IMF: Governance, Finances & Reforms Needed

Table of contents

The International Monetary Fund (IMF) is the principal International Monetary Institution established to promote a cooperative and stable global monetary framework.
It was created to establish a framework for economic cooperation and to prevent a relapse into protectionism and autarky after the Great Depression of the 1930s.
It acts as a “lender of last resort“.
It is a United Nations specialised agency.

Establishment

The IMF was established in July 1944 by 44 member countries at the Bretton Woods Conference in New Hampshire, USA.
It came into formal existence in December 1945, when its first 29 member countries signed its Articles of Agreement. India is a founder member of the IMF.
It began operations on March 1, 1947. Later that year, France became the first country to borrow from the IMF.
Headquarters: Washington, D.C
Current membership: 190 countries.
Objectives of IMF:
- Encourage international monetary cooperation.
- Assurance of Financial stability.
- Make international trade easier.
- Encourage high employment and long-term economic prosperity.
- Reduce poverty all around the planet.

Governance of IMF

The IMF is led by a Managing Director, elected for a 5-year term by the Executive Board.
The Board of Governors, Ministerial Committees, and Executive Board make up the International Monetary Fund (IMF).

Board of Governors

The Board of Governors is the highest decision-making body of the IMF. It consists of one Governor and one Alternate Governor from each member country.
The member country appoints the governor, usually the Minister of Finance or the Head of the Central Bank.
- For India, the Finance Minister is the ex-officio Governor on the Board of Governors of the IMF.
- The Governor of RBI is India’s Alternate Governor.
The Board of Governors usually meets once a year in September/October to discuss the work of the respective institutions at the Annual meetings.
Two ministerial committees, the International Monetary and Financial Committee (IMFC) and the Development Committee, advise the Board of Governors.

Functions of the Board of Governors

Right to approve quota increases and special drawing right (SDR) allocations.
Admittance of new members and compulsory withdrawal of members.
Amendments to the Articles of Agreement and By-Laws.

Executive Board

The Executive Board is a 24-member body that oversees the day-to-day work of the IMF.
The Board of Governors appoints the directors to the Executive Board.

IMF Finances

IMF funds come from 3 sources: member quotas and multilateral and bilateral borrowing agreements.

Quotas

Quotas represent the financial contributions that each member country is required to make to the IMF. An individual member country’s quota broadly reflects its relative position in the world economy.
Quotas are the building blocks of the IMF’s financial and governance structure and the primary source of funding.
Quotas are denominated in Special Drawing Rights (SDRs), the IMF’s unit of account.
How is the Quota determined?
1. Weighted average of GDP (weight of 50 percent) [GDP is measured through a blend of GDP—based on market exchange rates (weight of 60 percent)—and on PPP exchange rates (40 percent)],
2. Openness (30 percent),
3. Economic variability (15 percent),
4. International reserves (5 percent).
Quotas determine:
1. Maximum amount of financial resources a member is obliged to provide to the IMF.
2. Maximum amount of loans a member can obtain from the IMF under normal access.
3. Member’s share in a general allocation of SDRs.
4. Are a key determinant of voting power in IMF decisions. Members get one vote per SDR100,000 of quota plus basic votes, which are the same for all members.
The Board of Governors concluded the 16^th quota review in December 2023, approving an increase in quotas by 50 per cent.
- Any change in Quotas requires approval by 85% of the total voting power, and a member’s own quota cannot be changed without its consent.
The largest member of the IMF is the United States, with a current quota of SDR 42.1 billion, and the smallest member is Tuvalu, which has a current quota of SDR 1.8 million.
India’s current quota in the IMF is SDR 5821.50 million, giving it a shareholding of 2.44%.

Special Drawing Rights

SDR, also known as ‘Paper Gold’, is an international reserve asset, created by the IMF in 1969, to supplement its member countries’ official reserves.
It was created to supplement a shortfall of preferred foreign-exchange reserve assets, namely gold and the U.S. dollar. It is designed to provide liquidity and stabilise the global economy.
SDRs help provide financial stability by supplementing countries’ existing reserves, especially during economic or financial crises.
Aside from gold reserves, foreign currency assets, and the IMF Reserve Tranche, India’s foreign exchange reserves include SDR.
The SDR is neither a currency nor a claim on the IMF. Rather, it is a potential claim on the freely usable currencies of IMF members. SDRs can be exchanged for these currencies.

SDR Value

The value of the SDR is based on a basket of five currencies—the U.S. dollar (43.38%), the Euro (29.31%), the Chinese Renminbi (12.28%), the Japanese Yen (7.59%), and the British Pound Sterling (7.44%).
The SDR basket is reviewed every five years or earlier if warranted.
The value of the SDR is determined daily based on market exchange rates.
- A currency included in the SDR basket must meet two criteria:
  1. Export criteria: If the issuing country is an IMF member (or a monetary union that includes IMF members) and one of the top five world exporters.
  2. Freely usable criteria: If a currency is widely used in payments for international transactions and widely traded in the principal exchange markets.

SDR Allocation

The IMF allocates SDR to member countries in proportion to their IMF quotas.

SDR Uses

Countries can exchange their SDRs for hard currencies with other IMF members. This has historically been done voluntarily, with countries in a stronger financial position agreeing to help others when needed.
They can also use their SDRs in various operations with other countries or settle financial obligations to the Fund.
Many member countries that don’t need support have used SDRs to support concessional financing for low-income countries.

SDR Interest

SDR carries an interest rate, which is determined weekly based on a weighted average of interest rates on three-month debt in the money markets of the SDR basket currencies.

Who can hold SDRs?

IMF members – and the IMF itself – hold SDRs, and the IMF has the authority to approve other holders, such as central banks and multilateral development banks. Individuals and private entities cannot hold SDRs.

IMF Reserve Tranche Position

The reserve tranche is a portion of the required quota of currency that each IMF member country must provide to the IMF.
A country’s Reserve Tranche Position is the difference between the IMF’s holdings of that country’s currency and the country’s IMF-designated quota.
It is an emergency account that IMF members can access at any time without agreeing to conditions or paying a service fee.

New Arrangements to Borrow

It is the second line of defense after quota resources.
Through the NAB, certain member countries and institutions stand ready to lend additional resources to address challenges to the international monetary system.

Bilateral Borrowing Agreements

These are the third line of defense.

Voting Power in IMF

Voting power is based on the quota system. Each member has a basic number of votes and one additional vote for each Special Drawing Rights of 1,00,000 of each member country’s quota.
India is ranked 8^th in IMF with a quota of 2.76% and 2.64% of total votes.

Functions of IMF

Economic Surveillance: The IMF oversees the international monetary system and monitors the economic and financial policies of its member countries.
Lending: The IMF provides temporary financing to member countries experiencing actual or potential balance of payments problems.
Capacity Development: It works with governments to modernise their economic policies and institutions, train their people, and provide technical assistance and advice to correct the underlying problems.

Reports released by IMF

World Economic Outlook
Global Financial Stability Report
Fiscal Monitor Report
External Sector Report
Regional Economic Reports

Bretton Woods System

The Bretton Woods System was a global financial system established in 1944 during a conference held in Bretton Woods, New Hampshire, USA.
The system established fixed exchange rates, where currencies were pegged to the U.S. dollar, which was, in turn, convertible to gold at a fixed exchange rate of $35 an ounce.
The Bretton Woods system lasted until persistent U.S. balance-of-payments deficits caused foreign-held dollars to exceed the U.S. gold reserves, making it impossible for the United States to exchange dollars for gold at the official rate.
In 1971, US President Richard Nixon ended the dollar’s convertibility to gold. The Bretton Woods system collapsed, and gold was traded freely in the world’s markets.

India and the IMF

Borrowings

India borrowed SDR 3.9 billion during the period 1981-84. Again, from 1991 to 1993, India borrowed an amount of SDR 3.56 billion.
The repayment of all the loans taken from the IMF was completed on May 31, 2000.
In 2012, India became a creditor to the IMF, contributing to the Fund’s efforts to stabilise the Eurozone countries.

Article IV Consultation with India

The Executive Board of the IMF concluded the Article IV consultation with India in December 2023.
Under Article IV of the IMF’s Articles of Agreement, the IMF usually holds bilateral discussions with members annually.
An IMF staff team collects economic data, visits the country, and engages with authorities (RBI in India) to discuss economic developments and policies.

Financial Transactions Plan (FTP)

53 countries participate in the Financial Transaction Plan. India agreed to participate in the FTP of the IMF in late 2002.
By participating in FTP, India allows the IMF to encash its rupee holdings as part of our quota contribution for hard currency, which is then lent to other member countries who are debtors to the IMF.

IMF Bailout to Pakistan

In 2023, the IMF Executive Board approved the $3 billion Stand-By Arrangement (SBA) for Pakistan, the term for which is set to expire next month.
So far, two tranches have been issued while the last one is pending the review of the conditions set by the lender.

Stand By Agreement (SBA)

It provides short-term financial assistance to countries facing balance of payments problems.
Eligibility: All member countries facing actual or potential external financing needs. Most often used by advanced and emerging market countries, but low-income countries sometimes use the SBA together with the Standby Credit Facility.
Conditionality:
- Countries’ economic policies must address the problems that led the country to seek funding.
- Disbursements conditional on the observance of quantitative performance criteria.
Duration of assistance: Typically covers a period of 12–24 months, but not more than 36 months.

Debt Sustainability Framework (DSF) for Low-Income Countries

It is designed to guide the borrowing decisions of low-income countries in a way that matches their financing needs with their ability to repay now and in the future.
It requires regular debt sustainability analyses of a country’s projected debt burden over the next 10 years and its vulnerability to economic and policy shocks.
It classifies countries’ debt-carrying capacity into three categories – strong, medium, and weak.

Extended Fund Facility

The Extended Fund Facility is the lending facility of the fund of the IMF to help countries address medium and longer-term balance of payments problems. It was established in 1974.
It assists countries experiencing serious payment imbalances because of structural weakness or slow growth and an inherently weak balance of payments.
An EFF provides support for comprehensive programs, including the policies needed to correct structural imbalances over an extended period.
Amounts drawn under EFF are to be repaid over 4½–10 years in 12 equal semi-annual instalments.

Achievements of the IMF

After World War II, the IMF played a crucial role in stabilising war-torn economies in Europe through financial assistance and guidance.
During the Asian Financial Crisis (1997-1998), IMF provided emergency funding to countries like South Korea, Thailand, and Indonesia.
Helped former Soviet Union economies transition to a market-driven economy.

Criticism of IMF

Often being criticised as Western-dominated and a ‘dollar institution’.
It gives tied-up loans and imposes conditionalities, compromising the receiving country’s economic and political sovereignty.
Imposes policies without considering country-specific issues.
Failed to foresee Russian economic failure and Asian financial crisis.
Its policies have widened the gap between the poor and the rich. This is because its programs favour the rich.

Reforms in IMF: Way Ahead

IMF should provide its members with regular annual allocations of SDRs. This would provide an alternative to the US dollar as a source of global liquidity while also addressing the problem of chronic global imbalances.
Regarding its surveillance of countries’ policies, it needs to address its perceived lack of even-handedness; where emerging and developing countries are held to demanding standards, high-income countries like the US are let off the hook.
For its lending policies, it needs to decouple loan size from an anachronistic quota system and reduce the punitive interest rates charged to middle-income countries.
IMF needs to do better at organizing debt restructurings for low-income countries. It should support reforms to speed up restructurings and endorse initiatives to crack down on holdout creditors.
The Managing Director should be selected through a competitive process, and be just the most qualified European, as has historically been the case.
For antiquated reasons, the US possesses a veto over consequential IMF decisions. Decisions must be approved by an executive board of political appointees who in turn answer to their governments.