Uncertainty in the global economy is increasing. Capital flows to emerging and developing economies have slowed down significantly over the past six years and international reserves in several countries are declining. The growth in global trade has also been significantly smaller than expected in 2016, falling below the growth of GDP for the first time in fifteen years. Growing geopolitical tensions and increasing friction in countries’ domestic politics are introducing additional risks.
Many emerging economies could benefit from insurance against this backdrop of volatility. Fortunately, cheap and no-strings-attached liquidity insurance exists, in the form of the IMF’s Flexible Credit Line (FCL) for countries with very strong policy fundamentals; for countries with somewhat weaker, but still sound fundamentals, the Precautionary and Liquidity Line (PLL) offers a similarly good deal. But these precautionary instruments remain underutilized. We have some suggestions on how the IMF could fix this.
What do the Flexible Credit Line and Precautionary and Liquidity Line offer?
The Flexible Credit Line offers countries with “very strong” economic and policy fundamentals access to unlimited liquidity support if and when they want it (the actual size of the credit line is determined on a case-by-case basis). The less demanding Precautionary and Liquidity Line (PLL) can provide countries access up to 500% of their IMF quota over two years, with some conditions following approval. Introduced as part of the IMF’s reforms to its lending facilities in the wake of the global financial crisis, the credit lines found some takers early on: Colombia, Mexico, and Poland applied and gained access within months’ of the FCL’s introduction, while Morocco applied within a year of the establishment of the PLL. As Table 1 shows, the 3+1 initial users have continued to renew their credit lines with the IMF since then and have secured the right to quick access to large additional sources of liquidity.
What other emerging economies appear to qualify for the IMF’s precautionary credit lines?
Uptake by countries of the FCL and the PLL has stalled, with no new countries gaining access beyond the original 3+1. Could the IMF’s ex-ante qualification criteria be too stringent? In our recent CGD Working Paper, we show that the lack of expansion is certainly not for the lack of qualified member states. We created an eligibility index using three indicators of institutional quality and eight indicators of economic performance. Using our index, we find—perhaps surprisingly—that there are as many as 23 additional countries likely to be eligible for the FCL or the PLL (Table 2). Our methodology and possible alternative lists of likely qualifiers are displayed in more detail in our Working Paper.
Boosting the uptake of the IMF’s liquidity insurance
Given the increased unpredictability of movements in the global economy and declining reserves in emerging markets, there has never been a more opportune moment for countries to apply. In our Working Paper, we show that when compared to similar crisis management and prevention tools, such as foreign currency reserves or multilateral and bilateral swap agreements, the FCL and PLL fare better on close to all criteria—level of access, reliability of access, pricing—than other options. The experience of the current qualifiers also points to favorable market reactions and positive economic impact following a country’s approval for either of the two credit lines.
Providing extended opportunities for liquidity insurance to its members is clearly in the IMF’s own interest, as the warden of global financial stability in an increasingly volatile global environment. A greater number of emerging economies with access to precautionary lending would make the system more stable, particularly if even a limited increase in countries with access created positive spillovers for non-access countries. To address potential applicants’ concerns about IMF’s precautionary facilities that may hamper demand, and to address any uncertainty member states might have about the willingness—at the level of IMF staff and in the Board—to expand access to these new “insurance” instruments, we offer three practical recommendations for the IMF in a CGD Brief:
Improve the transparency and predictability of the qualification assessment. To address concerns regarding country eligibility for the two credit lines, the IMF could clarify which of the nine (FCL) or five (PLL) policy areas it assigns the greatest weights to and/or define a smaller subset of relevant indicators. Clarifying the institutional requirements for qualification would be particularly beneficial, given the difficulties in finding objective, accurate, comparable indicators of institutional quality. Currently, the only two indicators listed by the IMF in connection with the assessment of the strength of a country’s institutional policy framework are “policy cyclicality” and “effective response to shocks," and these are described as “complements” to the assessment, rather than as core components.
Consider making qualification for precautionary finance the ‘default.’ In a more radical move, as proposed by Ugo Panizza and also recommended in a report of the CLAAF group of former finance and central bank officials from Latin America, the IMF could make qualification the default when it comes to precautionary credit. Loss of eligibility due to insufficient policy or economic fundamentals could be shared privately by management with member states every six months or with some other Board-agreed periodicity. If all members were in principle pre-approved, the uncertainty over the outcome of an application and over the IMF’s willingness to lend as well as any political stigma associated with the current application process could be eliminated.
- Strengthen and disseminate more broadly existing analysis on positive economic impacts and devote more time and resources to research on public perceptions towards the Fund. Many countries view asking for IMF assistance in any form as an economic and political liability, despite the extensive reforms in the Fund in governance and interactions with borrowing members over the last 10 years. While there is no quick fix to eliminate any lingering political or economic stigma, more information in the public domain about the new credit lines, including their lack of any negative market repercussion for currently participating countries, would be a useful step. More analysis regarding the (potential) positive effects associated with access to the FCL or PLL could contribute to reducing the number of unknowns and make the ‘risk’ of a request for a precautionary arrangement clearer. More in-depth (informal) conversations about the perceived political stigma between policymakers and the IMF staff—particularly in the Asia region, given the fraught history of the Fund’s engagement there—could help reduce policymakers’ wariness regarding the use of the precautionary credit lines. A new, broader survey of public perceptions towards the IMF could also be useful in understanding any continuing basis for the stigma problem and in formulating strategies to address the problem where needed.
CGD blog posts reflect the views of the authors, drawing on prior research and experience in their areas of expertise. CGD is a nonpartisan, independent organization and does not take institutional positions.