillermo Calvo has underscored the important lender-of-last-resort role played by the IMF. With a stronger resource base, the Fund would also avoid the need to mobilize resources during a crisis, which may be more challenging in future crises. Reliable access to large-scale liquidity support could also reduce countries’ desire to self-insure by stockpiling reserves—which itself has been an important contributor to the build-up of global imbalances.
Is there a downside? Well, some have argued that too large a Fund could increase moral hazard and global risk, whether explicitly via a growing member of precautionary programs or implicitly by the mere existence of financing. But we have heard these arguments before, and the crisis has only rendered them more unconvincing—after all, fire departments don’t cause fires. Finally, let’s not forget that the resources available to the Fund are contingent and the Fund is increasingly providing contingent credit. Unless the funds are actually needed and disbursed, the resources will not be called. That is the elegance of contingent financing.
■ Over the next two weeks, Reza Moghadam will discuss some of the implications of the crisis for the Fund and the international monetary and financial system more generally.