A summary of our vision for the future of Covid-19 recovery finance.
Covid-19 has left economies reeling. Low-income countries across South Asia and sub-Saharan Africa in particular face severe economic scarring and damage to livelihoods. This year’s G7 summit, G20 talks and COP26 conference present opportunities for wealthier nations to act, but a gap has opened up in the finance available to achieve this.
OPM’s experts have been considering what should be on the agenda at these summits, sharing innovative ideas to reallocate finance quickly, and in turn speed up these economies’ post-Covid recovery.
This blog collates our latest research, ideas and resources.
Why is there currently a gap in international finance?
The multilateral system reacted quickly to support low- and middle-income countries at the height of the crisis in April-May 2020, with development banks and humanitarian agencies rapidly disbursing around USD 23 billion more than they had planned before the crisis. Our modelling shows that this quick initial response proved vital to mitigating economic damage at that point in time.
However, many countries now face at least 18 to 36 months of recovery and fiscal adjustment: our analysis shows that most African economies will be at least 6% below where they otherwise would have been. In South Asia, the figure is nearer 10%.
Multilateral financing now needs urgent replenishment just at a time when richer countries also face severe budget constraints.
Can we leverage SDRs?
SDRs are one proposed solution to the funding gap, with the IMF recently announcing a new issuance of US$650 billion of this global reserve asset to its members later this year. A new issue of US$650 billion would distribute US$21 billion to low income countries. This is a significant addition to their international reserves, but nowhere near enough.
There have been calls for richer countries to lend some of their SDR allocations to poorer ones to help speed global recovery. The most orthodox method would be for rich countries to lend SDRs to poorer ones through the PRGT – the concessional lending arm of the IMF. Despite carrying zero interest, this type of lending is still effectively a loan to central banks: there’s a very real risk that in the most financially constrained countries, governments won’t take on more debt and the economy is so weak that the private sector won’t want to use the credit either.
The question becomes: how to leverage SDRs as much more concessional financing? The answer is by using new SDRs to fund grants from donor countries for an early replenishment of the International Development Association (IDA).
Watch our CEO and Chief Economist explain their pioneering idea around SDRs in this European Political Economy Project webinar about the best use of the new SDR allocation.
Bridging the funding gap at scale and speed
Donating SDRs via. IDA is both unorthodox and innovative, presenting opportunities for recipient and donor countries alike.
IDA is a well-established global institution, it is targeted to low-income countries and the criteria for lending from IDA are aligned with the problems being faced by low-income countries in the wake of the pandemic.
For donor countries, donating SDRs to IDA effectively ‘frees up’ money elsewhere. This is because, sooner or later, there needs to be an IDA replenishment which would normally be funded from national budgets.
In the below letter, featured in the Financial Times, our CEO highlights the advantages of leveraging IDA in this way over other mechanisms for on-lending this type of finance.
The nuts and bolts of SDRs as a solution
While IDA is officially allowed to hold SDRs, there’s no precedent for it and the technicalities of making it happen would need to be worked out on a country-by-country basis as highlighted in this piece by David Andrews from the Centre for Global Development.
But it’s completely feasible. As our acting Chief Economist, Stevan Lee says, it is possible for the UK government to distribute the SDRs without damaging the already strained 0.5% aid budget. For the UK – this year’s G7 president and COP26 host – an SDR donation to IDA would unlock the equivalent of around GBP1.4billion per year for four years, with no cost to the Treasury, no increase to public sector borrowing, and no use of tax revenues.
This presents a significant opportunity to limit the impact of aid cuts currently being announced by freeing up money which can be re-programmed to support development reforms, urgent humanitarian needs, a refinancing of COVAX, and activities to tackle climate change and biodiversity loss.
Read our working paper for more detail on how this innovative idea could – and should – work in practice to help lift the hardest-hit countries onto the path out of the pandemic, leaving no-one behind and supporting global economic recovery.
Please do get in touch if you would like to discuss this further.