The world is in the historic moment of multiple crises. As countries continue to handle the fallout of the pandemic, the ongoing Russia-Ukraine war has added more uncertainties, both economically and geopolitically. Meanwhile, in an effort to curb severe inflation, central banks worldwide have embarked on un precedented monetary tightening, hoping not to endanger growth. The simultaneous rises of policy rates have led to currency volatility and tighter global financial conditions, leaving more countries with hard policy choices between their delayed economic recovery and financial stability. The debt-laden economies face more vulnerabilities and anticipate possible bankruptcies, should their debt situations become unmanageable.
The role of G20 in fostering multilateral cooperation
To prevent another global financial crisis, G20 countries – which constitute more than 80 percent of world GDP and represent both advanced and emerging economies – should continue to play a key role through coordinated actions.
First, the G20 is the prime place for multilateral cooperation, and should continue to keep multilateralism as its core principle to guide dialogue and actions. This pandemic and the following policy responses demonstrate that no country alone can deal with external shocks effectively.
The problem is that multilateral efforts have become increasingly scarce as a way to fight against common threats. While international financial institutions continue to play a key role in the short-term liquidity support and the long-term sustainable development financing, countries tend to look for bilateral arrangements and solutions with small groups.
Certainly, geopolitical tensions are the major driving force behind this fragmentation. The changing economic powers, in the absence of a new world order, also make it difficult for countries to come together and adopt multilateral approach when managing common risks. In fact, since the pandemic, G20 countries have made great efforts to tackle all the challenging issues in economic and social areas. Although member countries have their own prioritised issues and economic goals, the spirit of G20 lies in multilateral effort, which is much needed in the current fragmented world.
The need for coordinated monetary policies
Second, there is a strong case for policy coordination among central banks and finance ministries, to mitigate spillover effects caused by monetary tightening and market turmoil. It is reasonable that monetary policy focuses on domestic objectives, so that, at current stage, monetary tightening aims to curb high inflation. However, in the circumstance of excessive currency movements, volatile financial markets and the worsening position of countries’ external sectors may become a source for crisis. This problem is not just limited to emerging economies. Developed economies and advanced markets are also captured by the potential financial meltdown. When countries have to intervene and stabilise the market, the cost of individual action is extremely high and much less effective. Moreover, the lack of coordinated actions could intensify market turbulence and trigger economic friction, such as the vicious ‘beggar thy neighbour’ policy among countries.
In particular, emerging economies are facing squeezed policy space to keep pace with rising interest rates triggered by the Federal Reserve. As capital flows are affected by interest rate differentials, in the situation of a sharp rise of external policy interest rates, central banks in some emerging economies have to raise interest rates earlier, to avoid excessive currency depreciation and capital outflows. However, such actions reduce monetary autonomy, when a lower policy rate is needed for growth. In addition, in recent years, due to the deepening of the local currency bond market, many emerging economies are able to borrow in their local currency abroad. However, foreign currencies (mainly the U.S. dollar) still account for the majority of total borrowing in emerging economies. The fast pace of the FED tightening and the subsequent appreciation of the dollar has led to an increase in the repayment cost, making the countries that are heavily dependent on dollar denominated borrowing vulnerable to the sudden shift of external financial conditions.
There are options for policy coordination. For instance, the G7 can discuss the possibility of a new Plaza Accord to stabilise the major foreign exchange markets through coordinated policy adjustment, or intervention in the foreign exchange market. However, due to the lack of consensus, it is unlikely for the most advanced economies to take any immediate actions. Against this background, the G20 should step up and encourage the adoption of necessary measures. For instance, the central banks’ governors and finance ministers should initiate frequent policy dialogue to avoid disorder caused by changes in monetary policy and explore possible means to reduce unhealthy fluctuation of exchange rates of the major currencies.
A safety net to avoid the debt crisis
Third, the G20 should continue to strengthen the global financial safety net (GFSN) in response to a growing need for various financial assistances. In the past years, the GFSN has developed into multi-layered instruments to secure global financial stability, with the International Monetary Fund (IMF) playing the leading role.
As part of global effort for debt solutions, the G20 has made great progress with its Debt Service Suspension Initiative (DSSI), which has helped countries by temporarily suspending their debt repayments in order to concentrate their resources on fighting against the pandemic. The G20 also established the Common Framework to help those countries with debt in restructuring. In the new wave of potential debt insolvency, triggered by sluggish growth and limited fiscal space in some countries, the G20 should do more and actively engage in bilateral efforts and other multilateral initiatives to prevent severe debt crisis.
The past crises also indicate that an adequate and effective GFSN is essential for countries to tackle liquidity difficulties. For instance, the IMF approved $650 billion Special Drawing Rights (SDR) allocations in August 2021, aimed to help countries at addressing liquidity shortage and fiscal vulnerabilities. Since the allocation, over one hundred countries have deployed their SDR holdings. The current tightening of global financial conditions added more pressure on middle- and low-income countries, and some are facing quick losses in their international reserves.
More funding for financial institutions
Currently, a much-needed improvement would regard the funding resources of international financial institutions. One immediate action is to explore the possibility of a new round of SDR issuance with the IMF. This is especially important for providing countries that are in overlapping crises of food, energy and inflation with a direct liquidity injection.
A more fundamental move is the reform of the IMF’s quotas distribution, as quotas determine the size of the IMF’s funding adequacy and how the funding distributes among member countries. Currently, quota contributions from member countries account for less than half of the IMF’s overall $1 trillion capacity. The rest of the funding comes from two major, temporary arrangements – the New Arrangement to Borrow and bilateral borrowing arrangements. The lack of permanent funding sources limits the IMF’s capacity and undermines its legitimacy. As for quota distribution, the current quota formula that was set in 2008 is outdated. The changing economic and financial importance among member countries also requires an adjustment of quota shares. The IMF is undertaking the Sixteenth General Review of Quotas under the guidance of the Board of Governors, which is expected to be completed by Dec 15, 2023. The G20 should ensure that the new round of quota review will be concluded without any delay.
In the area of capital flow management, the IMF recently revised its Institutional View on the Liberalisation and Management of Capital Flow. This is a good start to update its surveillance with focus on disruptive capital flows. The IMF has intensively studied a feasible toolkit of macro-prudential capital flow management measures. Now it is the time to make more use of pre-emptive policies to manage capital flows, in this turbulent period of broad normalisation of monetary policy. The G20 should set a fast track to gather consensus among member countries and explore more options for capital flow management, in line with the IMF’s new framework of Institutional View.
The G20 emerged from the ashes of the global financial meltdown and, so far, it has played a critical role in healing damages caused by frequent crises in the past years. It has also become a major platform to promote multilateral efforts, based on consensus among top leaders of the G20 countries. At a time of high uncertainty like now, the G20 should further strengthen its role and help the world to face new challenges and prevent crises through international cooperation.
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