African economies, hit simultaneously by Covid-19 and low commodity prices, are facing a deadly liquidity crisis as governments desperately try to shore up crumbling economies. But, as Hippolyte Fofack explains, there is a neat solution to their problems – IMF Special Drawing Rights
As the world was reeling from the Covid-19 pandemic, the International Monetary Fund (IMF) issued an especially prescient economic statement in the April edition of its World Economic Outlook. The Fund said that advanced economies with well-equipped health systems and the privilege of issuing reserve currencies will, naturally, be better placed to endure this crisis.
As the pandemic unfolded, advanced economies did just that, especially on both sides of the Atlantic. Authorities injected countercyclical fiscal and monetary stimuli worth several trillions of dollars into their economies to augment social safety nets and engineer a speedy post-virus-containment recovery.
After activating the general escape clause in the European Union’s (EU’s) fiscal rules – which allowed member countries to overshoot institutional deficit targets – most EU governments injected more than $6trn into their economies, essentially becoming insurers of last resort.
The European Central Bank (ECB) expanded its bond-buying to help absorb the shock. Policy responses taken by US authorities were also unprecedented in scale and responsiveness. The IMF estimates that advanced economies have injected more than $14trn into their economies since the outbreak of the pandemic.
Avoiding a solvency crisis
Given the coronavirus’s rapid spread and the implementation of containment measures that resulted in sharp supply and demand shocks, a resulting liquidity crisis was among the most important short-term risks facing sovereigns and corporates.
The massive injection of liquidity by countries with the privilege of issuing reserve currencies, ensured the liquidity crisis did not morph into a solvency crisis and a cascade of bankruptcies.
In this regard, the decision by the US Federal Reserve to enhance the liquidity provision via dollar swap lines was a salutary move intended to avert the risk of contagion in the context of financial globalisation. Understandably, a torrent of defaults in developing and emerging markets would pose a threat to the financial stability of advanced economies.
However, while the Fed’s bold move may help reduce dollar funding strains during the Covid-19 crisis, its swap lines target very few countries, mainly advanced economies and only a few emerging markets.
This underscores the extent to which Africa remains excluded from the most efficient first lines of defence against liquidity crises. This despite the fact that, by virtue of its economic structure and patterns of trade, Africa, more than any other region, was set to face the most acute shortages of dollar liquidity.