Note4Students
From UPSC perspective, the following things are important:
Prelims level: IMF and its bailout packages.
Why in the News?
Argentina faces one of the world’s highest inflation rates and a decade-long economic stagnation.
- The International Monetary Fund’s (IMF) earlier decision to release $4.7 billion from a $57 billion bailout package to Argentina, despite missed targets, raised eyebrows.
IMF’s Controversial Decision:
- The IMF dispersed $4.7 billion, including overdue and advanced payments, to bolster President Milei’s nascent government.
- This move contradicted IMF guidelines requiring adherence to economic conditions, signaling geopolitical influence and strategic support.
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Argentina’s Economic Struggles
- Persistent fiscal deficits and chronic inflation have plagued Argentina, with historical inflation averaging 190% from 1944 to 2023.
- The government defaulted on sovereign debt nine times, exacerbating economic instability.
- Since 2009, fiscal deficits persisted, reaching 4.4% of GDP in 2023, fueled by overspending and reliance on the inflation tax.
- Milei’s administration targets fiscal reform to eliminate large deficits, contrasting with past failed attempts like the Austral Plan.
- Alfonsín launched the Austral Plan, an austerity program that implemented a new currency (the austral), wage and price controls, and currency devaluations.
IMF and its Bailout
- The IMF is an international organization (190 member countries) that provides loans, technical assistance, and policy advice to member countries.
- Established in 1944 to promote international monetary cooperation, exchange rate stability, balanced economic growth, and poverty reduction.
- Hq: Washington, D.C.
- An IMF bailout, or an IMF program, is a loan package provided to financially troubled countries.
- Bailout programs have specific terms and conditions that borrowing countries must meet to access the funds.
Types of IMF Bailout Packages:
|
Description |
Duration |
Conditionality |
| Stand-by Arrangements |
Short-term lending programs for countries with temporary balance of payments problems. |
1-2 years |
Specific macroeconomic policies for stabilization |
| Extended Fund Facility |
Medium-term lending programs to address balance of payments difficulties from structural weaknesses. |
Longer-term |
Extensive conditionality and significant reforms |
| Rapid Financing Instrument |
Loan program providing quick financing for countries with urgent balance of payments needs. |
Flexible |
Fewer conditions and shorter application process |
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| PYQ:
[2016] With reference to the International Monetary and Financial Committee (IMFC), consider the following statements:
1. IMFC discusses matters of concern affecting the global economy and advises the International Monetary Fund (IMF) on the direction of its work.
2. The World Bank participates as an observer in IMFC’s meetings.
Which of the statements given above is/are correct?
(a) 1 only
(b) 2 only
(c) Both 1 and 2
(d) Neither 1 nor 2 |
Note4Students
From UPSC perspective, the following things are important:
Prelims level: Bretton Woods Conference
Mains level: Functions of IMF and Recent Challenges Faced by Developing Countries
Why in the news?
Once again, mass protests in Kenya, where at least 30 people were fatally shot by police, highlight opposition to an IMF-supported finance Bill proposing essential goods tax hikes.
Bretton Woods Conference of 1944
- The Bretton Woods Conference was held in 1944 in New Hampshire, USA. It established the International Monetary Fund (IMF) and the World Bank.
- The IMF was designed to aid economic development and promote monetary cooperation and stability globally.
- Criticism: It has been criticized for reflecting and perpetuating power dynamics favouring Western financial interests, with voting rights disproportionately allocated based on financial contributions rather than equal representation.
Functions of IMF and Recent Challenges Faced by Developing Countries
- Functions: The IMF aims to provide financial assistance and policy advice to member countries facing balance of payments problems.
Challenges:
- Austerity Measures: IMF loans often come with conditions such as austerity measures (like tax hikes and spending cuts) that can be unpopular and detrimental to social services and economic stability.
- Dependency: Many developing countries face criticism for being overly dependent on IMF loans, which come with stringent conditions that may not always align with local priorities.
- Public Backlash: There is often a public and political backlash against IMF policies perceived as imposing Western economic ideologies without adequate consideration for local contexts.
SAP (Structural Adjustment Programs) and Its Impacts
- Definition: SAPs are economic policies imposed by the IMF and World Bank on developing countries in exchange for loans.
Impacts:
- Economic Restructuring: SAPs typically involve privatization, deregulation, and liberalization policies aimed at restructuring national economies towards export-led growth.
- Social Consequences: They often lead to job losses, reduced public spending on health and education, and increased poverty and inequality.
- Criticism of SAPs: SAPs have been criticized for exacerbating social inequalities and benefiting Western financial interests over local populations.
Way forward:
- Policy Transparency: The IMF could enhance transparency in its loan conditions and negotiations, ensuring that the terms and impacts of loans are clearly communicated to the public and local stakeholders.
- Local Consultation: Before implementing major policy changes or austerity measures, the IMF could mandate extensive consultation with local governments, civil society organizations, and affected communities to ensure that proposed measures align with local economic priorities and social needs.
Mains PYQ:
Q The World Bank and the IMF, collectively known as the Bretton Woods Institutions, are the two inter-governmental pillars supporting the structure of the world’s economic and financial order. Superficially, the World Bank and the IMF exhibit many common characteristics, yet their role, functions and mandates are distinctly different. Elucidate. (UPSC IAS/2013)
Note4Students
From UPSC perspective, the following things are important:
Prelims level: IMF bailout mechanism
Mains level: Read the attached story
Central idea: The International Monetary Fund (IMF) last week confirmed a $3 billion bailout plan for Sri Lanka’s struggling economy. However, Pakistan failed to get a penny. Countries seek help from the IMF usually when their economies face a major macroeconomic risk, mostly in the form of a currency crisis.
International Monetary Fund (IMF)
- IMF is an international organization that provides loans, technical assistance, and policy advice to its member countries.
- It was established in 1944 with the goal of promoting international monetary cooperation and exchange rate stability, facilitating balanced economic growth, and reducing poverty around the world.
- It has 190 member countries, and its headquarters is located in Washington, D.C.
- Its main function is to provide financial assistance to countries facing economic difficulties, such as the balance of payments problems, currency crises, and high levels of debt.
- It also provides technical assistance and policy advice to help countries improve their economic policies and institutions, and to promote economic stability and growth.
Governing of IMF
- The IMF is governed by its Board of Governors, which consists of one governor and one alternate governor from each member country.
- The day-to-day operations of the IMF are managed by its Executive Board, which is responsible for making decisions on financial assistance and policy advice.
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What is an IMF Bailout?
- An IMF bailout, also known as an IMF program, is a loan package provided by the International Monetary Fund (IMF) to financially troubled countries.
- These loan packages come with specific terms and conditions that the borrowing country must meet to access the funds.
- They typically have a set of conditions that a country must meet to qualify for the loan package.
- These conditions, also known as “conditionalities,” typically include measures that promote fiscal discipline, monetary stability, and structural reforms to improve the country’s economic competitiveness.
IMF programs are often seen as a last resort for countries facing financial crises, and they are only granted if a country cannot access capital markets on its own. IMF programs can be classified into three main types:
- Stand-by Arrangements: They are short-term lending programs designed to provide financial assistance to countries experiencing short-term balance of payments problems. These programs typically last for one to two years and require countries to implement specific macroeconomic policies to stabilize their economies.
- Extended Fund Facility: Such programs are medium-term lending programs designed to help countries with balance of payments difficulties resulting from structural weaknesses. These programs are typically longer-term and come with more extensive policy conditionality, which requires more significant structural reforms to the country’s economy.
- Rapid Financing Instrument: It is a loan program designed to provide quick financing to countries facing an urgent balance of payments need. The program is designed to be more flexible than other IMF programs, with fewer conditions and a shorter application process.
Why do countries seek IMF bailouts?
- Countries need IMF bailout when their economies face major macroeconomic risks, such as a currency crisis, due to gross mismanagement of the nation’s currency by the central bank under the covert influence of the ruling government.
- Such currency crises cause a rapid rise in the overall money supply, which causes prices to rise across the economy and the exchange value of the currency to drop.
- Bad luck such as a decrease in foreign tourists can also contribute to a crisis in a country like Sri Lanka.
Benefits provided by IMF bailout:
IMF programs provide several benefits to countries in financial distress. For instance:
- Access to funding: An IMF bailout provides immediate funding to a country experiencing a financial crisis, allowing it to meet its immediate financial obligations.
- Credibility push: A bailout can provide credibility to a country’s economic policies, signalling to international investors that the country is taking the necessary steps to restore its economy.
- Assistance with structural reforms: IMF programs require countries to implement structural reforms that can help address the underlying problems that led to the financial crisis, improving the country’s long-term economic prospects.
Limitations of an IMF bailout
- Harsh austerity measures: IMF programs often require countries to implement strict economic policies, which can be unpopular and difficult to implement.
- Limited resources: The IMF has limited resources, which can limit the amount of assistance it can provide to countries in need.
- Stigmatization: Bailout can stigmatize a country in the eyes of international investors, signaling that the country is unable to manage its own economy without outside assistance.
Try this PYQ from CSP 2022
“Rapid Financing Instrument” and “Rapid Credit Facility” are related to the provisions of lending by which one of the following?
(a) Asian Development Bank
(b) International Monetary Fund
(c) United National Environment Programme Finance Initiative
(d) Word Bank
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Note4Students
From UPSC perspective, the following things are important:
Prelims level: Bretton Wood Twins
Mains level: Transparency issues is International Organizations
This article discusses some inherent issues with the international organizations (IOs) i.e., the World Bank (Bank) and International Monetary Fund (IMF) (aka Bretton Woods Twins). This comes in the backyard of the WB decision to scrap its flagship publication, the ‘Doing Business’ report.
Issue over chair: A monopoly of the West
- Common individuals to head: The individuals which are common to them: Paul Wolfowitz, Jim-Kim, David Malpass, Rodrigo Rato, Dominique-Strauss Kahn, Christine Lagarde, and Kristalina Georgieva.
- Monopoly of US/EU: They have all become heads via a dual monopoly selection procedure: Only an American can head the Bank and only a European can head the IMF.
- Personal integrity: This has been called into question, the most recent being the revelations of malfeasance at the World Bank where data was apparently massaged to make at least two major countries — China and Saudi Arabia— look better than they would otherwise have been.
Issues with these heads: Hypocrisy
- Political accountability: Within countries, we expect reasonable standards of integrity from heads of important institutions, and democratic political accountability mechanisms exist to ensure that.
- Probity: The effectiveness and legitimacy of these individuals and indeed of the international institutions they head require personal qualities of probity.
- Non-virtuous preachers: These heads often go around the developing world, preaching the virtues of good governance, from arguing against the scourge of corruption to improving data integrity.
- Undue parameters: There are even World Bank indices to rank countries on those metrics.
How has this impacted these institutions?
Ans. The credibility of the institutions is lost.
- It is not just the charge of hypocrisy, but also the effect on the morale and motivation of the staff of these institutions.
- Many of them chose to work here because of a commitment to public service.
- The recent letter by more than 300 former World Bank staff, expressing their anguish at the recent revelations on the Doing Business index, captures this sentiment.
Why such issues grapple these institutions?
- Goal definition: International institutions operate in a grey zone of neither clearly being in or outside the realm of formal politics and hence have weaker mechanisms of accountability.
- Selection of heads: The selection procedure for choosing heads of the Bank and the Fund has been a dismal failure. Compromised heads are potentially more biased.
- Indoctrination: Contrast this with the growing alarm and anxiety that characterizes the rise of China and its attempts to place its own nationals in existing IOs as well as creating new ones.
Chinese has intruded even into these
- Countries place their nationals to head these institutions, both for prestige and to pursue their national interests.
- China has its own nationals now head four of the 15 UN specialized agencies (it suffered a rare setback to head the World Intellectual Property Organisation last year).
Conclusion
- The contest between the West (and especially the US) and China to shape the global order is becoming manifest.
- China’s efforts, its success, and more broadly its influence in IOs should certainly raise deep concerns, most notably the suppression of the inquiry into the origins of the coronavirus.
- Looking ahead, if the US and Europe do not hold themselves to the standards they exhort to the rest of the world, their credibility and legitimacy will continue to degrade.
- This will cede ground and soft power to geopolitical rivals.
Way forward
- So, global political leaders convening next week for the annual meetings of the Bank and Fund must act with urgency and conviction to stem the rot.
- They must open the selection of the heads of these institutions to the best candidate, regardless of nationality.
- And to pave the way, they should clear up the current mess over the Doing Business saga.
Back2Basics:
International Org. | Part 7 | Bretton Woods Institutions – World Bank Group
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Note4Students
From UPSC perspective, the following things are important:
Prelims level: SDR mechanism
Mains level: Issues with SDR mechanism
- Finance Minister has said that India could not support a general allocation of new Special Drawing Rights (SDR) by the IMF because it might not be effective in easing coronavirus-driven financial pressures.
- FM Nirmala Sitharaman has stated that such a global liquidity boost by the IMF could produce potentially costly side-effects if countries used the funds for “extraneous” purposes.
Details of SDR mechanism:
What is SDR?
- The SDR is an interest-bearing international reserve asset created by the IMF in 1969 to supplement other reserve assets of member countries.
- To participate in this system, a country was required to have official reserves.
- This consisted of a central bank or government reserves of gold and globally accepted foreign currencies that could be used to buy the local currency.
- It is based on a basket of international currencies comprising the U.S. dollar, Japanese yen, euro, pound sterling and Chinese Renminbi.
- It is not a currency, nor a claim on the IMF, but is potentially a claim on freely usable currencies of IMF members.
- The value of the SDR is not directly determined by supply and demand in the market but is set daily by the IMF on the basis of market exchange rates between the currencies included in the SDR basket.
Who can hold SDRs?
- SDRs can be held and used by member countries, the IMF, and certain designated official entities called “prescribed holders”.
- It cannot be held, for example, by private entities or individuals.
- Its status as a reserve asset derives from the commitments of members to hold, accept, and honour obligations denominated in SDR.
- The SDR also serves as the unit of account of the IMF and some other international organizations.
General allocation of SDRs
- An SDR allocation is a low-cost way of adding to members’ international reserves, allowing members to reduce their reliance on more expensive domestic or external debt for building reserves.
- The IMF has the authority under its Articles of Agreement to create unconditional liquidity through “general allocations” of SDRs to participants in its SDR Department (currently, all members of the IMF) in proportion to their quotas in the IMF.
The SDR Interest Rate
- The interest rate on SDRs, or the SDRi, provides the basis for calculating the interest rate that is charged to member countries when they borrow from the IMF and paid to members for their remunerated creditor positions in the IMF.
- It is also the interest paid to member countries on their own SDR holdings and charged on their SDR allocation.
- The SDRi is determined weekly based on a weighted average of representative interest rates on short-term government debt instruments in the money markets of the SDR basket currencies, with a floor of five basis points.
How many SDRs have been allocated so far?
The general SDR allocation of August 28, 2009 is by far the biggest allocation to date:
- SDR 9.3 billion was allocated in yearly installments in 1970–72.
- SDR 12.1 billion was allocated in yearly installments in 1979–81.
- SDR 161.2 billion was allocated on August 28, 2009.
What happens to the SDRs once they are allocated?
- The IMF’s SDR Department keeps records of members’ SDR allocations and holdings; the SDR Department is also the channel through which all transactions and operations involving SDRs are conducted.
- Once allocated, members can hold their SDRs as part of their international reserves or sell part or all of their SDR allocations.
- Members can exchange SDRs for freely usable currencies among themselves and with prescribed holders; such exchange can take place under a voluntary arrangement or under designation by the Fund.
- IMF members can also use SDRs in operations and transactions involving the IMF, such as the payment of interest on and repayment of loans, or payment for future quota increases.
Issues with new allocations
- New reserves are allocated according to members’ quotas — or shares in the IMF.
- A great deal of the benefit in 2009 went to advanced economies that didn’t need help in accessing markets or financing fiscal deficits.
- If the same system is being used now, only 40 per cent of the total would be given to the emerging economies. That is not good enough.
Other reasons
- The possible extraneous purposes FM could be referring to maybe misuse of resources for terror funding or some such purpose by neighbours.
- This may seem far-fetched to some, but is par for the course for the government.
- The other possibility is that India is merely trying to prove its loyalty to the Trump administration.
- India has already requested to access the US Fed’s currency swaps.
