How can we unlock aid finance to support low-income countries who have been hit the hardest by the Covid-19 pandemic?
The recovery of hard-hit low-income countries from the impact of the pandemic can be supported with sustained development finance and accelerated with reform.
The multilateral development finance system provided quick finance in 2020, principally through the IMF and the International Development Association (IDA), but both now face limits to sustaining the flows of finance needed to support recovery.
A fresh issue of Special Drawing Rights (SDRs) is now feasible. It will be allocated in proportion to quota – any variation is politically infeasible.
This is of great value to low-income countries: even their 3.2% of total quota is a significant addition to international liquidity relative to their existing international reserves.
Recovery could be accelerated if rich countries re-allocate some of their new SDRs. For example, at the time of the global financial crisis rich countries lent SDRs to the IMF’s concessional finance facility, the Poverty Reduction and Growth Trust (PRGT).
However, donor grants are also needed to cover the subsidy element of PRGT operations, now stretched after the sharp expansion in lending last year.
But bilateral donors are short of cash. The UK has cut Official Development Assistance (ODA) from 0.7% of GNI to 0.5%.
Innovation with the new issue of SDRs could unlock bilateral donor cash without increasing their ODA spending, and without changing their fiscal position. The initiative proposed in this paper sets out that innovation, as follows:
- A new issue of SDRs – expected to be of the order of US$500 billion.
- The G7 countries then forego 36% of their SDRs, without diluting quotas, which are redirected to IDA. This immediately replenishes IDA by US$80 billion. Part of making it work will be a re-arrangement of national reserves to re-balance SDR holdings.
- In consequence, the G7 countries no longer face an obligation to spend cash on an accelerated replenishment of IDA due soon, and they can then reallocate ODA, without worsening their own fiscal position – this costs taxpayers nothing.
- As a result, they create space for stronger bilateral support for reforms in low-income countries to complement sustained international development finance to accelerate recovery. Unlocking ODA cash also makes possible further contributions to COVAX, grants for the subsidy costs of the PRGT, and progress on climate change.
- What is more, they can use their increase in reserves to capitalise new institutions to strengthen their own recovery from the impact of the pandemic.