The International Monetary Fund And Global Economic Crises

Lending

The bad monetary and fiscal policies of a government may lead to a situation where there are balance of payment difficulties. A country may be unable to raise sufficient funds to meet net international payments. In the worst case, if there is no self-correcting mechanism in place, this situation may evolve into a crisis. The country currency may depreciate to great extents. This would not only damage the domestic economy but also lead to repercussions in other countries. To return the country's external payments position to health and to restore the conditions for sustainable economic growth, some combination of economic adjustment and official and/or private financing will be needed.

This is where the IMF comes in. It not only provides short-term assistance to tide the country over its imminent balance of payments problem but also advises on the economic policies that the country must adopt to make sure that the crisis does not evolve again.

The IMF has three different of lending policies that different implications in terms of the duration, repayment terms and lending conditions. They are also intended to address different types of balance of payment problems and the economic circumstances.        

1. Stand-by Arrangements are designed to deal with short-term balance-of-payments problems. A country may draw up to a specified amount, over a period 12-18 months.
2. Extended Fund Facility are intended for countries with balance of payments difficulties related to structural problems that are medium-term. A member country can draw up to a specified amount for 3-4 years a period to tackle structural macroeconomic problems.  
3. Poverty Reduction and Growth Facility aims at helping very poor member countries achieve economic viability, sustainable economic growth and improved living standards through subsidized low-interest loans.
4. Supplementary Reserve Facility is an additional short-term financing for countries that are experiencing a sudden loss of market confidence reflected in capital outflows, where the interest rate includes a surcharge over IMF’s usual lending rate.
5. Contingent Credit Lines is a source of short-term financing for countries that are suffering because of contagious economic situations that area fallout of another country’s problems.
6. Emergency Assistance is extended to cover certain situations that arise from sudden and unforeseeable disasters that are not necessarily due to the macroeconomic policies of the government.

Given below are the terms and conditions of the various lending facilities.

Although the IMF has defined arrangements falling under these heads, the economic policies will vary depending on the country’s circumstances. The IMF does not just lend money to help tide the country postpone its difficult decisions. It attacks the root cause of the economic ills that plague the country and seeks to solve them.

1. The IMF does not finance specific projects or developmental efforts. It lends to help member countries tackle balance of payment problems and achieve sustained economic growth by supplementing international reserves in the short to medium term.
2. IMF lending is conditional on policies: the borrowing country must adopt policies that promise to correct its balance of payments problem. The country and the IMF must agree on the economic policy actions that are needed. Also the IMF disburses funds in phases, linked to the borrowing country's meeting its scheduled policy commitments. The IMF requires that the borrowing country buy in on the policy framework suggested by the IMF.
3. IMF lending is temporary. Depending on the lending facility used, loans may be disbursed over periods as short as six months and as long as four years.
4. The IMF expects borrowers to give priority to repaying its loans. The borrowing country must pay back the IMF on schedule, so that the funds are available for lending to other countries that need balance of payments financing.
5. All but the low-income developing countries pay market-related interest rates and service charges, plus a refundable commitment fee. A surcharge can be levied above a certain threshold to discourage heavy use of IMF funds.
6. The IMF requires assessments of central banks' compliance with desirable practices for internal control procedures, financial reporting, and audit mechanisms.
7. Because of the confidence that the international lending community has on IMF’s policy framework for a borrower, although IMF provides only a relatively small portion of a country’s need, the borrower can usually obtain aid from other investors who are convinced that the country is now on the right track with regard to its economic policies.

Technical Assistance

The IMF provides technical assistance in its areas of expertise, which include fiscal policy, monetary policy, and macroeconomic and financial statistics. Assistance is normally provided free of charge. About three-quarters of IMF technical assistance goes to low and lower-middle income countries. Sub-Saharan Africa is currently the largest beneficiary of technical assistance. The following are the areas in which technical assistance is provided.

The recipient country is fully involved in the entire process of technical assistance, from identification of need, to implementation, monitoring, and evaluation.

What are the safeguards for IMF resources?

The IMF adopts policies that will establish adequate safeguards for the temporary use of the organization’s resources. These safeguards can be divided into those aimed at protecting currently available or outstanding credit and those focused on limiting the duration of, and clearing, overdue obligations.

Safeguards to protect committed and outstanding credit include:

1. Limits on access to appropriate amounts of financing, with incentives to contain excessively long and heavy use;
2. Conditionality and program design;
3. Safeguards assessments of central banks;
4. Post-program monitoring;
5. Measures to deal with misreporting; and
6. Voluntary services and supplementary information provided by the IMF, including technical assistance; the transparency initiative, comprising the establishment and monitoring of codes and standards, including statistical standards and codes for monetary and fiscal transparency and the assessment of financial sector soundness; and the improved governance initiative.

Safeguards put in place to deal with overdue obligations to the IMF include the following two broad areas:

1. Policies to assist members in clearing arrears to the IMF, including:

• the cooperative strategy, consisting of three components: prevention of arrears, collaboration in clearing arrears, and remedial measures, which are intended to have a deterrent effect, for countries that do not cooperate actively; and
• the rights approach, which allows a member in arrears to accumulate “rights” to future disbursements from the IMF.

2. Measures to protect the IMF’s financial position.

Why is the IMF criticized?

The Fund has been criticized for the conditionality of its support, which is usually given only if the recipient country promises to implement IMF-approved economic reforms. Unfortunately, the IMF has often approved “one size fits all” policies that, not much later, turned out to be inappropriate. It has also been accused of creating moral hazard, in effect encouraging governments (and firms, banks and other investors) to behave recklessly by giving them reason to expect that if things go badly the IMF will organize a bail-out. Indeed, some financiers have described an investment in a financially shaky country as a “moral-hazard play” because they were so confident that the IMF would ensure the safety of their money, one way or another. Following the economic crisis in Asia during the late 1990s, some policymakers argued for the IMF to be abolished, as the absence of its safety net would encourage more prudent behavior all round.

Who is affected by the conditional lending policies of the IMF?

Largely third world and developing countries. For example, Tanzania was forced to charge for hospital visits and school fees. Hospital treatment fell by 53% and the illiteracy rate soared. In Ecuador, the IMF ordered 26,000 jobs cuts along with a halving of real wages for the remaining workers. Meanwhile, it demanded the sale of the water system to foreign owners and an 80% increase in the price of cooking oil.

What is the rationale behind the policies?

The IMF is dominated by neo-liberal economics that decree countries are best served by making an easy fit with the world economy. Globalization allows them to provide products and services demanded by external markets and the theory goes bring in foreign investment. The removal of trade barriers and employment legislation makes the newly restructured countries more attractive to the multinationals.

Do these policies pay off for the affected countries?

GDP and life expectancy did rise in the last 50 years of the twentieth century, but global inequality is growing and besides some of these improvements took place in the days before the neo-liberal IMF, when per capita income grew by 74% in South America. At present, the rich nations are becoming richer and the developing world, crippled by debt repayment and "restructuring", has little control over its economic future much having already been surrendered.

But we do not know what would have happened to the developing world if the IMF had not given its assistance. The restructuring was after all - offered at times of economic crisis when previous models were judged to have failed, hit by rising oil costs and instability on the world financial markets.

The IMF in the context of Argentine Crisis

What factors led to the crisis in Argentina?

1. Increase in public sector indebtedness
2. Low share and high concentration of exports
3. Reliance on external savings
4. Lack of labour market flexibility
5. Heavy reliance on foreign-currency dominated borrowing
6. Political uncertainty

What was the crisis in Argentina?

1. Low consumer confidence
2. Exports would not help the recessionary situation due to the low share and high concentration of exports.
3. Labor market rigidity limited the adjustment of real wages and contributed to a sharp increase in unemployment which further eroded consumer confidence
4. The currency board regime of pegging the peso to the dollar precluded any monetary stimulus.

In December 2001, economic activity collapsed, with industrial production falling by 18 percent (year-on-year), construction by 36 percent, and imports by more than 50 percent. Tax revenues plummeted 17 percent (year-on-year) in the final quarter of 2001 (in December, tax collections fell by almost 30 percent, year-on year), and despite across-the-board spending cuts, the federal government ran an overall deficit of 4½ percent of GDP in 2001 against a (revised) program target of 2½ percent. Provincial finances also deteriorated, with the deficit widening to 2 percent of GDP against a program target of 1 percent. Moreover, out of Arg$17 billion of federal transfers to the provinces, about Arg$1 billion were in the form of federal guarantees of provincial treasury bills while the provincial governments issued about Arg$1.6 billion in provincial bills (quasi-monies) to pay wages and suppliers, some of which were acceptable by the federal government in lieu of tax payments.

What was the role of the IMF?

In January 2001, the IMF had already stepped in. An international support package of $40 billion was provided. Around $3 billion was released immediately. Additional packages of $1.3 billion was to be released during 2001 subsequent to reviews.

The objectives of the program were:

1. Economic growth through gradual fiscal consolidation
2. Improvements in tax enforcement.
3. Promoting private investment and competition in domestic markets

• elimination of tax disincentives
• continued implementation of already approved labor market reforms

But these and various measures of the government including a debt swap failed to restore the economy and consumer confidence. The IMF then decided to disburse $5 billion immediately pledging another $3 billion in support of debt restructuring.

The IMF came under severe criticism and was blamed for the crisis in Argentina. The Fund erred in its assessment of the Argentine economy by overestimating its growth potential and underestimating its vulnerabilities. This resulted in programs that were not very stringent.

The IMF in the context of Indian Oil Crisis

What factors led to the crisis in India?

1. Fiscal laxity and growing reliance on external borrowing
2. The Gulf War which increased India’s import bill dramatically due to increase in oil prices
3. Unstable coalition politics

What was the crisis in India?

1. Access to external borrowing was very costly and difficult
2. Even short-term credit was very elusive and expensive
3. Forex reserves dipped sharply and even fell below $1 billion.

By March 1991, the current account deficit in the balance of payments had touched a record level of nearly US$ 10 billion for the fiscal year 1990/91 or over 3 per cent of GDP. Exports were falling. The foreign borrowing spree had taken the ratio of short term external debt to foreign currency reserves to an astronomical 380 per cent. The debt service ratio soared to a new peak of 35 per cent. Foreign currency reserves skated close to a pitiful billion dollars throughout the spring and summer of 1991.

What was the role of the IMF?

India had to recourse to IMF financing. $1.8 billion was drawn in January 1991 under the Compensatory and Contingency Financing Facility and a First Credit Tranche arrangement. Under the stewardship of the IMF and Dr. Manmohan Singh, the following reforms were instituted:

Fiscal

• Reduction of fiscal deficit.
• Launching of reform of major taxes.

External Sector

• Devaluation and transition to a market-determined exchange rate.
• Phased reduction of import licensing (quantitative restrictions).
• Phased reduction of peak custom duties.
• Policies to encourage direct and portfolio foreign investment.
• Monitoring and controls over external borrowing, especially short-term.
• Build-up of foreign exchange reserves.
• Amendment of the Foreign Exchange Regulation Act (FERA) to reduce restrictions on firms.

Industry

• Virtual abolition of industrial licensing.
• Abolition of separate permission needed by “MRTP houses”.
• Sharp reduction of industries “reserved” for the public sector.
• Freer access to foreign technology.

Agriculture

• More remunerative procurement prices for cereals.
• Reduction in protection to manufacturing sector.

Financial Sector

• Phasing in of Basle prudential norms.
• Reduction of reserve requirements for banks, notably the cash reserve ratio (CRR) and the statutory liquidity ratio (SLR).
• Gradual freeing up of interest rates.
• Legislative empowerment of the Securities and Exchange Board of India (SEBI).
• Establishment of the National Stock Exchange (NSE).
• Abolition of government control over capital issues.

Public Sector

• Disinvestment programme begun.
• Greater autonomy/accountability for public enterprises.

Conclusion

While IMF-led reforms led to large-scale poverty and unemployment in Argentina, India’s recovery from the oil crisis has become IMF’s greatest success story. The IMF is criticized the world over, including India, as the hand-maiden of the US Treasury department. There has also been a much-publicized spat between the IMF and Joseph Stiglitz, the Chief Economist of the World Bank from 1997 to 2000. Stiglitz believed that the IMF ’s structural adjustment programs are often unduly deflationary, imposing tight fiscal and monetary policies. The abolition of the IMF has been called for. But the sympathetic maintain that the IMF should retain the role that it was formed to perform – the lender of last resort. It remains to be seen whether the IMF which has now found a Indian voice in Dr. Raghuram Rajan, the Chief Economist now, will reinvent itself as a champion of developing and poor countries with its latest programmes.