By Mario Blejer
The current financial crisis is putting substantial pressure on emerging markets. Many if not all face a serious risk of a sudden and severe slowdown in credit as a consequence of the withdrawal of international liquidity pools until recently available to these countries. The consequences of a credit crunch could be dire for both their public and corporate sector. This would ultimately stall the last engine of growth on which the world economy relies. The International Monetary Fund should quickly put together a preventive facility to restore the capacity of countries with healthy macroeconomic accounts to borrow from private capital markets.
An important reason for the drying up of liquidity for emerging markets has to do with the huge increase in risk aversion and the general de-leveraging process currently underway that places emerging markets, as a class, among the more risky assets that are unattractive in present circumstances. Indeed, private net external financial flows from banks and non-bank institutions to emerging markets are projected to fall from $602bn in 2007 to less than $300bn in 2009.
One possible way to help re-open liquidity flows, to buttress the capacity of emerging countries to overcome the current wave of risk aversion and to enable them to roll-over their debt with private creditors at reasonable spreads is to open an IMF-sponsored guarantee facility.
Countries with basically sound macroeconomic positions that face immediate liquidity constraints and need to roll-over external obligations could apply for an IMF guarantee that would reduce significantly the default risk. The modalities of the guarantee will have to be worked out in terms of maturities and instruments, but the idea is to offer covenants that include a Fund promise to honour the debt in case of a country’s default (in which case, the member country contracts an equivalent with the Fund).
In terms of eligibility, it should be offered to countries with strong macroeconomic fundamentals that in normal conditions would pass the standard tests for total debt sustainability. To calculate access, it would be necessary to assess the Fund risk in each case and the associated provisioning requirements. That would be the amount to be allocated against the quota.
Clearly, this has advantages against direct lending since it requires less Fund resources, does not substitute private creditors, and does not require extraordinary access in many cases. In addition, it could prove more effective in mobilizing foreign resources and facilitating roll-overs than direct lending since Fund lending does not necessarily reduce spreads or assure liquidity when there is a flight to quality, as today.
Another advantage of this proposal is that it may reduce or eliminate the perceived stigma attached to requesting the use of Fund resources. It could be simply seen as a mechanism to reduce borrowing costs.
Consideration could also be given, in a case by case manner, to delegating authority to the government of the member country utilizing the facility, to use the facility to extend its own guarantee to local financial institutions that have been liquidity starved by the credit crunch. But the Fund should not extend direct guarantees to private sector agents.
The calculations of Fund risk would also be used to determine the fee to be charged for the guarantee and its cost should be incremental to discourage the prolonged use of the facility.
As a whole the Fund could leverage its resources many times and reduce the overall risk in the system. Conditionality should be minimal and the bureaucratic process should be streamlined and shortened as much as possible (although debt sustainability assessments will have to be very much up to date). It would be advisable that executive authority is given to the Fund management to authorize the use of the facility based on a short staff report following the request of the member country and consultation with the Executive Board.
This facility should include a sunset clause, underscoring its emergency character (open for, say, one year with an option for extension after a thorough assessment by the Board of Directors) although the guarantees themselves should have longer time horizons to match the roll-over needs of the specific member country as well as the characteristics of the debt sustainability analysis. To limit the Fund exposure it should also be possible to set up a maximum volume of guarantees that management could authorize with the option to expand it subject to Board approval.
Mario I. Blejer is a former Governor of the Central Bank of Argentina and has worked for the IMF and the Bank of England. He is currently an independent economic consultant.