Ways to fix the lender of last resort

Jill Dauchy is founder and CEO of Potomac Group LLC, a Washington DC-based financial advisory firm for sovereign governments and public sector borrowers, as well as a podcast host.

To meet the demands of the 21st century, our international financial architecture requires urgent renovation.

The cornerstone of architecture is paradoxically the piece that is missing today. In the obscure and little-understood policies of the IMF, there is a concept of “financing insurancewhich must be given before the IMF’s Executive Board can approve an IMF program and disburse funds. As a lender of last resort financed globally by taxpayers’ money, the fund must be assured that the country in question has a financing plan for the period of the program and will not use the funds of the IMF to satisfy other creditors.

Previously, financing assurances were easy to provide. The debtor country would normally call the IMF and at the same time request debt relief from the Paris Club of official creditors. Conveniently, the major shareholders of the IMF were the same countries that made up the Paris Club, which meant that they had effective veto power over the program, and at the time they also enjoyed a considerable influence on domestic commercial banks active in emerging markets. Formal debt relief and comparability of treatment between creditor groups was therefore an efficient process and funding assurances could essentially be taken care of from the outset.

But therein lies the problem. In the much-negotiated wording of IMF policies, financing assurances can only be given by a “representative permanent forum”—and the only representative permanent forum recognized by the IMF is the Paris Club. But the Paris Club is no longer representative. Most countries owe very little debt to their 22 permanent member countries after providing debt relief under the HIPC Initiative from the late 1990s and early 2000s; In today’s world, emerging markets are borrowing heavily from China and international financial markets. There is no forum – recognized or not – that brings together these various actors and no mechanism to provide assurances to the fund.

The Common Framework, introduced in response to the Covid-19 pandemic, is a valiant attempt to copy and paste Paris Club practices and approach to the G20. Developing countries, however, are not convinced. They look with awe at the downgrades and years of delay suffered by Chad, Ethiopia and Zambia – the only three countries to have initiated debt relief through the Common Framework. Zambia recently received IMF Executive Board approval for its program, based on financing assurances from the creditors’ committee co-chaired by China and France, however, negotiations are continuing with official bilateral and private creditors. on the conditions for effective debt relief. It does not inspire confidence that the IMF Executive Board itself continues to hesitate to recognize common framework as a representative permanent forum.

All eyes are now on Sri Lanka, a middle-income country in undeniable debt distress that has just entered that period of vacuum between approvals at staff level and at board level, where everything depends on insurance of financing. With rates rising in developed economies, other countries will likely soon follow.

It is time to think boldly and courageously and create a system that can deliver financing assurances – through debt relief, grants and concessional finance – quickly and efficiently and targeted to meet the many needs low- and middle-income countries. Four proposed reforms include:

  1. Automate the suspension of debt service on debt owed to G20 member countries. When a low-income country applies for the Common Framework, G20 countries should automatically grant debt service suspension during the IMF programming period. This would provide immediate funding assurances from official bilateral creditors.

  2. Dedicate early engagement with all creditors. The IMF’s Debt Sustainability Analysis (DSA) is essentially an internal tool for determining a debtor country’s ability to repay the fund. In practice, it effectively sets the parameters for negotiations with other creditors. The IMF should at an early stage be more transparent with these creditors to allow them to understand the underlying assumptions of the DSA, allow them to formulate their own views and, at the IMF’s option, obtain information on the AVD. It is, after all, those people from whom assurances of funding are sought and who will contribute to the success of the IMF program.

  3. Introduce automatic stabilizers in bonds and other debt securities to ensure private sector participation. Building on lessons learned from collective action clauses and catastrophe bonds, as well as past designs of GDP-indexed bonds, contractual terms and conditions could be developed to provide an automatic suspension of service from the debt if a “triggering event” occurs. IMF staff approval of an IMF program could be such an event.

  4. Use global momentum around climate and nature. Debt swaps and sustainability bonds are tools we can use to provide credible and specific debt relief and new financing to struggling countries. Global actors willing to support vulnerable countries must be involved. Programs and instruments that will allow new funds to flow into the country must complement the demand for funding assurances that otherwise risk being synonymous with losses. UN agencies, the World Bank, regional development banks, global funds such as GEF and GCF, and others like The Nature Conservancy have shown interest and creativity in mobilizing funding and supporting debt relief efforts by linking them to sustainable outcomes that can be specified, monitored. , and checked. These techniques can be used to address existing debt owed to official bilateral and/or private creditors, as well as to raise new financing with credit enhancements.

These innovations would reintroduce an element of automaticity that is currently lacking in the international financial architecture, while providing information to all parties early in the process and allowing them to find creative solutions beyond haircuts. By engaging other global actors and investors, it also helps mobilize new funds that can be used for a wide range of development goals.