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.
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.