15 Finance: International Institutions (International Monetary Fund)

The International Monetary Fund (IMF) is widely regarded as the central institution of global financial governance. It takes a substantial role as the lead crisis lender in mitigating financial risk factors that are associated with high rates of globalization to prevent “cross-border financial contagion” (Larsen, 2001). With globalization at its peak, many countries are easily susceptible to the rippling effects of financial crises triggering financial instability. When this happens, the IMF steps in as the de-facto “international lender of last resort” and serves as a source of emergency funding to countries that have high debts and face the risk of default in payment (Fischer, 1999). The IMF is a huge institution with a broad range of member nations, employees, and funding sources. The institution has dedicated itself to its mission statement of, according to the homepage of its website, ensuring greater “global monetary cooperation, secure financial stability, facilitating international trade, promoting high employment and sustainable economic growth, and reducing poverty around the world” (IMF, 2023). Thus, the IMF’s role as the world crisis lender has transformed it to one of the most powerful multilateral institutions.

How the International Monetary Fund Works

Currency

Because the IMF is an institution that also oversees exchange rates, the money that enters its reserves cannot be classified as a form of currency; rather, it’s an asset. The IMF has created its personal international reserve asset called Special Drawing Rights (SDR) whose value is determined daily and is backed by five world currencies; US dollar, Euro, Chinese Yuan, Japanese Yen, and the British Pound (IMF, 2023). In order to be one of the five currencies that backs the SDR, there are two criterion that need to be met: export criteria, which requires that the nation must be an IMF member and one of the world’s top 5 exporters, and free use of currency, which requires that the currency be regularly used to make international payments and widely traded in principle exchange markets (IMF, 2023).

SDR is also very important when it comes to the number of votes a member country has within the IMF. Typically, each country has a set number of votes, but is able to gain additional votes, and overall influence in the IMF, for every 100,000 SDR that it contributes to the IMF reserves.

Funding

With the International Monetary Fund being thought of as a world lender, a question arises: where does this money, or SDR, come from? The IMF has three main ways of funding its reserves; member quotas, New Arrangements to Borrow (NAB), and Bilateral Borrowing Agreements (BBA) (see IMF website for more information about member quotas).^[1]

Member Quotas

The funding that brings in the most money to the IMF is member quotas. The quotas are assigned to each member country, which there are currently 190 of, by the IMF’s Board of Governors in what is called the Quota General Review and are based on its relative position of the member country in the world economy. This position is reevaluated in roughly five year intervals using the following formula to assess a country’s economic global standing:

(0.50 * GDP + 0.30 * Economic Openness + 0.15* economic variability+0.05* Foreign Reserves)

Evidently, as a country’s place in the world economy rises, so do their quotas. These quotas not only represent the financial commitment that the member country has to the IMF, It also dictates the country’s voting power, their access to IMF resources and SDR allocations. Quotas can also be amended on an ad-hoc basis. Most important was the 14th General Review of 2010 bc it had the largest quota increase and had considerable impact on major realignment shares (IMF, 2017). The 2020 quota reform is the latest, and evidently determined there was no need to increase member quota from the 2010 general review. Notably, the 2010 general was the most influential in IMF history since the review did recommend an increase in quotas of its member states to a combined SDR 477 billion (about US$ 659 billion) from about SDR 238.5 billion (about US$ 329 billion) from the previous quota that was initiated in 2008 (IMF, 2023).

New Arrangements to Borrow (NAB)

Multilateral borrowing, the second most influential form for IMF reserve, employs the use of New Arrangements to Borrow (NAB) which works as a credit arrangement between the IMF and creditors. Under NAB there are 40 participants composed of 40 IMF member countries and 2 institutions. Additionally, NAB is only activated in times where the IMF needs to supplement its quota resources for lending purposes (IMF Staff, 2020). However, 85% of creditors need to comply in order for NAB to be activated. The latest NAB reform, instituted in Jan. 2021, took effect following consents from NAB participants almost doubling its size to $521 billion for the period from 2021- 2025.

Bilateral Borrowing Agreements (BBA)

The bilateral borrowing arrangements are seen as a last-ditch effort after quotas & the NAB for the IMF to fill its reserves and maintain its 1 trillion lending capacity. These bilateral borrowing agreements are used to cause the onset of the global financing crisis. The IMF has arranged several borrowing agreements with leading institutions who are the creditors. Typically, these agreements have a term lasting three years which is also extendable for an additional year under the discretion of the creditor. The 2020 bilateral borrowing agreements are currently on track to include 42 creditors with 40 of them already proven effective, and prospective agreements with the remaining two underway garnering a total of SDR 135 million (US $ 193 billion).

Conditionality

To effectively enhance global financial security, a substantial variation in the lending policies of the IMF can be justified under the basis of conditionality. Conditionality is when economics and policy literatures come into play in determining the varied amounts a country can borrow and subsequently lend (IMF, 2023). It is through this that the institution takes into special consideration the design of the loan to be disbursed while simultaneously undertaking any policy adjustments to ensure longer-term debt sustainability and to further stimulate economic growth. In this case, conditionality are the policies the IMF expects a member to follow to get full loan credit (IMF, 2023). We can witness the bipolarity of these IMF loan programs; on one hand they are explicitly linked to amounts, depending on factors including the country’s GDP, and on the other they rely on implementation of certain conditions. There are several different types of conditionality in these IMF loan programs that depend on its content, degree to which it is binding, and specifics.

Indeed, the degree to which it is binding as well as the level of specificity advertently creates two major categories of conditionality; “hard conditions” which are more stringent and specific in nature, and may often require countries to implement significant policy reforms in short period of time, and “soft conditions” which are relatively less stringent providing countries with more flexibility on implementation and policy reforms (Edwards, 2011).

Hard conditions include performance criteria (PCs), which can be further subdivided into structural PCs, and prior actions (PAs) which typically are regarded as hard conditions as they are explicitly specified in IMF program documents as requirements that must be performed for the borrower country to receive full loan credit. PCs usually specify quantitative targets for key macroeconomic policy variables, such as limits on external borrowing, government budget balances, and international reserves (IMF, 2023). Furthermore, IMF programs have increasingly incorporated “structural” PCs which involve qualitative measures that include requirements such as privatization of state-owned enterprises, price control removal, reformation of social welfare policies, and bolstering national financial regulation (Mussa, 1999). On the other hand, Prior action (PA) requirements are measures that the country agrees to implement before accepting the loan.

The IMF also has other additional types of conditionality which are essentially non-PCs as they don’t quantitatively target macroeconomic policy tools, inherently making them less stringent. They include indicative targets which are non-binding on the borrower country and structural benchmarks which are like structural PCs but less stringent in that the “benchmarks” used are “measures that do not need to be monitored objectively enough to be PCs or for small steps in a critical reform process that would not individually warrant an interruption of Fund financing.” (Copelovitch, 2010) Adherence to these conditions are monitored by the IMF. It conducts periodic program reviews that occur at intervals of four to twelve months depending on the designated program length.

The International Monetary Fund (IMF) determines its lending policies based on two factors: liquidity, where the Fund provides financing to a country to help it pay off its debts, and moral hazard, which creates incentives for borrower countries and international lenders to take on more risk with the expectation that the IMF will provide future bailouts (IMF, 2023). The IMF weighs these factors to determine the amount of lending and concessions it provides to countries.

As the IMF makes its lending decisions, many economists have speculated about how it weighs this tradeoff. Existing literature suggests a couple of perspectives regarding the underlying thinking, including economic and political perspectives. From a purely economic standpoint, the IMF’s policy on the value of borrowing is contingent on the economic policies that rendered a borrower country bankrupt, as well as macroeconomic shocks resulting from capital flight by investors. However, other scholars argue preference heterogeneity is the key determinant of variation of IMF loan size and conditionality with the G5 countries exercising de facto control in the executive board hence acting collectively as its political principal (Copelovitch, 2010).

International Monetary Fund Loan Types

The IMF has several lending instruments or systems that are programmed to provide assistance or relief in critical situations. The main lending instruments can be categorized into two primary programs or “facilities” – the Stand-By Arrangement (SBA) and the Extended Fund Facility (EFF) (IMF, 2023). Whereas SBAs are designed to provide loan assistance on a short-term basis, EFFs are intended to assist countries facing longer-term crises, requiring implementation of more extensive reforms.

Countries from around the world draw on IMF credit in a variety of ways. In March 2009, the IMF established its current credit line, known as the Flexible Credit Line (FCL). The FCL was designed to promote flexibility and, to a lesser extent, offset the stigma of IMF borrowing. It allowed countries, particularly middle-income and low-income countries, to use this line of credit as a precautionary instrument to handle potential balance of payment needs without being subject to traditional IMF conditionality (IMF, 2010). This was designed to help governments, particularly middle- and low-income countries, in managing external vulnerabilities and reducing the risk of financial crises. The FCL enabled countries to draw on its credit line without certain conditions, as it is open to countries known to have strong policy frameworks as well as good track-records in economic performance (IMF, 2023). In this way, the FCL works as the renewable credit line providing a valuable backstop to countries facing imminent danger of regional financial crises

The IMF also issues concessional loans to lower income countries under the Poverty Reduction and Growth Facility (PRGF) which replaced two former policy instruments in the mid-1980s to late-1990s; the Structural Adjustment Facility (SAF) and the Enhanced Structural Adjustment Facility (ESAF) (Edwards, 2011). Generation of source funding for the Poor Reduction and Growth facility (PRGF) loans are primarily facilitated by payment of quotas.

History of the International Monetary Fund

1944 Bretton Woods Conference

Coming off of multiple economic disasters like WW1 and the Great Depression, there was a need for some form of economic stability as the long-standing gold-standard was showing obvious signs of weakness and was beginning to crumble. As a response to these shortcomings 44 countries came together at Bretton Woods, New Hampshire in 1944 for what would later be known as the Bretton Woods Conference or the United Nations Monetary and Financial Conference. These 44 countries came together with the intention of creating a new international monetary system which led to the drafting of the Article of Agreement, subsequently creating an international organization that would supervise the new international monetary system, hoping to promote world trade, investment and economic growth by maintaining stable exchange rates.

After ratification by 29 countries, the Article of Agreement entered into force in December 1945. Thus, the IMF was born, tasked with three main goals: “promoting international monetary cooperation, supporting the expansion of trade and economic growth, and discouraging policies that would harm prosperity” (IMF, 2023). Another notable outcome of the Article of Agreement was the establishment of the Bretton Woods system as the exchange rate standard that pegged the exchange rates for gold to the US dollar, with the IMF.

1956 Suez Canal Crisis

The first big test for the IMF came in October of 1956 with the Suez Canal crisis that involved Egypt, France, United Kingdom, and Israel (occupied Palestine). Previously, the IMF was mainly tasked with helping countries establish currency convertibility. That was until the Suez Canal closed as a result of Egypt nationalization of the canal in July of 1956 and France, the

United Kingdom and Israel took military action against Egypt in October (Boughton, 1997). By September the countries began to look to the IMF for financial assistance. Egypt requested that the IMF stabilize its economy after it had taken control of the Suez Canal. Israel requested assistance to offset the effects of repressed inflation as it was a new country and had yet to set a fixed exchange rate for its currency. France requested assistance as it had an abundance of financial burden related to previous wars and reduced agricultural ability due to climate conditions. Last to make a request from the IMF was the UK whose request differed from the others as they requested assistance not to avoid economic crisis but from the possible psychological impact of a political crisis on its financial markets (Boughton, 2000). In 1956-1957, beginning with the Egyptian credit, total drawings from the IMF reserve jumped to 1.7 billion, with the four participants of the Suez crisis loans totaling 989 million, roughly 60% of the total loans for the year (Boughton, 1997).

This event was what launched the IMF into a position of international leadership when it comes to crisis management. When faced with this very politically charged crisis, the institution was able to maneuver it with both a flexible, neutral stance and proved the importance of the IMF as well as showcasing its capabilities.

1971 Nixon Shock

On August 15th, 1971, U.S. President Richard Nixon unpegged the U.S. dollar to gold as part of one of his new economic policies to “defend the dollar”. In his speech “The Challenge of Peace ” Nixon asks that the U.S. secretary pause the convertibility of the U.S. dollar into gold or other reserve assets with the exception of conditions determined to be in the interest of monetary stability and of the best interest of the United States (Youtube, 2021). This evidently marked the end of the Bretton Woods system and the fixed exchange rate the IMF was initially tasked to oversee and be responsible for.

As a result of the death of the Bretton Woods System, the world turned to a new international monetary system with IMF members being able to choose from multiple forms of exchange arrangements that they feel would best fit their economic needs. These arrangements include; floating exchange rates, pegging their currency to another or a basket of currencies, adopting the currency of another country all together, participating in a currency block, or forming part of a monetary union (IMF, 2023). Additionally, since countries were no longer required to keep a rigid fixed exchange system, the original concern of currency manipulation arose once again. In this sense the original job of the IMF had not shifted, if anything the IMF’s job of exercising firm surveillance over its members’ exchange rate policies (Ghosh, 2021) became more important than ever.

1982 Debt Crisis

The Debt Crisis of 1982 was spurred by the rising inflation in the United States. With interest rates rising as a response, many developing countries that had taken out large amounts of loans were finding it difficult to impossible to make the payments they needed. This became evidently clear when Mexico defaulted on $80 billion in debt. While the crisis had started in Mexico, it spread to cover many developing countries. As a response, banks stopped many developing countries’ access to loans. This action further exacerbated the crisis, as these countries had been using these loans to pay off their previous loans as they had drastically increased due to variable interest rates rising. As a result, a plan needed to be put into place so that investors could get a portion of their capital back.

The IMF was in an ideal position for helping bring forward the needed changes. Through the short-term loans which helped with the liquidity issues, allowing time for structural reforms to take place. The long- term loans which were needed to resolve the overall crisis, however, came with changes that had to be made to receive the capital. These loans were known as conditional loans and provided a way to force the countries that needed major change to change. If a country ran a large deficit, it was less likely that they would be able to pay back the loans as the cost of the loans went up. In turn these conditions forced the cutting of the spending. Eventually, the crisis came to a halt due to the Brady Plan in 1989, but it was the IMF who was able to cushion the blow from many of the detrimental economic impacts.

Additionally, the crisis also marked a shift in the response in how the IMF set the conditions for their loans. Prior to the crisis the conditions mainly focused on macroeconomic measures (Gilpin, 2001). Following the crisis, the measures became more focused on structural problems and overall economic conditions.

1997 Asian Financial Crisis

As covered in chapter on the Asian Financial Crisis, the IMF played a role in resolving and reducing the crisis. The crisis was unlike the 1982 Debt Crisis as it was not due to the running of fiscal deficits, but rather a deficit in their current account. This meant that the response and conditions of IMF support also had to vary. Rather than the focus on changes to the spending of governments the goal had to be to address the problems that were plaguing their economies. The focus of “these reforms were designed to deregulate and liberalize the economy” (IMF Policies in Asia, 1999).

This crisis demonstrated the IMF shortcomings as it was not as successful at achieving its intended goals and implementing policy as it was in the 1982 Debt Crisis or the Suez Canal Crisis. This crisis demonstrated that the IMF was not omnipotent at achieving reform in countries that had a crisis. In these situations, if they attempted to achieve too much or went against an opposing government the reforms were either partially or entirely muted by internal politics.

IMF in Present Day

In recent times the International Monetary Fund has been essential in assisting countries that are on the verge of economic crisis caused by either flawed fiscal policy or war. At the time of writing, Argentina (SDR 33.2 Billion), Egypt (SDR 13.4 Billion), Ukraine (SDR 8.9 Billion) and Pakistan (SDR 5.5 Billion) are the biggest debtors to the IMF.

Argentina has continuously been one of the most indebted countries to the IMF due to its very complex economic standing over the years caused mainly by the country’s poor investment climate, high inflation and stale economic growth (Porzecanski, 2021). As of now Argentina is experiencing its fourth review of its current 30-month Extended Fund Facility Arrangement and approval of this will give the country access to an additional SDR 4 billion. The main concern that the IMF policies are working towards is updating the country’s macroeconomic framework. To do so Argentinian and IMF representatives have agreed to strengthen their fiscal policy by; implementing energy subsidies and better management of capital spending, proactive debt management, mobilization financing from multilateral and bilateral sources as well as focusing on the rise of inflation plaguing the country.

Egypt requires less assistance from the IMF than Argentina, and for a different reason. Egypt has been shifting from its former rigid exchange rate to one that has a bit more flexibility. In the past these rigid and heavily surveillance exchange rates were not working for the country and would often lead to imbalances in its foreign reserves and a large external financing gap. The large external financing gap was caused between projected demand and supply of foreign currency financing and demand to rebuild foreign central bank reserves (IMF, 2022). The IMF has been tasked with observing two-way movements of currency as well as supplying money to fix a large external financing gap. Conditions usually include development of privatization of the most profitable industries and greater transparency policies when it comes to state-owned and fiscal policies.

Egypt is undergoing a financial transition, but the IMF also helps nations that are undergoing turbulent events like wars. Considering the current Russian-Ukrainian War, the Ukraine government has requested assistance from the IMF to offset the public debt, fiscal deficit, and social impact the country is experiencing. Apart from the standard IMF assistance, because of the highly uncertain outcome the country is currently facing, Ukraine was able to be approved for the IMF’s Upper Credit Tranche (UCT) which lends additional funds to countries in dire need. As far as policies that the IMF is implementing to help Ukraine there is a focus on debt sustainability, financial stability with an emphasis on disinflation and lastly establishment of anti-corruption institutions that will help promote public trust and overall governance of the country.

The Russian-Ukrainian war affects more than just those two nations. For roughly a decade Pakistan has been dealing with a currency crisis due to the rapid devaluation of the Pakistani Rupee caused by the shift from formal currency exchange to one determined by the market, a drop in the country’s foreign reserve, trade deficit, inflation and debt (Humza, 2023) and as of recently there are perceived spillover effects from the Ukraine war afflicting the country. To offset all of these economic strains, the country has often turned to the International Monetary Fund for assistance with the most recent request coming in August of 2022. The IMF accepted the countries request and stated in the September 2022 press release that although the EFF commitments that were agreed upon were poorly implemented the Pakistani government was taking the steps necessary to ensure proper application and would be receiving IMF assistance. The commitments the Pakistani government agreed to include employing new tax measures, limiting spending, strengthening of the energy sector, reduction of poverty and protection of those who are the most vulnerable to the economic crisis.

Criticisms of the International Monetary Fund

The role of the IMF as head of global financial governance has been viewed critically by renowned economists. They accuse the IMF of failing to maintain global financial stability, misdiagnosing causes and solutions of financial crises, exacerbating poverty in the developing world, and catering to the demands of developed countries and Wall Street bankers. Most criticisms of the IMF generally stem from two key areas of its operation – conditionality and implementation.

Some field scholars speculate that reduced conditionality for certain states stems from the geopolitical logic of US and its foreign policy allies receiving more favorable treatments as “valued clients,” like Germany, France, the UK and Japan (Copelovitch, 2010). Other scholars cite the ‘principal-agent’ theory which portrays the IMF staff as “rent-seeking bureaucrats” whose engagement in lending guarantees them more generation of capital reserves as countries pay back with interest (Breen, 2013).

We can see the conflicts surrounding the conditions imposed by the IMF and their perceived unequal application in the Thai financial crisis of 1997 and their reaction to the US financial crisis of 2008. One of the IMF conditions for Thailand in 1997, which was characterized as a recommendation, was bankruptcy reform. This bankruptcy reform pushed by the IMF “curbed state support for debt-stricken firms. That led to strings of bankruptcies and thousands of job losses” (Cropley, 2008). This reform was not met with enthusiasm. There was fierce opposition from many in Thailand, although in the end the legislation was passed. The role the IMF played in what many see as forcing harmful change in Thailand is still a sore subject. When America faced its own financial crisis in 2008, the reaction from many in Asia regarding the steps taken by the government and the IMF were bitter. “This Hamburger Crisis is showing the hypocrisy and the true color of the West, from the World Bank to IMF to the United States,” Thai Business Radio FM 98 host Danai Ekmahasawadi said (Cropley, 2008).

Issues in implementing the changes recommended by the IMF look different for different countries. Let us return to our example of Thailand in 1997. The implementation of IMF suggested reforms were rapid in some areas and limited in others. Thailand had conformed to most recommendations made by the IMF, as they had closed 58 financial institutions involved in the crisis. However, not every recommendation was fully followed. This shows that the IMF had limits at achieving its goals. The Heritage Foundation sums it up quite well that “even when a government is genuinely committed to implementing reform, as it [was] in Thailand, progress can be slow” (O’Driscoll, 1999).

This issue of implementation was echoed in Indonesia’s response to the IMF. Indonesia was in a period of violent political upheaval when the IMF came into the country, and the reforms were considered harsh by many (O’Driscoll, 1999). This resulted in little reform actually being done.

We can see that the IMF is not always able to institute reform in countries which have had a crisis. In these situations, if they attempt to achieve too much or go against an opposing government, reforms may be either partially or entirely muted by internal politics. When a country does not want to make the changes recommended by the IMF, or is unable to make them, the IMF does not hold any actual power to force them. The reforms in Indonesia demonstrated that even with compliance to some measures, others that may be more politically risky may not be achieved.

Conclusion

The International Monetary Fund was created out of the ashes of war and economic depression, to provide cooperation and help rebuild economies. What began as a venue to share economic knowledge became one of the most powerful tools in our global economic arsenal. Over the years the IMF has adapted to new economic environments and implemented innovative strategies to keep our global economy from disaster.

This chapter covered how the IMF works, including the currency it uses, how it sources its funds, its requirements for member states, and the loans it gives out. The IMF includes a broad variety of countries, each with their own unique issues and needs (see Figure 14.4). You learned about how the IMF has addressed those needs historically, and the measures it continues to take today. In addition, the IMF is in a constant state of evolution, and its operations can shift drastically over time. You can now understand how the IMF began, and how it reached its current policies.

Fig 14.4. The IMF family: Circle of national flags (World Bank, 2023), which is the emblem of the meetings of the World Bank Group and the IMF.

Can the IMF evolve enough to continue its relevance in a world that is increasingly turning away from constraints placed on the global economy? The whims of the IMF have struck many as exclusionary and US-centric. Nations feel constrained by the IMF’s policies of “conditionality” and there have been increasing arguments over what some nations perceive to be unequal application of IMF rules (Copelovitch, 2010).

Beyond common criticisms of the IMF, it is true that general member support due to other global factors is decreasing. We see a decrease in Western influence on the international economy as Asian nations increasingly generate global output and tensions between key nations like the US and China rise. China is increasingly attempting to situate itself as a competitor to the IMF on the global stage. It gave large scale loans to the Global South in the mid-2000s and has begun to present itself as a new option for countries that would rather not turn to the IMF and its conditional lending policies for help (Sundquist, 2021). This tension impedes the cooperation that is central to the success of the IMF and brings with it a more general global shift away from liberalized globalization and towards more inward, nation-specific economic policies. This shift reduces the efficacy of the IMF, as it requires widespread member support and participation to succeed (Wolf, 2019). As the US, one of the key participants in the IMF, increasingly turns towards populist politics and protectionism, the IMF may not be able to adapt sufficiently.

General global evolution will also force the IMF to adapt quickly or suffer the consequences. Technology brings with it rapidly shifting complications for the International Monetary Fund, including massive shifts in labor markets and the dangers of cybersecurity attacks (Wolf, 2019). Ballooning global debt also underpins an increasingly unstable global financial system.

That said, the historical track record of the IMF cannot be disputed, and its greatest asset is exactly its capability to adapt and change. Perhaps someday an increasing rejection of globalization and international tensions will bring an end to the IMF, but as things stand now, the International Monetary Fund is a cornerstone of global financial governance, and its impact on the global economy is profound.

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