Global Financial Cooperation
repercussions of COVID-19 pointed up remaining
the global financial
architecture and underscored the need to correct them.
By: Barry Eichengreen
The COVID-19 pandemic is the mother of all stress tests for the global
economy, and not least for emerging markets and developing economies. Early
on, there were hopes that the virus might bypass low-income countries, which
have fewer air-transportation links to the rest of the world, or that it
could be contained in countries with past epidemic experience—in sub-Saharan
Africa, for example. Such hopes were disappointed. We now know that the
virus threatens all parts of the world. Moreover, even where countries have
been able to avert a full-blown health crisis, the financial effects have
That financial impact preceded COVID-19’s physical arrival in the developing
world. Between February and April, more than $100 billion in financial
capital flowed out of emerging and frontier markets, five times as much as
in the first three months of the global financial crisis. The World Bank
forecast that remittances would fall by an additional $100 billion in 2020,
four times as much as during that earlier crisis. Global trade was forecast
to fall even faster than in 2009. Commodity prices collapsed in response to
the global recession, while emerging market and developing economy
currencies weakened against the dollar.
This was a shock of unprecedented proportions. Governments responded with
emergency spending packages in support of households and firms. Emerging
market central banks cut interest rates and in some cases undertook
purchases of securities. As a result, the negative impact on economies and
financial systems was somewhat less than anticipated initially.
For emerging markets, this policy response was unprecedented. It was the
opposite of the actions they were forced to take in earlier crises. The
contrast was indicative of progress made in building fiscal space and
anti-inflation credibility. One indication lies in the actions of emerging
market central banks that adopted a formal inflation-targeting framework as
a credibility-enhancing device. Through the first five months of 2020, those
central banks were able to cut interest rates by 40 to 50 basis points more
than their non-inflation-targeting counterparts.
This is not to deny the existence of financial stress. But the tidal wave of
debt defaults, currency crashes, and financial system collapses some had
predicted has not come to pass. At least not yet.
Governments, especially the governments of countries that issue
key international currencies, are not inclined to cede control
of their central banks’ balance sheets to the international
Having averted the worst does not mean that emerging market and developing
economies averted the bad. The financial repercussions of COVID-19 pointed
up remaining flaws in the global financial architecture and underscored the
need to correct them.
To start, the pandemic is a reminder of how much the global economy—and
emerging market economies in particular—relies on the dollar for
international liquidity. The international interbank market, in which banks
borrow and lend to one another, runs heavily on dollars. The dollar is
involved in 85 percent of foreign exchange transactions worldwide. It is far
and away the most important vehicle for trade invoicing and settlement.
Bonds marketed and sold to foreign investors are disproportionately
denominated in dollars.
Countries can shield themselves from sudden liquidity shortages, when banks
refuse to lend, by holding dollar reserves. There has been significant
movement in this direction by central banks and governments in recent
decades, which is one reason there was not a more severe pandemic-induced
dollar shortage and greater financial distress.
But a more important explanation for the absence of disruptive dollar
scarcity is the extraordinary action of the US Federal Reserve (Fed), which
leapt into the breach with dollar swaps and Treasury bond repurchase
facilities for foreign central banks. The Fed purchased a wide range of
fixed-income assets, flooding financial markets with liquidity and bringing
credit spreads back down to precrisis levels. Investors seeking
higher-yielding investments had nowhere to look but emerging markets, whose
debt was one of the few fixed-income assets the Fed did not buy. This
explains much of why capital flowed back to emerging markets after the
initial period of strain.
While the Fed’s forceful action prevented global financial markets from
seizing up, it also pointed to a fly in the international financial
ointment. The Fed provided swaps only to a selection of countries, and the
selection criteria were not transparent. Nor is it obvious that there will
be an equally foresightful Federal Reserve Board to do the same in a future
This has led to suggestions that the Fed, and perhaps other advanced economy
central banks as well, should delegate the decision to extend swaps to an
impartial arbiter, such as the IMF. Since central banks are not members of
the IMF, this would be a decision for governments—which is a problem.
Governments, especially the governments of countries that issue key
international currencies, are not inclined to cede control of their central
banks’ balance sheets to the international community.
IMF and World Bank roles
This mention of the IMF points to another source of dollars for emerging
market and developing economies: IMF lending facilities. The IMF moved
quickly in response to the pandemic to create the
Short-term Liquidity Line, a new facility for disbursing liquidity
assistance, while enhancing access to existing facilities, including some
that allow for lending without a full-fledged program. In the first half of
2020, it received more than 100 calls for emergency funding.
The IMF’s overall lending capacity is limited to $1 trillion. This sum may
not be enough to deal with the full impact of the pandemic and with whatever
comes next. Shrinkage of IMF resources was averted by renegotiation of the
Fund’s multilateral and bilateral borrowing arrangements, including the New
Arrangements to Borrow. However, efforts to augment those resources through
an increase in IMF quotas have not produced results. Further, there has not
been the requisite agreement of a supermajority of countries on a new
allocation of Special Drawing Rights (SDRs), despite widespread calls from
the official and scholarly communities. Reforming IMF governance in the
context of the General Review of Quotas and enhancing the international role
of the SDR are long-standing issues. The COVID-19 crisis is a reminder that
these efforts are incomplete, and that their incompleteness weakens the
global financial safety net.
The IMF’s sister institution, the World Bank, could point to pandemic bonds
as its contribution to weathering the crisis. In 2017, in response to the
outbreak of Ebola in West Africa, the World Bank, with financial support
from a set of advanced economy donor nations, underwrote bonds to be placed
with private investors that paid out in a pandemic. Ex ante, this instrument
seemed ideally suited to providing poor countries with insurance against
It didn’t turn out that way. The bonds now look to have been overengineered;
their documentation was so complex that neither investors nor governments
knew what they were getting. The stringent conditions triggering payments
were satisfied only 132 days into the outbreak and after more than
2 million cases were identified worldwide. One of the variables triggering
payouts was the number of cases identified and reported at the national
level, and poor countries were the least able to identify and report cases.
Unlike catastrophe bonds, which pay out in response to a hurricane or
earthquake affecting one or a handful of countries, pandemic bonds triggered
many simultaneous payouts, because the COVID-19 pandemic was global.
Investors in these bonds therefore saw their stakes wiped out.
The distaste for this structure for both developing economies and investors
became apparent when the World Bank abandoned plans for another
pandemic-related issue this year. The notion of some form of financial
insurance for pandemics is sound conceptually, but a satisfactory structure
has yet to be found.
Dealing with debt
Last, there is the challenge of servicing debt when commodity prices and
global trade have collapsed. Acknowledging these realities, in April 2020
the IMF provided debt service relief for an initial six months to 29
low-income countries that were previous loan recipients. In addition,
Managing Director Kristalina Georgieva called on governments with bilateral
loans to low-income countries and on private sector creditors to suspend
repayments. Following a meeting of finance ministers and central bank
governors, the Group of Twenty (G20) issued a declaration, the “G20 Action
Plan,” voicing support for these ideas.
These initiatives faced collective action problems, however. For official
bilateral creditors, it made little sense to suspend payments if other
governments failed to do likewise. In this case, the debtor would receive
only limited relief, and the governments that agreed would end up footing
Since the 1950s, the official community has addressed this issue through the
Paris Club, a group of creditor countries
originally made up of Group of Seven governments, whose chair is a French
Treasury official. Unfortunately, China, now the source of more official
bilateral poor country debt covered by the G20 initiative than all other
creditor countries combined, is not a member. China has agreed to match the
Paris Club’s debt relief terms, but it is not clear whether this commitment
extends to loans by state banks and state-owned companies. It is not even
clear how much poor-country governments owe to the Chinese official sector
overall. All this would have been easier to sort out had China been a
full-fledged member of the Paris Club, but it is not—yet another failure to
update the global financial architecture to match the realities of the 21st
In the case of private debt, the task of setting out terms and organizing
negotiations was outsourced to the Institute of International Finance (IIF),
the association of institutional investors. This response had something of a
fox-in-the-henhouse quality. The IIF cautioned emerging markets that seeking
to restructure their debt could jeopardize market access. It warned that
institutional investors were responsible to their clients, not to
governments or the global community. Early efforts at renegotiating
Argentine government bonds got hung up over conflicting contractual terms
governing different bonds, reflecting the absence of a single standard for
bond covenants. Progress was slowed by obstacles thrown in the way by
There was no sense that the existing ad hoc machinery had the capacity to
deal with a flood of cases. The absence of an international facility or even
a standard procedure to deal with a wave of restructurings was glaring.
What, then, have we learned about the financial architecture from the
COVID-19 crisis? We have been reminded that resilience starts with
institution and resource building at home. Governments possessing fiscal
space have been able to put it to use. Where inflation expectations are well
anchored, central banks have been able to support financial markets and the
economy. A surprising number of emerging markets—surprising by the standards
of past crises—have been able to implement supportive policies. This
capacity reflects their success at building more robust monetary, fiscal,
and financial institutions.
Experience at the international level is less heartening. Cross-border
financial transactions remain dollar-based. There is reason to think that
this will change, but little reason to think that it will change anytime
soon. While the demand for dollars is global, the supply remains national:
it depends on the policies of the Federal Reserve. There are potential
alternative sources of dollars—not least the IMF, which could provide
greater access through its existing programs and lending facilities if it
had more resources. A new allocation of SDRs is another possibility.
Unfortunately, there is as yet no consensus on how to proceed.
Although the performance of pandemic bonds has been disappointing, the idea
of using financial instruments and markets to insure against these risks is
sound. Streamlining the design of such instruments and increasing the
subsidy element provided by donors could make them more attractive to both
governments and investors. The question is whether this would be enough.
is the need to strengthen arrangements for dealing with debt. The structure
of the Paris Club should be updated to match the realities of the 21st
century. Official institutions should take a larger role in negotiations
over restructuring private debt. They can set standards for such
negotiations. They can encourage regulatory agencies to mandate
institutional investors’ adherence to those standards. Governments and
regulators can require provisions in loan contracts (so-called single-limb
aggregation clauses) that encourage rapid restructuring when a pandemic or
other global crisis hits. They can prohibit trading of bonds that lack these
provisions. This strategy just might work. If it doesn’t, then calls for a
more heavy-handed approach, involving some kind of international bankruptcy
court for sovereigns, will be back.