Organization: THE IMF

Student: Mustafa Malaki

Event: TIMUN 2000, Alternative Assignment

 

 

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An appropriate song
(Pink Floyd's "Money")

 

The International Monetary Fund (IMF)

 

History

The International Monetary Fund was established, along with the World Bank, as the UN Monetary and Financial Conference that was held in 1944 in Bretton Woods of State of New Hampshire in the United States of America. The actual operation of the organization started three years later in 1947. The IMF enjoys legitimate legal authority under the Articles of Agreement signed in December 1945. The main statutory purposes of the IMF are the promotion of stability in international monetary exchange system, using the gold standard, and the extension of aid to countries with balances of payment difficulties.

It also requested member nations to pay 25 percent of their subscriptions as gold. As the organization realized that its financial status was unstable, it reached the General Agreement to Borrow in 1962 as the first change in the organization’s policy since its establishment. Later in 1967, the fund created the Special Drawing Rights as a standard international unit account.

In 1971, the fund’s par value system was reviewed to raise the exchange rate fluctuation ranges from what had been 1% to 2.5%. Also, a 10% devaluation of the US Dollar (the official currency of the IMF) was set. However, the record-high oil prices after 1973 compelled the member nations to cancel the Bretton Woods agreement and restrict exchange rate fluctuations. Since many industrial nations imported OPEC oil, the boost of prices led to high-rate inflation in these countries. In accordance, the industrial nations (which were usually the loaners) raised interest rates on their loans and reduced their imports. Developing countries being the most affected were faced with high oil prices, higher amount of debts, and reduced markets for their exports. As a result, the IMF initiated the Oil Facility in 1974 to aid members in balance of payments difficulties, and an Oil Facility Subsidy Account to soothe the cost of borrowing under the Oil Facility. In 1976, the role of gold in the IMF.

In the 1980s, the excessive lending of the IMF to developing countries led to a large debt crisis where debtors were incapable of repaying them as a result of their deteriorating economies. The organization devised programs towards the betterment of the lending system. They also encouraged commercial banks to lend, and developed countries to lend money for the reorganization of the disorganized economies of other nations.

The IMF gradually lost its initial purposes of controlling exchange deals, for other currency markets and organizations such as the European Exchange Rate Mechanism were allowed to control exchange rates. However, crises such as the ones in Mexico, Asia, and Russia proved the IMF’s weakness and the inequality of its fund distribution to the vast amounts of private capital in the world economy. The IMF itself believes that its main purposes have not changed ever since its establishments, and that the change has been in its operations which have developed over time. However, because the gold standard has been eliminated, the IMF is accused of having lost its statutory purposes. Practically, the main purpose of the IMF right now lies in its lending of money to countries experiencing imbalances in their balance of payments.

Functions

The main purposes of the IMF, as stated in Article I of its Articles of Agreement are:

1) To promote international monetary cooperation through a permanent institution which provides the machinery for consultation and collaboration on international monetary problems.

2) To facilitate the expansion and balanced growth of international trade, and to contribute thereby to the promotion and maintenance of high levels of employment and real income and to the development of the productive resources of all members as primary objectives of economic policy.

3) To promote exchange stability, to maintain orderly exchange arrangements among members, and to avoid competitive exchange depreciation

4) To assist in the establishment of a multilateral system of payments in respect of current transactions between members an din the elimination of foreign exchange restrictions which hamper the growth of world trade

5) To give confidence to members by making the general resources of the fund temporarily available to them under adequate safeguards, thus providing them with the opportunity to correct maladjustments in their balance of payments without resorting to measures destructive of national or international prosperity;

6) In accordance with the above, to shorten the duration and lessen the degree of disequilibrium in the international balances of payments of members.

Therefore, IMF is concerned with the problems of individual countries and also the working of the international monetary system as a whole.

The IMF is an international institution that provides the field for member governments to provide temporary financial aid and assistance to any member that undergoes balance of payment difficulties, as in difficulties in paying for imports and services and/or servicing its foreign debt. This aid gives the members with unstable economies the "opportunity to correct maladjustments in their balance of payments without resorting to measures destructive of national or international prosperity." (www.imf.org/external/np/exr/facts/howlend.htm)

The IMF has always developed policies correspondent to the financial situation in the world. Its policies respond to new challenges, most recently the globalization of capital markets and the increasing risk of financial crises. One of these policies is the exercise of "firm surveillance" over the policies of the members towards the institution. Under the Articles of Agreement, such surveillance monitors how well the members cooperate and fulfill their obligations among themselves to ensure a stable monetary exchange rate system and orderly exchange arrangements. The obligations of the members consist of directing the economic and financial policies to enhance the economic growth with a stable price and to promote stability by enhancing orderly economic and financial situations and to avoid any manipulating the exchange rates, hence preventing any unfair competitive gain over other members or any balance of payments adjustments. These obligations should be compatible with the exchange rates policies, which in turn, members are to comply with.

Surveillance is exercised by the IMF in two ways:

1) Multilateral surveillance: The Executive Board of the IMF periodically reviews the current monetary system in the world and its developments using certified reports and outcomes of discussions in the international capital markets.

2) Bilateral surveillance: (under article IV) A specialized board of the IMF consults individual member countries annually to discuss their economic and financial status.

Briefly, these two types of surveillance are exercised by the IMF to be further acquainted and kept up-to-date with the financial and economic conditions in every member country. Surveillance basically means "monitoring" or "keeping everything under control". Bilateral surveillance is indeed to the best benefit of poor members which will be allowed to discuss their problems with the institution. When the IMF keeps up with the monetary system in the world through multilateral surveillance, it strengthens further its role and is able to act more adequately if any maladjustments show up.

Global liquidity, the capacity to provide financial assistance, is a major policy of the International Monetary Fund. Liquidity measures how much the IMF can provide assistance to its members during a specific period in the short term. The financial assistance here means how much reserve assets the IMF can provide a member with. Liquidity can also be described as the ease with which a reserve asset can be converted into a member’s economy’s medium of exchange, in this case money. SDRs are considered to be liquid assets, as they do not take a long period of time to be transacted back and forth among the IMF and its members. This is particularly applicable to poor economies. When a country experiences a heavy attack in its currency, it finds it difficult to recover because of the great amounts of money it owes and it has in investments. Hence, it is not as possible for it to buy up large amounts of its currency. At the same time, creditors tend to request payments in dollars. This delays or hinders the recovery of the currency, and the economy falls in heavy depression. When such a country seeks help, it looks for a body that would supply it with currencies in the shortest amount of time, and IMF liquidity would do, since SDRs and other currencies are readily usable and liquid at the IMF, as in they are not tied up in investments. Since the IMF is the only recognized agent for the insurance of a successful monetary and payments system in the world, it pays much attention to the level and composition of reserves and resources available to member nations that would meet their requirements, as well as grant them access to capital markets. The IMF has also granted its members with certain rights, called the special drawing rights (SDR). The IMF therefore expands its liquidity when a considerable number of member nations become in need of additional world reserves.

The IMF provides its members with its resources whenever any of them faces balance of payment difficulties, and therefore it is always necessary to maintain a fixed amount of reserves. These resources are initially and primarily provided by the quota subscriptions and revolve around as SDRs leave the IMF account and quotas refill it. The IMF supplements these resources by borrowing, and to do so, member countries are required to show proof that they are experiencing balances of payment difficulties.

The IMF contains the General Resources Account (GRA), which is responsible for all transactions that occur between the IMF and its members. This board also monitors the allocation of IMF resources to member countries. There are two types of resources, the ordinary resources, and the borrowed resources. The ordinary resources are those made up of currencies and SDRs, while the borrowed resources are made up of amounts borrowed by the IMF under particular arrangements.

Quota subscriptions in the IMF are determined by each member’s size in the world economy. The quotas, in turn, determine the maximum amount of financial resources that each member has to provide to the IMF, voting power in IMF decision-making, and a member’s share of the SDR.

The IMF’s unit of account is SDR, whose value is calculated daily on the basis of a "valuation basket" comprising the five major currencies (Dollar, Sterling Pound, Yen, Mark, and Franc).

Each member in the institution is assigned a quota expressed in SDRs, equal to the subscription of capital to the IMF. One of the basic functions of a quota, apart from providing the IMF with its financial resources, is that the quota determines the number of votes of a member. Every member in the IMF has 250 basic votes, and is granted an additional one for each SDR 100,000 of quota. The quotas also determine the amount of financial assistance a member can receive for balance of payments difficulties. Quotas can be paid by gold, currencies, or SDRs.

The IMF aids a member country financially by providing it with reserve assets (SDRs or currencies from quota subscriptions). The member country first purchases reserve assets with its own currency. When the borrower has improved its economic conditions, it repurchases its own currency using the international reserve assets. This is also known as the purchase-repurchase mechanism. The borrowers would have to repay the assets with an interest rate determined by the average, short-term interest rates in the domestic markets of the United States, United Kingdom, Germany, France, and Japan. Since these countries enjoy the best economies and markets, the IMF has decided to use their interest rates for the repayment of loans.

The assets granted by the IMF are deposited with the fiscal agent that the member chooses to be its official side in all transactions. The central bank of that country is usually the agent, but not necessarily. The fiscal agent is thereafter free to use the amount as needed without any restrictions from the fund.

The capacity of the IMF to provide its members with financial assistance is known as its liquidity. Whenever there is a decrease in the budget or in the amount of reserve assets (probably as a result of borrowers not paying back on time), the IMF seeks to increase the quotas of members to make up for the loss. This is particularly disadvantageous to rich, industrial countries who are not heavily indebted, since they have to pay more whenever poor, indebted countries do not pay back their loans on time.

Budget

The Executive Board of the IMF takes the responsibility of reviewing the three-year and five-year term budget plans annually. In the latest of these reviews, certain initiatives were decided, such as the establishment of the Poverty Reduction Strategy Papers (PRSP), and the enhancement of IMF-World Bank cooperation through the organization of the Financial Sector Assessment Program. Policies such as surveillance, technical assistance, and external communications were also reviewed.

The IMF annually sets its goals for the upcoming fiscal year. As for fiscal year 2001, its objectives are:

1) strengthen and broaden its ability and capacity to implement surveillance, lending, and technical assistance, in addition to other programs;

2) prepare the institution for the activities necessary to the improvement of the global financial system in methods such as:

a) increasing and facilitating IMF access and outreach to international markets and members;

b) expand the role of financial sector in fiscal and monetary policymaking of the IMF;

c) work towards the growth and reduction of poverty in poor regions and individual countries;

3) promote higher efficiency and effectiveness in the implementation of IMF internal operations.

In fiscal year of 2000, which ended in April 2000, the administrative budget was approved at $585.1 million, net of reimbursements. The capital budget was approved at $67.3 million, from which $18.0 would be spent on building facility projects, $29.3 million on electronic data processing (EDP) and information technology projects, and $20.0 million on the new building design and preconstruction. During the same year, the average expenditures of the administrative budget totaled $583.0 million, and #39.3 million for the capital budget.

About 66% of the administrative budget resources were used for technical assistance to countries in need, and the rest was spent on:

1) surveillance (the close observation and monitoring done by the IMF to ensure that members fulfill their obligations)

2) external activities tending to provide more transparency for IMF policies and operations (5%) (transparency refers to how well the IMF can publicize itself, its policies, and its data so that it would be clear and comprehensible by all members in order to avoid any suspicion of where the funds are being used)

3) investments in technology and work practice improvements, in addition to other administrative support (20%)

4) Board of Governors and Executive Board (9%)

The operational budget of the IMF determines the amount of SDRs and currencies that are to be used in purchases, repurchases, and other IMF-member transfers during the budget period. Such currencies are selected by the Executive Board. The Executive Board approves of currencies of countries that enjoy an economically strong external position at the time, and thus those will be called "usable" currencies. Once these currencies have been identified, the amount of each currency to be used in transfers are calculated so as to create over time balanced positions in the IMF among the members participating in the budget. This budget will then be used for transfers between the IMF and member countries. Rich countries such as the United States and Western European nations are contribute the most to the IMF.

 

Estimated Cost of Major IMF Activities,

Financial Year 1999-2001

(In millions of U.S. dollars)

Financial Year

Percent of

Financial Year

Percent of

Budget Financial

Percent of

1999

Total

2000

Total

Year 2001

Total

Activity

Staff and management

Surveillance

135.6

26

151.7

26

181

27.9

Use of Fund Resources

102.7

19.7

123.3

21.1

132.2

20.3

Technical assistance

109.3

21

109.3

18.7

131.6

20.3

External relations

24

4.6

30.5

5.2

33.9

5.2

Administrative support

98.5

18.9

114.2

19.6

113.2

17.4

Subtotal

470.1

90.3

529

90.7

591.9

91.1

Board of Governors and

Executive Board

50.5

9.7

54

9.3

57.9

8.9

Total

520.6

100

583

100

649.8

100

 

 

Strengths and Weaknesses

When the IMF was established, it adopted a gold standard by which it would value a specific amount of currency. However in 1971, when this standard was abandoned by countries such as the United States, the IMF became more of a development bank for poor countries, something that was a responsibility of the World Bank. Though this step was appreciated by many countries and can be considered as a strength, evidence shows that since 1971, most of the less developed countries that had received IMF loans have the same or lower per capita wealth now, and that many others are currently worse off economically. According to www.heritage.org, out of 89 countries that received IMF loans between 1965-1995, 48 are not better off economically despite the loans. Of these 48 countries, 32 are poorer, and out of these 32, 14 have smaller economies right now than they had before they received the loans.

A strength of the IMF has been its secretiveness. The IMF does not allow details of its loans to be publicized, which served the national interests of some countries. On the other hand, for countries such as the United States where tax rates are fairly high, it should be clarified to the people as to where their taxes are being spent. This is true since these taxes constitute a portion of the US quota subscription to the IMF which are, in turn, lent to poor countries as loans.

Some analysts believe that the IMF should not exist anymore since it is outdated. The IMF, as mentioned before, was initially established to buy, sell, and lend currencies of member states in order to maintain a value for them in terms of gold, also known as the gold standard. This was the main purpose of its creation. However, after the elimination of the gold standard and emergence of a floating exchange rate system, the IMF no longer had to set a gold value for a currency, and the main reason for its existence had disappeared.

The IMF also lacks the ability to influence exchange rate stability since only part of its resources are readily available for financial transactions. In today’s world, foreign exchange transactions reach up to $2 trillion a day, most of which takes place in the private sector and out of the IMF’s control. While the fund has $220 billion, only a small portion of it can be used. Moreover, the IMF lacks the quickness in response to exchange rate fluctuations. World currencies today undergo minute-by-minute changes that are not responded by the IMF at the same speed. By the time the IMF reacts to fluctuations of exchange rates of a country’s currency, the country will have suffered from financial consequences. In some cases such as the Mexican crisis in 1994, the IMF’s decision went into effect just by the time the Mexican economy had started to recover. Hence, the IMF is believed to be ineffective and slowly responsive to the speed and growth of currency transactions.

However, this ineffectiveness is not applicable to all situations. The IMF has proved effective in very few instances, such as the problem with the Turkish currency. The IMF and other institutions such as the World Bank are considered to be acting unfairly and marginalising the role of the private sector in the world economy. After the collapse of the Soviet Union in 1990, the IMF and other organizations started investing in Eastern and Central Europe in large amounts, thus narrowing the path for private investors to gain. Hence, the IMF has entered an unfair competition against private investors despite the wide gap between their resources, and has discouraged more economic activity.

A certain contradiction in the IMF’s lending programs has also been used against it. According to the Articles of Agreement, the IMF’s loans are supposed to be short-term. Recently, this principle has been violated since many of the less developed countries are allowed long-term loans, which have eventually created long-term dependence by these countries on the IMF. Looking at this from another perspective, a positive point is also present, for the IMF is currently extending loans to more countries more often and with greater frequency than it had before the 1980.

Another disadvantage of the IMF is its discouragement of economic growth policies in less developed countries. Whenever a member country asks for financial assistance from the institution, it has to implement certain policies within its economy to receive a loan, also known as conditionality. Some of these policies include balancing the budget, devaluing the recipient’s currency, maintaining tariff rates, and keeping or raising tax rates. Unfortunately, these policies do not promote significant economic reform in the long term. For example, many Latin American economies experienced massive budget deficits when their governments spent large amounts on unprofitable state-owned businesses. Moreover, a country applying for IMF loans is required to reduce its budget deficit. In order to do so, it has to raise taxes or tariffs to increase revenue, or print more money, thus devaluing its currency and causing more inflation. However, according to the Phillips Curve, this will create an advantage of reducing unemployment.

The IMF does not act seriously and firmly when it comes to lending money to certain countries that have corrupt records in the past. The IMF has repeatedly entered into agreements with countries that have a history of violating its requirements and contracts. Despite that, the IMF still continues to aid these countries with a new or altered contract, hoping to achieve better results in the future. A positive aspect of this policy is that it gives a second chance to countries in need.

Another disadvantage of the IMF’s quota subscriptions is that the national currencies paid by many countries are not all available for the IMF to use at all times. Furthermore, fluctuations in the level of usable currencies are possible for reasons that are unrelated to the demand for the IMF resources. The IMF has also failed to promote confidence in both purchase and creditor members, for it has not been able to meet all demands for its resources.

Because the IMF draws on the currencies of a wide range of members it is said to underestimate its cooperativeness and revolving nature of its resources.

The IMF’s not establishment of an investment account in the general department, though it has been authorized to do so, has always been postponed and this is a clear sign of the IMF’s incapability of implementing its decisions.

The IMF is considered to be equitable since its quota subscriptions taken regard the economies of its members. For example, the United States has the largest subscription, obviously because it enjoys the best economy among all other member nations. On the other hand, it is inequitable in its SR allocation, an issue that has been discussed several times in the seminars organized to discuss major IMF policies.

 

Political Allies

The United States of America, without doubt, is the most promising and trustworthy member of the IMF. The IMF, almost in all cases, resorts to the United States as a means of improving its conditions. The United States of America is both famous and notorious economically, and uses such power to dominate itself in all situations around the world. Western European nations are also considered as strong allies of the IMF, especially countries such as Germany, France, Italy, Switzerland, Great Britain, etc. In fact, the current president of the institution is German.

The United States is so powerful in the IMF that it enjoys the most voting rights; that is, 17% of the total votes of the IMF members. This is theoretically due to it having the highest quota subscription. In reality, however, the situation may vary. This is evident when looking at the quota subscriptions of other countries and their corresponding voting rights, for there are slight, unnoticeable, and most probably deliberate errors in the equations. The United States of America frequently applies international pressure on the IMF to reduce its subscription, attempting at the same time to maintain approximately the same voting rights. Unfortunately, this is clearly unfair and discriminatory.

The IMF nonetheless sees no other alternative to acquiescing with American requirements. This is useful in a way that the United States, apart form the subscriptions, is always the first volunteer to help whenever global crises occur. In order to keep close ties with Turkey and to use the latter’s grounds as air bases for itself, the United States hurried to re-stabilize the sudden drop in Turkish currency and restore its original economic condition.

The IMF has also kept an eye on members across the Atlantic Ocean. The British, Dutch, and French economies rank second after the United States. The IMF has also granted these members with voting rights and other privileges. The United Kingdom alone is a main contributor when it comes to financing African economies and lending them money. Of course, the major reason dates back to the colonial era. Now, the United Kingdom views its own benefit to aid its ex-colonies through economic means such as the IMF. This is not done as a sign of British good will, but because the United Kingdom seeks to colonize the Africans economically and politically, rather than physically occupying them. Unlike the World Bank, the IMF has acted more leniently towards its loaners. The World Bank has been shocked, over the last two years, by protests held against it claiming that it has not given loaner countries longer periods for repayment. Some even asked for forgiving the poor nations. The IMF, despite accusations of being weak, has always attempted to allow loaners a greater amount of time to repay their loans or debts. Therefore, more nations are in favor of IMF existence than the World Bank.

 

Bibliography


· Cowley, Corbin. "International Monetary Fund Reform." http://www.lib.utah.edu/epubs/hinckley/v2/cowley.htm.

· "How We Lend." http://www.imf.org/external/np/exr/facts/howlend.htm.

· "International Monetary Fund." Microsoft Encarta Encyclopedia, Microsoft Corporation, 2000.

· "International Monetary Fund: The Role of the IMF and IMF History." http://www.cftech.com/BrainBank/FINANCE/IMFHistory.html.

· Johnson, Bryan T. "The International Monetary Fund: Outdated, Ineffective, and Unnecessary." http://www.heritage.org/library/categories/trade/bg1113.html.

· Kojm, Christopher A. The Problem of International Debt. New York: The H.W. Wilson Company, 1984.

· "Overview of the IMF as an International Monetary Institution." http://www.imf.org/external/pubs/ft/pam/pam45/I/1A.htm.

· Steil, Benn. "The IMF and the World Bank." http://www.foreignpolicy2000.org/library/issuebriefs/IBIMFandWorldBank.html.

· "Usability of the IMF's Resources." http://www.imf.org/external/pubs/ft/pam/pam45/II/IIE.htm.