(C) Center for Economic & Policy Research This story was originally published by Center for Economic & Policy Research and is unaltered. . . . . . . . . . . Tinkering with a Broken Policy: The IMF’s 2024 Surcharge Reform [1] ['Made With'] Date: 2025-01 Results of the Surcharge Review While the reform package provided a welcome measure of relief, it fell well short of widespread demands for the complete discontinuation of surcharges, and leaves in place a policy that — as our estimates make clear — remains onerous to the countries affected. That the IMF elected to maintain the surcharge policy, and to stand by its procyclical logic, is particularly curious in light of the evidence presented as a result of the review process. The IMF’s review corroborated a number of concerns regarding surcharge policy, including the fact that “the number of members paying surcharges has increased to a historical high” and that “borrowers are also paying surcharges for longer periods.” It further found: In the current global monetary policy tightening cycle, the increase in the total cost of Fund borrowing for the largest borrowers has been more pronounced than for other GRA borrowers. While the increase in the total cost of Fund borrowing for surcharge payers since 2021 has been lower than the increase in the market cost of borrowing, the burden metrics for mean and median GRA borrowers have increased significantly since 2021. The review emphasizes that Fund lending “is counter-cyclical in volume and in prices relative to market borrowing costs.” In other words, as might be expected of an institution whose goal is global financial stability, the Fund lends more in times of crisis, with borrowing costs that are “lower and more stable than market borrowing costs.” However, the review found that IMF lending is “not [counter-cyclical] in terms of its absolute cost. … Fund rates do increase when global interest rate [sic] rise, driven by the variable SDR interest rate. They also rise with the volume of borrowing and its duration, reflecting level-based and time-based surcharges, thus increase [sic] when members face particularly large and prolonged imbalances.” In other words, surcharges are procyclical in nature, increasing the cost of borrowing for countries facing economic challenges, including those caused or exacerbated by exogenous shocks such as the COVID-19 pandemic. Given the considerable risks to the global economy in the coming decades, including from health crises, war, climate change, and economic fragmentation, surcharges are thus not only unjust for surcharge-paying countries facing these sorts of external shocks, but at odds with the objectives of maintaining macroeconomic stability and fostering sustainable development. The Fund defends these procyclical and growing costs by noting that, even with surcharges, the cost of borrowing from the IMF remains lower than the cost of market financing. While this is true, the case is not made for why the market rate would be an appropriate bar by which to measure the cost of Fund lending. As a multilateral intergovernmental organization with a mission to promote financial stability and monetary cooperation, typically by acting as a lender of last resort to countries facing severe financial crises with limited market access, cost decisions should presumably be guided by their role in achieving these public goods, not in relation to the market’s profit-maximization incentive. Maintaining costs below market rates is a given, as otherwise the IMF would not have a role to play. It would be like comparing the low lending rates that the US Federal Reserve offered to corporations in 2008 to market rates at that time, taking into account the fact that many of these corporations had defaulted on loans or had bonds with junk status. The most significant novel contribution of the surcharge review is an assessment of the policy’s effectiveness in disincentivizing large and prolonged use of Fund resources. Noting that “establishing conclusively whether the incentives provided by level- and time-based surcharges have discouraged excessive borrowing from the Fund and promoted early repayment is methodologically challenging because counterfactuals cannot be observed,” the IMF researchers reviewed the evidence of payment patterns surrounding the surcharge threshold. Ultimately, the researchers find that “countries facing moderate or short-lived financing needs are more responsive to level-based surcharges.” Countries that “have generally experienced manageable financing pressures” tend to maintain outstanding credit levels that hover just below the surcharge threshold, while countries that have borrowed moderately above the threshold during periods of need tend to reduce their credit to just below the threshold when financial pressures are mitigated. This is significant, as the IMF had not previously provided evidence of the effectiveness of the policy. However, critically, the review also finds that for countries experiencing high and protracted financing pressures … there is little evidence to suggest that the level-based threshold has influenced access decisions and for many of them Fund credit has remained high for a considerable time. These countries are currently having very high balance of payments needs and have no or only very limited access to alternative sources of financing. This category of countries is responsible for over 90 percent of total surcharge payments, both before and after the reforms, as illustrated in Figure 4. Figure 4 In other words, the countries that bear over 90 percent of the surcharge burden are the very countries for which the IMF admits that surcharges do not work. It is difficult to reconcile this finding with the decision to maintain the policy. Indeed, the top five surcharge-paying countries, Argentina, Ukraine, Ecuador, Pakistan, and Egypt, have repeatedly refinanced their IMF debt, and owed increasingly more in surcharges each year from 2014 through 2023.4 With regard to time-based surcharges specifically, the evidence is even more mixed: “The incentive mechanism of time-based surcharges appears to have worked for pre-2016 review cases related to the GFC [Global Financial Crisis] and for some post-review cases, while the evidence on effectiveness is less clear for more recent cases, mostly associated with the COVID-19 crisis.” The cases specifically cited as successes, in which early repayments were made to avoid surcharges, are Hungary, Iceland, Ireland, Latvia, and Portugal before 2016, and Cyprus, Greece, Morocco, and St. Kitts and Nevis since. All but three of these — Iceland, Morocco, and St. Kitts and Nevis — are members of the European Union, and thereby have additional access to liquidity from the European Central Bank, and all but one — Morocco — are high-income countries. That this is a group of Fund borrowers largely of a different category to that of the vast majority of current borrowers is not discussed, though one footnote does note that the “Low global interest rate [sic] was conducive for large European borrowers to resolve balance of payment issues” and therefore to regain market access as an alternative to IMF lending — conditions that do not prevail today, particularly for countries that are not high-income. In cases where surcharges may disincentivize taking on additional IMF lending, the review does not consider whether this is or is not necessarily beneficial for the long-term financial stability and development of the borrowing countries. In order to make the early repurchases necessary to bring outstanding credit below the surcharge threshold, countries may need to reduce spending in other areas, including potentially on necessary public goods such as education, health, climate action, or development. For example, the IMF points to the fact that Morocco made an early repayment of $936 million (SDR 650 million) in January 2021 as its only example of the successful incentivizing effects of time-based surcharges among low- or middle-income countries. That very month and the following, the country suffered serious flooding which damaged infrastructure, destroyed homes, and killed dozens. The January 2021 early repurchase alone represents nearly two-thirds of the budget ($1.5 billion) of the country’s entire 20-year National Flood Prevention Program. In other words, surcharges, even if effective as a disincentive to further borrowing, may simultaneously incentivize increased austerity, with social and economic consequences that are not considered. Finally, as the IMF notes, quota thresholds, which are fixed nominally, have a tendency to “erode” in real terms over time. By the IMF’s calculation, to counteract this erosion and bring the surcharge threshold back in line with its real value at the time of the last review in 2016, the threshold would need to increase to 280 percent of quota. Thus, the decision to increase the threshold to 300 percent of quota, while nominally a notable change, in fact does not go significantly beyond a return to the real value of the threshold in 2016. 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