Ali Mansoor, Chairman of the Regional Multidisciplinary Centre of Excellence (RMCE)
As the COVID pandemic recedes many governments are faced with the need to build resilience and sustainability against future unforeseen events whilst also responding to climate challenge. These additional priority needs add to those which predated the COVID-19 crisis. These include:
- Boosting infrastructure investments. The African Development Bank (AfDB) estimated Africa’s infrastructure financing gap to be in the range of $68-$108 billion a year.
- Strengthening social safety nets, including cash transfers for the most vulnerable segments of the population. Drawing on a sample of 27 countries, UNICEF points out that coverage of cash transfers announced in response to COVID would expand by 8%, on average, from 6.5% to 14.4%. This suggests that planned temporary expansions could boost the coverage of cash programs to 11% of the population in selected LICs, on average, and to 18% in selected LMICs.
- Addressing debt vulnerabilities, notably by reducing borrowing costs and averting potential liquidity and solvency crises facing a growing number of African countries.
- Supporting adaptation and mitigation efforts. At the recent COP26 summit held in Glasgow, the African Group of Negotiators on Climate Change called for $1.3 trillion annual climate finance to be mobilized by the international community for the continent from 2025.
Ministers responsible for Development Aid in advanced economies may make the case for additional assistance as part of a global effort to combat climate change and prevent future pandemics. However, the Ministers of Finance may be reluctant to use scarce political capital to pilot such requests through parliaments. In the face of an ageing population which requires higher social spending and doubts about aid effectiveness,[1] it becomes harder to convince the population (and hence elected representatives) to mobilize additional aid for developing countries. Mobilizing aid to assist Middle- and High-Income countries with grants and/or concessional assistance is particularly difficult.
It is in this context that the G7 and G20 endorsed a novel approach of using Special Drawing Rights (SDRs) to get around the problem of mobilizing domestic support whilst enabling all developing countries to build resilience and sustainability.
In their Rome declaration, the G20 Leaders called “on the IMF to establish a new Resilience and Sustainability Trust (RST)—in line with its mandate—to provide affordable long-term financing to help low-income countries, including in the African continent, small island developing states, and vulnerable middle-income countries to reduce risks to prospective balance of payments stability, including those stemming from pandemics and climate change.”[2] At the same time, they advocated for the new RST to preserve the reserve asset characteristics of the SDRs channeled through it.
Understanding the SDR, its limitations and opportunities
The IMF explains that “The SDR is an international reserve asset created by the IMF in 1969 to supplement the official reserves of its member countries. The SDR is not a currency. It is a potential claim on the freely usable currencies of IMF members. As such, SDRs can provide a country with liquidity. A basket of currencies defines the SDR: the US dollar, Euro, Chinese Yuan, Japanese Yen, and the British Pound.”
The key point is that a new SDR allocation supplements countries’ reserves, but it is not money. Instead, SDRs remain within the IMF system and countries with a Balance of Payments need can exchange their SDRs for hard currencies with other IMF members.
The creation of SDRs allow countries with a Balance of Payments need to meet this without national parliaments having to mobilize budget resources to finance aid.[3] However, SDRs are allocated according to IMF quota. Consequently, Africa received only $33 billion of the $650 billion created. Moreover, most of the SDRs went to countries without Balance of Payments needs. Therefore, the G7 committed to recycle $100 billion of what its members received and the G20 plans to recycle $45 billion.
Since SDRs are part of a country’s reserves and not freely usable money, SDRs can only be held by a limited number of institutions in addition to the IMF.[4] As noted by Andrews and Plant (2021), rechanneling SDRs to prescribed holders could be relatively easy compared to other institutions that need an 85 percent approval by the IMF’s Executive Board to achieve a similar status. However, whilst technically straightforward getting agreement in the G7 let alone the G20 would be politically complicated and take time. Given that the World Bank and Regional Multi-lateral development banks (such as the African Development Bank) have all recently benefitted from large capital increases, there is no immediate urgency to press for such reallocation. Extending the holding of SDRs to other institutions is even more complicated and not worth pursuing at this stage, notwithstanding the support, for example, from African countries to a liquidity facility proposed by the UN Economic Commission for Africa.
Given the urgent needs, the best course of action is to go along with the decisions of the G20 and G7 urging the IMF to create a Resilience and Sustainability Trust (RST) whilst pressing for design that will be most helpful. This course of action is also warranted because the G7 and G20 for the first time are suggesting that concessional financing could be provided by the IMF not only to low income countries but also to vulnerable middle income countries and high income Small Island Developing States.
Ensuring an effective approach
The OECD sets out the parameters for an effective RST: “The establishment of the RST through the recent SDR allocation is of critical importance. To play a key role in global climate action, the RST will need to be scaled up over time through additional SDR issuances and rechanneling efforts, with replenishment and expansion through hard currency contributions. The scale of the RST needs to be proportionate to the response required by the climate crisis and the development needs of the membership. The IMF can’t make the global climate crisis adapt to its instrumentation, it must adapt its instrumentation to address the climate crisis and sustainable development goals. An ambitious and well-designed RST could do just that.”
Learning from the Poverty Reduction and Growth Facility (PRGF)
We propose an innovative approach to ensure that the RST has maximum impact and avoids the stigma that may be associated with an IMF program. Our proposal draws on the lessons from the PRGF where insufficient country ownership and the challenges of coordination between the IMF and the World Bank led to poorer outcomes than expected at the outset.
The World Bank Operations Evaluation Department and the IMF Independent Evaluation Office note that “Progress varies with individual country circumstances and is constrained by preoccupation with formal requirements and tensions regarding domestic ownership. … PRSPs do not yet provide an adequate analytical framework for policy choice and prioritization. …. ” On the positive side the same report notes that “The PRS Initiative has led to increased emphasis on dialogue and results”.
The RST could be more effective if access required a resilience and mitigation strategy that is produced by the government in consultation with Civil Society and adopted by the National Parliament. The World Bank and the IMF could provide technical assistance and capacity building to ensure that the country strategy is robust, realistic and fits within the macro-framework.
Proposed Approach
As part of Article IV consultations or an IMF-supported program, the IMF would assist the authorities to carve out the fiscal space for a multi-year resilience and mitigation program. Within this fiscal space, the Government would work with Civil Society to propose specific interventions supported by appropriate reforms. This package would be approved by the National Parliament as the National Resilience and Sustainability Plan (NRSP). The NRSP would be updated annually as part of the Budget process to align it with the Budget and allow for implementation of new projects to be integrated.
Burden sharing on financing the NRSP
To strengthen the impact and ownership of RST-supported programs, part of the resources required to build resilience, say 20 percent, could be mobilized by the country through domestic mobilization efforts such as tax measures, particularly green taxes, and/or a reorientation of spending, with emphasis on eliminating carbon related subsidies.[5]
The balance for the remaining 80 percent would come from the RST, World Bank financing, and other development partner support. The IMF, given its catalytic role would, say, match the national effort with equivalent financing from the RST and leverage 3 times its own contribution from other development partners. This means, in our illustration, that the international community would contribute four times the national effort.
For example, subject to the caveats below on counterpart financing, if a country mobilizes $10 million in one year to build resilience and sustainability, this would be complemented by $10 million from the RST and $30 million from other partners and create fiscal space of $50 million for projects at the community level endorsed by the Parliament in the National Resilience and Sustainability Strategy.
Within this $50 million envelope, from our illustration, the World Bank would coordinate the action of all development partners. This would ensure that the projects with the highest net socio-economic benefits are implemented first. Also, within this envelope, some space, say 10 percent or $5 million would be used to turn the most promising ideas into bankable projects that could be financed within the available fiscal space once the project is ready.
IMF role in line with its core mandate
The IMF would monitor adherence to the macro-framework with emphasis on the resource mobilization commitments by the country. This could be done without new conditionality or requiring an IMF supported program as part of Article IV consultations or existing program reviews. This would take care of any stigma attached to an IMF program whilst enabling the IMF to play the primary role in its mandate to support countries to implement sound macro-economic policies.[6]
World Bank role to implement development projects
The World Bank would take up key interventions in the strategy as part of its project portfolio. Bank-financed projects could benefit from parallel financing by other development partners or, with World Bank support, the country authorities could share out the financing of agreed projects across development partners.
Country Ownership
The National Resilience and Mitigation Strategy would not formally be endorsed by the Boards of either the Fund or the World Bank. The staff would, however, offer their assessment in relevant documents to the Executive Boards of these two institutions (Article IV or program review in the Fund and Country Partnership Framework (CPF) and project documents in the case of the World Bank). This is a similar approach to how the IMF and World Bank treat national development plans.
Conditionality
Access to the RST, within overall access limits discussed below, would only depend on adherence to the macro-economic framework, particularly carving out the agreed fiscal space from tax and spending measures. The amount of disbursement would be related to the funding required for World Bank and development partner financed projects. In line with the catalytic nature of IMF support, the RST would finance for each project the same contribution as the Government. Since the IMF support is for balance of payments, it is only for the annual quantum that the co-financing by Government would be used rather than directly linked to disbursements. For example, if in a given year the planned co-financing for projects building resilience and sustainability amounts to $7 million, then the country could draw up to $7 million from the RST. For ease of implementation, the annual tranche to be drawn from the RST would coincide with the budget year and the drawings would occur at the start of the fiscal year. Even if project implementation is delayed, this does not matter from the perspective of the RST as eligibility for the RST would rest on actions, within the agreed macro-economic framework, to carve out fiscal space for action on sustainability and resilience. Thus, there is an implicit broad IMF conditionality around the framework that ensures that RST drawings are linked to actions by Government to at least create the space for acting. The IMF need not and should not, however, get into the weeds of project design and implementation in areas where it has no technical comparative advantage.
The actual action taken to design and implement suitable projects will depend on the collective efforts of local communities, Civil Society (in the widest sense including the Private Sector as well as Civil Society Organizations and ad hoc citizen groups working to build sustainability and resilience).
Incentives for strong national effort
In the above approach, other than the IMF and World Bank remaining within their core mandate and leveraging their comparative advantage, access rules to the RST would incentivize Governments to (i) make a larger fiscal effort in favor of sustainability and resilience if they want a larger RST drawing and (ii) work with local Communities, Civil Society and Development partners to have as large an annual project implementation envelope as possible to maximize the drawings they could make from the RST.[7]
Aligning incentives and capability
The above approach avoids excessive conditionality related to building resilience, promotes ownership by Government, Civil Society and affected communities and provides strong incentives for vulnerable states to rethink their tax and expenditure policies. It also offers a practical way for World Bank expertise to turn ideas into implementable projects and offers a framework for the IMF and World Bank financing to be catalytic and promote parallel financing by other development partners. Incidentally, this is also a way to recycle SDRs to the World Bank and African Development Bank without the complications of a formal legal transfer. The two Banks would benefit from SDR recycling because the RST would provide financing towards the projects they support.
Financing the RST
Given that the RST would be available to a larger list of countries than the PRGT and that it will support reform over the medium term, it will need significant resources. According to the UN Environment Program (UNEP) in its Adaptation Gap Report 2020, developing countries already need $70 billion per year to cover adaptation costs, and will need $140 billion-$300 billion in 2030. This is why it is important to be ambitious in setting up the RST. If the RST catalyzes government action, civil society support and development partner financing to successfully build resilience and promote adaptation, further recycling of SDRs to the RST should be a high priority once the initial allocation is taken up.
In the above proposal, until a country reaches its access limits, annually a country could draw up to either its fiscal effort in favor of action on resilience and sustainability or its counterpart contributions for projects that advance this objective. For example, if a country makes a fiscal effort of $8 million but contributes $12 million as counterpart funds, it would only be eligible to draw $8 million from the RST. Conversely, if it makes a fiscal effort of $9 million but only contributes $6 billion in counterpart funds, it could only draw $6 million.
Access limits will need to be set to ensure the RST remains viable. As repayments will only make a small difference since repayment periods will need to be long as discussed below, the key issue for setting access limits is how much funding there is for the facility.
An IMF staff paper forecast demand of $30 billion to $50 billion for the new trust over 10 years, assuming income-based eligibility for all 69 countries eligible for the PRGT, 15 small developing states and 55 middle-income countries.
If US$ 50 billion of SDRs are recycled as loans to the RST and the RST is catalytic using the ratios suggested above (governments eligible for RST support make the same contribution as the RST and development partners treble the IMF contribution), this would provide US$ 250 billion towards building resilience and sustainability. Relative to the estimates above, this would cover about 4 years of efforts to combat climate change.
If the initial $50 billion allocation to the RST produces clear positive results rapidly, and thus exhausts the RST, there would be strong incentives for replenishment not only from the G20 but from all IMF members with strong reserve positions.[8]The government contribution would come from fiscal space created by introducing green taxes and eliminating fossil fuel subsidies as well as broader tax reform and more efficient public spending.
Such success would set the stage for the IMF to invite members with strong external positions to recycle more of their unused SDRs (beyond the initial $100 billion) to support the RST. Potentially another $200 billion could be mobilized which, with the same assumptions as above, would produce a global war chest of $1 trillion, enough to act on climate change for another 14 years.
Access limits
As long as the RST can finance action on climate change there should be no access limits. The limits would be self-determined based on (i) the fiscal effort the country is willing to make and (ii) the quality of good projects that get the endorsement of the World Bank and other development partners. Given the urgency of action on Climate Change, it would be counterproductive to limit action due to some artificial bureaucratic construct that discourages those able and willing to act.
We propose that initially there should be no access limits. Once three quarters of the RST has been disbursed, if the additional $200 billion can be mobilized by recycling unused SDRs there would be no need for access limits. If at that juncture the pledges for replenishment are insufficient, then access limits may have to be introduced.
If they are to be introduced, instead of basing the access limits on quota, it would be more effective to have access limits related to the amount of disbursed RST (which would reflect the effort that the country is making to fight climate change if our proposals are adopted). Therefore, access limits would incentivize countries to make more effort to be able to draw resources that support their ambition. Given the large externalities on climate change, such an approach is the best way to incentivize a coordinated global response in developing countries whilst relying on local ownership and decentralized implementation.
Nature of contributions to the RST
Nature of contributions to the RST and repayment terms
In the interest of speed and given the consensus in the G20, African countries would benefit from a rapid setting up of the RST. This means working within the framework that potential donors’ have set out. These donors have stated their desire to preserve the reserve asset characteristics of the SDRs which implies a preference for SDR on-lending over donations.
Additionally, compared to the PRGT, the RST expands coverage to vulnerable middle-income countries and small island developing states. This suggests that zero interest lending may be difficult to achieve as donors are more willing to subsidize LICs than countries with higher income even if they are vulnerable.
Moreover, it will make more sense having the RST quickly provide additional liquidity than delaying its operations until grants are mobilized to subsidize interest payments. In the current low interest environment with the SDR interest rate at 0.05 percent, the cost of access to RST funding is much less important than access to liquidity. Critically, the RST could offer more medium-term support to build resilience to natural disasters as well as pandemics and other shocks.
These considerations suggest that the RST should be set up based on loans from IMF members that are willing to do so. These members would be remunerated at the SDR interest rate. In view of the urgency of action on climate change we propose that the IMF does not cover any part of its operational costs from the RST which suggests that the lending rate would be the same as the rate of remuneration to those lending to the facility. This approach is justified because the additional work of the Fund in disbursing the RST will be limited if our proposals are adopted.
The IMF would not have to conduct any special missions but do the RST related work as part of Article IV consultations and/or program review. The role of the Fund in evaluating country action would also be limited to its core functions of carving out fiscal space within a sound macro-framework. Thus, no additional technical or staff resources would be required. The only additional cost would be for loan administration, a minor cost for which the systems already exist at the Fund.
Repayment
The PRGR has a repayment period of 10 years which is long for the IMF but relatively short. Partly this is because the PRGF depends on grants and its viability is facilitated by replenishment in part from beneficiary countries paying back loans received.
In our proposal there are no grants required and there is no noticeable cost to IMF members lending to the RST as their overall reserve position would be unaffected. Only the nature of their SDR reserves would change.
Moreover, there should be enough firepower for the RST to be sustained at least for 4 years and, with additional recycling of SDRs for a further 14. These considerations make it unnecessary to replenish the RST by repayment of loans.
At the same time, for recipients having to combat climate change by investing over at least one generation, it makes more sense to reinvest the marginal dollar in building resilience and sustainability rather than paying back to the IMF. For the global community this make even more sense given the large positive externalities from developing countries collectively tackling change. Other than the obvious environmental benefit, there may also be a political payoff as action in developing countries would facilitate adoption of difficult measures in advanced economies.
We, therefore, propose that repayment is modelled on IDA with a 40-year repayment period and a grace period of 10 years.
Conclusion
There is increasing urgency for vulnerable countries to build resilience and sustainability. Following COVID, it is ever more difficult to find the domestic resources to do so. At the same time, due to their own post-COVID fiscal challenges, it is problematic for advanced economies to mobilize additional aid, especially for Upper and High-Income countries, notwithstanding their vulnerability.
The creation of SDRs and the setting up by the IMF of the RST offers a novel approach that allows vulnerable Middle-Income Countries and Small Island Developing States (SIDS) to obtain the resources they need to build resilience and sustainability. The challenge is for the RST to operate in a manner that is helpful and effective. The IMF needs to build on lessons from the PRGF and receiving countries need to set up the appropriate collaborative approaches between Governments, Civil Society and communities in need. If this challenge is met, potentially large amounts of additional financing could be created by issuing SDRs every five years at no cost to national budgets in donor countries. The IMF, G7, G20 and recipient countries need to work together to show that this is the way to combat climate change and prepare for future pandemics and other natural disasters.
This article draws on a paper by Daouda Sembene and the author prepared for the Open Society Foundation (Mansoor, Ali and Daouda Sembene. Options Paper on SDR Reallocations for Africa, AFRICATALYST Global Development Advisory, Dakar, Senegal. January 2022) and a paper submitted to the Organization of African, Caribbean and Pacific States.
Charles Telfair Centre is an independent nonpartisan not for profit organisation and does not take specific positions. All views, positions, and conclusions expressed in our publications are solely those of the author(s).
Main Photo from Simone D. McCourtie / World Bank on Flickr
[1] See for example, Easterly, William,Ross Levine, David Roodman. New data, new doubts: a comment on Burnside and Dollar’s “Aid, policies, and growth” (2000), National Bureau Of Economic Research Working Paper 9846, 1050 Massachusetts Avenue, Cambridge, MA 02138,July 2003 at http://www.nber.org/papers/w9846
[2] Paragraph 10 of the G20 Rome Leaders Declaration following their meeting on October 30th and 31st.
[3] However, legislation may limit the approval of the creation of new SDRs. For example, in the US (which holds a veto in IMF voting, under federal law, Congress must approve SDR allocations unless the U.S. share of an allocation falls below a certain threshold amount over a five-year period. Therefore, the current creation of SDRs was limited to $650 billion to avoid the need for Congressional approval. It also means that the next creation of SDRs without Congressional approval would only be possible in 5 years’ time.
[4] Currently there are 15 prescribed holders: four central banks (European Central Bank, Bank of Central African States, Central Bank of West African States, and Eastern Caribbean Central Bank); three intergovernmental monetary institutions (Bank for International Settlements, Latin American Reserve Fund, and Arab Monetary Fund); and eight development institutions (African Development Bank, African Development Fund, Asian Development Bank, International Bank for Reconstruction and Development and the International Development Association, Islamic Development Bank, Nordic Investment Bank, and International Fund for Agricultural Development).
See also “Questions and answers on special drawing rights (SDRs)”. August 23, 2021 at https://www.imf.org/en/About/FAQ/special-drawing-right
[5] According to Nature, fossil fuels are still being subsidized, receiving some $554 billion per year between 2017 and 2019, by one estimate. See https://www.nature.com/articles/d41586-021-02846-3
[6] When the IMF finds that the macro-economic framework is not consistent with medium term stability, the country will need to agree with the IMF and implement corrective measures to be eligible for RST drawings. An IMF program could be the vehicle for this but is not required. Regular follow up of implementation of agreed corrective action could be assessed as part of regular Article IV consultations.
[7] We assume that the larger the project envelope the larger the counterpart funds from the budget and, with a one to one matching, the larger the drawing from the RST.
[8] Smaller advanced economies like New Zealand and the non-G20 members of the EU as well as some of the Upper middle income and high income developing states with strong balance of payments positions.