Proposal for a new IMF country insurance facility

• Author: Tito Cordella/Eduardo Levy Yeyati
• Position: IMF Research Department/Universidad Torcuato di Tella, Argentina
• Pages: 70-71

Page 70

Voicing what has become a widespread concern among emerging market economies, Henrique de Campos Meirelles, Governor of Brazil's central bank, recently said that his country "would like to see a facility that prevents crises, particularly when they are caused by changes in market sentiment that have nothing to do with emerging markets in general."With available "insurance" options against runs being limited and costly, is there anything that the international community can do? One possible alternative, a new IMF Working Paper argues, is to create a facility that could extend automatic credit to eligible countries at a predetermined interest rate.

Many recent emerging market financial crises followed a similar script: a sudden increase in the perceived debt rollover risk led to an escalation of interest rates that made otherwise sustainable levels of debt unsustainable. As a result, emerging market economies have started to feel that globalization, for all its potential benefits, opens the door to self-fulfilling runs. In the absence of better insurance alternatives, most such economies have been favoring self-insurance via the accumulation of reserves, either in the central bank or in the banking sector through the imposition of liquid asset requirements. In many cases, however, the cost of holding reserves- that is, the country's borrowing costs in excess of the returns offered by high-grade liquid assets- can be substantial.

Unsuccessful options

Other options have been explored. Two countries- Argentina and Mexico-have experimented with private insurance in the form of a contingent credit line with a consortium of financial institutions, but with disappointing results. There is little scope to diversify highly correlated emerging market risk, which limits the coverage and increases the cost. And, unlike standard insurers, insuring banks can hedge their exposure by selling the country's assets, thereby fueling the run.

Another alternative is to insure with the IMF. The problem is that current IMF facilities are more suited to fundamental solvency crises than to nonfundamental selffulfilling runs. These facilities emphasize corrective actions, and their disbursements are backloaded and conditional, and usually follow arduous negotiations. This combination explains why governments in emerging...