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 IMF, which has become integral to the development of financial markets worldwide and growth of developing countries.

Key Takeaways

  • The IMF came into existence in 1945. Along with World Bank, it was created to bring financial stability to the world following World War II.
  • The IMF is funded by quota subscriptions. Member states pay according to the size of their economy, and voting rights are based on this quota.
  • Special Drawing Rights (SDRs) is the unit of account of the IMF. The SDR is made up of a basket of five currencies: the U.S. dollar, the euro, the Japanese yen, the Chinese RMB, and the British pound.
  • When member countries run into trouble, they can turn to the IMF for advice and financial assistance.

What Does the IMF Do?

The IMF came into formal existence in 1945 following the Bretton Woods Conference held the year before. Along with its sister organization, the World Bank, it was created to prevent economic crises such as the Great Depression. It is a specialized agency of the United Nations and is run by its 184 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 provides 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 impacts its exchange rate, governmental budget, money and credit management. The IMF will also appraise a country's financial sector and 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 entrusted with nurturing economic growth and maintaining high levels of employment within countries.

How Does the IMF Work?

The IMF is funded by quota subscriptions paid by member states. The size of each quota is determined by the size of each member's economy. The quota in turn determines the weight each country has within the IMFand 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 1969, 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 value of SDRs 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 IMF (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 includes the U.S. dollar, the Japanese yen, the euro, and the British pound. In November 2015, the IMF added the Chinese RMB to the basket.

The larger the country, the larger its contribution. Thus the U.S. contributes 17.44% while the Seychelles Islands contribute a modest 0.005%. If called upon by the IMF, a country can pay the rest of its quota in its local currency. So far, SDR 204.2 billion (about $293 billion) have been allocated to members.

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 Programs (SAPs).

There are three more widely implemented facilities by which the IMF can lend its money. A Stand-By Arrangement (SBA) offers financing of a short-term balance of payments, usually between 12 to 24 months, but no more than 36 months.

The Extended Fund Facility (EFF) is a medium-term arrangement by which countries can borrow a certain amount of money, typically over a four to 10 years. 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.

The IMF 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 South Korea during the 1997 financial crisis in Asia, which allowed it to avoid sovereign default. Emergency funds can also be loaned to countries that have faced economic crisis as a result of a natural disaster.

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 population. 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. Countries that are under IMF programs are typically 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 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.

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.