International Monetary Fund (IMF)

• The genesis of the International Monetary Fund (IMF) lies in the experience of countries during the Great Depression.
• In the 1930s, many countries attempted to maintain domestic income in the face of shrinking markets through competitive devaluation of their currencies and by resorting to exchange and trade restrictions.
• Such measures could achieve their objectives only by aggravating the difficulties of trading partners, who, in self-defence, were led to adopt similar policies.
• There was a growing recognition of the largely self-defeating nature of these ‘beggar-my-neighbour policies’ at the country level.
• These policies contributed to lower trade and employment and a less efficient allocation of resources at the global level.
• This resulted in a widening acceptance of the need for an agreed code of conduct in international trade and financial matters.
• It was against this background that at the United Nations Monetary and Financial Conference, attended by representatives of 45 countries, held at Bretton Woods, New Hampshire, in July 1944, the decision to set up the International Monetary Fund was taken.
• The IMF came into existence on December 27, 1945, when 29 countries signed the Articles of Agreement.
• The inaugural meeting of the Board of Governors was held in Savannah, Georgia, on March 8, 1946.
• The first meeting of the Executive Board was held at the Fund’s headquarters in Washington, DC, on May 6, 1946.
• The Fund commenced financial operations on March 1, 1947.

Objectives

• The first Article of the Fund’s Charter laid down six objectives for the organization.
  1.  To promote international cooperation by providing the machinery for consultation and collaboration by members on international monetary issues.
  2.  To facilitate the balanced growth of international trade and, through this, contribute to high levels of employment, real income, and the development of productive capacity.
  3. To promote exchange stability and orderly exchange arrangements and facilitate the avoidance of competitive currency depreciation.
  4. To foster a multilateral system of payments and transfers for current transactions and seek the elimination of exchange restrictions which hamper the growth of world trade.
  5. To make financial resources available to members, on a temporary basis and with adequate safeguards, to permit them to correct balance of payments imbalances without resorting to measures destructive of national or international prosperity.
  6. To seek reduction of both the duration and magnitude of payments imbalances.

Structure and Management

Functions

• The functions of the IMF can be broadly classified into three main categories.
  1.  To formulate and administer a code of conduct regarding exchange rate policies and restrictions on payments for current account transactions.
  2.  To provide members with financial resources to enable them to observe the code of conduct while correcting or avoiding payments imbalances.
  3.  To provide a forum in which members of the IMF could consult with one another and collaborate on international monetary matters.

History of IMF

• In regard to code of conduct regarding exchange rate policies, the basic objective was avoiding disruptive fluctuations that had occurred in the 1930s and the rigidity that prevailed under the international gold standard.
• It may be recalled that under the international gold standard, disturbances in price levels in one country would be wholly or partly offset by an automatic balance of payments adjustment mechanism called the price–specie flow mechanism (specie refers to gold coins).
• The gold standard broke down during World War I and was briefly reinstated from 1925 to 1931 as the Gold Exchange Standard.
• Under this standard, the United States and England could hold only gold reserves, but other nations could hold both gold and dollars or pounds as reserves.
• In 1931, England departed from gold in the face of massive gold and capital flows, an unrealistic exchange rate, and the Gold Exchange Standard was finished.
• Thereafter, countries devalued their currencies to maintain trade competitiveness.
• These policies, in which nations cheapened their currencies to increase exports at others’ expense and reduce imports, led to trade war.
• It is generally believed that protectionist trade and exchange policies fueled the global depression.
• It seemed clear at Bretton Woods that neither a policy of fixed exchange rates nor of fully fluctuating rates was conducive to the balanced growth of international trade.
• Hence, under the Agreement implemented in 1946, every member country was required to:
  • Establish a par value for its currency either directly in terms of gold or indirectly in terms of the gold content of the US dollar of July 1, 1944 (888.671 grams of fine gold or $35 = 1 oz. of fine gold).
  • Maintain the market rate within 1 per cent on either side of parity.
  • Change the par value only after consultation with the IMF, and only to correct a fundamental disequilibrium.
  • Avoid discriminatory currency practices and restrictions on payments (obligation under Article VIII to maintain current convertibility).
• The Fund was provided with financial resources to assist members in financing temporary deficits and in adapting adjustment policies without recourse to measures inconsistent with the code of conduct.
• The IMF Charter laid down principles with respect to exchange restrictions.
• Article VIII obliges members to avoid discriminatory currency practices and restrictions on current payments.
• Article XIV allows members to continue temporary restrictions on international payments and transfers.
• The par value system appeared to have worked well during the first two decades.
• Members with strong payments positions accumulated US dollars, and deficit countries adopted domestic corrective measures.
• Exchange rate changes were largely confined to developing countries with high inflation and did not lead to competitive depreciations or retaliatory restrictions.
• In the 1960s, cracks in the Bretton Woods System became clearly visible.
• Periodic foreign exchange crises arose when governments failed to make necessary policy adjustments.
• Exchange rate stability reduced uncertainty in international trade and investment, promoting growth.
• The system imposed discipline on national economic policies.
• In cases of fundamental disequilibrium, reserves including IMF borrowings became inadequate.
• Restrictive monetary policies could reduce inflation, but were often impracticable due to their impact on output and employment.
• Exchange rate decisions were delayed or avoided.
• Between 1946–1971, most devaluations occurred under IMF pressure, and were often a precondition for IMF assistance.
• The system collapsed on August 15, 1971, when President Richard Nixon terminated convertibility of the dollar, even for central banks, and devalued the dollar.
• The collapse was due to US inflation, inability to maintain gold price at $35 an ounce, and refusal by West Germany, Japan, and Switzerland to import inflation.
• The US New Economic Policy introduced suspension of gold convertibility, floating of the dollar, and a 10 per cent import surcharge.
• Many countries subsequently floated their currencies, marking the collapse of the Bretton Woods System.
• Post-1971 Developments and Smithsonian Agreement- Floating of major currencies created uncertainties, leading to the Smithsonian Agreement.
• The Agreement, signed on December 18, 1971, provided for realignment of parities and widening of bands.
• Japan (16.7%) and West Germany (13.6%) revalued their currencies against the US dollar.
• Other revaluations included Belgium (11.6%), Netherlands (11.6%), France (8.6%), Italy (7.5%), and Sweden (7.5%).
• The band for market fluctuations was widened to 2.25 per cent on either side.
• The official price of gold was raised to $38 per ounce.
• The system failed as the UK floated the pound on January 23, 1972, followed by the US dollar.
• These events showed that fixed exchange rates had outlived their utility.
• Kingston Accord (1976)- The IMF Interim Committee meeting (January 7–8, 1976) produced a broad agreement.
• It legalised floating exchange rates.
• It revised quotas.
• It abolished the par value system in terms of gold and the official price of gold.
• Of 60 million ounces of gold held by the IMF, 25 million ounces were to be returned to members and the rest sold over four years.
• Profits from gold sales financed the Trust Fund for least developed countries.
• Necessary amendments to the Articles of Agreement were made.
• Current System of Exchange Rate Determination
• The current system is a hybrid system.
• Major currencies float on a managed basis.
• Some currencies freely float, while others follow various pegged arrangements.
• Surveillance over Exchange Rate Policy
• The IMF oversees the international monetary system and members’ obligations.
• The Fund exercises firm surveillance over exchange rate policies under Article IV.
• Members must provide information and consult the Fund when requested.
• Principles guiding exchange rate policies include:
  • Refraining from manipulation of exchange rates to prevent balance of payments adjustment or gain unfair competitive advantage.
  • Intervention in exchange markets to counter disorderly conditions and disruptive short-term movements.
  • Taking into account the interests of other members in intervention policies.
• IMF staff collects information through regular and special consultations.
• Reports are reviewed by the Managing Director to assess consistency with surveillance principles.
• IMF principles aim to foster a multilateral system of payments for current transactions and promote balanced growth of world trade.
• Article VIII obliges members to avoid discriminatory currency practices.
• Article XIV allows temporary restrictions for members not yet ready to accept Article VIII obligations.
• Article VIII applies only to current transactions.
• For capital transactions, the Articles were silent, allowing members policy freedom.
• With growing capital market integration, the IMF addressed capital account convertibility in 1997.
• Directors supported an amendment to the Articles to promote capital account liberalization.
• The Interim Committee (April 1997) endorsed making capital account liberalization a specific purpose of the IMF and asked the Board to frame recommendations.

Financial Resources and Policies

• • The resources of the IMF come from two sources, viz. (i) subscription by members and (ii) borrowing.
  • Every member of the Fund is required to subscribe an amount equivalent to its quota.
  • According to IMF rules, each member is assigned a quota expressed in Special Drawing Rights (SDRs).
  • Quotas are used to determine the voting power of members, their contribution to the Fund’s resources, their access to these resources, and their share in allocation of SDRs.
  • A member’s quota reflects its economic size in relation to the total membership of the Fund.
  • Each member pays a subscription equivalent to its quota, and the Board of Governors decides the proportion to be paid in SDRs or in the member’s currency.
  • A member is generally required to pay 25 per cent of its quota in SDRs or in currencies of other members selected by the IMF, and the remainder in its own currency.
  • These quotas are reviewed at intervals of not more than five years.
  • The IMF is authorised to supplement its ordinary resources by borrowing from official entities as well as from private sources.
  • Under the General Agreement to Borrow (GAB), the IMF entered into an agreement initially in 1962, which was renewed, revised, and enlarged from time to time.
  • To further supplement resources, on January 27, 1997, the IMF decided to establish the New Arrangements to Borrow (NAB) in addition to the GAB.
  • The NAB is the facility of first and principal resort in the event of a need to provide supplementary resources to the Fund.
  • The amount potentially available under the NAB is up to SDR 34 billion, which is also the maximum combined amount under the GAB and NAB.

Financial Assistance

• • “Transactions” of the Fund are exchanges of monetary assets for other assets, while “operations” are other uses or receipts of monetary assets, such as allocations of SDRs or payment of charges to the Fund.
  • The financial operations and transactions of the Fund are carried out through the General Department and the SDR Department.
  • The Fund provides balance of payments assistance by selling to members, in exchange for their own currency, the currencies of other members or SDRs.
  • Members to which the Fund sells currencies or SDRs are said to make “purchases” (or “drawings”) from the Fund.
  • Technically, purchases are not borrowings, since the purchasing country deposits an equivalent amount of its own currency with the Fund, but their economic effects are the same as borrowings.
  • The Fund’s resources are available for limited periods, and members must subsequently repurchase their currencies or SDRs from the Fund.
  • Such repurchases have economic effects identical to repayments.
  • The Fund’s resources typically support programmes under stand-by arrangements, but increasingly support longer-term adjustment programmes.
  • In some cases, support is given through consecutive one-year stand-by arrangements linked to medium-term adjustment.
  • In others, support is provided through a three-year extended arrangement, or occasionally a three-year stand-by arrangement.
  • The number of facilities under which the Fund provides financial assistance has increased since the mid-1970s.
  • Access to these facilities has been liberalized by raising quota limits and excluding certain drawings from reserve tranche calculations.

Reserve Tranche Drawing

• • • It refers to a member’s right to draw to the extent of the Fund’s holdings of its currency in the General Resources Account, excluding holdings arising from purchases.
    • Such purchases are subject to balance of payments need, but the Fund has no power to challenge the member’s statement of need.
    • There are no charges and no repurchase requirement.

Credit Tranche Facilities

• • These facilities are available in four tranches, each of 25 per cent of quota.
  • For the first credit tranche, members must demonstrate reasonable efforts to overcome balance of payments difficulties.
  • Upper credit tranche purchases are associated with stand-by arrangements.
  • These arrangements focus on macroeconomic policies, including fiscal, monetary, and exchange rate policies.
  • Performance criteria such as budgetary, credit, and external debt ceilings are applied, and purchases are made in quarterly installments.
  • Repurchases are made in 3½ to 5 years.
  • Extended Fund Facility
  • Loans are provided for a longer duration than stand-by arrangements.
  • Buffer Stock Financing Facility
  • Resources are provided to finance members’ contributions to approved buffer stocks.
  • Repurchases are made in 3½ to 5 years.

Emergency Assistance

• • Provided to help members overcome balance of payments problems arising from natural disasters or post-conflict situations.
  • Such purchases involve no performance criteria and normally no phasing of disbursements.
  • Repurchases are made in 3½ to 5 years.
  • Facilities for Low-Income Countries
  • Structural Adjustment Facility (SAF) and Enhanced Structural Adjustment Facility (ESAF) provide resources on concessional terms.
  • They support medium-term macroeconomic adjustment and structural reforms.
  • Members develop a medium-term policy framework for three years, with IMF and World Bank assistance.
  • Programmes include quarterly benchmarks, and loans are repaid in 5½ to 7 years.
  • ESAF differs from SAF in scope, access, monitoring, and funding.

Systemic Transformation Facility (STF)

• • Created in April 1993 to assist transition economies from centrally planned to market-based systems.
  • Provided assistance for balance of payments needs due to disruption in trade and payments arrangements.
  • Access was limited to 50 per cent of quota, with repurchase terms similar to the Extended Fund Facility.

Conditionality

• • The Fund attaches conditionality to the use of its resources to ensure repayment without strain.
  • The degree of conditionality depends on the nature of the balance of payments problem.
  • Temporary problems require continuation of existing policies, while deep-seated problems require policy changes.
  • Conditionality evolved through practice, and in March 1997, the IMF adopted revised guidelines.

Special Drawing Rights (SDRs)

• • SDRs were created in 1969 to reduce reliance on gold or dollars.
  • Initially, 3.5 billion SDRs were allocated.
  • SDRs are fiduciary reserve assets allocated without conditionality.
  • SDRs form part of international reserves and are used in official transactions.
  • The SDR is the unit of account of the Fund.
  • Initially valued equal to one US dollar, SDR valuation later shifted to a basket of currencies.

Other Activities

• • The IMF provides a forum for consultation and collaboration on international monetary matters.
  • It collects and maintains up-to-date economic information on member countries.
  • It provides technical assistance, training, and research support.
  • Training is provided through courses and seminars at the IMF Institute.