Covid-19 is disrupting heavily the global economy. Internationally, it led to massive financial turmoil, a sharp fall of international trade, and a major global recession, possibly even bigger than the Great Depression. It resulted in significant flight of portfolio capital from emerging markets: over $100bn according to the IMF.

In many countries, sovereign debt repayments will be due soon, and it may become impossible, to raise new funds in private markets, for both governments and private companies to roll-over their debts, or even less increase borrowing. Even before the corona pandemic hit the world economy, many developing and emerging economies were already facing severe debt and liquidity problems.

Problems will be compounded by sharp falls in commodity prices -illustrated dramatically by the recent collapse of the price of oil.  The coronavirus crisis can, therefore, trigger large-scale balance of payments crises across the developing world, as well as a sharp fall in output, employment, and increase in poverty. To avoid this, emerging and developing economies, would need $2.5 trillion of funding, as estimated by the IMF and UNCTAD.

A number of key measures need to be taken urgently by the international community to provide key international liquidity and development finance to emerging and developing economies, so they can minimize economic slowdown, and facilitate recovery.

These measures should be seen as important steps towards beginning a major reform of the international financial system. This is particularly important in the case of the global financial safety net, which remains patchy: it lacks coverage and resources to deal with a crisis of the magnitude we are currently facing.

The International Monetary Fund (IMF) should agree a rapid issuance of at least $500bn in international liquidity, in the form of additional Special Drawing Rights (SDRs). This would build on the enlightened decision, taken by the G20, under the leadership of Gordon Brown, at their London meeting in 2009 to issue SDRs equivalent to $250bn. The UK, as well as the G7 and G20 should take leadership on this now as well. 

It is highly disappointing that in the recent spring IMF/World Bank meetings, the issue of SDRs was vetoed by the United States, with the surprising support of India, even though major European countries supported it. It is key that the issue is proposed again, especially as the world economy continues to deteriorate.

The SDRs are international monetary assets issued by the IMF – acting. They are part of the foreign exchange reserves of countries, and they can be sold or used for payments to other central banks. Close to two-fifths of this allocation would enhance the international liquidity in the hands of emerging and developing countries, the main users of SDRs.

Furthermore, this should be the beginning of a deep discussion about the role of SDRs in the international monetary system. They are the only true global money, backed by all IMF members. However, it has remained as one of most underused instruments of international cooperation.

Though international liquidity is crucial, especially for balance-of-payments constrained developing and emerging economies, provision of sufficient long-term development finance, to help them fund investment is equally key, both to help support demand and future growth, as well as facilitate major structural transformation to a fairer societies and low carbon economies.

At the multilateral, regional and bilateral level (as well as the national one), public development banks can offer significant additional funding, especially at times when private capital and banking markets are unwilling or unable to take risks in the face of uncertainty and provide enough finance. It is therefore important to increase rapidly the capital of multilateral banks –the World Bank and the regional development banks like the European Investment Bank and the African Development Bank—, as well as of bilateral development banks –like Dutch FMO or German DEG—, to allow higher lending from them to take place speedily. It is important also that these banks, including especially the World Bank, do not attach structural conditionalities (particularly greater market reforms) to such loans, as the causes of the increased demand and need  for their loans is not determined by economic policies but by the internal and external effects of the COVID pandemic.

By significantly increasing their lending in a counter-cyclical way, these larger multilateral, regional and bilateral development banks can support depressed short-term economic activity and, particularly, job creation, and help build a more equitable and sustainable economic development model.

In the medium-term, a more balanced financial system, both internationally and nationally, with a significantly increased role for development banks can help create a system that far better serves the economy, society and the planet than the current one.

Image credit: flickr/niawag

Stephany Griffith-Jonesis is a Council Member of PEF; she is Emeritus Professorial Fellow at IDS, Sussex University and Financial Markets Director, IPD, Columbia University.

José Antonio Ocampo, a professor at Columbia University, is a former Minister of Finance of Colombia, and former United Nations Under-Secretary-General for Economic and Social Affairs.

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Development banks help to counteract the pro-cyclical nature of the private financial system, which lends too much in booms and rations credit during crises. The private sector also often fails to provide enough financing for small and innovative companies and infrastructure projects. Nor does it support enough of the investments in innovative activities, credit to small producers, and environmental projects that are urgently needed to make economies more dynamic, inclusive, and sustainable.

Although governments provide their paid-in capital, development banks raise funds on national and international capital markets. Moreover, these banks’ loans are typically co-financed by the private sector, which is especially helpful for governments facing budget constraints during and after economic crises.

The World Bank and regional multilateral development banks (MDBs) sharply increased their lending during and after the 2007-2009 financial crisis. The European Investment Bank, the largest MDB, doubled its paid-in capital and is playing a central role in implementing the European Commission’s so-called Juncker Plan, which aims to generate €500 billion ($561 billion) of additional investment across the European Union by the end of 2020. In addition, the recent establishment of two other large MDBs – the Asian Infrastructure Investment Bank and the New Development Bank established by the BRICS countries (Brazil, Russia, India, China, and South Africa) – will contribute further to a more balanced public-private mix in development finance.

The financial crisis also prompted some European, African, and Asian governments to establish new NDBs, and other countries to expand theirs. As a result, the total assets of NDBs reached approximately $5 trillion in 2015. Today, they are an important feature of most developed and middle-income countries’ financial sectors, notably in China, Germany, India, and South Korea. And large NDBs can have a big impact, especially in emerging economies.

Unsurprisingly, academic researchers are finally starting to pay more attention to NDBs after a long period of neglect. They are looking to understand how these banks operate, which instruments, incentives, and governance structures work best, and how such institutions interact with the private sector and government policies.

In a recent book, we analyzed NDBs in seven countries – China, Germany, Brazil, Mexico, Chile, Colombia, and Peru– and concluded that these banks tend to be successful overall. They have been broadly efficient instruments of national development strategies in their respective countries, and they have helped to overcome major market failures in a flexible way.

Our research identifies five crucial functions of NDBs in the development process: providing counter-cyclical finance; encouraging innovation and structural transformation; enhancing financial inclusion; supporting infrastructure financing; and promoting environmental sustainability, in particular by combating climate change.

NDBs were strongly counter-cyclical in the wake of the global financial crisis. According to World Bank data, NDBs increased their lending from $1.16 trillion in 2007 to $1.58 trillion in 2009. This 36% increase was far greater than the growth in private bank credit in the same countries over that period.

NDBs have been innovative, notably in supporting new activities. China’s CDB, Germany’s KfW, and Brazil’s BNDES have financed technological advances, for example, while others, including Chile’s CORFO, have supported entrepreneurship. Such banks have also introduced guarantees and established new equity (including venture capital) and debt funds. Furthermore, they have developed new programs to increase financial inclusion, such as “correspondent” stores and post offices that provide financial services from one or more banks.

In addition, NDBs have been prominent supporters of important new sectors, such as renewables and energy efficiency. For example, KfW was initially the sole lender to private companies investing in solar energy in Germany; private banks got on board later. In China, CDB helped to design policies to encourage investment in renewable energy – particularly solar – and provided significant initial funding. As a result, Germany and especially China have been major global promoters of solar power, helping to make it increasingly competitive relative to fossil-fuel energy.

To be clear, we favor “good” development banks: well-governed institutions with highly professional staff and clear mandates that fulfill their functions well. Such banks should maximize their development impact rather than profits, while ensuring some minimal level of return.

Countries that already have NDBs should aim to expand their role, while others should consider establishing them. Doing so would help to create a financial system that better serves countries’ economic and social needs.

This piece was cross-posted from Project Syndicate. Photo credit: Flickr / Steintec.

Copyright: Project Syndicate, 2019

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