May 5, 2009
The recent increase in IMF resources has facilitated the reform of the Fund’s lending policies and has led to the introduction of a new Flexible Credit Line. The FCL will provide “well-managed” emerging markets with very substantial ex-ante, upfront financing. Less “well-managed” emerging markets will continue to have access to traditional Stand-by Arrangements. The increase in IMF resources should sharply reduce any concerns about the Fund’s ability to “bail out” the emerging markets.
The commitments made by the G20 just over one month ago in terms of additional funding for the IMF and the MDBs have sharply reduced the risk of a systemic emerging markets (EM) crisis. The Fund will see its loanable resources double, rising from USD 250 bn to USD 500 bn. This amount is to be raised to USD 750 bn over time. In addition, the Fund plans to issue USD 250 bn worth of SDRs to increase global reserve assets. The summit also pledged funds to increase MDB lending and put in place a trade financing facility for EMs. Combined with the recent reform of IMF lending policies, this has helped improve investor sentiment towards EMs.
The new IMF lending facility, the Flexible Credit Line or FCL, offers borrowers very attractive terms (e.g. large up-front borrowing, only ex-ante conditionality, relatively attractive financial terms). Ex-ante conditionality means that only “well-managed” countries will have access to it. The FCL is meant to signal to investors that well-managed EMs have almost unlimited access to official liquidity. This should alleviate investor concerns about an EM liquidity crisis, lead to a renewed focus on counterparty credit risk and hence a greater willingness to extend credit to EMs. So far, Mexico has signed up to a FCL and Colombia and Poland are in the process of doing so. Other well-managed EMs may request credit lines in the coming weeks and months.
Unlike during previous “sudden stop” episodes, most EM sovereigns continue to have access to international capital markets. This time, the problem lies with an EM private sector encountering difficulties to roll over its external obligations with G10 banks (and other lenders). Countries with sufficient FX reserves like Brazil were able to deal with this situation by putting in place large FX reserve backed-financing lines to support the private sector. Countries with lower FX reserves, understandably keener to preserve their less ample assets, have not been able (or willing) to act as preemptively as Brazil. The additional financial cushion provided by the FCL will make it much easier for key EMs to support their foreign exchange-strapped private sector.
Even if you believe that the financing problem is due to the supply side (capital-constrained G10 banks) rather than the demand side (excessive EM risk), the new IMF facility will improve the outlook for capital flows to EMs by improving the risk-reward trade-off for investors, at least as far as well-managed EMs are concerned. Traditional, politically less attractive Stand-by Arrangements (SBA) will remain an option for less well-managed EMs (read: countries in need of adjustment). Here also, the substantial increase in IMF funding should reduce whatever concerns there may have lingered about the ability of the Fund to support EMs.
While previous “emergency” facilities were never taken up (e.g. CCL, SLF), probably due to the stigma attached to them and lower access limits than under the FCL, the FCL is likely to be popular, and demand for IMF funding may therefore increase significantly. Outstanding loan commitments (including Colombia and Poland) currently amount to USD 145 bn versus USD 500 bn in loanable funds. Turkey and several smaller Eastern European countries will sign SBAs soon. Add a couple of mid-sized SBAs from other parts of the world and a few more FCLs and IMF loan commitments could quickly exceed the pre-G20 summit level of loanable resources of USD 250 bn. But as the larger EMs (China, India, Brazil, Russia) are unlikely to request FCLs, total IMF loan commitments are not likely to exceed USD 400 bn anytime soon. Nonetheless, following the reform of lending policies, the Fund would be well advised to ensure that the G20 make good on their commitments. For now, the USD 500 bn in loanable resources should be enough to “bail out” the emerging markets – assuming, that is, that no developed market will require IMF financial support.
The lending reform and increased Fund resources should sharply reduce concerns about a general financial meltdown in the EMs – concerns that were probably overstated in the first place. Investor sentiment towards EMs may remain volatile, moving in large measure in tandem with changing financial market conditions in the developed markets. Nonetheless, the G20 agreement has put a firm cap on EM risk.
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