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The International Monetary Fund (IMF) is an international organization that
provides financial assistance and advice to member countries. This article will
discuss the main functions of the organization, which has become an enduring
institution integral to the creation of financial markets worldwide and to the
growth of developing countries.
What Does It Do?
The IMF was born at the end of World War II, out of the Bretton Woods
Conference in 1945. It was created out of a need to prevent economic crises
like the Great Depression. With its sister organization, the World Bank, the
IMF is the largest public lender of funds in the world. It is a specialized
agency of the United Nations and is run by its 186 member countries. Membership
is open to any country that conducts foreign policy and accepts the
organization's statutes.
The IMF is responsible for the creation and maintenance of the international
monetary system, the system by which international payments among countries
take place. It thus strives to provide a systematic mechanism for foreign
exchange transactions in order to foster investment and promote balanced global
economic trade.
To achieve these goals, the IMF focuses and advises on the macroeconomic
policies of a country, which affect its exchange rate and its government's
budget, money and credit management. The IMF will also appraise a country's
financial sector and its regulatory policies, as well as structural policies
within the macroeconomy that relate to the labor market and employment. In
addition, as a fund, it may offer financial assistance to nations in need of
correcting balance of payments discrepancies. The IMF is thus entrusted with
nurturing economic growth and maintaining high levels of employment within
countries.
How Does It Work?
The IMF gets its money from quota subscriptions paid by member states. The size
of each quota is determined by how much each government can pay according to
the size of its economy. The quota in turn determines the weight each country
has within the IMF - and hence its voting rights - as well as how much
financing it can receive from the IMF.
Twenty-five percent of each country's quota is paid in the form of special
drawing rights (SDRs), which are a claim on the freely usable currencies of IMF
members. Before SDRs, the Bretton Woods system had been based on a fixed
exchange rate, and it was feared that there would not be enough reserves to
finance global economic growth. Therefore, in 1968, the IMF created the SDRs,
which are a kind of international reserve asset. They were created to
supplement the international reserves of the time, which were gold and the U.S.
dollar. The SDR is not a currency; it is a unit of account by which member
states can exchange with one another in order to settle international accounts.
The SDR can also be used in exchange for other freely-traded currencies of IMF
members. A country may do this when it has a deficit and needs more foreign
currency to pay its international obligations.
The SDR's value lies in the fact that member states commit to honor their
obligations to use and accept SDRs. Each member country is assigned a certain
amount of SDRs based on how much the country contributes to the Fund (which is
based on the size of the country's economy). However, the need for SDRs
lessened when major economies dropped the fixed exchange rate and opted for
floating rates instead. The IMF does all of its accounting in SDRs, and
commercial banks accept SDR denominated accounts. The value of the SDR is
adjusted daily against a basket of currencies, which currently includes the
U.S. dollar, the Japanese yen, the euro, and the British pound.
The larger the country, the larger its contribution; thus the U.S. contributes
about 18% of total quotas while the Seychelles Islands contribute a modest
0.004%. If called upon by the IMF, a country can pay the rest of its quota in
its local currency. The IMF may also borrow funds, if necessary, under two
separate agreements with member countries. In total, it has SDR 212 billion
(USD 290 billion) in quotas and SDR 34 billion (USD 46 billion) available to
borrow.
IMF Benefits
The IMF offers its assistance in the form of surveillance, which it conducts on
a yearly basis for individual countries, regions and the global economy as a
whole. However, a country may ask for financial assistance if it finds itself
in an economic crisis, whether caused by a sudden shock to its economy or poor
macroeconomic planning. A financial crisis will result in severe devaluation of
the country's currency or a major depletion of the nation's foreign reserves.
In return for the IMF's help, a country is usually required to embark on an
IMF-monitored economic reform program, otherwise known as Structural Adjustment
Policies (SAPs). (For more insight, see Can The IMF Solve Global Economic
Problems?)
There are three more widely implemented facilities by which the IMF can lend
its money. A stand-by agreement offers financing of a short-term balance of
payments, usually between 12 to 18 months. The extended fund facility (EFF) is
a medium-term arrangement by which countries can borrow a certain amount of
money, typically over a three- to four-year period. The EFF aims to address
structural problems within the macroeconomy that are causing chronic balance of
payment inequities. The structural problems are addressed through financial and
tax sector reform and the privatization of public enterprises. The third main
facility offered by the IMF is known as the poverty reduction and growth
facility (PRGF). As the name implies, it aims to reduce poverty in the poorest
of member countries while laying the foundations for economic development.
Loans are administered with especially low interest rates. (For related
reading, check out What Is The Balance Of Payments?)
The IMF also offers technical assistance to transitional economies in the
changeover from centrally planned to market run economies. The IMF also offers
emergency funds to collapsed economies, as it did for Korea during the 1997
financial crisis in Asia. The funds were injected into Korea's foreign reserves
in order to boost the local currency, thereby helping the country avoid a
damaging devaluation. Emergency funds can also be loaned to countries that have
faced economic crisis as a result of a natural disaster. (For a better look at
how economies make the transition from being state run to free markets, see
State-Run Economies: From Private To Public.)
All facilities of the IMF aim to create sustainable development within a
country and try to create policies that will be accepted by the local
populations. However, the IMF is not an aid agency, so all loans are given on
the condition that the country implement the SAPs and make it a priority to pay
back what it has borrowed. Currently, all countries that are under IMF programs
are developing, transitional and emerging market countries (countries that have
faced financial crisis).
Not Everyone Has the Same Opinion
Because the IMF lends its money with "strings attached" in the form of its
SAPs, many people and organizations are vehemently opposed to the its
activities. Opposition groups claim that structural adjustment is an
undemocratic and inhumane means of loaning funds to countries facing economic
failure. Debtor countries to the IMF are often faced with having to put
financial concerns ahead of social ones. Thus, by being required to open up
their economies to foreign investment, to privatize public enterprises, and to
cut government spending, these countries suffer an inability to properly fund
their education and health programs. Moreover, foreign corporations often
exploit the situation by taking advantage of local cheap labor while showing no
regard for the environment. The oppositional groups say that locally cultivated
programs, with a more grassroots approach towards development, would provide
greater relief to these economies. Critics of the IMF say that, as it stands
now, the IMF is only deepening the rift between the wealthy and the poor
nations of the world.
Indeed, it seems that many countries cannot end the spiral of debt and
devaluation. Mexico, which sparked the infamous "debt crisis" of 1982 when it
announced it was on the verge of defaulting on all its debts in the wake of low
international oil prices and high interest rates in the international financial
markets, has yet to show its ability to end its need for the IMF and its
structural adjustment policies. Is it because these policies have not been able
to address the root of the problem? Could more grassroots solutions be the
answer? These questions are not easy. There are, however, some cases where the
IMF goes in and exits once it has helped solve problems. Egypt is an example of
a country that embarked upon an IMF structural adjustment program and was able
to finish with it.
The Bottom Line
Providing assistance with development is an ever-evolving and dynamic endeavor.
While the international system aims to create a balanced global economy, it
should strive to address local needs and solutions. On the other hand, we
cannot ignore the benefits that can be achieved by learning from others.
by Reem Heakal