Imf Explained

8/12/2019 Imf Explained

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The Role and Evolution of theInternational Monetary FundEsteban Ugalde

Introduction

During the Great Depression (1929 1938 in the United States) many

countries tried to raise barriers to foreign trade in an effort to help their

failing economies. These attempts were useless and caused world trade

to decline drastically, leading to a drop in employment and living

standards in many countries. This led to the 1957 founding of the

International Monetary Fund (IMF), an institution charged withmanaging the international monetary system (the system of exchange

rates and international payments that enables countries and their

citizens to buy goods and services from each other). The goals of this

organization were to ensure stable exchange rates and encourage all

member countries to eliminate exchange rate restrictions that got in the

way of international trade.

The Work of the IMF

The work of the IMF occurs in three main ways. When a country

becomes a member of the IMF, this country makes a pledge to use

policies that will encourage economic growth and price stability so that

the desire to gain an unfair competitive advantage by manipulating

exchange rates can be avoided. The IMF monitors the countrys

economic policies to identify weaknesses that could cause financial or

economic instability. This process is known as surveillance.

Secondly, the IMF provides technical assistance to member

countries by helping them to manage their economic policy and


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financial affairs productively. The IMF does this by helping countries to

reinforce their human and capital resources, and by proposing

appropriate macroeconomic financial re-structuring policies.

Finally, the IMF is most well-known for its work with lending

to member countries. A country with serious financial trouble that is

unable to pay its international bills could be a potential problem for the

global international financial system. The IMF was created to protect

countries from this international financial problem; it was created to be

a lender of last resort. Any member country can go to the IMF for loans

if the member country displays a balance of payments need. This means

that the member country does not have necessary resources in the

capital markets to make its international payments and keep a safe level

of assets.

The Lender of Last Resort

The IMFs main framework deals with this lending. If the IMF did not

lend, many countries would be in financial crisis. The IMF uses aspecific process in order to approve a loan to a member country. An

IMF staff team travels to the member country in need of a loan. Once in

the member country, the team members and the countrys leaders will

assess what the financial needs of the member country may be.

As soon as an understanding of the financial needs has been

reached an IMF officer formulates a financial package that will aid the

member country to bring its capital back to a competitive level. Once

this financial package has been prepared, the package is then sent to the

IMFs executive board to review. When the executive board agrees on

the package the loan is disbursed to the member country. IMF lending

gives breathing room to countries so they can put into practice policies

and reforms that will restore strong and sustainable growth,

employment, and investment.In the 1980s the IMF was a lender of last resort for most of the

developing countries at the time. Many of the developing countries have

applied for loans during this financial crisis as well, making specific

arrangements with the Fund. The most common arrangement that


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developing countries have with the IMF is a precautionary arrangement,

which means they will not draw from the Fund unless it is needed

(About the IMF, n.d.). For example, Jamaica signed a 1.3 billion dollar

loan with the IMF hoping that it can address the countrys economic

imbalances and give the country a sustainable growth. This

arrangement made by the Jamaican government and the IMF will only

be accessible if Jamaica cannot cover their international debt.

Many of the financial needs that come from countries like

Jamaica have come from an increase in imports and a decline in exports.

But the biggest problem many of the Caribbean, and low income,

countries face is mismanagement of, and consequent decline in, tourism.

Additionally, many other low income countries that have depended on

tourism from the recently weakened United States and European

markets, have experienced a decline in those revenues. This has in turn

created problem for these countries to serve their external debts.

After the recent global financial meltdown (2007-2009), many

more developed countries have exercised their right to borrow from theIMF; most recently Greece and Ireland have borrowed from the IMF.

This has happened because, for many of the developed countries, an

end to the recession is not in sight.

Industrial countries with strong economies borrowed money

from the IMF in the 1900s to help them advance in technology and

other things that would help those countries to be competitive in

international markets. The vast majority of these industrial countries

did not find the need to borrow from the IMF after they paid back their

initial loans because their economies seemed stable and able to meet

their international financial duties.

During the recent global economic downturn, several

industrialized countries had to resort to the IMF for help. As noted, one of

these countries has been Greece. Greece has experienced financial needfollowing years of much low cost borrowing and little fiscal discipline; the

government was continuing in its practice of not reinforcing financial

reforms when the global economic downturn struck.


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Figure 1, below, shows Greeces economic problem indicators.

In 2005, Greece had the highest budget deficit and it was projected to

return to this level in 2009. This graph also displays Greeces public

debt. In 2005, the public debt was 98.5% of their GDP. The next two

years this public debt was reduced marginally, but grew again in 2008

and it was projected to go as high as 103.4%. Greeces debt has reached

close to $413.6 billion, which is bigger than the countrys economy and

the biggest debt that has been seen in a European country in years.

Figure 1. Budget Deficit Changes and National Debt

Figure 2 illustrates that the actual deficit as a percentage of GDP rose

alarmingly in 2009, far higher than projected as Greece was caught up

in the world wide recession. These numbers, combined with conditions

in credit markets, assured that Greece access to financing on private

markets would be extremely limited and very expensive. These

conditions led to application for an IMF loan.

GREECE; ECONOMIC INDICA!OR

B"DGE! DEFICI!B"DGE! DEFICI! P"BLIC DEB!P"BLIC DEB!

(A % OF GDP):(A % OF GDP): (A % OF GDP):(A % OF GDP):

2005 -5.1 98.8

2006 -2.8 95.9

2007 -3.6 94.8

2008 -5.0 97.6

2009 -5.1 (,''&) 103.4 (,''&)

SOURCE: Eurostate C1:3*()5 SRAFOR 2009 888.SRAFOR. $


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Figure 2. Impact of the Great Recession on Greece

Source: Edward Hugh, So Whats It All About, Costas? Global Economic

Perspectives, Greece Economy Watch, December 14, 2009, available

at http://greekeconomy.blogspot.com/2009/12/so-whats-it-all-about-costas-html(accessed March 15, 2010).

IMF Policy

Any country that is entering the lending process with the IMF needs to

go through a process. As a part of this process, the country must agree

to follow all IMFs policies, which include monetary austerity, fiscal

austerity, privatization, and financial liberalization. Monetary austerity

means a tightening up the nations money supply designed to increase

internal interest rates to whatever level is deemed necessary in order to

stabilize the value of home currency (About the IMF, n.d.). This form of

policy is likely to have the effect of raising domestic returns, but is likely

to put downward pressure on the countrys GDP. Also, this policy will

force the exchange rate to decrease, making the currency in this countryappreciate. This will eventually benefit the countrys economy by making

their currency stronger relative to other currencies, allowing its citizens

and businesses to import at lower cost (Feenstra and Taylor, 2007).

Year

-14.0

-12.0

-10.0

-8.0

-6.0

-4.0

-2.0

0.0

200920

0820

0720

0620

0520

0420

032002

2001

2000

-3.7-4.4

-4.7

-5.6

-7.5

-5.1

-3.1

-3.7

-7.8

-12.7

Greeces Fiscal Deficit

PercentageofGDP


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The second policy, fiscal austerity, is the imposition of fiscal

discipline within the country by increasing tax collections and reducing

government spending drastically (About the IMF, n.d.). This policy is

designed to limit interest rate increases caused by monetary austerity,

reign in excessive government spending, and eventually lead to an

interest rate drop, based on reduced government debt load. This should

cause GDP to grow and will make domestic investment more appealing

(Feenstra and Taylor, 2007).

The next policy, privatization, is related to fiscal austerity; this

policy requires the sale, and oversight of sales, of public enterprises to

the private sector. This policy is designed to help the borrowing

countrys markets run freely, without government intervention. The

final policy, related to privatization, is financial liberalization. Financial

liberalization is implemented to do away with restrictions on the inflow

and outflow of international capital as well as restrictions on what

foreign businesses and banks are allowed to buy, own, and operate.

This policy is designed to encourage international market investmentin the country, though in a managed way so that the countrys currency

does not drop in value. Only when all of these policies are met will the

IMF let the member country borrow money from the Fund to cover

international loans that would be due and otherwise unpayable

(About the IMF, n.d.).

The Debate Regarding the Impact of IMF Policies

Do these policies really help countries? Is there such a thing as one

economy fits all? Many people have argued that the IMF involvement in

many poor, low income countries has hurt them drastically in the past.

Under the guiding hand of the IMF, national income in most African

countries income dropped by 23 percent (Shah, 2010). This is not the

only difficulty that low income countries face.Also when low income countries get involved with the IMF,

the policies implemented by the Fund often undermine fledgling

democracies in those countries by preventing their governments from

making important investments for their people. Low income countries


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often require investment in health, education and infrastructure before

they are able to compete in the international markets. IMF policies

remove a governments ability to make such investments, while forcing

low income countries into competition in the international markets.

These low income countries are not capable of competing in

international markets on an equal footing with developed nations.

For this reason, many argue that the IMF undermines the economic

development of low income countries and ignores the needs of citizens

of these countries. According to the United Nations International

Childrens Emergency Fund (UNICEF) over 500,000 children in the late

1980s died under the IMFs structural adjustment programs because

many of these programs required the termination of price supports and

essential food-stuffs (Shah, 2010). As George (1988) has written, The

IMF cannot seem to understand that investing in [a] healthy, well-fed,

literate population is the most intelligent economic choice a country

can make.

IMF policies also encourage all of its member countries thathave made loan arrangements with it, to export; free trade is a major

goal of the IMF. But for a developing country export will likely mean the

export of raw materials, again discouraging domestic development of

industry, which in turn limits the overall export exports of a nation.

Figure 3 illustrates the export history of several African nations relative

to those of the United States.


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Figure 3. Exports of Several African Nations versus those of the US

Source: IMF Balance of Payments from 2009 Yearbook

The figure illustrates the limited international involvement of these

countries, where most exports are in fact raw materials, often oil. The

encouragement, by the IMF, of export behavior has a different impact

on low income countries than it does on developed nations.

A similar contrast can be seen when comparing specific

developed nations, however. Figure 4 illustrates exports for China, the

United States, and several European Union nations, all developed

economies. For several European Union countries, a request for loans

from the IMF has become necessity during the current economic

downturn; if not for actual loan arrangements, some nations have feltthe need to formulate backup plans with the IMF should their own

austerity initiatives not be sufficient to encourage international

investments.

As discussed previously, one example of this is Greece. This

nation has a very large GDP compared to countries like the African

nations discussed above and, as a member of the European Union (EU),

could have the support of the EU if necessary. Greece has had debt

related difficulties, however, that have gone beyond what could be

supported by the EU only and has had to resort to going to the IMF for

financial relief. The IMF and Greece came to an agreement in the

spring of 2010; in this agreement the IMF committed to becoming


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involved only on the condition that the EU would be willing to work

with Greeces debt as well. In Figure 4, it is illustrated that Greeces

exports compare to those of its healthier developed peers in much the

same way that African nations compare to the US.

Figure 4. Export Data for Greece, the United States, China, and

other European Union Members

Source: IMF Balance of Payments from 2009 Yearbook

As the figure shows, most of the other nations featured have seen great

increases in their exports, as compared to Greece. The unique situation

faced by other members of the EU is that this economic crisis faced by

Greece will ultimately have a negative effect on other EU member

nations as well, as all member nations share the Euro currency. This

means that an extreme current account deficit in Greece could create a

current account deficit to be experienced by the Union as a whole. A

nations current account measures current international activity and

broadly measures that nations trade deficit; that is exports minus

imports. Where exports minus imports results in a negative value, this

deficit will drag down the nations GDP. That Greeces deficit could becontagious for other EU nations, and drag down the Euro zone overall,

makes its situation desperate far beyond its own national borders.

Figure 5, below, shows Greeces current account deficit and how it is

projected to go lower in the years to come.


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Figure 5. Greece Current Account Projected through 2011

Source: Edward Hugh, The IMF Is Ready to Help Greece If AskedSo Why Not Ask

Them? Global Economic Perspectives, Greece Economy Watch, January 5, 2020,

available at http://greekeconomy.blogspot.com/201-/01/simf-is-ready-to-help-greece-if-asked-so.html (accessed March 15, 2010).

The IMF policies are designed to trigger growth in the Greek economy

and bring down the current account deficit. It remains to be seen

whether the experience of Greece will resemble that of its fellow

developed nations in the past, or whether it will look like the experience

of those African nations that have not yet become fully participating

international players. During the current crisis, however, reducing the

current account deficit provides Greece and its fellow EU member

nations some breathing room. A similar argument can be made for

Ireland, a more recent recipient of IMF intervention.

Emerging MarketsThe role of IMF as a lender of last resort in the global financial system

has been recently challenged by emergence of new economic

powerhouses. The Great Recession (2007 2009) has been the biggest

financial crisis since the Great Depression and many markets have

Greeces Current Account Deficit

Ann

ualPercentageofGDP

-16

-14

-12

-10

-8

-6

-4

-2

0

Year

2011

2010

2009

2008

2007

2006

2005

2004

2003

2002

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1999

1998

1997

1996

1995


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suffered greatly from it. Certain countries have emerged out of this

financial crisis however, more quickly and strongly, and have the

capacity to help the international economy substantially. The most noted

of these countries are the BRICs, Brazil, Russia, India, and China. These

BRIC nations hold close to 40 percent of the population and also hold

25 percent of the global GDP (Lettieri and Raimondi, 2009). Figure 6

illustrates projections of the combined GDPs of the BRICs nations

relative to the historic economic powerhouse of the G6 nations (France,

Germany, Italy, Japan, the United Kingdom, and the United States). As

illustrated, the BRIC nations will surpass the GDP of the G6 nations in

less than forty years, making the BRICs the biggest emerging economies

in the world.

Figure 6. GDP of the BRICs Nations as Compared to the G6

Source: IMF World Economic Outlook

In a slightly broader view, from the IMFs own data, figure 7 illustrates

GDP growth rates, emerging nations as compared to developed nations.

The emerging economies have surpassed the developed countries in

their annual GDP growth by close to five percent and in the future theycould eventually double their growth.

BRICs Have a Larger US$GDP Than the G6in Less Than 40 Years

GDP(2003 us$bn)

2000 2010 20302020 2040 2050

100,000

90,000

80,000

70,000

60,000

50,000

40,000

30,000

20,000

10,000

0

BRICs

G6 2025: BRICs

economies

over half as

large as the G6

By 2040:BRICS

overtake

the G6


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Figure 7: GDP Growth Rates, Emerging Nations Compared to

Developed Nations

Source: IMF World Economic Outlook

What is significant about the economies of emerging nations, relative

to the experience of developed nations, is their different, and often far

smaller, reliance on exports. In Brazil and India, exports accounted for

less than 15 percent of their GDP in 2008 (Lettieri and Raimondi, 2009).Even China, the largest of the BRIC economies suffered a 25 percent

decline in exports in 2008, but the economy still grew six percent by the

first half of 2009. India also had a four percent growth, excelling in the

export of textiles and electronics, but sharing with the other BRICs

nations an increased reliance on domestic investment. BRIC nations are

an essential part of the international economy and are demanding

changes in the IMF.

As they make these demands, the BRIC nations are not tying their

own economic welfare exclusively to that of the large developed nations,

but instead are working independently and trying to maintain a close

relationship with one another. An illustration of this can be seen in Figue 8

which shows Brazils changing trade status. Brazil is moving away from

exports relying greatly on the United States; instead Brazil is exporting far

more to China now, increasing its ties with the Chinese economy.

AnnualGDPGrowthRate(%)

8%

7%

6%

5%

4%

3%

2%

1%

0%

Developed Emerging

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007


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Figure 8. Brazils Exports to the US and China

Note: 2009 data thru Oct. Source: Bra!il Ministr of Development, Industr, and Commerce.

BRICs Demands to the IMF

Among their demands to the IMF, is the BRIC demand that the IMF bereorganized in such a way that the greater economic power of BRICs

nations be recognized by giving a greater voice to BRICs nations. The

ability of the BRICs nations to bring pressure to the IMF stems from the

IMF need for more financing to meet demands brought on by the great

recession. The IMF has had to raise over 1 trillion dollars from its

member countries. BRICs nations, unlike other nations, have this kind

of capital during these economic times and have used their ability to

control financial assets to gain more voting power. These gains are not

proportionate, however, to the economic gains, existing and projected,

of the BRICs countries.

Nations from the historic leading member countries of the IMF

have not been quick to recognize a new world order and other demands

made by the BRICs countries have been paid little attention by worldleaders. Even if the BRICs are the main countries to drive global

economic recovery, giving them an increased role in the IMF would

make their international influence substantially greater than is deemed

desirable by many of leaders of the G-20. The Group of Twenty (G-20)


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Finance Ministers and Central Bank Governors was established in 1999

to bring together systemically important industrialized and developing

economies to discuss key issues in the global economy; this group

includes the BRICs nations but works closely with the European led

IMF and US led World Bank (What is G-20, n.d.). This ongoing debate

about how much influence should be wielded by the emerging

economies is likely to continue.

In addition, there is the BRIC request that the international

monetary system move away from one based on the US dollar, to a

system based on a market basket of currencies. BRIC nations hold

a great deal of US dollar denominated reserves, based on the current

structure of the IMF, and are vulnerable to a decline in the value of the

dollar. Several BRIC countries have raised the issue of moving away

from the dollar (and US influence), most clearly China; other nations,

specifically Iran has announced its intention of holding its reserves in

Euros and gold (Boyle, 2010). The call to restructure the IMF to better

reflect a new economic order has not only been made by BRICs nations,but this group is increasingly making its voice heard in the IMF and

world groups.

The IMF Post Crisis: Conclusions

As time passes and the extremes of the Great Recession recede, the IMF

still recognizes the huge issues facing the world economy. In advanced

economies, financial markets are still acting with great caution,

especially in reference to sovereign debt. Banks in those nations have

been slow to increase lending to the degree that unemployment may

be driven down and economic growth can gain momentum.

The historic mission of the IMF to make loans to developing

nations has been recognized as insufficient by many member nations.

Currently, IMF focus has been on rebalancing world trade betweendeveloped nations which often are deficit nations, and the emerging

economies, which are generally surplus nations. This focus does not

generally jibe with that of emerging nations, especially China and Brazil.


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The IMF mission of providing relief to countries in trouble is

an essential part of the international economy. The IMF, acting as

lender of last resort, provides breathing room for many countries during

times of economic crisis, but the lesser role allowed to emerging

economies and the IMF approach of one economy fits all is outdated.

A reorganized IMF, one that is not as Euro and US-centric and

recognizes the legitimacy of its critics, would better fulfill its mission

as enabler of world trade and interaction.

References

About the IMF. (n.d.). International Monetary Fund website. Retrieved April 5

2010, from http://www.imf.org/external/about.htm

Bird, G. (1995). IMF lending to developing countries: issues and evidence.

New York: Routledge.

Boyle, J. (Dec. 29, 2010 Jan. 4, 2011). Brazil new contributor to IMF. The Rio

Times, Issue LXXXXIV - Weekly Edition: December 29 - January 4, 2010.

Retrieved December 30 2010, from http://riotimesonline.com/brazil-

news/rio-politics/brazil-new-contributor-to-imf/

BRICs show new influence at G-20 finance ministers meeting. (2009). Bridges

Weekly Trade News Digest, 13(10), Retrieved April 20 2010, from web.

Emmanuel. (2009, April 27). What BRICs want from IMF in exchange for $750b.

Retrieved from http://ipezone.blogspot.com/2009/04/what-brics-want-from-

imf-in-exchange.html

Feenstra, R. and Taylor, A.M. (2007). International macroeconomics. New York:

Worth Publishers.

George, S. (1988).A fate worse than debt: The world financial crisis and the poor.

New York: Grove Weidenfeld.

The IMFs approach to international trade policy issues. (2008, June 13).

Retrieved from http://www.ieo-imf.org/eval/ongoing/Trade_IP.pdf


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Will IMF loans hurt the poor this time around?(2009, February 13).

Retrieved from http://www.brettonwoodsproject.org/art-563607

Jidong, D, & Yang, A. (2010, April 16). BRIC has growing world influence.

Retrieved from http://www.chinadaily.com.cn/china/2010-

04/16/content_9737299.htm

Lettieri, M, & Raimondi, P. (2009, July 22). BRICs drive global economic recovery.

IMF Survey Magazine: What readers say. International Monetary Fund.

Retrieved May 1 2010, from

http://www.imf.org/external/pubs/ft/survey/so/2009/rea072209a.htm.

Presto: another $750 billion. (2009, April 19). The Wall Street Journal, Retrieved

from http://online.wsj.com/article/SB123966889497015459.html#

Roff, P. (2009, June 5). Democrats shouldnt put IMF bailout over troops. U.S.

News, 1, Retrieved from http://www.usnews.com/opinion/blogs/peter-

roff/2009/06/05/democrats-shouldnt-put-imf-bailout-over-troops

Shah, A. (2010, February 20). Structural adjustmenta major cause of poverty.

Retrieved from http://www.globalissues.org/article/3/structural-adjustment-a-major-cause-of-poverty

Thomas, A. (2009, March 11). Financial crises and emerging market trade.

International Monetary Fund. Retrieved from

http://imf.org/external/pubs/ft/spn/2009/spn0904.pdf

Truman, E. (2009, January 23). The IMF and the global crisis: role and reform.

Retrieved from http://www.iie.com/publications/papers/truman0109.pdf

What is G-20. (n.d.) About G-20. Group of Twenty. Retrieved April 14, 2010, from

http://www.g20.org/index.aspx

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Imf Explained