Credit tranche refers to a system of releasing loan funds in phases that the International Monetary Fund (IMF) uses to govern its lending activities with member countries. When a member nation applies for a loan to help with economic difficulties, the IMF will disburse the loan in a series of credit tranches. The credit tranches are portions of the loan that are released to the member country, usually upon the member fulfilling conditions or requirements set forth by the IMF.
Understanding Credit Tranches
Credit tranches are the chunks of credit that the IMF makes available to a member country as they make financial reforms according to IMF guidance. Generally, the reforms have a free market focus and may include making it easier for entrepreneurs to start businesses, reducing public debt, and privatizing nationalized sections of the economy.
How IMF Credit Tranches Work
An International Monetary Fund loan usually lasts between 18 months and three years. At the start of the loan, the borrowing nation must demonstrate that reasonable efforts have been taken to overcome its financial difficulties. If this requirement is met, the country will receive the first credit tranche of the loan, which is usually kept within 25% of a member’s quota. Quota is assigned to new member countries based on their GDP, economic openness, and international reserves.
The later series of credit tranches will have additional conditions, each of which the borrower must satisfy before receiving the next portion of funding. The purpose of the conditions is to remove the moral hazard that might be created by the IMF essentially bailing out a country. Instead of merely giving over capital, the IMF requires economic reform to ensure that the country is stable and able to weather future challenges.
IMF Credit Tranches in Action
There are many case studies of IMF successes and failures. Successes include countries like Jordan that have completed an IMF program and have emerged as global economies. Failures are sometimes harder to analyze, as one of the criticisms of the IMF is that social spending suffers under the free-market reforms. This no doubt has some truth, but social spending is usually at the point of unsustainable before the IMF comes along with the austerity solution.
The IMF granted a three-year, $12 billion bailout program to Egypt in 2016. After Arab Spring saw Hosni Mubarak’s 30-year regime topple, investors and tourists gave the country a wide berth. This badly damaged the Egyptian economy, and the country’s debt-to-GDP ratio climbed. The first credit tranche of $2.75 billion was released to Egypt in November 2016 following Egypt’s abandonment of a currency peg to the U.S. dollar. The money helped, but so did the depreciation in the currency. Egypt’s GDP growth climbed from 1.8% in 2011 to 4.3% in 2016. Egypt has been making other reforms, including bankruptcy reform, labor reform, and streamlining the business startup to access further tranches.