Considering the macroeconomic challenges faced by emerging markets, Eichengreen and Gupta outline a few key aspects of the financial agenda that G20 members could address. They discuss seven areas of improvement, including broadening central bank currency swaps, easing access credit lines, reallocating resources to low-income countries, improving the measures used and transparency of credit rating agencies, taking climate-risk into account when lending to vulnerable countries, creating hedging instruments to address currency mismatch, and establishing an effective mechanism for restructuring debts.
Emerging markets and developing economies are currently facing major challenges from global shocks, including a slowdown in global growth; increase in food and energy prices; a decline in risk appetite of international investors; unsustainable debts in low-income countries; and ongoing climate risks. To be sure, emerging-market economies have made significant progress in strengthening their policy frameworks and institutions over the past two decades. In this period, they have brought down formerly high rates of inflation, often through the adoption of inflation targeting as a monetary framework, and by strengthening the independence of their central banks. They have also turned to greater exchange rate flexibility to facilitate adjustment; and have accumulated foreign exchange reserves to allow intervention. They have strengthened fiscal rules and institutions; maintained sustainable public debt-to-GDP ratios; embraced macro-prudential policies; and effectively communicated their monetary, fiscal and regulatory policy frameworks and actions to financial markets and other stakeholders.
Yet progress at the national level alone is not enough. These efforts need to be complemented by changes in the global economic and financial architecture, through G20 discussions and other wider engagements designed to make the world a safer place for emerging markets. In a recent paper (Eichengreen and Gupta 2023), we focus on the financial aspects of this agenda, a few important aspects of which have remained unaddressed. The financial agenda as we see it has seven key elements: (i) reform of central bank swap lines; (ii) reform of International Monetary Fund-contingent credit lines; (iii) Special Drawing Rights (SDR) reallocation; (iv) reform of credit rating agencies; (v) inclusion of climate-resilient debt clauses in new debt instruments; (vi) steps to streamline the debt restructuring process; and (vii) creation of currency hedging instruments.
We detail our main recommendations below, and urge the G20 members to prioritise these on their reform agenda:
i) Generalise central bank swap lines
Central bank currency swaps have been shown to have positive effects of financial stability and financial efficiency in periods of significant volatility. The G20 should therefore encourage central banks to broaden their networks of currency swaps. The Federal Reserve can extend swaps to additional central banks. Other central banks with partners that do business in their currency can provide swaps more widely. Temporary swaps can be made permanent.
Central banks with ample dollar reserves can make these available to partners. Such arrangements should be formalised where they are currently ad hoc, and the terms should be made transparent. This would help to fill the gaps in the global financial safety net.
ii) Reform IMF-contingent credit lines
The introduction of IMF-contingent credit lines was stimulated by the observation that holding foreign reserves is costly and that even ample reserves may not suffice to insulate countries from global shocks beyond their control. The Fund now has three contingent lines: the Flexible Credit Line; the Precautionary and Liquidity Line; and the Short-Term Liquidity Line. Only eight countries have signed up for one of these lines to date, and only three have ever drawn on them.
The G20 should endorse measures to enhance the role of IMF-contingent credit lines, as another important element of the global financial safety net. The IMF could prequalify countries based on their macroeconomic strengths, rather than requiring them to apply and can include its qualification status in the Article IV report1. The amount of the credit line, and charges attached to initial qualification could be eliminated. Credit lines could disburse automatically when there is an ‘Emerging Market sell off’, as identified by IMF staff and verified by the Executive Board.
iii) Reallocate SDRs
The historic decision of IMF members to authorize a new $650 billion allocation of Special Drawing Rights (SDR) in response to the Covid-19 economic crisis was supposed to be accompanied by reallocation of those SDR resources to low-income countries in balance-of-payments and fiscal distress. Yet more than a year later, there has been little such reallocation.
To facilitate that reallocation process, in October 2022 the IMF agreed to create the Resilience and Sustainability Trust, or RST. This is progress, but relative to ambitions attached to the 2021 SDR allocation, the RST remains underpowered. Among the measures that can be taken are lifting the 150% quota cap; and further simplifying and streamlining conditions attached to the associated staff monitored programmes. The G20 can also resolve that additional advanced-country governments, beyond the pioneering six, should contribute to the trust.
Relatedly, the imbalance between the votes and voices of advanced and emerging G20 members in the IMF has continued to grow, rather than shrink. Continued quota reform should be an integral element of the G20 agenda.
iv) Reform rating agencies
Compared to advanced G20 countries, emerging markets receive lower ratings, which remain inexplicable even after accounting for a comprehensive set of debt and macroeconomic indicators. Emerging markets with no history of debt default receive lower ratings than what their observed debt loads and macroeconomic performance would otherwise lead one to expect.
Statistically, this differential could be accounted for by institutional and governance indicators. But the weight attached to such indicators is arbitrary and opaque, and the measures are of dubious quality. Concerns that credit ratings are arbitrary and unfair for emerging markets are fueled by rating agencies’ lack of transparency and by their reluctance to acknowledge uncertainty surrounding their judgments.
Addressing these concerns requires efforts on the part of multilaterals and others to improve the quality of the institutional/governance measures they produce, while being more transparent about how they produce them. It also requires more transparency on the part of rating agencies to indicate exactly how they use the resulting measures and other indicators in their assessments.
v) Insert climate-resilient debt clauses into debt contracts
The G20 countries should include climate-resilient debt clauses in their own bilateral, regional and multilateral lending to climate-sensitive low-income countries in order to deepen the market and reduce any adverse signaling. They could further use regulation to persuade and incentivise private creditors to do likewise. They could subsidise the interest premium for such contingent lending through multilateral institutions. A standard template for such bonds would make for a more homogenous, liquid market, and reduce the transactions cost of issuance. The G20 should encourage and endorse this initiative.
vi) Create hedging instruments
Many low-income and middle-income countries have no choice but to borrow in foreign currencies. This exposes them to financial risk and economic dislocation from exchange-rate volatility. Hedging instruments at the relevant maturities and affordable cost would help to mitigate these dangers. Developing such markets for additional countries and currencies would be a significant step toward reducing financial fragility. A G20 agreement to provide the funding needed to scale up hedging significantly would help address the currency mismatch problem that results in financial fragility.
vii) Create a more efficient mechanism for restructuring debts
The World Bank and IMF have suggested that distressed debtors seeking relief under the Common Framework should receive statutory protection from asset seizures by national courts when suspending debt service payments. However, that protection needs to be implemented by creditor-country governments through legislation or an executive order. The G20 can adopt a resolution to this effect.
Beyond the immediate need to fix the Common Framework, there is a need to address the increasingly diverse and fragmented nature of the creditor base, which heightens free-rider problems and complicates debt restructuring. To this end, new creditors such as China should be admitted as official members of the Paris Club2.
Most new debt issues by emerging markets and developing countries now include collective action clauses (CACs).3 However, other instruments, such as newly-issued syndicated loans and foreign-law-governed sub-sovereign bonds, still do not include CACs; these should be added. More creditor countries can adopt 'anti-vulture fund' legislation, along the lines of acts adopted by the United Kingdom, Belgium and France. Doing so will prevent private creditors from holding up renegotiation by rushing to the courthouse (Gill and Buchheit 2022).
In 2021, the OECD launched a Debt Transparency Initiative encouraging private creditors to provide more complete information on their loans and investments, but few private creditors have participated so far. The G20 governments can make this a regulatory requirement.
The authors thank Prof Sanket Mohapatra for sharing the data on credit ratings, and Ayesha Ahmed, Aakansha Atal, S. Priyadarshini, and Sakshi Rathee for valuable research assistance.
- Under Article IV of its Articles of Agreement, the IMF has a mandate to exercise surveillance over the economic, financial and exchange rate policies of its members in order to ensure the effective operation of the international monetary system. The IMF’s appraisal of such policies is included in this report.
- The Paris Club is an informal group of creditor countries whose aim is to find sustainable solutions to difficulties in repayment of bilateral sovereign debt by debtor countries.
- Collective action clauses allow bondholder trustees to modify the bond repayment terms subject to the approval of a qualified majority. When unanimous consent of all bondholders is required, it allows 'vulture funds' to hold bond restructuring hostage to achieve their preferred outcome.
- Eichengreen, B and P Gupta (2023), ‘Priorities for the G20 Finance Track’, NCAER Working Paper No. 145.
- Gill, I and L Buchheit (2022), ‘Targeted Legislative Tweaks Can Help Contain the Harm of Debt Crises’, Brookings Institution Policy Brief.