By Carolyn Cohn
LONDON, Sept 3 (Reuters) - A worldwide liquidity injection by the International Monetary Fund is already helping smaller emerging economies to support their currencies and improve their credit standing, although it may carry inflation risks.
Just ahead of the G20 finance ministers' meeting in London this weekend, the IMF last week transferred an allocation to its 186 country members of $250 billion in special drawing rights (SDRs), the IMF's internal unit of account.
The allocation was part of the $1.1 trillion in extra funds promised for the IMF at the G20 summit in April, and around $110 billion is going to developing economies.
"It's $110 billion of additional potential liquidity for emerging markets -- that's a positive," said Simon Quijano-Evans, Europe and Middle East economist at Cheuvreux in Vienna.
The promise of more funds has helped to boost the fortunes of economies with worrying imbalances in recent weeks, reducing the costs of insuring their debt against default.
The SDR, used as the unit of payment for IMF loans, is made up of a basket of euro, yen, sterling and dollars.
The size of each country's SDR allocation is linked to the size of its "quota" with the multi-lateral lender, based on the country's relative size in the world economy.
This means the SDR allocation varies greatly even among emerging markets, from around $11 million for Dominica to around $10.5 billion for China.
For a country like China, which has more than $2 trillion in foreign exchange reserves, the allocation is tiny.
However, for smaller countries with balance of payments problems, the allocation is significant, analysts say.
"The liquidity-positive impact (is) to be felt most greatly in countries with a smaller FX reserve stock, providing them with a greater cushion to withstand balance of payments pressures," said analysts at RBC in a client note.
A stronger foreign exchange reserves position will leave economies less at risk of a currency crisis.
Credit ratings agencies also look at the strength of a country's FX reserves when making ratings decisions, with a stronger reserves position cited by Fitch this week, for example, when it upgraded its outlook on South Korea.
RESERVES BOOST
In Ukraine, which has been considered an extremely vulnerable economy over the past year, five-year credit default swaps have fallen by around 300 basis points in the last few weeks to around 1,100 bps, from levels above 3,000 at the time of the G20 summit in April.
This is despite protracted efforts to restructure $1.6 billion of quasi-sovereign debt from state-owned energy firm Naftogaz, Ukraine's largest company and seen by many as a reflection of its financial attractiveness or otherwise.
Ukraine has foreign exchange reserves of around $30 billion, and its SDR allocation totals around $2 billion.
"The (IMF) news should be a positive signal for the market, as the funding from the IMF global package should boost the (Ukraine central bank's) FX reserves and give the (central bank) more room to support the hryvnia," said analysts at ING in a client note.
Ukraine's current account deficit was $1.2 billion in the first seven months of the year, and the central bank has imposed controls on its currency.
Latvia, whose currency has looked at risk in recent months, is receiving an SDR allocation of nearly $200 million.
The IMF says the cash injection, effectively a printing of $250 billion, is only 0.5 percent of global GDP and is not likely to be inflationary.
However, analysts say there could be an inflationary risk for smaller countries in the sudden increase in reserves.
While developing countries have been grappling to head off deflation this year, some emerging markets are still in the grip of inflation.
In Africa, Nigeria's inflation rate was over 11 percent year-on-year in July, and Ghana's annual inflation rate topped 20 percent.
"If they simply print local currency in place of the increase of the hard currency they are being given, that could mean a one-to-one increase in inflation," said Richard Segal, director, emerging markets research, at Knight Libertas.
SPECIAL PAYMENT
On top of the $250 billion, the IMF will make a one-off allocation of an additional $33 billion on Sept 9, which will particularly benefit countries which joined the IMF after 1981 and so have never received an SDR allocation.
These include most of the former eastern European communist countries.
All the SDR payments, which come without a requirement to meet any fiscal conditions, will go into a country's foreign exchange reserves.
The country can then, if they wish, sell them to IMF members with "sufficiently strong external positions", according to the IMF. These countries are likely to be larger economies who may be looking for SDRs in order to diversify their reserves.
The resulting hard currency can be used to support the country's local currency.
"It means a global increase in money supply, that will be quite helpful to the emerging markets, especially the African markets," said Segal.
The no-strings allocation will also benefit countries reluctant to resort to the IMF for a loan, due to the financial conditions attached and the perceived stigma of needing to do so, analysts said. (Editing by Andy Bruce)