This blog reports on a seminar in the Political Economy of European Climate Action series, hosted by the European Studies Centre of St. Antony’s College Oxford, on May 3, 2021, which examined the political and technical issues surrounding the SDR allocation and discussed options. Mark Plant (Center for Global Development) gave an overview of the SDR allocation and the issues it raises for G7 policymakers; Mark Henstridge (CEO, Oxford Policy Management) and Stevan Lee (Chief Economist, Oxford Policy Management) then gave a UK perspective on aid priorities; and Adrienne Cheasty (EuPEP, Oxford) chaired. Click here for the podcast of this session
Mark Plant explained how SDRs work: they are central bank reserve assets (meaning assets that are globally acceptable for international payments, and liquid); specifically, they entitle countries to access any of the IMF’s reserve currencies on demand. Hence, creating more SDRs would help the world compensate for loss of foreign earnings during the pandemic, supplementing countries’ capacity to pay for imports, debt service, etc.
SDRs must be allocated to countries in proportion to their voting power in the IMF, which is historically related to their economic size. If the issue is approved (expected in August 2021), the UK and the EU together will receive 30 percent of the total (£20 billion and €142 billion respectively). But of course, rich countries like the UK and the EU are not payments-constrained; hence there are growing calls on the G20 to reallocate/recycle the SDRs, so as to channel them to poorer countries that need them.
To respond to these calls, two challenges would have to be surmounted. A first is that SDRs have technical properties that significantly limit how they can be used (and some of these differ across countries, depending on national legislation). For instance, one important technical constraint is that only a few institutions worldwide are eligible to hold SDRs. Hence, it would be easiest to redistribute them if they were kept within the IMF. They could be on-lent to countries via the IMF’s low-income country trust fund (the PRGT). But it is up for debate whether all SDRs should be channeled to low-income countries; notably, middle-income countries are suffering some of the worse pandemic crises and expected climate-change costs.
A second challenge is that—no surprise—myriad proposals for competing uses of the funds have begun to jockey for airtime. These include a top-up to COVAX or a separate vaccine fund; climate financing for developing countries; and financing to help achieve the Sustainable Development Goals (SDGs).
Stevan Lee began to tease out possible aid priorities for Britain in redistributing the SDRs, by describing the difficult issues facing a sample of developing countries in the pandemic.
o The estimated loss of GDP 2019-21 is more than 5 percent in all but one of them, and more than 9 percent in India and Bangladesh. Advanced countries have confronted comparable losses but have had the means to fight back with a substantial counter-cyclical fiscal response. Developing countries have varied widely in their capacity to undertake fiscal stimulus, with little relation between the severity of the covid shock and the size of their fiscal support to the economy. Some big countries like South Africa and India have had the financial scope to provide stimulus, but most poor countries have had little scope to expand, with some even having to tighten pro-cyclically. Moreover, all countries except India have had to slash investment to pay for urgent current spending. Such cutbacks are likely to worsen the scarring from the pandemic and retard economic recovery.
o An OPM model demonstrates that the size of stimulus will make a major difference to the length and depth of countries’ recessions. As an example, foreign aid (ODA) to pay for stimulus, given in exchange for country reforms, could end Uganda’s GDP decline before end-2021; whereas Uganda is likely to remain in recession through 2024 if left without assistance. But in the case of Uganda, foreign aid will be difficult to marshall without extraordinary measures, since it has already drawn down all the IMF/IDA funds it is currently eligible for. Many other small countries face comparable constraints: without a continuation of the exceptional levels of aid offered in 2020, they will have little capacity to sustain any fiscal stimulus. The larger countries like India, Nigeria, and South Africa will be able to borrow for longer, but doing so will worsen their already unsustainable public finances; for instance, India’s fiscal deficit reached 12½ percent of GDP in 2020.
Mark Henstridge then took the baton to show how deploying the SDR issue could best help these countries.
- A first point, not to be disparaged, is that even the 3.2 percent of the planned SDR allocation that will go to low-income countries in the absence of a reallocation will be of real value to them, given the small size of their economies and the scarcity of alternative sources of aid. In 2020, the major sources of aid were the IMF’s low-income facility (PRGT) and the World Bank group’s international development assistance (IDA).
- IDA, in particular, is large enough to make substantial contributions to poor countries’ GDP; it is a pool of around US$80 billion that had been intended to last through 2022 but which is being prematurely exhausted. A redistribution of $80 billion worth of SDRs to pay for a full early replenishment of IDA would cost rich countries only one-third of their new SDR allocation, but be game-changingly large if redistributed to IDA-eligible countries. An early replenishment could, for instance, make available around 16 percent of GDP to Burkina Faso and more than 12 percent of GDP to Sierra Leone (assuming their 2019 shares in IDA are maintained).
- Redistributing the SDRs to IDA would overcome the technical difficulties that make a viable SDR-reallocation strategy so difficult. The World Bank is one of the few institutions eligible to hold SDRs. IDA is an established vehicle for efficient and fast distribution of funds—and also has a good reputation for doing so transparently. Most importantly, the countries eligible for IDA are exactly those whose finances are most inadequate to support post-covid economic recovery.
- Use of SDRs to replenish IDA would also have benefits for the UK that most other SDR-strategies would not. Since IDA will have to be replenished by World Bank shareholders (i.e., all country members) very soon anyway, an early replenishment financed by SDRs would preclude the need for shareholders to find cash for the replenishment—meaning they would be left with extra cash-in-hand to apply to their own bilateral aid budgets (or other domestic spending). In Britain, this would amount to an estimated £3-6 billion (depending on the IDA contribution) of unencumbered resources. The freed-up cash could be used to further Britain’s own agenda—for instance by reconstituting its eroded ODA budget, or by contributing more to COVAX, or to pay for the fight against climate change.
The offline discussion focused on the merits of using the SDRs for replenishing IDA. Doing so would create a risk of zero supplementary support for poor countries—despite the appearance of additionality—depending on how donor countries used the freed-up resources. Commentators also emphasized the urgency of raising funds to meet the global promise of $100 billion for poor countries’ fight against climate change, which is likely to be an onerous challenge for the UK as the host of COP26. Devoting an SDR redistribution to, say, a climate action fund administered by the IMF and World Bank would not only address the climate financing shortfall, but would ease and speed the delivery of financing (which is an unresolved problem in the current institutional set-up of climate funds).
Adrienne Cheasty (Academic Visitor, St Antony's College, Oxford)
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