Academics and other observers of the international monetary system have often noted in recent years an enduring fault line, despite the systemic reforms that followed the 2008 financial crisis, in the shape of a lack of institutional mechanisms to ensure sufficient liquidity in times of global financial stress. The unprecedented economic shock associated with the COVID-19 pandemic has again underlined the importance of developing such protections.
When economies around the world went into lockdown in 2020 as part of efforts to curb the spread of the virus, there were expectations in some quarters that an international liquidity crisis could ensue. Fortunately, it seems that such fears have not been realized to date. Apart from short-lived stress in US dollar markets in March 2020, global markets did not seize up in response to pandemic-inflicted financial pressures. And while capital outflows from emerging markets in that month set a historic record, no systemic liquidity crisis ensued.
This owed much to the speedy reuse and, in some cases, massive scaling up of many pre-existing policy instruments, drawing on a suite of strategies that might collectively be termed the ‘global financial crisis playbook’. This was complemented by significant ad hoc policy innovations by central banks in both developed and emerging markets, as well as by the G20.
So far, so good. But more difficult issues lie ahead, as the economic toll of the pandemic is expected to be long-lasting, and as spending aspirations on healthcare (notably vaccines) and green infrastructure will be higher than ever, generating financing needs many countries may struggle to meet.
Given this context, this briefing paper identifies four issues that would benefit enormously from international cooperation – and that indeed may be intractable without it. These are: (i) addressing potential donor fatigue in liquidity provision; (ii) isolating liquidity problems from solvency problems (and dealing expeditiously and sustainably with the latter as such); (iii) anticipating the inevitable challenges when central banks start to normalize monetary policy (in some cases, such challenges will arise earlier); and (iv) making the task of ‘building back’ better and greener less insurmountable for developing countries.
The paper proposes the following ideas for consideration in response to these issues: (i) substantial allocations of IMF Special Drawing Rights (SDRs), to take over from the G20-sponsored Debt Service Suspension Initiative (DSSI); (ii) development of a more complete and transparent framework for sovereign debt restructurings, drawing lessons from previous failures to durably restore solvency; (iii) a playbook for dealing with policy normalization; and (iv) coordinated actions to spur the development of deep and liquid markets for emerging-market impact bonds and local-currency bonds.