The IMF introduces the Short-term Liquidity Line to redeem itself.

  • + The predicted global GDP growth rate for 2020 is -3%. 
  • + Due to this, the IMF has introduced a Short-Term Liquidity Line.
  • + But countries may not borrow from it because of the IMF stigma.

Here’s a fun fact for you: in the past few months, 103 out of the 189 member states of the International Monetary Fund (IMF) have approached the institution to seek loans. If that doesn’t worry you, how about a predicted global GDP growth rate of -3% for 2020? And if that still doesn’t bother you, what do you think of portfolio outflows worth $100 billion from emerging economies in just 2 months (three times higher than the exact period during the Global Financial crisis back in 2008)? I know in times of the pandemic, we’re all looking for positive news, but an economic recession anticipated to be nearly as bad as the Great Depression is hard to overlook. 

But we’ve also seen countries become far more proactive with their economic policies to try to salvage their markets. It has been predicted that countries will be taking fiscal actions amounting to $8 trillion and central banks have already lowered the interest rates. While governments have dealt with economic recessions previously, they never had to deal with a health crisis simultaneously. Moreover, the IMF has stated that even if the lockdowns across the globe get lifted by mid-2020, only a partial recovery can be expected in 2021. 

But along with the countries, the IMF has also prepared to help countries that would need financial aid. The IMF has a lending capacity of $1 trillion and this time, it has also doubled its access to emergency facilities up to $100 billion. The institution has also revamped its Catastrophe Containment and Relief Trust to help 29 under-developed economies. Moreover, the G-20 countries have also suspended the bilateral debt repayments amounting to $12 billion from underdeveloped countries. A high level of international cooperation has been observed in the past few months because most countries, especially the developed nations, realise that they need a healthy global economy for themselves to stay afloat. 

A new measure that the IMF has taken after almost 10 years is the Short-Term Liquidity Line (SLL). The idea behind this measure is that countries with strong policy frameworks who are facing short-term liquidity shortages as well as the balance of payments needs can approach the institution for loans. The loans will be extended for a period of 12 months. Something unique about this credit line, compared to its predecessors, is that it has ‘revolving access’. This allows borrowing countries to partially or fully repurchase loans and repay them during the 1-year duration to meet their short-term liquidity demands. 

A country that borrows from the IMF and is endorsed by the institution would be giving a signal to the global markets that it has a strong economic framework and this could lower its borrowing costs; it would now be considered ‘platinum quality.’ Moreover, the SLL can prevent insolvency due to liquidity shortages so that they don’t require greater financing in the future. Currently, the estimated demand for SLL by countries is $50 billion. But if you’re familiar with the IMF loaning mechanisms, you’re probably wondering: what’s the catch? 

Well, this time, the IMF has really tried to destigmatize the idea of borrowing from the institution, something that has stuck with it ever since the adoption of the Bretton Woods System. The countries have to meet the same criteria that apply to a Flexible Credit Line. The SLL does not have any ex-post conditionality that has often led to a lack of policy sovereignty for borrowing countries.  Some of the prerequisites for taking on a loan would be low and stable inflation, a financial system that is not at risk of insolvency, and a sustainable external position. Thus, while 103 countries have approached the IMF for this loan, many of them will not meet all the criteria. 

Furthermore, countries that have already been receiving concessional lending from the IMF will not be able to borrow through the SLL either. Apart from those, countries that have greater access to issuing reserve currencies, such as the Euro Area, will not be counted in either. Although the IMF does not usually grant loans based on the income levels of countries, it will predominantly be focusing on helping the emerging economies. Moreover, countries that face a larger balance of payments shock and risks, will have to use the FCL instead since the SLL is present solely to address short-term needs. It is possible, however, to switch from one to the other depending on the situation. 

Yet, only time will tell if countries actually end up borrowing from the institution. Considering the IMF’s track record, it seems like the numbers are not going to be staggering. The FCL was introduced after the 2008 Financial Crisis to remove the stigma of taking on loans from the IMF but nothing much had changed. Till date, only three countries have used the FCL. So even after removing so many ex-post conditionalities, countries have always been sceptical of the IMF. Even the Precautionary and Liquidity Line (PLL), in which the IMF can overlook one or two of the criteria stated by the FCL, has only had two countries as beneficiaries. Of course, this is largely due to the PLL’s focus on ex-post conditionality. The IMF does admit that previously, its borrowing limits were not high enough and the repayment periods for the countries were too short and this led to additional pressure on the countries. Most countries see the IMF as the ‘lender of last resorts’ but painstakingly avoid using its resources. So, what routes do countries often take during these times then?

Domestically, they implement more expansionary fiscal and monetary policies. Moreover, countries also stock up on reserve currencies such as the USD. This was done during the 2008 financial crisis and is evident even now, as the demand for the USD has surged especially amongst the emerging market economies. Another measure countries often take is establishing central bank liquidity swap lines between domestic and foreign central banks across the world. In the previous crisis, the US Federal Reserve played a key role in providing liquidity and has once more taken on responsibility through its Repo Program. Both of these methods have been very popular amongst countries because they don’t incur high levels of debt. Borrowing from the IMF not only comes with conditionality but also a burden on the already high government debts. Thus, most countries prefer to provide liquidity in the market through these measures. 

The SLL will not only aid the countries but also help the IMF maintain its relevance. If again, countries rely on themselves or bilateral ties to improve their economies, the role of the IMF would get further diminished in the international community. Apart from its $1 trillion fund, there’s really not much of a difference between the IMF and any other think tank that analyses data and gives policy recommendations to countries. The USA, along with its Federal Reserve, seems to have more say in policy matters lately. The institution definitely needs to step up a notch if it wants to preserve any credibility after the financial crisis has passed. 

Ishwari Sawant

Team Member of Research & Analysis