The IMF – Is It Harmful or Helpful?
Therefore,
the IMF is now playing actively at the global economic stage to deal with the global
Corona pandemic risks after a brief rest from the global financial crisis
2007/09. That reflects a part of the design feature of the IMF. It becomes active
when global economic instabilities are around and goes silent when such risks
are muted, due to the nature of its role in the global economy.
IMF’s
Global Role
Its
role is three-fold, provision of short and medium-term financing facilities to
resolve balance of payment and stabilization problems confronted by member
countries (190 at present), surveillance on the international monetary system and
economic and financial policies of member countries and capacity building of
member countries by providing technical assistance and training to help members
build effective economic institutions. It also issues several global
publications (International Financial Statistics, World Economic Outlook,
Global Financial Stability Report, Fiscal Monitor) and research articles to
share international financial and economic information among the global public.
As such,
the IMF is not a profit-motivated institution. By end of April 2021, its total asset base was
SDR 508.3 bn with a total profit of SDR 4,812 mn for the year ending April 2021
as compared to a loss of SDR 1,447 mn for the previous year.
The
Origin
The IMF
was established in 1944 on the Bretton Woods Agreement by 44 countries as part
of initiatives to rebuild those countries from the destruction by the World War
II. The IMF is the institution set up to look after the international monetary
system while the World Bank was set up to facilitate development.
Bretton
Woods International Monetary System
Until
1944, the international monetary system was based on gold in which banks and
monetary authorities-issued currencies primarily based on receipts of gold and
gold-based colonial currencies. As a result, the world followed a multiple
exchange rates system. At the Bretton Woods, the US dollar was recognized as
the global currency at the exchange rate of US$ 35 per ounce of gold and the US
Central Bank (Fed) to buy and sell gold freely.
In turn, IMF member countries agreed to fix their currency exchange rates against
the US$ (which is freely convertible into gold) and maintain the rate fixed
through buying and selling US$ freely. Therefore, other currencies were
indirectly gold-based through the US$. This is known as the gold exchange
standard. The IMF was the policeman to monitor this US$-gold-based
international monetary system. As such, the US$ became the leading reserve
currency in the world.
Collapse
of the Bretton Woods International Monetary System
However,
the US started printing money mainly for the war against Vietnam and US social
spending programmes causing high inflation. Therefore, due to heavy global
dollar supply and the over-valued dollar against gold, countries started converting
their US$ currency reserves into gold from the Fed which was a run-on the US gold
reserve. In response, followed by failed devaluation to stop gold outflow, then
President Richard Nixon in August 1971 temporally suspended gold-dollar
convertibility.
By failing some attempts made to restore the gold convertibility of the US dollar, leading member countries started their own exchange rate arrangements for currencies of their trade partner countries outside the Bretton Woods system. As a result, Bretton Woods international monetary system collapsed in 1973. Some countries floated the exchange rate against the US$.
As a result, now
countries follow floating, fix and mix exchange rate systems and the IMF has no
control over them. However, IMF’s present policies promote greater flexibility
in exchange rates and many countries have moved to flexible exchange rate
systems where exchange rates are permitted to be determined largely by market
forces.
IMF’s
Special Drawing Rights (SDRs) as a Global Reserve Asset
SDR
was introduced in 1969 at the time of the Bretton Woods system. At that time, as
the international reserve currency, the US Dollar, was largely dependent on gold production, it was belied that international liquidity could not expand to
facilitate rising global trade and investments. Therefore, SDR was introduced
by the IMF as an internationally accepted reserve asset to be maintained in
foreign reserves of countries in addition to the US Dollar, gold and other
leading currencies. Therefore, SDR supply can be increased administratively
from time to time to support the global liquidity for international
transactions.
The
first issuance was at the value of one SDR equal to one US Dollar or 0.888671
grams of gold. However, its value exchange rate for the US$ now is determined
in a basket of 5 currencies, US$, Euro, Sterling Pound, Yen and Yuan based on
weights given to each currency to reflect the currency’s importance in the
global trade and finance. Up to the end of August 2021, new SDR issuances have been
made at five instances with a total of SDR 660.7 bn (worth US$ 935.7 bn).
The largest issuance of SDR 456.5 bn worth US$ 650 bn (single largest so far) was made in last
August to provide liquidity/financial support to member countries for the
recovery from the pandemic-hit economic crisis since early March 2020.
When
SDRs are issued, they are allocated among the members based on the quota (known
as SDR quota) for each member determined based on the member’s
ownership/capital in the IMF. Therefore, the majority of SDR is allocated to
rich, developed countries. For example, the present SDR quota is 17.43% for the
US, 6.47% for Japan, 6.4% for China, 5.59% for Germany, 4.23% for the UK and
4.23% for France (total 44.35%).
As SDRs
are issued to member countries, it is a reserve asset of the government
available for fiscal needs. However, in some countries, SDRs are held in the
balance sheet of the central bank. With the recent large new SDR allocation, a
conflict has arisen between the government and central bank in several
countries (e.g., Mexico) as to who is legally authorized to own and use SDRs.
How
does the SDR system operate?
All
SDRs are recorded in the IMF’s SDR Department as assets and liabilities for
each member country. In addition, there are 15 international institutions designated
to hold SDRs of member countries on behalf of the IMF.
Accordingly,
the IMF bears a liability and assets for each member country. Therefore, the
IMF pays interest to the member on the liability and charges interest from the
member on the asset. The interest rate on SDR is weekly determined on the benchmark
interest rates of 5 SDR basket currencies.
If a
member country does not use the SDR quota, IMF’s asset and liability in respect
of the member do not change. Therefore, net interest on the Member’s SDR
holding is zero as interest charge is equal to interest payment. At present,
the SDR interest is around 0.05% due to interest rates close to zero of SDR
basket currencies.
- Example 1– if the SDR quota for member A is SDR 5,000 mn, and SDR interest rate is 0.05%, IMF charges interest SDR 20.83 mn monthly from A and simultaneously pays interest SDR 20.83 mn monthly. Therefore, net interest is zero and no income or cost to member A on his SDR quota.
However,
if a member country withdraws SDRs from the quota to be used for international
payments, IMF’s liability goes down by the amount of withdrawal while the asset
remains unchanged. Therefore, the member country is involved in payment of net
interest to the IMF which is a cost to the member country for the use of SDR
quota. Such use of IMF quota is similar to borrowing from the IMF and the cost
is the net interest payment.
When
a member country withdraws SDRs from its quota, it has to sell those SDRs to
another member country through the IMF SDR exchange system and receive any
international reserve currency such as US$ and Euro for making international
payments as required. Accordingly, that amount of SDR is transferred to the SDR
liability of the buying member at the IMF SDR account. As a result, IMF’s SDR
liability to that member increases beyond the SDR asset (quota) on the member.
Therefore, that member earns a net interest income from the IMF which is
covered by the net interest paid by the SDR withdrawing member.
- Example 2 – if the member A withdraws SDR 2,000 mn and sells it to member B to receive US$, IMF charges interest SDR 20.83 mn monthly from A (on a total quota of SDR 5,000 mn) and pays interest SDR 12.5 mn monthly for reduced quota liability (SDR 3,000 mn). Therefore, member A has to pay net interest of SDR 8.33 mn monthly to the IMF. This is the cost of the use of SDR 2,000 mn from the quota. Simultaneously, IMF liability to member B rises by SDR 2,000 mn involving DSR 8.33 mn net interest payment to member B. Accordingly, net interest payment by member A to the IMF is transmitted to member B being the new holder of SDR 2,000 mn sold by member A.
Similarly,
a member country can borrow SDR from the quota of another member and IMF member
accounts will be updated and interest will be charged and remitted on the
amount of borrowing accordingly.
All
such, SDR trades among the members take place on the IMF SDR exchange and there
is no trading system outside the IMF.
Therefore,
SDR is not a currency or debt or loans but an official reserve asset being used among the IMF
members within the IMF exchange. Practically, SDRs are potential claims over reserve currencies of member countries as SDRs are generally exchanged for reserve currencies for making global payments. The SDR transactions system has been designed to prevent multiple creation of SDR by members through
lending and borrowing in contrast to reserve currencies which
are legal tenders. Further, as the value of SDR is determined in a basket of five global reserve currencies, the SDR can be used as a stable unit of account. Therefore, IMF's financial statements are prepared in SDR values.
IMF’s
Financing Facilities to Member Countries
The IMF
offers financing facilities on non-concessional terms to member countries from
its General Reserve Account (GRA) under the following programmes. At present, the
IMF’s lending is about US$ 250 bn and has a lending capacity of around US$ 1
trillion supported by members.
- Stand-By Arrangement (SBA) to members confronting short-term or potential balance of payment problems.
- Standby Credit Facility for low-income members confronting balance of payment problems.
- Extended Fund Facility to members confronting protracted balance of payment problems.
- Extended Credit Facility to low-income members confronting protracted balance of payment problems
- Flexible Credit Line and Precautionary and Liquidity Line to members who follow sound policies to mitigate crises and boost market confidence.
- Rapid Financing Instrument and Rapid credit Facility to low-income members to provide rapid assistance for urgent balance of payment needs arising from commodity price shocks, natural disasters and domestic fragilities.
In
addition, debt service relief to members also is provided under the Catastrophe Containment and Relief Fund (CCRF).
IMF’s
Corona Pandemic Response and New SDR Issuance
At
the onset of the Pandemic, the IMF allocated US$ 50 bn for urgent lending to
assist members on the fight with the pandemic and stated that it was ready to
mobilise a total fund base of US$ 1 trillion. The IMF advised members that
lending would be provided with easy terms based on evidence on expenses
incurred in the pandemic control. Many low-income countries received this
support.
By
end of August 2021, the IMF has provided facilities of SDR 83.7 bn (worth US$.
115.9 bn) to 85 countries under above-mentioned lending schemes in respect of
pandemic control. Most of these facilities were provided under Rapid Financing
Instrument and Rapid Credit Facility. In addition, debt relief was provided to
29 countries with a total of SDR 519.6 mn (US$ 726.7 mn) under
Catastrophe Containment and Relief Fund.
IMF also made a new allocation of SDR 456.5 bn (worth US$ 650 bn) in August 2021 to support members with new international liquidity. This is 2.24 times the existing total SDR holding prior to this (SDR 204.2 bn). As many developing countries confront acute balance of payment problems due to disruptions in global trade, investment and supply chains caused by the Corona pandemic since early 2020, this new liquidity will be a significant boost.
While members can use these new SDRs (as
explained above) to ease their balance of payment problems, existing lending
facilities from the IMF also will expand as they are proportional to the SDR
quota of member countries. Therefore, new SDR allocations were free life oxygen
to many low-income countries although they received a small portion. However,
when countries use allocations for payments, they have to incur SDR interest
rate (0.05% at present).
Further,
G7 countries received 43.5% and G20 countries received 68.2% of the new
allocation due to their high quotas. It is unlikely that these countries will
use new SDR allocations. All emerging market economies including low-income
countries received 42.32%.
IMF’s
Membership
At
present, IMF membership is 190 countries. Members are assigned with quotas valued
in SDRs based on the relative economic power of the respective members in the
global economy. The voting rights of the members are determined by the size of the
quotas. Members have to pay for the quota with 25% in SDRs or recognized reserve
currencies and the balance 75% in the member country’s currency. The total quota subscription
as at end of April 2021 was SDR 475.8 bn.
IMF’s
Geopolitics and Conditionalities
As the
majority ownership of the IMF is held by developed countries who respect market-based economic principles and transparent governance systems, IMF’s policies on
lending and other member services are also driven by such principles.
Upon the request for IMF support programmes, IMF officials visit the member countries and examine causes that have led to balance of payment problems. They usually examine how the budget deficit, market controls and BOP current account deficit have caused the macroeconomic and BOP problems. They generally see the rising budget deficit as the cause for balance of payment difficulties. also, they do not like direct restrictions imposed on international trade and payments like import controls and letters of credit. Accordingly, IMF recommends several macroeconomic reform targets as conditions for lending facilities in order to resolve chronic causes over time. These conditions are in line with the promotion of market principles and transparency.
Accordingly, loans are disbursed by
installments based on the review of the progress on fulfillment of conditions. If
such conditions are materially non-complied, remaining installments are
suspended and the country can withdraw from the programme, if necessary. Other than that, the IMF does not seek any
ownership or mortgages of country properties or businesses as collaterals like
in the case of alternative bilateral loans. There is no free lunch in this world with diverse forces of geopolitics cutting across the countries.
The
IMF generally recommends member countries introduce policy reform to lower
budget deficits, promote markets and flexible exchange rates and focus the
monetary policy for macroeconomic stabilization based on price stability or
inflation targets. Therefore, when seeking IMF facilities, the local team must
be knowledgeable on market principles and their importance if they are to be successful
in negotiations with the IMF.
Therefore, some
developing country authorities with highly state-led/intervened economies find
difficulties to adapt to IMF services in normal times due to those conditions.
However, almost all developing countries have received IMF support during
crisis times in the past.
Importance
of IMF Support – Bailouts or Bail-ins
The IMF
support or programmes promote largely market-based discipline in macroeconomic
management. Therefore, IMF lending support while helping to mitigate balance of
payment problems promotes investor confidence. As a result, the country’s credit
ratings tend to improve and foreign investors start channeling funds to
financial markets. Therefore, macroeconomic activity and stability are expected
to improve. In this sense, IMF programmes are known as bailouts of countries
from balance of payments-driven crises. In fact, they are bail-in programmes as
countries themselves have to reposition the economies to sort out chronic causes
behind the balance of payment difficulties.
Therefore,
economic crisis management especially in developing countries will be difficult
and painful without the support of the IMF in the present system of global stability network.
P. Samarasiri
Former
Deputy Governor, Central Bank of Sri Lanka
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