This article is the first in a series of articles in Executive Magazine’s upcoming “Financial Economy Special Report” prepared in collaboration with handpicked experts to cover key aspects of the current Lebanese economic, currency, and banking crisis. The report aims at achieving a common understanding of the policies and solutions that need to be implemented, while also allocating responsibility for past damages.
On August 2, 2021, the International Monetary Fund (IMF) approved the distribution of a new package of Special Drawing Rights (SDRs) amounting to SDR 458 billion to all its member countries. Each country willing to participate has been allocated approximately its relative share in the quota system. The local media published the good news, and how the amount allocated to Lebanon, (estimated at SDR 605 million, which are equivalent to approximately USD 860 million), would be spent. Initial media reports neglected to mention previous cumulative distributions in favor of Lebanon, which amounted to SDR 196 million, to bring the total to SDR 801 million (USD 1.137 billion).
Describing the SDRs as “a shot in the arm for the world” in a time of many crises, IMF managing director Kristalina Georgieva presented the 2021 allocation with a message that countries could reduce their reliance on more costly debt. It must be noted, however, that SDR use is a form of debt like any other debt when used but at the SDR rate rather than market rate. “Countries can use the space provided by the SDR allocation to support their economies and step up their fight against the crisis,” she said. Additionally, the IMF has been deliberating on possibilities of channeling more of these precious resources from its stronger members to countries in need with the tools of its Poverty Reduction and Growth Trust and a new Resilience and Sustainability Trust.
The worldwide SDR allocation includes Lebanon at a time or renewed urgency to realize an agreement with the IMF. However, there is no connection between SDR allocations and IMF negotiations. The SDR department is a separate and independent department and has nothing to do with negotiations with the IMF through its General Resources Department. It has a complex structure that may or may not be conveyed clearly in IMF statements. Whereas any SDR inflow to our country can be good news, it is premature to speculate how the aforementioned sums of the Lebanese allocation or any eventually mobilized flows through above trusts will be spent. At this point, it rather is necessary to explain the modus operandi of the IMF and the role of Lebanon as an IMF member, in order to clarify the picture and the impact of this distribution.
The IMF was established in 1944 by 44 countries. Lebanon joined in 1947. It currently includes 190 member countries. The main objective of its establishment was to create an institution that fosters international economic cooperation, develops international trade and growth, and maintains the stability of the global financial system. According to the IMF’s bylaws, “The key functions of the IMF are the surveillance of the international monetary system and the monitoring of members’ economic and financial policies, the provision of Fund resources to member countries in need, and the delivery of technical assistance and financial services.” To achieve this, the fund has been monitoring from its early days the economic and financial developments and the balance of payments of member countries. It provides the necessary advice to member countries facing economic troubles and shortage of hard currency reserves. It also provides foreign currency reserve financing to central banks that face protracted balance of payments deficits and a severe and critical decline in their reserves that could hamper its trade in goods and services.
The two main departments of the IMF
The IMF consists of two main departments: the General Resources Department and the Special Drawing Rights Department. The fund is managed by a Board of Governors comprising two representatives from each member state. The Executive Board, consisting of 24 elected executive directors, oversees the management of day-to-day operations. Moreover, all the IMF’s financial capacities are calculated on the SDR (the IMF’s unit of account). One SDR is composed of a basket of five major currencies. At time of writing this article, the value of one SDR equates the sum of USD 0.58, €0.387, £0.0859, ¥11.9 and 1.017 Chinese renminbi. The currency shares reflect the quota of each of these countries and the European Union.
The currency amounts of the SDR are allocated once every five years, or earlier if needed, while ensuring that the basket mirrors the relative importance of the five currencies in the world’s financial system. Cross-exchange rates however determine the actual weights of the currencies. The value on the other hand is a daily determination according to the market exchange rates.
The Special Drawing Rights Department is responsible for distributing SDRs as needed, free of charge, to stimulate international trade, and it is entitled to cancel these rights. The department is independent of the General Resources Department. It was established in 1969 with the aim of providing additional voluntary reserves for member states. Each country receives a share of each distribution as a percentage of its quota in the fund. The total distributions of SDRs carried out in several stages amounted to SDR 662 billion, including the last distribution of SDR 458 billion. The distribution is recorded in each country’s account at the IMF as both credit and debit entries. So on a net basis, the distribution does not provide additional reserves.
Each Friday, the IMF dictates the SDR interest rate. It is based on the weighted average of a 3-month debt interest rate in the five countries’ money markets. Each member must pay interest on the quantities of SDRs it uses, and abide by Article 19 of the IMF Agreement, which clarifies the terms and conditions of swapping the SDRs with reserve currencies. The most important clause in Article 19 is the third clause, which requires the country to show the need to use the SDRs to finance the balance of payments, and not for the subsidization of goods, which falls within the scope of the Ministry of Finance.
Holding SDRs is considered as a potential reserve and not as an actual foreign currency reserve, as the SDRs are not used in external financing until they are exchanged for reserve currencies in accordance with the country’s ability to comply with all the terms of the Voluntary Exchange Arrangement, set up by the IMF as a platform to facilitate exchange of SDRs with other currencies. Whereas all members are entitled to participate in the Special Drawing Rights Department, they are not obligated to respond to any transaction related to the use of SDRs.
Most SDR transactions in the Special Drawing Rights Department are currently conducted under the supervision of the IMF’s platform of Voluntary Exchange Arrangement.
Since the Lebanese central bank Banque du Liban (BDL) had not previously resorted to using the Special Drawing Rights Department, it seems prudent if the central bank were to investigate the details of its modus operandi to determine its ability to replace SDRs with currency reserves. We must be aware that resorting to this department depletes the country’s holdings of special drawing rights and requires its service according to the prevailing interest rate on SDRs. Using SDRs comes at a cost, and in no way should they be perceived as a grant.
Urgent negotiations with the General Resources Department
The IMF obtains its resources in the General Resources Department, which was established at its inception to help countries facing shortages in their reserves, from subscriptions of member countries to the IMF capital, which is based on a quota system that reflects the size of each member country such as the size of its GDP, foreign trade, and reserves. The quota is managed by the General Resources Department. Lebanon’s share in the General Resources Department is only SDR 633.5 million (0.1 percent) out of the total quota of SDR 477 billion.
25 percent of the quotas of each member are paid in hard reserve currency (reserve quota) while the remaining 75 percent are paid in a country’s local currency. Therefore, Lebanon’s share of unconditional ready-to-use reserves in the IMF is only SDR 158 million (USD 224 million), but if it expresses the need to finance its balance of payments, it may have access to more IMF lending. The country can use other IMF facilities as needed and during a specified period within a maximum withdrawal limit ranging between 50 percent and 145 percent of the quota annually, taking into account the country’s ability to serve its debt obligation resulting from such borrowing and ability to adhere to a reform program. As a maximum, a country could access about 400 percent of the quota if it undertakes a serious reform, while continually meeting the performance indicators of the reform programs agreed upon with the IMF. The repayment of these facilities would usually start within a few years. The crucial issue is to determine the need for these funds and the capacity of the country to service such debt which will become due within a short period of time.
Resorting to the General Resources Department in excess of the reserve quota requires an agreement between the IMF and the Lebanese state. It has been firmly established that the reaching of such an agreement is contingent on stringent reforms, the most important of which, in the case of Lebanon, is seeking to achieve sustainable fiscal and balance of payments balance. I will discuss the objectives and requirements of IMF negotiations in the next comment pieces in the current series. Borrowing from abroad without reform may once again lead to a potential default on its foreign currency debt service, which has been the main cause of the current crisis.
Mounir Rached, PhD, is the president of the Lebanese Economic Association (LEA) and a former IMF Senior Economist (1983-2007). Executive editors contributed to the updating of this comment piece originally published in Arabic on August 26, 2021 in Al Joumhouria.