Global Policy Forum

By Stephanie Flanders

It wasn't long ago that Gordon Brown wanted to downgrade the lending side of the International Monetary Fund (IMF) and make it an independent economic watchdog instead.

In a world of plentiful private capital, the lending side of the organization seemed a bit passé. But that was then. In the current crisis, the IMF has already bailed out seven countries in the past six months, to the tune of $46bn (£32.7bn). That means it has about $150bn left to lend this year, a figure that will shrink further if Turkey gets the $20-25bn program that most expect. In normal times that would be plenty. But thanks to the drying up of private capital flows and trade credit, the IMF thinks it could need a lot more - about $250bn more, in fact.

An IMF staff study published last week suggest that 16 emerging market economies could be vulnerable to a Thailand-style capital account crisis, where domestic and foreign investors take flight, taking the country's foreign exchange reserves with them. We don't know the precise list of countries, but similar private sector analyses suggest that it includes a large number of Central and Eastern European countries and, probably, South Africa and Pakistan. Some of these economies might need Fund programs worth more than 5% of their GDP. The Fund reckons it would cost an extra $230bn to help all sixteen.

Poor country problems

And that's just the emerging market piece of the problem. On Tuesday the IMF Managing Director, Dominique Strauss Kahn highlighted the vulnerability of many of the poorest countries to this crisis as well. Staff calculate that at least 22 such economies now face "acute financing constraints" and may need international support of around $25bn simply to be sure of paying for their imports. To put that figure in perspective, that represents about 80% of the annual aid to all low-income countries in the past few years. If the global situation gets any worse, the Fund's new study suggests that the number of vulnerable countries could nearly double, and the financing need could rise to $140bn.

Coming up with the cash

Even a few months ago, most G8 governments were sceptical of the need for a bigger IMF. Some, such as Germany, still are. But last week a majority of the IMF's Executive Board (which includes most of the G8 and several others in the G20) said they supported doubling the Fund's lending capacity by $250bn. The British are hopeful that all of the G20 will endorse the idea of beefing up the IMF by the time of the London Summit. Japan has already stepped up to the plate, with a $100bn loan.

But where will the other $150bn come from? That's a question the G20 sherpas - who are planning the meeting - have yet to answer. But we know what the leading options are. Option one is that the IMF simply borrow the money, either from individual governments, as in the Japan case, or by expanding existing standby facilities that the Fund has with groups of rich economies, such as the General Arrangements to Borrow, or GAB. This kind of borrowing is fairly uncontroversial - but also limited. It might well be difficult to raise $150bn through additional borrowing alone.

Creating money

Option two is a lot more exciting, but also less palatable to rich countries that would want the extra money to come with strings attached. This would be a general allocation of Special Drawing Rights (SDR), the IMF's own currency, which is made up of a basket of all the world's leading currencies (and one SDR is currently worth around $1.50). It sounds arcane. And it is. But a new general allocation of SDRs would be like giving every member of the IMF a cheap overdraft facility. Each would get an increase in SDR reserve assets, which they could use to acquire foreign currency at the IMF's prevailing SDR interest rate, which is less than 0.5%. Since it would be proportionate to countries' existing quotas, 60% of these SDRs would go to industrial countries - some 18% would go to the US alone. But those countries could simply not take up their allocation, or lend it on to others: for example, Western European governments could lend theirs to their struggling neighbors in Eastern Europe.

Unconditional funds

Ted Truman, formerly a senior official at the Federal Reserve and US Treasury, is pushing for a huge - $250bn - allocation of SDRs to respond to the crisis. He says that about $17bn would flow to the poorest economies, and $80bn to other developing countries. A traditional argument against such allocations is that the money would be unconditional - you couldn't stop countries wasting the funds. But Mr Truman thinks that's a plus in a world where many countries need to act to stimulate their economies but don't have the cash. The other main objection is that it is inflationary: after all, it is the global equivalent to a central bank deciding to print money. However, it would significantly increase developing countries' access to international resources. It would be cheap. And it wouldn't require the approval of the US Congress. The same cannot be said of many of the other proposals floating around the G20.