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The IMF’s latest attempt to boost fiscal spending
In August 2021, the IMF approved a general allocation of Special Drawing Rights (SDRs) equivalent to USD 650 billion to boost global liquidity and support the global economic recovery. Although this represented the largest SDR allocation in the Fund’s history, it went almost unnoticed. In this Macro Flash Note, Joaquin Thul argues the additional liquidity will help lower-income economies to partially offset the negative impact of Covid-19, but it is unlikely to affect the recovery of developed and emerging markets.
What are SDRs and how are they valued?
SDRs are a synthetic reserve asset, first created by the IMF in the late 1960s to supplement the supply of gold as an additional global reserve asset. These instruments can be held by countries, exchanged for hard currencies with other IMF members and be used to settle financial obligations of countries with the Fund and other international organizations. However, they cannot be held by private entities or individuals. Originally, SDRs had a fixed 1-to-1 parity with the US dollar. This fixed rate was abandoned in 1973 and replaced with a basket of 16 currencies. Since October 2016 the value of SDRs has been derived from a basket of only five currencies: the US dollar, the euro, the Japanese yen, the British pound and the Chinese yuan.
As part of the IMF’s Articles of Agreement, adopted after the UN Bretton Woods conference in 1944, the Fund has the potential to issue unconditional liquidity in proportion to members’ quotas in the IMF. In recent decades, it has used SDRs for that purpose. The SDRs are intended to enhance reserve assets and boost the country’s access to IMF financing to tackle long-term needs.
Figure 1. US dollar to SDR rate
The IMF plan for economic recovery
IMF Managing Director, Kristalina Georgieva, stated in January that countries should increase fiscal spending to offset the negative effects Covid-19 on their economies. She urged countries to “Please spend. Spend as much as you can and then spend a little bit more”.1
Most countries significantly increased public spending in 2020 and financed those large fiscal policy packages by issuing debt. On average, the governments of developed economies delivered a stimulus equivalent to over 17% of their GDP since January 2020, taking into account both extra spending and liquidity support. Emerging economies and low-income countries increased spending by an equivalent of 6% and 3.4% of their GDP respectively. One year later, the capacity of some of these countries to maintain or expand their fiscal support through 2021 and follow Georgieva’s advice was limited, particularly for non-developed economies.
To address this problem, in August 2021 the IMF’s Board of Governors approved a general allocation of SDR 456 billion, equivalent to approximately USD 650 billion. These SDR allocations complement member countries’ reserves, allowing them to reduce their need to issue public debt, which is normally more costly.2
Figure 2. Historical SDR general allocations (in billions of US dollars)
2021 SDR General Allocation
Until this year, there had been three general allocations of SDRs, in 1970, 1979 and 2009. The latter was intended to support market liquidity following the Global Financial Crisis. The 2021 allocation is the largest in history, distributing over USD 650 billion in assets proportionally to each country’s quota in the Fund - see Figure 2. However, despite the IMF’s efforts to boost the fiscal firepower of member countries, its actions went almost unnoticed by analysts and markets. Low expectations regarding the plan’s success are attributed to two main factors.
First, the proportional distribution of these funds according to each country’s contribution to the IMF means developed economies will receive over 60% of the allocated funds. Part of the IMF’s assumptions for global growth in 2021 depend on countries vaccinating a significant portion of their populations against Covid-19. The IMF is encouraging countries to exchange SDRs for funds they can use to purchase vaccines. While developed economies have approximately 50% of their citizens fully vaccinated, the percentage is significantly lower in emerging and low-income economies where only 10% and 1% of the population respectively are fully vaccinated. Therefore, the fact emerging countries will receive only a combined $250 billion will limit the overall impact of the program on vaccination rates.
Second, despite the fact developed economies will receive close to $400 billion from the SDR allocation, the impact on overall fiscal packages will be marginal as it represents 3% of last year’s total fiscal support. G7 economies3 , which represent over 40% of the IMF’s total SDRs, will receive over $280 billion from the latest allocation, representing approximately 1% of their GDP. This is a very small amount when compared with the fiscal support provided by these economies in 2020 - see Figure 3.
Figure 3. SDR allocation for G7 economies is low in comparison to fiscal support in 2020 (% of GDP)
When considering the aggregate figures for both developed and emerging nations the SDR allocation is also considerably lower than their average 2020 fiscal packages. However, for low-income economies, this allocation is more important, see Figure 4. For reference, the three largest economies in this group are Nigeria, Vietnam and Bangladesh, which collectively make up almost 50% of the GDP of the low-income group.
Figure 4. Average SDR allocation and fiscal measures implemented due to Covid-19, by country group (% of GDP)
The recent general allocation of SDRs by the IMF will provide some additional fiscal support to member countries. Countries have been encouraged to use these allocations to fund the fight against Covid-19, allowing economies to use of foreign currency reserves to fund economic stimulus, healthcare spending and the purchase of vaccines. But countries could also maintain their allocations in SDRs to act as a cushion against market volatility. Overall, the proportional distribution of SDRs limits its economic impact for developed and emerging economies given the low value relative to GDP. Nevertheless, the initiative should be welcomed by low-income countries which have limited space to increase external debt, as they are a cheaper way to fund public spending. The overall boost to economic activity will depend on whether these funds are used to finance pro-growth initiatives.
3 Canada, France, Germany, Italy, Japan, United Kingdom and United States.