Role of International Monetary Fund (IMF) in India

Let us make in-depth study of the role of IMF in India.

International Monetary Fund (IMF):

The International Monetary Fund, which is briefly called IMF, is one of the twin institutions which were established as a result of discussion among the monetary and financial delegations of the member countries of the United Nations held at Bretton Woods (U.S.A.) in 1944.

Its establishment on 1st March, 1947, is a great landmark in the history of international economic relations, particularly in the monetary field.

IMF and its Membership:

The funds of the IMF. consist of the subscription of the members, who have been assigned their respective subscription quotas. In 1982, it had 146 members whose total subscribed capital stood at $ 60 billion. Twenty-five per cent of the quota or 10 per cent of the official gold holdings of the member country, whichever is less, is payable in gold—the rest of the quota is to be paid in terms of the member’s national currency. Recently, the requirement of gold payment has been done away with.

Under the IMF articles, a member country can purchase foreign currency not exceeding one- fourth of its quota in any 12-month period. The total holdings of foreign currencies by a member country must not, however, exceed 200 per cent of its quota, which means in effect that the upper limit for IMF’s short-term assistance is equivalent to the country’s quota plus its gold contribution.

With effect from January 2, 1970 a system of Special Drawing Rights (SDRs) was set up. The SDRs are designed to supplement the gold and the reserve currencies, viz., the pound and the dollar. The SDRs represent entirely a new form of paper money which will serve like gold or US dollar, and hence are called Paper Gold.

Main Functions of IMF:

The main functions of the International Monetary Fund are:

(i) Regulating Rate of Exchange:

Each member-country on joining the Fund has to declare the par value of its currency in terms of gold or U.S. dollars (now in terms of SDRs) is required to maintain this parity. It can, however, change it up to 10 per cent without the IMF’s permission.

For further changes up to 10 per cent the IMF will have to be consulted which will have to give the acceptance or refusal to the proposed change within 72 hours. Changes beyond 20 per cent can be effected but only with the concurrence of the IMF and only to correct a “fundamental disequilibrium” in the balance of payments. The internal policies of the member-countries to restore equilibrium are not to be interfered with by the IMF.

(ii) Assistance for Meeting Balance of Payments Deficit:

When a country suffers from a deficit in its balance of payments on current account, it can obtain from the IMF, in exchange for its own currency, the currency which it needs to pay off its deficit. There is, however, a limit to the amount which it can thus obtain.

(iii) Rationing out Scarce Currencies:

Currencies which are in great demand by the member- countries and IMF cannot meet all demands for them are declared as scarce currencies and are rationed by IMF among the countries needing them. The IMF can also increase the supply of such ‘scarce’ currencies by borrowing or by purchasing them against gold. The member-countries are permitted to impose exchange restrictions in cash of such ‘scarce’ currencies.

(iv) Elimination of Exchange Restrictions:

IMF has to see that the member-countries do not impose exchange restrictions on current transactions. In view of the abnormal conditions existing after the war. IMF allowed a period of transition extending over 3 years during which the members could remain such restrictions. The period is over and many countries have relaxed their exchange restrictions. However, their complete removal is not likely in the near future.

Leading Mechanism by IMF:

The IMF helps its member countries under a number of different programmes:

Stand-by Arrangements:

The most widely used way to lend by IMF is stand-by arrangements. Under this arrangement a credit tranche which is equal to 100 per cent of member country’s quota is available for lending to it. A member country can borrow from IMF from this credit tranche to meet its balance of payments difficulties. A certain norms regarding government expenditure and money supply targets have to be fulfilled before resources are released, especially in higher credit tranches.

It is expected that government of a country borrowing under this arrangement will adopt measures to rectify the balance of payments disequilibrium. Typically, stand-by arrangements last for 12-18 months period. Repayments of loans under this arrangement are made within 3-5 years of each drawing the money from IMF.

Extended Fund Facility (EFF):

The Extended Fund Facility was created in 1974 to help the developing countries over longer periods (upto 3 years) than stand-by arrangements (12-18 months). Further, in this facility developing countries can borrow more than their quota. The loans taken under this facility can be paid back over a period of 4-10 years.

Under the extended fund facility, since developing countries can borrow to meet for long- term balance of payments difficulties stringent conditions are to be fulfilled for availing borrowing facility under this scheme. A country borrowing under this programme has to provide every year a detailed statement of measures and policies it has adopted to solve its balance of payments problems.

IMF releases resources in installments with conditionality’s regarding the particular steps to be taken by the borrowing country, Commenting on this extended fund facility, Thirwall writes that despite the conditionality’s “the facility represented an important and significant shift in emphasis from viewing the balance Of payments as a stabilisation problem to recognising the balance of payments as a fundamental long-term constraint on growth that cannot be rectified in a short period of time.”

Stand-by arrangement and extended fund facility (EFI) are very important methods of finance support by IMF for meeting balance of payments difficulties of developing countries. However in recent years other special facilities provided by IMF are being extensively used by the developing countries to tackle their problem arising from balance of payments.

The important special facilities are:

(1) Poverty Reduction and Growth Facility (PRGF)

(2) Supplemental Reserve Facility (SRF), and

(3) Contingent Credit Line (CCL).

We briefly explain them below:

Poverty Reduction and Growth Facility (PRGF):

This was set up in 1999 to provide financial assistance to low income (i.e., developing) countries for reduction of poverty. Prior to this, IMF provided financial assistance to the poor developing countries under a programme known as Enhanced Structural Adjustment Facility (ESAF) so that they can undertake structural adjustment reforms. In 1999 it was felt to focus more on poverty reduction in the developing countries.

Therefore, in 1999 Enhanced Structural Adjustment Facility was replaced by Poverty Reduction and Growth Facility (PRGF). Assistance under this programme is given by IMF on the basis of Poverty Reduction Strategy Paper prepared by a poor country in cooperation with World Bank and other experts. Interest charged on the loans given by IMF under this programme is only 0.5 per cent per annum. Moreover, the borrowing country can repay the loans taken under this programme in a long period of 10 years.

Supplemental Reserve Facility (SRF):

This was set up in 1997 in response to Financial Crisis in East Asia and other developing countries. Under this facility, IMF provides financial assistance to the member countries who are experiencing exceptional balance of payments problems arising from a sudden loss of market confidence in their currencies. Assistance under SRF in not subject to usual quota limits but instead depends on the country’s requirements, its ability to repay the loan and policies it adopts to restore confidence. The repayments have to be made within 2.5 years of taking the loan.

Contingent Credit Line (CCL):

This facility was established in 199 to deal with the problem of countries who are anticipating a financial crises that well cause capital outflow on capital account of balance of payments. It was a precautionary measure to provide assistance to a country to overcome the impending crises on capital account. It may be noted that financial assistance under this facility was aviated only when crises actually occurred. The repayment period for the loan taken is also 2.5 years.

Special Oil Facility:

The oil crises of 1973 touched off by the Arab oil producing countries created a most serious balance of payments problem for the developed as well as developing countries. Among the developing countries India was the most severely hit. To aid member-countries, the IMF has started a special fund, from which the member-countries in acute difficulties are helped out. This is called the special oil facility.

Benefits to India from International Monetary Fund’s Membership:

It is good that India joined the IMF. There is no doubt that this membership has been greatly beneficial to India.

(i) International regulation by IMF in the field of money has certainly contributed towards expansion of international trade and thus prosperity. India has, to that extent, benefitted from these fruitful results.

(ii) Large Financial Assistance. Not only indirectly but directly also, her membership has been of great advantage. We know how, in the post-partition period, India had serious balance of payments deficits, particularly with the dollar and other hard currency countries.

She could not possibly reduce her imports, since these consisted of essential foodstuffs, capital equipment and industrial raw materials. Her exports, on the other hand, could not be immediately expanded since under conditions of limited production in the country, increased exports were sure to create serious internal shortages. Under such difficult circumstance, it was the IMF that came to her rescue.

Subsequently, India has been one of the most frequent borrowers from the IMF. From the inception of IMF up to March 31, 1971, India purchased foreign currencies of the value of Rs. 817.5 crores from the IMF, and the same have been fully repaid. Recently, since 1970, the assistance that India, as other member countries of the IMF, can obtain from it has been increased through the setting up of the Special Drawing Rights (SDRs).

India had recourse to borrowing from the Fund in the wake of the steep rise in the prices of its imports, food, fuel and fertilizers. A total of Rs. 753.8 crores had been drawn till the end of August 1975, when the second oil facility drawing of Rs. 207 crores took place. In November 1981, India was given a massive loan of about Rs. 5,000 crores to overcome foreign exchange crisis resulting from persistent deficit in balance of payments on current account.

(iii) The total figures of borrowings by India from the IMF do not convey the extent of the support that it extended to her. What are of greater significance are the crucial timings of and special circumstances under which such assistance was availed of. Such help was forthcoming when the country was faced with critical foreign exchange situations.

(iv) Aid from World Bank and Other International Financial Agencies. The membership of the IMF has benefited India in yet another important way. India wanted large foreign capital for her various river projects, land reclamation schemes and for the development communications. Since private foreign capital was not forthcoming, the only practicable method of obtaining the necessary capital was to borrow from the International Bank for Reconstruction and Development (i.e. World Bank).

The membership of the IMF is a necessary condition precedent to the membership of the World Bank. Thus, India’s membership of the IMF has entitled her to be a member of the World Bank and its affiliates viz., International Finance Corporation (IFC) and International Development Association (IDA). In fact, in absolute figures though not on per capita basis, India has been the largest borrower from the World Bank group.

The International Finance Corporation:

The International Finance Corporation (IFC) has made substantial investment in Indian companies engaged in the production of fertilizers, caustic soda, ball and bearings, pumps, etc. A large bulk of the financial assistance obtained by India from World Bank is from the Soft-loan Affiliate, the IDA—loans from it are payable over 50 years, are interest-free; bear only a service- charge of 0.75 per cent per annum.

Since the fiscal year 1975-76 (July-June), the World Bank has been extending “Third Window” loans meant to help countries with a per capita income of less than $ 375. India got a substantial share out of the ‘Third Window’ fund.

(v) India has availed of the services of specialists of the IMF for the purpose of assessing the state of the Indian economy. Teams of experts have often been coming to India and submitting reports. In this way India has had the benefit of independent scrutiny and advice.

(vi) Contribution to International Monetary Concord. The important place which India has thus occupied in the international councils in the fields of world trade and finance has been a guarantee that her interests would not suffer. Rather, she can avail of whatever facilities are available from the more fortunate nations. Then, apart from her own gain, by her membership, she is contributing to international concord and co-operation in the monetary and financial fields.

(vii) Provision of Oil Facility. The balance of payments position of India having gone utterly out of gear on account of the oil price escalation since October 1973, the IMF has started making available oil facility by setting up a special fund for the purpose. According to a report of the IMF,

India is the worst hit among the developing countries of the world. This special aid from IMF is, therefore, of great value to her. In October 1974, India drew Rs. 194 crores from IMF and Rs. 207 crores in August 1975.

In 1981 India succeeded in getting a massive loan of Rs. 5000 crores from IMF to tide over the balance of payments problem faced by it. This was the single largest loan made by IMF to a member country. India prudently used this loan and used only Rs. 3900 crores and surrendered the balance to IMF.

IMF and European Debit Crisis:

The IMF has been called upon to bail out several European countries such as Greece, Spain, Italy, Portugal which are faced with severe sovereign debt crisis. The IMF has $ 384 billion in its lending funds which are quite insufficient and limited to finance the needs of European countries’ needs. At the same time current economic and political climate in the advanced economies such as the US, Germany makes it highly unlikely that they are in a position to provide additional resources to the IMF.

Tripling IMF resources was part of the G20 leaders’ response to the global recession in 2009. As the European debt crisis threatens to spread and further damp the global recovery, the IMF was asked by its steering committee in Oct. 2011 to review whether its resources are sufficient.

According to Christine Laggard, the present chairman of IMF, the funds credibility and hence effectiveness rests on its perceived capacity to cope with worst-case scenarios. She further adds that lending capacity “looks comfortable today but pales in comparison with the potential financing needs of vulnerable countries and crisis in the debt-ridden European Countries”.

A Critique of the Role of IMF:

The role of IMF in providing financial assistance to developing countries for overcoming balance of payments problem and undertaking structural adjustment for promoting economic development has been severely criticised. Besides, the manner in which IMF dealt with financial crisis in East Asian countries in the late nineties has also come under severe attack.

In its structural adjustment policies IMF has been guided by the supremacy of the free market in promoting economic growth. Thus, according to Stiglitz, a winner of Nobel Prize in economies. “Over the years since its inception the IMF has changed markedly. Founded on the belief that markets often worked badly, it now champions market supremacy with ideological fervor. Founded on the belief that there is a need for international pressure on countries to have more expansionary economic policies such as increasing expenditures, reducing taxes or lowering interest sates to stimulate economy, today the IMF typically provides funds only if countries engage in policies like cutting deficits or raising interest rates that lead to a contraction of the economy”.

The same policy approach has been applied to the vast majority of developing countries as if they all were one homogeneous mass and could be properly treated in the same way. Joseph Stiglitz has severely criticised the functioning of IMF for serving the needs of G-7 (the group of seven developed countries) and has failed to promote global economic stability for which it was set up.

He writes, “A half country after its founding, it is clear that IMF has failed in its mission. It has not done what it was supposed to do… provide funds for countries facing an economic downturn, and in spite of IMF efforts during the past quarter century, crisis around the world have been more frequent (and with the exception of the Great Depression, deeper….. Worse, many of the policies that the IMF pushed, in particular premature capital market liberalisation have contributed to global instability.”

IMF policy of providing financial assistance to the poor developing countries subject to the fulfillment of certain conditions by the latter has come in for severe criticism.

These conditionalities refer to the structural adjustment policies, namely:

(1) Privatisation of public enterprises,

(2) Capital market liberalisation,

(3) Market-based pricing (that is, withdrawal of subsidies granted by the government),

(4) Liberalisation of foreign trade and investment.

If commitments regarding fulfillment of these conditionalities by the developing countries in need of finance were not forthcoming, no financial assistance was provided. In fact, capital market liberalisation proved to be disastrous for many countries because they were not ready and able to deal with the great volatility of capital inflows and outflows.

This policy of premature capital-market liberalisation actually resulted in severe East Asian crisis in the late nineties. The Fund was undoubtedly shaken by the 1997 East Asian crisis which it does not foresee even though there was a massive build-up of current account deficits and capital had started to flow out of South-East Asia long before the crises hit” The IMF now conceders that liberalising capital and financial markets contributed to the East Asia’s crisis of 1990.

As regards market-based pricing which involves elimination of food and fuel subsidies also landed the poor developing countries into trouble. Elimination of subsidies has been resisted by the people in developing countries. So far even in India government has not succeeded very much in this regard. The riots broke out in Indonesia in 1998 when food and fuel subsidies were withdrawn at the instance of the IMF.

Even policy of trade liberalisation has not been entirely successful in attaining its objective of reduction of poverty and unemployment. The issue of trade liberalisation is being hotly debated at WTO sponsored Ministerial Conferences where developed countries of EU (European Union) and the United States are reluctant to eliminate subsidies and reduce tariffs sufficiently which they are providing to protect their agriculture and manufacturing industries. As 2 result, market access for the products of developing countries is quite limited.

Besides, the result of liberalisation of trade (i.e., heavy reduction of tariffs and removal of quantitative restrictions) by the developing countries resulted in increase in unemployment in them. Commenting on this Stiglitz writes, “It is easy to destroy jobs and this is often the immediate impact of trade liberalisation as inefficient industries close down under pressures from international competition. IMF ideology holds that new more productive jobs will be created as the old, inefficient jobs that have been created behind protectionist walls are eliminated. But this is simply not the case…. It takes capital and entrepreneurship to create new jobs and in development countries there is often shortage of them. … The IMF in many countries has made matters worse because its austerity programmes often entailed such high interest rates sometimes exceeding 20 per cent”.

In the view of present author the small-scale and medium enterprises in India which employ a large number of workers could not complete with the imported products and also multinational corporations. As a result, many small firms in India closed down. Of course these is higher industrial growth due to the use of highly capital-intensive technologies but unemployment rate has increased in the post-reform period as a result of structural adjustment policies.

To conclude, IMF policy of laying emphasis on elimination of subsidies, liberalisation of trade and capital market privatisation as conditions for providing financial assistance to the developing countries has not led to the solution of the twin problems of poverty and unemployment in the developing countries. In case of many developing countries IMF policies led to economic crises. In recent years there has been realisation on the part of IMF of the improper nature of its policies and therefore some corrections are being made to achieve the goals of rapid global growth, global economic stability and the solutions of the problems of poverty and unemployment in the poor developing countries.