More than 50 countries, composing half of the world’s poorest people, are facing severe debt distress. “Crisis” might be an overused term in global politics, but surely this qualifies as one.
The International Monetary Fund (IMF) serves as the “lender of last resort” for financially distressed countries – its role to lend at reasonable terms when no one else will. The hope is to prevent crises from getting worse, and, along with imposing policy changes, to ultimately help countries sustainably exit economic troubles.
Less well appreciated, however, is that the IMF often imposes significant “surcharges” well beyond its basic lending rate. These surcharges have long been controversial. But after the twin shocks of Covid-19 and the invasion of Ukraine, there are renewed and growing calls for these surcharges to be abolished, including from Nobel prize-winning economist Joseph Stiglitz and some member countries.
The IMF for its part says that surcharges are important for protecting the Fund’s financial integrity by discouraging “large and prolonged use of IMF resources”. It further claims surcharges help manage credit risk, encourage early repayment, and contribute to IMF resources. This economic logic is dubious. Rather than reduce the burden placed on the IMF, surcharges seem more likely to increase the eventual financial burden while also undermining its legitimacy.
IMF loans come with a standard (currently about 5 per cent) interest rate, with surcharges imposed based on certain criteria. An additional 2 per cent a year is charged for outstanding amounts above 187.5 per cent of a country’s standard allocation. A further 1 per cent a year is charged if outstanding debts remain above this threshold after three years. Surcharges do not apply to low-income countries but do apply to still economically fragile lower-middle income countries.
There is little evidence that the surcharge policy has achieved its purpose. The IMF itself states that the “heaviest users of Fund resources have consistently accounted for the bulk of the Fund’s total surcharges income”, with 95 per cent of surcharge income drawn from recurring debtor countries.
The most obvious problem with surcharges is they are procyclical – reinforcing economic downturns by further constraining fiscal space for governments during a crisis. Plenty of IMF research demonstrates the importance of countercyclical fiscal policy to combat economic crises. Imposing procyclical costs works directly against this rationale.
Related to this, in seeking to deter excessive borrowing, surcharges conversely risk encouraging governments and IMF staff to design unrealistic adjustment programs predicated on premature fiscal consolidation and over-optimistic assumptions for recovery.
For instance, the IMF’s Independent Evaluation Office concluded that program targets and timelines in the wake of the 2007-08 global financial crisis were over-optimistic – reflecting forecasting errors, underestimation of the negative effect of premature fiscal consolidation, and overestimation of the benefits from structural reforms. Similarly, others find systematic over-optimism in the IMF’s debt projections of emerging market developing economies.
The IMF should encourage countries to seek early assistance – timeliness is critical to containing crises. By making the IMF less attractive, surcharges do the opposite. These lead to greater bailout costs, reducing the success rates of IMF programs, and undermine the Fund’s reputation and role as the global lender of last resort.
Sri Lanka is a prime example of these dynamics. Since independence the country has been forced to turn to the IMF a total of 17 times. Despite obviously worsening economic conditions since 2019, the government delayed approaching the Fund again until it was already at breaking point – having run out of foreign exchange reserves and defaulted on its debt obligations. The design of the IMF program already looks unrealistic, targeting only limited debt relief that would see Sri Lanka’s public debt still at 95% of GDP a decade from now. The result is a high probability this will not be the last time the country turns to the IMF for help.
To make matters worse, surcharges undermine the IMF’s legitimacy while it profits from countries in crisis. One perverse outcome can be seen in Ukraine, a country fighting back against an illegal invasion, which having turned to the IMF for assistance will also face significant surcharge costs, potentially amounting to as much as $423 million, equal to 25 per cent of Ukraine’s health sector spending over the pandemic.
At the most basic level, it is not clear why the IMF needs to use surcharges to deter countries from seeking larger-than-normal support. The Fund can simply deny requests beyond either what it thinks is needed or a reasonable share of its financing capacity. Meanwhile, preferred creditor status implies the IMF faces little risk in practice that it will not be repaid.
Over the next decade, the Fund is estimated to receive over $14 billion from developing country surcharge payments. Yet foregoing these payments would not substantially alter the Fund’s precautionary balance sheet. Some forecasts have the precautionary balance hitting target by 2027 without any surcharge income.
Getting rid of surcharges has been called for many times. However, given reluctance of the IMF’s shareholders to do so, useful smaller steps could include enhancing the transparency around surcharge costs, waiving or easing surcharges on loans provided in response to recent external shocks, and shifting to a progressive surcharge policy based on country income and vulnerability.