International Monetary Fund (IMF) | International Trade | Economics

In this article we will discuss about:- 1. Introduction to IMF 2. Objectives of IMF 3. Organisation 4. The IMF Quotas 5. Functions 6. Operations 7. Conditionality 8. Criticism 9. IMF and Group of 20.

Introduction to IMF:

In view of serious monetary chaos throughout the inter-war period and its adverse repercussions on international trade, payment adjustments and capital movements, the international negotiations were started in 1943 for correcting disorder in the monetary system. In these negotiations, the United States proposal put forward by Dexter and White advocated the institution of a stabilisation fund. It was termed as “Dexter-White Plan.”

The British proposal, put forward by Lord J.M. Keynes, was more ambitious. It emphasised upon the creation of an international clearing union and was termed as “Keynes Plan”. At a meeting of the representatives of 44 countries held at Bretton Woods, New Hampshire in the United States in July 1944 a compromise between the American and the British Plans was agreed upon. This led to the creation of International Monetary Fund (IMF) in December, 1945 with a membership of 30 countries. It, however, commenced its operations in March, 1947. Its membership has presently risen to 184.

Objectives of IMF:

The purposes and objectives of the IMF were specified in Article 1 of its Articles of Agreement. Two amendments were incorporated in this Article in 1969 and 1978.

In its present form the objectives of the Fund are as:

(i) Promotion of international monetary co­operation through a permanent institution that provides the machinery for consultation and collaboration on international monetary matters.

(ii) Expansion and balanced growth of global trade and thereby promotion and maintenance of high levels of employment and real income and the development of productive resources of all the member countries.

(iii) Promotion of exchange rate stability and the avoidance of competitive depreciation of exchange rates.

(iv) Establishment of multilateral system of payments and conversion of national currencies and the elimination of exchange controls and exchange restrictions that hamper the international trade.

(v) Re-establishment of multilateral trade among the member countries.

(vi) Imparting of confidence to the member countries by making available to them the resources of the Fund under adequate safeguards, thus providing them with opportunity to correct maladjustments in their balance of payments without resorting to measures destructive of national or international prosperity.

(vii) Shortening of the duration and lessening of the degree of disequilibrium in the international balance of payments of the members.

Organisation of IMF:

The organisation of the IMF consists of a Board of Governors, an Executive Board, a Managing Director, a Council and a staff. The headquarters of the IMF is located in Washington in the United States. There are ad hoc and standing committees appointed by the Board of Governors and Executive Board. There is also an interim committee appointed by the Board of Governors.

The apex body of IMF is the Board of Governors. It comprises of one Governor and one alternate Governor appointed by each member country. Normally the minister of finance or the governor of central bank of a country acts as its Governor at the IMF. The alternate Governor can participate in the deliberations of the Board of Governors but he can have the voting right only in the absence of the Governor.

The meeting of the Board of Governors takes place once a year in which the detailed account of the activities of the Fund in the previous year is presented. The decisions regarding the policies of the Fund are also taken at the annual meeting. Special meeting of the Board of Governors can be convened by any of the five member countries having 25 percent or more of the total voting rights.

Apart from the Board of Governors, another decision making organ of the IMF is the Executive Board. In practice, the majority of the decision­-making powers of the Board of Governors have been delegated to the Board of Executive Directors. These include decisions on the access of the members to the resources of the Fund, decisions on charges and remunerations and the review of consultations between the Fund and its members. The decisions of Board of Governors or the Executive Board are binding upon the member countries.

The Executive Board consists of 21 members. Five executive directors are the appointees of the five member countries having the largest quotas (U.S.A., U.K., Germany, France and Japan). Saudi Arabia appoints a sixth Executive Director on account of its being one of the two largest contributors to the Fund. The remaining executive directors are elected by the member countries for a period of two years roughly on a geographical basis. The Board of Executive Directors elects a Managing Director, who is usually a politician or an important international official.

Managing Director is the non-voting Chairman of the Board of Executive Directors. The Executive Board is the most powerful organ of the Fund. It exercises vast powers conferred on it by the Articles of Agreement and the powers delegated to it by the Board of Governors. These powers are connected with all the financial activities of the Fund apart from the regulatory and supervisory powers.

The Executive Board meets several times a week and is, therefore, supposed to be in continuous session. The Managing Director apart from acting as the chairman of the Executive Board is responsible also for the organisation and administration of the personnel of the Fund.

An important decision making body appointed by the Board of Governors has been the Interim Committee which was constituted in October 1974. The Second Amendment to the Articles of Agreement proposed the constitution of a council “by a decision of the Board of Governors taken with an 85 percent majority of the total voting power of the member states of the Fund.”

The IMF Quotas:

On becoming the member of the IMF, a country is assigned a quota of subscription, its voting power and its drawing rights.

The subscription clause stipulates that the subscription quotas are fixed on the following basis:

(i) 2 percent of national income,

(ii) 5 percent of gold and dollar reserves,

(iii) 10 percent of average annual imports,

(iv) 10 percent of maximum variation in annual exports, and

(v) the sum of (i), (ii), (iii) and (iv) increased by the percentage ratios of average annual exports to the national income.

The subscription clause provides that- (a) 25 percent of that amount of subscription must be paid by the country in the form of gold or the U.S. dollars (or 10 percent of all holdings of gold and U.S. dollars with the country, if this is less) and (b) 75 percent of the remaining amount is payable in terms of the domestic currency of the country concerned.

The subscription component of 25 percent of the quota constitutes the so-called ‘gold tranche’ and 75 percent of the quota composed of national currencies constitutes what is called as the so-called ‘credit tranche’. The subscription quotas of the member countries taken together determine the major financial resources of the Fund. The total subscription to the Fund was originally $ 8.8 billion. By 1993, it had grown to $ 205 billion (or 145 billion SDR’s).

According to the Twelfth General Review of Quota in January 2003, the maximum size of member countries quota was SDR 213.7 billion. The Fund was delinked from gold in April 1978 and the practice of keeping gold reserves with the Fund was discontinued. Presently a member country maintains the subscription quota in terms of its own currency and in terms of Special Drawing Rights (SDR’s). The quotas of the member countries are reviewed from time to time.

Originally the U.S. quota was the largest at 31 percent of the total. The respective quotas of the five leading industrial nations stands presently at 21 percent for the U.S.A., at 7 percent for the U.K., at 6 percent for Germany and at 5 percent each for France and Japan. The voting power of the member states and their borrowing capacity is contingent upon the quotas allocated to them.

Functions of IMF:

The major functions of the IMF are as follows:

(i) The Fund operates as a short-term credit institution.

(ii) It acts as a reservoir of the currencies of all the member countries. A borrowing country can borrow the currency of another country out of this reservoir.

(iii) The IMF is like a lending institution in foreign exchange. It extends loans in foreign exchange to the member countries for financing only the current transactions and not the capital transactions.

(iv) The IMF provides machinery through which the par value of the currency of a member country can be altered. The IMF provides a mechanism for ensuring smooth adjustment of the exchange rates and improvement in the long-term balance of payments position of the member countries.

(v) The IMF provides machinery to the member countries for international consultations.

(vi) The IMF provides technical advice to the member countries on various economic problems on monetary and fiscal matters.

Operations of the IMF:

The IMF undertakes its operations in such a way that there is efficient realisation of its objectives.

The main operations of the IMF are as below:

1. Lending Operations:

The IMF acts as the international financial institution. It attempts to cater to the short-term loan requirements of the member countries. The resources at the disposal of the IMF consist of gold and specified quantities of the currencies of the member countries received in the form of quota subscriptions. The capacity to borrow of the member countries is in proportion to their respective quota subscriptions.

The voting strength of the member countries as well as the allocation of the international liquidity or Special Drawing Rights (SDR’s) is also in proportion to the quotas of the member countries. A member nation, under the original rules of the Fund, could borrow no more than 25 percent of its quota in any one year, upto a total of 125 percent of its quota over a five-year period. A nation could borrow the first 25 percent of its quota, called gold tranche, almost automatically without any condition or restriction.

On further borrowing in subsequent years, called as credit tranche, each of 25 percent of its quota, the Fund charged higher and higher interest rates and imposed more and more conditions and supervision to ensure that the deficit nation was taking appropriate measures to wipe out deficit.

The repayments are to be made within 3 to 5 years. It involved the nation’s repurchase of its own currency from the Fund with other convertible currencies approved by the Fund until the IMF once again had no more than 75 percent of nation’s quota in nation’s currency. The Fund permitted repayments to be made in currencies of which it had less than 75 percent of the issuing nation’s quota.

If the Funds holding of a nation’s currency fell below 75 percent of its quota, the nation could borrow the difference from the Fund without having to repay its loan. This was called as super gold tranche. In the event that the Fund ran out of the currency altogether, it would declare the currency ‘scarce’ and allow the member countries to discriminate in trade against the scarce currency nation.

The reason for this was that the Fund treated balance of payments adjustment as the joint responsibility of both surplus and deficit nations. However, the Fund has never invoked this scarce currency provision during many years of its operations.

The limit of borrowing by the member countries under the credit tranche has been gradually raised by the Fund over the years. Presently the members can draw upto the equivalent of 450 percent of their new quotas on the total net use of the Fund’s resources. The Interim Committee set the borrowing rights of the member countries in September 1984 under the Enlarged Excess Policy at 95 to 115 percent of its quota each year upto 280 to 345 percent over a three year period and cumulative limits of 408 to 450 percent.

The limit is to be reviewed every year. The Executive Board retains at present the right to approve standby or extended financing arrangements. The borrowing facility upto this limit is allowed if the given member country makes a particular strong effort to correct the balance of payments disequilibrium and adjust its economy.

Since 1960’s, the IMF has expanded its credit facilities for the member countries.

The new credit facilities set up by the Fund include:

(i) Compensatory Financing Facility (CFF):

The Compensatory Financing Facility (CFF) was adopted in 1963. It enables the member countries to draw from the Fund upto 100 percent of their quota when they experience balance of payments difficulties caused by the temporary shortfall in their export receipts. The countries which avail of the IMF assistance under CFF are required to co­operate with the Fund in an effort to find an appropriate solution for their balance of payments deficits.

(ii) Buffer Stock Financing Facility (BSFF):

This financing facility was created in 1969. It may be used by the member country to draw upto 50 percent of its quota to finance international buffer stock arrangement. The country seeking assistance from the Fund under this facility is expected to co­operate in the stabilisation of commodity prices within the country.

(iii) Extended Fund Facility (EFF):

This facility was created in 1974. The Fund provides credit to member countries under this facility to tide over their balance of payments difficulties resulting from structural imbalances. The member countries can draw upto 140 percent of their quotas for a period of 3 years or more. The credit under this facility may be extended upto a period of 10 years. This credit facility is based upon performance criteria and drawings of installments. Many countries including India have availed of this loan facility.

(iv) Supplementary Financing Facility (SFF):

This facility was created by the Fund in 1977. Under it, the member countries can have supplementary credit facilities in much larger amounts and for longer periods than are available under regular and standby arrangements. This facility was extended by the Fund to low income developing member nations. For the purpose of reducing the cost of borrowing, the Fund established a Subsidy Account in 1980. Under it, the payment of subsidy is made to the borrowing countries.

(v) Oil Facility:

In the wake of serious oil crisis in 1973-74 and the consequent steep rise in oil prices, the non-oil producing countries faced severe balance of payments difficulties. To deal with this situation, the oil facility was set up by the IMF in 1974. The funds were borrowed by the IMF from some surplus countries and were advanced to the deficit countries at the competitive rates. This facility had been utilised fully by 1976.

(vi) Trust Fund:

The IMF constituted this fund in 1976 for providing concessional assistance to the countries experiencing continued BOP deficit on account of persistent high petroleum prices. It was decided to dispose of one-sixth of the gold by the IMF for constituting this fund.

In addition, the contributions were obtained also from some advanced countries. The advances to the deficit nations were provided out of the Trust Fund at the concessional rate of interest of 0.5 percent. The repayments were to be made by the borrowing countries in ten installments beginning after 5-1/2 years from the date of the disbursement of loan.

(vii) Systematic Transformation Facility:

This facility is intended to assist the erstwhile centrally planned economies that are becoming market economies and are faced with BOP difficulties during the transition.

2. Operation of Exchange Rate Policy:

Under the original Articles of Agreement of the IMF, each member country was required to express the par value of its currency in terms of gold or the U.S. dollar. This was intended to evolve a regime of stable exchange rates. The member countries could make change in the par value not exceeding ± 1 percent. A change in excess of these limits required the permission of the IMF. Since 1971, the changes have been effected in these provisions and the international monetary system has moved from the fixed to flexible exchange rates.

Although the IMF has no direct control over the exchange rate adjustments of the member countries, yet it has laid down principles for the guidance of the member countries in pursuing their respective exchange rate policies. In addition, the Fund undertakes the ‘surveillance’ of adjustment policies of the member countries.

After the Smithsonian Agreement of December 1971, the band of fluctuation of exchange rate was enlarged from ±1 percent to ±2.5 percent on either side of the central rate. After the Jamaica Agreement of 1976, attempt was made to make the system of managed float to work better.

In the present international monetary system, the member countries are allowed either to float or peg their currencies. In the event of pegging, these are not fixed in terms of gold but pegged to the currency of particular country, the SDR or a basket of currencies. There are no specified limits on the margins within which these rates are pegged. There are also no rules related to effecting variations in the exchange rates. But the exchange rate pegging or adjustments are subject to IMF supervision or guidance.

Conditionality of IMF Assistance:

The IMF has to operate under severe financial constraints on account of limited resources at its disposal. A large number of the member countries are faced with mounting and persistent BOP deficits and foreign exchange difficulties. For tackling the temporary BOP deficits of the member nations, the IMF provides assistance on an unconditional basis. But that cannot be permitted in the situations of permanent or fundamental disequilibrium.

That will result in the locking up of scarce IMF resources over a long period and seriously hamper the functioning of this international lending institution. That is why the extension of assistance to the member countries for adjusting the fundamental disequilibrium has been related to the performance of the borrowing countries.

The conditionality refers to a set of conditions which the IMF intends to apply to the borrowing countries for ensuring a high degree of efficiency of their economic policies. The Executive Board of IMF has prescribed certain specific guidelines or conditions which the recipient country is expected to fulfill for securing financial accommodation for correcting a permanent BOP deficit.

The broad guidelines or conditions are as follows:

(i) The recipient country is required to undertake such tax reforms as provide incentives to the producers to step up domestic production.

(ii) It is required to liberalise and, if found necessary, to remove controls on prices so that the favourable conditions are created in the economy for increasing production.

(iii) The prices of products of public enterprises should not be administered as these would entail loss in efficiency for these undertakings.

(iv) Wherever possible, the artificial supports such as subsidies should be eliminated.

(v) The borrowing country should take appropriate steps to ensure export promotion and conserve energy in the interest of development.

(vi) The investment programme of the country should be oriented to the objective of steady growth.

Criticisms of IMF:

The IMF conditionality has met with criticism from the borrowing countries.

The main objections raised against it are as below:

Firstly, the less developed borrowing nations view the IMF conditions with deep suspicions. They consider the conditionality as a subtle way to preserve the hold of international capitalism and western imperialism.

Secondly, the IMF conditionality impinges upon the sovereign decision-making of a country. The borrowing countries have to accept dictates from the IMF bosses. Sometimes the decisions enforced by the IMF are detrimental to the welfare-maximising policies adopted in a country.

Thirdly, the IMF stresses on the opening up of markets by the borrowing countries without placing any such obligations upon the advanced countries.

Fourthly, the IMF conditionality makes the economies of the borrowing nations as generally subservient directly to the IMF and indirectly to the advanced countries.

Fifthly, it has been often found that the IMF conditionality has been monetarist and deflationary and obliges the assistance seeking countries to reduce their demand for imports by curtailing the overall demand through slashing both private and public spending. Such cutbacks are likely to result in a fall in consumption, investment and employment.

In view of the deflationary impact of IMF conditionality, there is need for having some alternative strategy based upon adjustment with growth emphasising upon “promoting production, both to increase exports and to meet a higher proportion of local demand from local production. Although there have been inclinations of a change of IMF policy in this direction, there is as yet no well-articulated agenda of reform.”

Some of the objections raised by the borrowing countries certainly have some substance. It is, therefore, important that the IMF policy framers should have more understanding of their susceptibilities. The IMF should only guide and not dictate.

The borrowing nations too on their part, should have a more open mind. If the policy reorientation and readjustments can help in overcoming the problems of fundamental disequilibrium in BOP and international debts, they should willingly accept the IMF prescriptions and conditionality.

IMF and Group of 20 (G-20):

The Group of Twenty (G-20) industrial countries of the world met in London on April 2, 2009 while the world economy was faced with the worst economic and financial crisis since the depression of 1930’s. The leaders of G-20 resolved at the meet to restore confidence, growth and jobs, to repair the world financial system to enlarge lending, to strengthen financial regulation, to reform the international financial institutions, to promote global trade and investment, not to take recourse to protectionism and to build an inclusive and sustainable recovery.

The Indian Prime Minister emphasised upon the need for long term reforms of the global financial architecture including increased representation of developing and emerging market economies; reform of the global financial system through stronger regulation and improved supervision; developing an effective early warning system and bringing tax havens under closer scrutiny and transparency. The leaders of G-20 agreed upon certain initiatives particularly related to the IMF.

These initiatives were as under:

(i) The resources available to the IMF would be tripled to US $ 750 billion for helping the countries with troubled economies.

(ii) A new SDR (Special Drawing Right) allocation of US $ 250 billion would be supported.

(iii) An additional lending of at least US $ 100 billion by the multilateral development banks (MDB’s) would be supported.

(iv) The member countries would ensure US $ 250 billion of support for trade finance.

(v) The additional resources raised from agreed IMF gold sales would be used for the provisional concessional finance for the poorest countries.

(vi) An additional US $ 1.1 trillion programme of support would be constituted for supporting credit, growth and jobs in the global economy.

(vii) The member countries of G-20 called upon the IMF to complete the next review of the IMF quota by January 2011, as against the original schedule of 2013.

(viii) For strengthening the world financial system, a new Financial Stability Board (FSB) including all G-20 countries and representatives of some new entities, would be constituted to collaborate with the IMF to provide early warning of macroeconomic and financial risks and to suggest actions needed to address them.

(ix)The leaders of G-20 countries committed to implement the package of IMF quota and support reforms for strengthening the global financial institutions.

(x) The governance structure of the IMF and World Bank would be revised to give the bigger developing countries the authority they now deserve.

A meeting of G-20 Finance Ministers and Central Bank Governors was held in Istanbul in February, 2015. The disappointment was expressed by several countries including India on the non-implementation of IMF reforms related to quota, voting rights and governance even upto 2014.

Had the quota reforms been implemented, India’ voting share in IMF would have increased from the current 2.44 percent to 2.75 percent and India would have become the eighth largest quota holder at the IMF from its current 11th position. The lack of urgency on the part of developed countries towards the IMF reforms again remains a big stumbling block.