The International Monetary Fund Finance Essay
Created in 1946 in continuation of the agreement reached at the international financial conference held at Bretton Woods in 1944, the IMF (International Monetary Fund) was formed to ensure the prevention of the financial disorder and actions that occurred across European nations between the 1920s and the 1940s (Stone, 2002, P 18 to 88). Such actions, which included various protectionist policies, arbitrary currency devaluations, and obstruction of international financial flows, accelerated economic turbulence, deepened global depression, and created financial turmoil (Stone, 2002, P 18 to 88). The IMF, technically a specialised but virtually autonomous UN agency, was formed to restrict or check this sort of economic misconduct. Required to obey the directions of the U.N. Security Council, (but not the U.N. General Assembly), the fund has 185 member nations whose voting share depends on the extent of their quota or financial obligation to it (Stone, 2002, P 18 to 88).
The present day role of the IMF is significantly different from what was envisaged at its conceptualisation in July 1944. The primary objective of the IMF, from 1946 to1973, was to administer the established system of worldwide exchange rates decided upon in 1944. With the dollar fixed to gold at USD 35 per ounce, the currencies of all members of the fund were set to the dollar at various rates (Stone, 2002, P 18 to 88). The fund checked and supervised the broad economic and currency policies of fund members and helped them to prevail over crises related to balance of payments with short-term lending, designed to help currencies to regain their fixed value. Such functioning ended abruptly in 1973, when the USA first floated the dollar, and thereafter initiated the current arrangement of floating exchange rates (Stone, 2002, P 18 to 88).
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The fund changed at the closure of the fixed rate arrangement by developing into the last resort lender to states distressed by BOP crises (Sharma, 2003, P 16 to 99). Its present functions and obligations can be categorised into three sorts of services, namely providing loans, technical assistance and surveillance (Sharma, 2003, P 16 to 99). Lending involves the provisioning of monetary resources, with particular conditions, to help states suffering from BOP problems; technical assistance entails assistance in enhancing the worth and efficacy of decision making of states in policy areas; surveillance represents the checking of fiscal and economic developments and giving relevant advice to members (Sharma, 2003, P 16 to 99).
The efforts of the IMF during the last three decades have, for reasons related to its lending policies, not just provoked intense criticism and controversy but led to the distancing of many developing countries from its functioning and involvement (Molle, 2003, P 271). The global financial crisis, which assumed grave dimensions in 2008 and continues to affect the economies of numerous nations across the globe, has nevertheless brought the functioning of the IMF into sharp focus and reaffirmed its relevance in ensuring international financial stability and averting severe boom and bust cycles (Sanford & Weiss, 2009 P 1 to 25). The fund faces critical challenges and whilst it has secured the backing of the G20 nations, its responses in coming times will determine its relevance in the global financial dispensation (Sanford & Weiss, 2009 P 1 to 25).
This study attempts to analyse the various challenges that have arisen for the fund on account of the current economic crisis and its ability and readiness to help in bringing stability and order to the international financial system.
The Causes and Ramifications of the Financial Crisis
The international financial crisis, which was developing for some time, emerged in 2007 and became fully blown in 2008 (Ponnuru, 2008, P18 +).
With a sustained economic boom creating enormous confidence in the financial markets and the global economy, the sub-prime crisis, the first development of the financial crisis, came about primarily on account of the spiralling greed of investment bankers and their largely unregulated activities (Ponnuru, 2008, P18 +). Such reasons led to the misuse of a financial method, namely securitisation for pooling of numerous loans into saleable assets and off-loading risky loans to other financial institutions (Ponnuru, 2008, P18 +). The adoption of such methods, helped along by poor regulation and inadequate monitoring by credit rating agencies, led banks to progressively increase their risks; they resulted in the creation of thousands of bad loans and the development of a huge housing bubble, which when it burst created financial panic and disaster, first in the USA, and then across the world (Ponnuru, 2008, P18 +).
The erosion in confidence and fall in values of bank and institutional assets led to the collapse of a number of investment institutions, the requirement to inject capital into the system, and a spate of bailouts, mergers and acquisitions (Ponnuru, 2008, P18 +). The problem assumed such dimensions that even banks with substantial capital reserves experienced serious fund depletion and had to approach governments for help (Ponnuru, 2008, P18 +).
With the sub-prime crisis sending the US and other western economies into a free fall, the economic contraction of these major global players created an international economic downturn that spread across continents and which continues to be a cause for major concern (Sanford & Weiss, 2009 P 1 to 25). The IMF revised its forecast for global economic growth for 2009, in April 2009, to -1.3 %, the lowest level of global growth since the Second World War (Sanford & Weiss, 2009 P 1 to 25). The fund's sister organisation, The World Bank, has also predicted that the global economy will contract in 2009 (Sanford & Weiss, 2009 P 1 to 25).
Whilst the advanced countries of North America, Europe and Japan are suffering from economic decline, the economic growth rates in a number of developing and emerging economies are also headed south (Sanford & Weiss, 2009 P 1 to 25). Although the economies of China and India continue to grow, their rates of growth have reduced substantially (Sanford & Weiss, 2009 P 1 to 25). Such economic declines, along with equity losses of trillions of dollars and reductions in credit are not just hindering individuals and businesses, but also global trade and fresh exploration for oil reserves (Weiss, 2008, P 1 to 6). Global unemployment is expected to increase to 30 million workers in 2009 compared to 18 in 2007 (Weiss, 2008, P 1 to 6).
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"The International Labour Organisation expects global unemployment to increase to more than 50 million if the situation continues to deteriorate. In the latter case, some 200 million workers, mostly in developing economies, could find themselves in extreme poverty." (Weiss, 2008, P 3)
The developing economies are witnessing sharp growth declines because of various reasons (Sanford & Weiss, 2009 P 1 to 25). Whilst the economic slump in the advanced nations is resulting in reduction in demand, such economies are also suffering from sharp collapses in commodity prices (Sanford & Weiss, 2009 P 1 to 25). Although the rapid economic advancement in India and China in recent years leading to sharp increases in prices of oil, foods and commodities, the reduction in demand for these over 2008 and 2009 has led to sharp declines in commodity prices and in many cases inflicted significant damage on the economies of poor countries (Sanford & Weiss, 2009 P 1 to 25). Yemen, an oil exporting nation is for example being forced to reduce public expenditure by half because of lower oil export revenues (Sanford & Weiss, 2009 P 1 to 25).
The global economic downturn is further expected to lead to higher levels of international impoverishment, not just in the poorer countries of sub-Saharan Africa but also in growth centres like India and China, the two most populated countries in the world (Sanford & Weiss, 2009 P 1 to 25). Whilst both these countries have been growing rapidly during much of the current decade, economists estimate that even small reductions in growth in these two nations could push millions of people into poverty (Sanford & Weiss, 2009 P 1 to 25). Recent World Bank reports reveal that practically 40 % of the developing countries are exposed to the risk of poverty because of the impact of reducing growth rates on already high levels of poverty (Sanford & Weiss, 2009 P 1 to 25). Another 56 % of countries are also exposed but more moderately than the others, either because of high levels of poverty or reducing growth (Sanford & Weiss, 2009 P 1 to 25).
Although the advanced nations are being able to accelerate growth with the help of increased fiscal deficits and strong stimulus packages, such options are open to only 25 % of the countries who are exposed to poverty risks (Weiss, 2008, P 1 to 6). Nearly a third of developing countries, it is estimated, are dependent upon aid and will need substantial external support in order to enhance fiscal spends (Weiss, 2008, P 1 to 6).
The Role and Challenges of the IMF in the Global Financial Crisis
The current financial crisis has created significant challenges for the IMF, in all its areas of operation, lending, surveillance and provisioning of technical support (Brummer, 2008, P 21+).
Whilst the major objective of the fund is to provide short term financial support to nations suffering from BOP problems and the effects of the economic downturn, the fund does not really have the financial resources to provide funds to the USA or to other North American or West European countries (except possibly Iceland) impacted by the downturn (Brummer, 2008, P 21+). The fund had 257 billion USD of usable resources in August 2008; the maximum lending it had ever provided being USD 40 billion to Argentina, Turkey, Uruguay and Brazil between 2001 and 2003 (Brummer, 2008, P 21+). Again whilst the fund is incapable of providing the required funding to the USA and other western countries, it is also highly unlikely that the United States, or the advanced western nations, as large contributors to Fund resources, will actively approach the IMF for help (Sanford & Weiss, 2009 P 1 to 25). In fact the last occasion when the advanced nations took loans from the IMF occurred in the mid 1970s, when the UK, Spain and Italy approached it to handle the aftermath of the increase in petroleum prices in the early 1970s (Sanford & Weiss, 2009 P 1 to 25).
The alienation of the Fund from numerous developing economies, because of their intensely negative perception of the attitude of the IMF management, has created a deep rift and led such countries to adopt fiscal policies aimed at making them independent of the IMF's ministrations (Brummer, 2008, P 21+).
A number of emerging economies have taken advantage of the high commodity prices that prevailed during the last few years and their high savings rates to build up strong foreign exchange reserves (Brummer, 2008, P 21+). Such actions, taken in continuation of their intensely negative response to the policies set by the IMF towards countries who needed loans in order to ensure that they did not have to ever return to the Fund, has led to the escalation of global foreign exchange reserves from 1.2 trillion USD in 1995 to more than 7 trillion USD today (Brummer, 2008, P 21+).
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Such reluctance on the part of both developing and developed economies, albeit for different reasons, to ask for the IMF's help make its function of acting as the lender of the last resort difficult (Brummer, 2008, P 21+). Increases in foreign exchange stockpiles in the developing economies, along with increases in FDI (foreign direct investment) flows reserves, has been instrumental, not just in reduction in demand for IMF lending but also for deterioration in the Fund's budget situation (Brummer, 2008, P 21+).
The resentment in the attitudes of emerging economies towards the Fund, whilst existing for decades, has increased in recent years because of the improvement in their economic situation (Sanford & Weiss, 2009 P 1 to 25). The overwhelming majority of the developing nations have consistently felt the IMF to be grossly and wrongly influenced by the western nations, led by the USA, (because of their greater share in the Fund's corpus), to the disadvantage of the developing world (Brummer, 2008, P 21+). Such biases, they believe often lead the Fund to adopt a one shoe fits all approach towards borrowers that is based upon western neo-liberal concepts and is often unsuitable for developing countries. The unhappy experiences of Argentina with Fund policies in 2003 and that of the Southeast Asian nations during the Asian crisis of 1997 are often cited to demonstrate the inappropriateness of the IMF's policies (Brummer, 2008, P 21+). The IMF's recent policies in Latvia, (where it is providing bail-out assistance), entail measures like increasing rates of water and electricity, and are considered instrumental in accelerating the country's economic contraction (Sanford & Weiss, 2009 P 1 to 25). The largest debtors to the IMF in current times (May 2009) are detailed in the table provided below (Sanford & Weiss, 2009 P 1 to 25):
The disenchantment of the emerging economies with the Fund has led to the creation of new challenges (Jenkins, 2009, P 3+). Such economies, especially those from East Asia and Latin America, feel their current shareholding in the IMF to be grossly disproportionate to their economic roles and want a larger quota and a greater voice in decision making (Jenkins, 2009, P 3+). Many of the poorer countries believe the Fund to be prejudiced against them, even though they constitute the majority of the borrowers (Jenkins, 2009, P 3+).
The IMF has also been suffering in recent years from severe under financing on account of its financial resources not growing in consonance with the global economy. "The IMF reports that its resources would need to grow by 55% to match the levels relative to global output that prevailed during the Asian financial crisis of 1997-1998" (Sanford & Weiss, 2009 P 9)
The current economic downturn has served a salutary purpose by exposing the positive and negative attributes of the IMF. The IMF, before the surfacing of the crisis was felt to have become substantially redundant. Shunned by many developing countries, its lending had reduced to the lowest level ever in the last 25 years. Countries like Argentina and Brazil had decided to abstain from borrowing from the IMF, even as regions in Latin America and Asia had decided to set up their own funds for making money available without the accompanying policy measures favoured by the IMF.
The current rush of member states for funds because of the economic downturn has changed the situation significantly. Whilst the IMF is again being recognised as an important last resort lender and possibly the only organisation able to coordinate the complex demands of the global monetary system, the crisis has also brought out the Fund's lack of global mandate and its weak resource position.
The need to augment the resources of the Fund appears to have now found widespread acceptance. The decision of the G20 countries to make 750 billion USD available to the Fund to assist recession affected countries will certainly empower it to meet the needs of its members (Shah, 2009, P1).
The reforms of the IMF need to ensure both resources and mandate. With developing countries continuing to be opposed to the fund's west centric control and attitudes, its reforms need to specifically focus on increasing the representation of emerging and developing nations in its quota and its decision making process. Whilst the IMF has embarked on a reform process and the G20s decision to reallocate 3 % of the quota is welcome, (Shah, 2009, P1), much more needs to be done, especially in the engagement of the poor and developing countries in the reform process.
Experts feel that the IMF needs to radically alter its loan policies to incorporate more stimulatory measures (Shah, 2009, P1). The current crisis has provided an opening for the Fund to revive itself and assume a positive role in lessening its impact in two ways, (a) through assistance to countries to resolve their BOP challenges, and (b) by helping to bring about much needed reforms in the global monetary system.
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