A fresh allocation of IMF Special Drawing Rights (SDRs), if implemented, would provide a welcome boost to the depleted foreign exchange reserves of some distressed frontier economies. But an allocation wouldn’t address underlying dire debt dynamics, notably in Ecuador, Sri Lanka, Ethiopia and Zambia.
- A fresh allocation of IMF Special Drawing Rights (SDRs), if implemented, would provide a welcome boost to the depleted foreign exchange reserves of some distressed frontier economies. But an allocation wouldn’t address underlying dire debt dynamics, notably in Ecuador, Sri Lanka, Ethiopia and Zambia.
- An SDR allocation was first mooted during the COVID-19 crisis at the height of the market turmoil in March last year, but opposition from the US quashed the plan. (SDR allocations require 85% approval by IMF members, and the US holds 16.5% of the votes.) The proposal has now been resurrected thanks to new impetus from the Biden administration. Following a letter from US Treasury Secretary Janet Yellen, the G20 yesterday gave the IMF the “green light” to “work on” a new SDR allocation.
- A $500bn allocation has been floated. That would dwarf the $250bn and $34bn allocations in the Global Financial Crisis, although it would be lower than the $1trn floated in April 2020. One reason why $500bn looks more likely is that the US can vote for an allocation of up to $649bn without congressional approval.
- In terms of the impact on frontier economies, three points are worth making. First, the boost to the depleted FX reserves of debt-distressed frontiers would be large. One common criticism of SDR allocations is that about 70% go to developed economies and richer emerging markets with ample FX reserves like China, so the most distressed frontiers would receive relatively fewer resources. This is because allocations are made according to IMF quotas, which in turn are determined by a formula based largely on GDP.
- But in percentage terms (rather than absolute terms), the poorest and most debt-distressed EMs would receive the greatest uplift in gross FX reserves. A $500bn SDR allocation would increase FX reserves in Sri Lanka, Ecuador, Argentina, Ethiopia and Belize (where bonds are trading at highly distressed levels) by 10-15%, and Zambia’s (where the sovereign is currently in default) by almost 90%. In contrast, the boost to reserves would be just 1-3% in China, Korea, India, Thailand, the Philippines and Russia.
- The second and related point, though, is that the boost would clearly be bigger if the G20 and the IMF agreed to a mooted “reallocation mechanism” – but we’re not holding our breath. Any country can in theory lend or gift its SDRs to another country. But a more formal reallocation mechanism managed by the Fund would involve complex (and highly political) judgements about which countries need the SDRs and which do not. Another complication may be that some countries might ask for the reallocated SDRs to be conditional on economic reforms, much like traditional IMF programmes. Or they might ask for constraints on how the reallocated SDRs can be spent (e.g. on food imports rather than debt servicing).
- Third, an SDR allocation would not address underlying dire debt dynamics of highly distressed EMs. Larger gross reserve assets might help countries to make near-term debt repayments and plug gaps in their balance of payments. Indeed, reports earlier this week suggested that Argentina could use a fresh SDR allocation to make a debt repayment (ironically to the IMF!) in September. Other distressed EMs could follow suit.
- But this would simply delay the inevitable. And by sustaining economic imbalances for longer, it could potentially even make eventual debt restructurings and macro adjustments more painful. Accordingly, even if a fresh SDR allocation is implemented, we continue to expect sovereign debt restructurings in Zambia, Ethiopia, and possibly Sri Lanka too. And further restructurings will be needed Argentina and Ecuador.
Edward Glossop, Senior Emerging Markets Economist, firstname.lastname@example.org