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EXECUTIVE SUMMARY
International monetary fund is an international organisation which was set up
with an aim to stabilize exchange rates and assist the reconstruction of theworlds international payment system. It plays a very important and crucial role
in world financial system. The expansions of the IMFs membership, together
with the changes in the world economy, have required the IMF to adapt in a
variety of ways to continue serving its purposes effectively.
The primary mission of the IMF is to provide financial assistance to
countries that experience serious financial and economic difficulties using funds
deposited with the IMF from the institution's 187 member countries. Member
states with balance of payments problems, which often arise from these
difficulties, may request loans to help fill gaps between what countries earn
and/or are able to borrow from other official lenders and what countries must
spend to operate, including covering the cost of importing basic goods and
services.
To simply say INTERNATIONAL MONETARY FUND & BANK OFINTERNATIONAL SETTELMENT are the two most crucial role players in
international financial market as well system. The International Monetary Fund
keeps account of international balance of payments accounts of member states.
The IMF acts as a lender of last resort for members in financial distress,
e.g., currency crisis, problems meeting balance of payment when in deficit
and debt default.
To simply conclude International Monetary Fund, IMF can be defined as
an intergovernmental organization that oversees the global financial system by
following the macroeconomic policies of its member countries. IMF was
important when it was first created because it helped the worl d stabilize the
economic system and today it is even more important because it is a leading
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significantly over-valued or under-valued currencies run the risk of facing
balance of payment crises. Thus, the structural adjustment programs are at least
ostensibly intended to ensure that the IMF is actually helping to prevent
financial crises rather than merely funding financial recklessness.
The World bank & IMF together pulled out the solution for the crisis in
2007-2009 and there emerged an developing countries union G -20.The G-20
Summit was created as a response both to the financial crisis of 20072010 and
to a growing recognition that key emerging countries were not adequately
included in the core of global economic discussion and governance. The G -20
Summits of heads of state or government were held in addition to the G-20
Meetings of Finance Ministers and Central Bank Governors who continued to
meet to prepare the leaders' summit and implement their decisions.
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HISTORY OF INTERNATIONAL MONETARY FUND
The International Monetary Fund was conceived in July 1944 during the United
Nations Monetary and Financial Conference. The representatives of 45
governments met in the Mount Washington Hotel in the area of Bretton Woods,
New Hampshire, United States, with the delegates to the conference agreeing on
a framework for international economic cooperation. The IMF was formally
organized on December 27, 1945, when the first 29 countries signed its Articles
of Agreement. The statutory purposes of the IMF today are the same as when
they were formulated in 1943.
Since last few centuries gold has been used as a form of money. Most
European countries which even used silver coins as money for trade transaction.
The countries which followed gold and silver as any one metal were said to
follow monometalism and those which used both gold as well as silver coins
were said to follow bimetallism. Use of gold as money is called as Gold
Standard System its the oldest system and was in operation till First World
War. This system is based on value of gold and relates to the a mount of gold
held by the monetary authority of a specific country. There are three known
kind of Gold Standard System that have been adopted since early 1700s The
gold specie, the gold bullion, and the gold exchange standard system.
With the outbreak of First World War, the United Kingdom ended using
the gold specie system and so did the British Empire, instead another system
where authorities agree upon amount an amount to sell gol d; however the gold
coins are not actually in circulation.
The country kept treasury notes instead of actually circulating the gold
coins. Officially the gold specie system had not been repealed (abolished) until
1925 when the Bank of England had been requested by someone to trade in
their paper money for gold.
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Then the bullion standard was put into effect; however this standard only
lasted until 1931, when the United Kingdom ended the bullion standard because
of large amounts of gold going overseas. Australia, New Zealand and Canada
also ended the gold standard because of money problems that were associated
with the Great Depression.
By First World War most countries were on the gold standard, but most
suspended it so they could print enough money to pay for their investment in the
war. The Gold Standard System came to an end for the United States in 1933
when President Roosevelt prohibited owning gold privately, except for
jewellery.
In this way after the Second World War the IMF was emerged and till date
plays a very crucial and a significant role in the global financial economies,
market as well as the global financial system. It can be said that the IMF is the
roots for the smooth working of the financial system worldwide.
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BRETTON WOODS SYSTEM.
Due to many events, including the breakdown of Gold standard System, world
monetary system was not really a system at all. It was an utter chaos. After the
Second World War, policy makers from United Kingdom and United states
along with other allies initiated the process of reviving world monetary system.
In 1944, representatives from around 40 countries met at Bretton Woods a town
in New Hampshire States of the United States. The system evolved was named
as Bretton Woods System. Also as results of this meet, two super- national
institution of world were formed, viz., International Monetary Fund (IMF) and
the International Bank for Reconstruction and Development, now known as the
World Bank.
The former was designed to monitor exchange rates and lend reserve
currencies to nations with trade deficits, the latter to provide underdeveloped
nations with needed capital although each institution's role has changed over
time. Each of the 44 nations who joined the discussions contributed a
membership fee, of sorts, to fund these institutions; the amount of each
contribution designated a country's economic ability and dictated its number ofvotes.
In an effort to free international trade and fund post war reconstruction,
the member states agreed to fix their exchange rates by tying their currencies to
the U.S. dollar.
On August 15, 1971, the United States unilaterally terminated
convertibility of the dollar to gold. This action, referred to as the Nixon shock,
created the situation in which the United States dollar became the sole backing
of currencies and a reserve currency for the member states. An American dollar
played an very important role in this system . The Bretton Woods System was a
modified version of Gold Exchange Standard and the main features were as
follows:
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1. The United States of America undertook to convert the US dollar ($)freely into gold at fixed parity of $ 35 per ounce. (1 ounce = 28.35 gram s)
2. Other countries (member countries) agreed to maintain their currencies atspecific parities (ratio) with US Dollar. 1% variation in this parity (+ or -)
was allowed. If the exchange rate of these member countries tended to
exceed this 1% limit, then their monetary authorities (the monetary
authorities can be Central Bank or Organisation of the country under the
law of that specific country) shall take the necessary measures to restore
it. This was supposed to be done by buying and selling dollars in the
international financial markets. Its simple to understand that if the
market of some specific country is buying dollars heavily then themonetary authorities of that specific country should sell dollars in
financial markets worldwide to maintain the parity fixed with the US
Dollars.
3. If there is any kind of problem in maintaining or in order to maintainparity obligations, if required, the members countries may borrow US
Dollars from International Monetary Fund (IMF).
4. If there is a genuine problem in maintaining parity to the particularmember country, then it can change it s parity itself by 10% (+ or-),
without consulting IMF. If desired to exceed this 10% limit, then the
member country or countries has to inform IM F and seek its consent.
Because of this feature, the Bretton Woods system was often referred as
Adjustable Peg System.
The Bretton Woods system of monetary management established the rules
for commercial and financial relations among the world's major industrial
states in the mid 20th century. The Bretton Woods system was the first
example of a fully negotiated monetary order intended to govern monetary
relations among independent nation-states.
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MECHANISM OF BRETTON WOODS SYSTEM
Dollar was universally accepted exchange currency.US did not have freedom to
change gold parity of its own currency. All other countries were willing to
accumulate by selling goods and services to US. However, US can buy these
goods from other countries by simply printing dollars, so long as they are
confident to convert those many dollars to gold, on demand. Being the power as
well as excepting to give Gold on demand to other countries in exchange of the
U.S Dollars ($) the American government started printing more and more
currency, on other side the member countries of IMF started acquiring more and
more ($) by providing America with goods and services.
The countries other than US had to accumulate more and more dollars so
as to carry out international trade. So US had to supply unlimited dollars. It had
to run balance of payment (BoP) deficits. Initial years while this deficit was at
moderate levels, it was fine. When it started to be higher and higher levels,
other member countries started doubting the capability of the US to convert
dollars into gold. Mainly France started demands of such actual conversion after
1960s. Soon it was evident that US did not have enough gold to honour its
commitment of conversion of dollars into gold.
COLLAPSE OF BRETTON WOODS SYSTEM
In 1960 Robert Triffin noticed that holding dollars was more valuable than gold
because constant U.S. balance of payments deficits helped to keep the systemliquid and fuel economic growth. What would later come to be known
as Triffin's Dilemma was predicted when Triffin noted that if the U.S. failed to
keep running deficits the system would lose its liquidity, not be able to keep up
with the world's economic growth, and, thus, bring the system to a halt. But
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incurring such payment deficits also meant that, over time, the deficits would
erode confidence in the dollar as the reserve currency created instability.
The first effort was the creation of the London Gold Pool on November 1
of 1961 between eight nations. The theory behind the pool was that spikes in thefree market price of gold, set by the morning gold fix in London, could be
controlled by having a pool of gold to sell on the open market that would then
be recovered when the price of gold dropped. Gold's price spiked in response to
events such as the Cuban Missile Crisis, and other smaller events, to as high as
$40 per ounce. The Kennedy administration drafted a radical change of the tax
system to spur more production capacity and thus encourage exports. This
culminated with the 1963 tax cut program, designed to maintain the $35 peg.
In 1967, there was an attack on the pound and a run on gold in the sterling
area, and on November 18, 1967, the British government was forced to devalue
the pound. U.S. President Lyndon Baines Johnson was faced with a brutal
choice, either institute protectionist measures, including travel taxes, export
subsidies and slashing the budgetor accept the risk of a "run on gold" and the
dollar. From Johnson's perspective: "The world supply of gold is insufficient to
make the present system workableparticularly as the use of the dollar as a
reserve currency is essential to create the required international liquidity to
sustain world trade and growth." He believed that the priorities of the United
States were correct, and, although there were internal tensions in the Western
alliance, that turning away from open trade would be more costly, economically
and politically, than it was worth: "Our role of world leadership in a political
and military sense is the only reason for our current embarrassment in an
economic sense on the one hand and on the other the correction of the economic
embarrassment under present monetary systems will result in an untenable
position economically for our allies."
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While West Germany agreed not to purchase gold from the U.S., and
agreed to hold dollars instead, the pressure on both the dollar and the pound
sterling continued. This was unsuccessful, however, as in mid-March 1968 a run
on gold ensued, the London Gold Pool was dissolved, and a series of meetings
attempted to rescue or reform the existing system. But, as long as the U.S.
commitments to foreign deployment continued, particularly to Western Europe,
there was little that could be done to maintain the gold peg.
All attempts to maintain the peg collapsed in November 1968, and a new
policy program attempted to convert the Bretton Woods system into an
enforcement mechanism of floating the gold peg, which would be set by
either fait policy or by a restriction to honour foreign accounts.
In this way the system of Bretton Woods collapsed on 15TH August,
1971.And after that in 1971, at Smithsonian Institute, Finance Ministers
attempted to retain and defend the Bretton Woods System. The US agreed to
raise the official price of gold from ($) 35 to ($) 38 i.e. 7.9% devaluation of US
dollar ($).This agreement was also an incomplete solution to the problem
explained by Triffin, hence it was unsustainable for long time.
After several attempts to revive the system by parity changes, dollar
devaluation, etc. The system was practically abandoned in 1973 and officially in
1978. US lost its role as an anchor of the world monetary system.
But even though the Bretton Woods System collapsed but, the
International Monetary Fund and the International Bank for Reconstruction and
Development, now known as the World Bank are yet working in the benefit of
International financial system.
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INTERNATIONAL MONETARY FUND
The International Monetary Fund (IMF) is the intergovernmental organization
that oversees the global financial system by following the macroeconomic
policies of its member countries, in particular those with an impact on exchange
rate and the balance of payments. It is an organization formed with a stated
objective of stabilizing international excha nge rates and facilitating
development through the enforcement of liberalising economic policies on other
countries as a condition for loans, restructuring or aid. It also offers
highly leveraged loans, mainly to poorer countries. Its headquarters are
in Washington, D.C., United States. The IMF's relatively high influence in
world affairs and development has drawn heavy criticism from some sources.
ORGANIZATION AND PURPOSE
The International Monetary Fund was conceived in July 1944 originally with 45
members and came into existence in December 1945 when 29 countries signed
the agreement, with a goal to stabilize exchange rates and assist the
reconstruction of the world's international payment system. Countries
contributed to a pool which could be borrowed from, on a temporary basis, by
countries with payment imbalances (Condon, 2007). The IMF was importa nt
when it was first created because it helped the world stabilize the economic
system. The IMF works to improve the economies of its member countries. The
IMF describes itself as "an organization of 187 countries (as of July 2010),
working to foster global monetary cooperation, secure financial stability,
facilitate international trade, promote high employment and sustainable
economic growth, and reduce poverty".
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MEMBERSHIP
Members of the IMF are 186 of the UN members and Kosovo.
Former members are: Cuba (left in 1964), and Taiwan (expelled in 1980 due to
political reasons),
The other non-members are: North Korea, Andorra, Monaco, Liechtenstein,
Nauru, Cook Islands, Niue, Vatican City and the rest of the states with limited
recognition.
All member states participate directly in the IMF. Member states are
represented on a 24-member Executive Board (five Executive Directors are
appointed by the five members with the largest quotas, nineteen Executive
Directors are elected by the remaining members), and all members appoint a
Governor to the IMF's Board of Governors.
All members of the IMF are also IBRD members, and vice versa.
DATA DISSEMINATION SYSTEM
In 1995, the International Monetary Fund began work on data dissemination
standards with the view of guiding IMF member countries to disseminate their
economic and financial data to the pub lic. The International Monetary and
Financial Committee (IMFC) endorsed the guidelines for the dissemination
standards and they were split into two tiers: The General Data Dissemination
System (GDDS) and the Special Data Dissemination Standard (SDDS).
The International Monetary Fund executive board approved the SDDS
and GDDS in 1996 and 1997 respectively and subsequent amendments were
published in a revised "Guide to the General Data Dissemination System". The
system is aimed primarily at statisticians and aims to improve many aspects of
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statistical systems in a country. I t is also part of the World Bank Millennium
Development Goals and Poverty Reduction Strategic Papers.
The IMF established a system and standard to guide members in the
dissemination to the public of their economic and financial data. Currently thereare two such systems: General Data Dissemination System (GDDS) and its
superset Special Data Dissemination System (SDDS), for those member
countries having or seeking access to international capital markets.
The primary objective of the GDDS is to encourage IMF member
countries to build a framework to improve data quality and increase statistical
capacity building. This will involve the preparation of meta data describing
current statistical collection practices and setting improvement plans. Upon
building a framework, a country can evaluate statistical needs, set priorities in
improving the timeliness, transparency, reliability and accessibility of financial
and economic data. Some countries initially used the GDDS, but lately
upgraded to SDDS.
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GLOBAL FINANCIAL SYSTEM
The global financial system (GFS) is the financial system consisting
of institutions and regulators that act on the international level, as opposed to
those that act on a national or regional level. The main players are the global
institutions, such as International Monetary Fund and Bank for International
Settlements, national agencies and government departments, e.g., central
banks and finance ministries, private institutions acting on the global scale,
e.g., banks and hedge funds, and regional institutions, e.g., the Euro zone.
Deficiencies and reform of the Global Financial System have been hotly
discussed in recent years specifically from 1990s.
The history of financial institutions must be differentiated from economic
history and history of money. In Europe, it may have started with the first
commodity exchange, the Bruges Bourse in 1309 and the first financiers and
banks in the 15th17th centuries in central and western Europe. The first global
financiers the Fuggers (1487) in Germany; the first stock company in England
(Russia Company 1553); the first foreign exchange market (The Royal
Exchange 1566, England); the first stock exchange (the Amsterdam Stock
Exchange 1602).
Milestones in the history of financial institutions are the Gold
Standard (18711932), the founding of International Monetary Fund (IMF),
World Bank at Bretton Woods, and the abolishment of fixed exchange rates in
1973.
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PRESPECTIVE
There are three primary approaches to viewing and understand ing the global
financial system, which are as follows:
(1)The liberal view holds that the exchange of currencies should bedetermined not by state institutions but instead individual players at a
market level. This view has been labelled as the Washington Consensus.
(2)The Washington Consensus view is challenged by a socialdemocratic front which advocates the tempering of market mechanisms,
and instituting economic safeguards in an attempt to ensure financ ial
stability and redistribution. Examples include slowing down the rate of
financial transactions, or enforcing regulations on the behaviour of
private firms.
(3)Outside of this contention of authority and the individual, neoMarxists are highly critical of the modern financial system in that it
promotes inequality between state players, particularl y holding the view
that the political north abuse the financial system to exercise control of
developing countries' economies.
THE MAJOR PLAYERS IN THE GLOBAL FINANCIAL SYSTEM
International institutions
The most prominent international institutions are the International Monetary
System (IMF), the World Bank and the WTO:
(a)The International Monetary Fund keeps account of international balanceof payments accounts of member states.
(b)The World Bank aims to provide funding, take up credit risk or offerfavourable terms to development projects mostly in developing countries
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that couldn't be obtained by the private sector. The other multilateral
development banks and other international financial institutions also play
specific regional or functional roles.
(c)The World Trade Organization settles trade disputes and negotiatesinternational trade agreements in its rounds of talks (currently the Doha
Round).
Also important is the Bank for International Settlements, the intergovernmental
organisation for central banks worldwide. It has two subsidiary bodies that are
important actors in the global financial system in their own right - the Basel
Committee on Banking Supervision, and the Financial Stability Board.
In the private sector, an important organisation is the Institute of
International Finance, which includes most of the world's largest commercial
banks and investment banks.
Government institutions
Governments act in various ways as actors in the Global Financial System,primarily through their finance ministries: they pass the laws and regulations
for financial markets, and set the tax burden for private players, e.g., banks,
funds and exchanges. They also participate actively through discretionary
spending. They are closely tied (though in most countries independent of) to
central banks that issue government debt, set interest rates and deposit
requirements, and intervene in the foreign exchange market.
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Private participants
Players active in the stock-, bond-, foreign exchange-, derivatives-
and commodities-markets, this includes the participant like hedgers, speculators
and arbitrageurs.
Investment banking, including: Commercial banks, Hedge funds and Private
Equity, Pension funds, Insurance companies, Mutual funds, and Sovereign
wealth funds.
Regional institutions
It includes Commonwealth of Independent States (CIS), Euro zone, Mercosur,
North American Free Trade Agreement (NAFTA), South Asian Association For
Regional cooperation (SAARC) etc.
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ROLE OF INTERNATIONAL MONETARY FUND (IMF) IN
GLOBAL FINANCIAL SYSTEM.
The global economy and financial system are in the midst of a massive
deleveraging process. The increased globalization of the world economy and,
more important, of the world financial system in recent decades means that
countries can run, but not hide, from this crisis or future crises. Every country
has been affected, and those with the weakest policies and the most precarious
financial circumstances have been affected first. The incidence and virulence of
future crises may be reduced by decisions taken in the wake of this crisis, but
crises will not be prevented. What is important now is to cushion the impacts of
the global recession and to restore stability to financial markets.
The world has turned to the International Monetary Fund (IMF) . Under
managing director Dominique Strauss-Kahn, the IMF has moved aggressively.
In the fourth quarter of 2008, the IMF committed about $45 billion to six of its
member countries to support their adjustment programs. A program for Belarus
was approved on January 12, and programs for several more countries are in the
pipeline.On another front, on October 27, the IMF executive board approved a
new short term lending facility (SLF). Countries with sound economic and
financial policies and underlying fundamentals plus sustainable external and
internal debt positions (on the basis of their most recent Article IV
consultations) can borrow immediately as much as five times their IMF quotas
for three months with two possible rollovers. (Normally a member can only
draw the amount of its IMF quota over the course of one year.) The executive
board notionally set aside an initial $100 billion for this facility. This is out of
its estimated total forward lending capacity of about $200 billion as of the end
of September$250 billion including financing available under established
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IMF borrowing arrangements. Government of Japan offered to lend the IMF an
additional $100 billion.
Also on October 27 last year, the Federal Open Market Committee
(FOMC) of the Federal Reserve System approved reciprocal swap, or short-
term lending, arrangements with each of four emerging -market countries
Brazil, Korea, Mexico, and Singaporeof $30 billion each. It remains to be
seen whether any country draws on the SLF and how that facility interacts with
the Federal Reserve swap arrangements with these four and the other ten central
banks.
As of the end of 2008, the Federal Reserve had extended more than $600
billion in dollar credit to the fourteen. (In early January, a small portion of thatamount has been repaid.) Thus, the Federal Reserve lent to other countries
almost twice the amount that the IMF can lend out of its normal resources. Its a
most prominent international institution; the International Monetary Fund keeps
account of international balance of payments accounts of member states. The
IMF acts as a lender of last resort for members in financial distress,
e.g., currency crisis, problems meeting balance of payment when in deficit
and debt default. Membership is based on quotas, or the amount of money a
country provides to the fund relative to the size of its role in the international
trading system.
ROLE AND REFORMS OF IMF
The primary mission of the IMF is to provide financial assistance to countriesthat experience serious financial and economic difficulties using funds
deposited with the IMF from the institution's 187 member countries. Member
states with balance of payments problems, which often arise from these
difficulties, may request loans to help fill gaps between what countries earn
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and/or are able to borrow from other official lenders and what countries must
spend to operate, including covering the cost of importing basic goods and
services. In return, countries are usually required to launch certain reforms,
which have often been dubbed the " Washington Consensus". These reforms are
thought to be beneficial to countries with fixed exchange rate policies that may
engage in fiscal, monetary, and political practices which may l ead to the crisis
itself. For example, nations with severe budget deficits, rampant inflation, strict
price controls, or significantly over-valued or under-valued currencies run the
risk of facing balance of payment crises. Thus, the structural adjustment
programs are at least ostensibly intended to ensure that the IMF is actually
helping to prevent financial crises rather than merely funding financ e to themember countries.
EBBING OF INTERNATIONALISM
Since the early days of the Fund (leaving out the abnormal post -war lows),
world trade has grown, from 10% of world GDP in 1960 to almost triple that in
2005. World GDP itself has grown at an average rate of 3.5% over this period,
faster than at any other period in human history. In short, judging by the Fund's
goals at its founding, it has been a great success.
The Fund was a partnership of the heedful, and given that a country could
be a creditor one day and a debtor the next, it was also a community of common
interests. Over time, however, industrial countries recovered from their post -war
weakness. They rebuilt their capability to undertake policy analysis. And the
system of capital controls and fixed but adjustable exchange rates broke down
for reasons well described elsewhere. Most industrial countries moved to
floating exchange rates. This move, coupled with their political stability and
strong institutions, ensured that private capital markets would be a reliable
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source of finance. As a result, industrial countries stopped borrowing from the
Fund as late as 1975, nearly half of Fund lending was to industrial countries,
but by the late 1980s, it was zero.
This had two important consequences:
(1)It was that with little to gain from the vetting of their policies by thelarger Fund membership, important industrial countries started forming
groups outside the Fund, with serious policy discussion and economic co -
operation taking place within these group s. The most prominent avatar of
this First Circle is now the G-7. While not denying the global benefits of
frank policy dialogue and coordination within the group, an unfortunate
consequence has been to diminish the relevance of the multilateral
discussion that takes place within the Fund.
(2)It was that the Fund itself was divided between industrial countrycreditors who would never borrow and held the weight of the
shareholding, and potential debtors who had to subject their policies to
multilateral advice either within the context of a Fund-supported policy
program or for fear they might otherwise lose access to Fund resources in
their time of need. The tensions between these groups centred around
program conditionality the conditions the Fund imposed in lending
programs to ensure repayment, and to ensure that the resources were used
to promote, rather than postpone, adjustment and reform.
In the early days of the Fund, conditions were primarily imposed on a
country's exchange rate and macroeconomic policies. But as the Fund began
lending to more developing, emerging market, and formerly planned economies,
it began to place conditions relating to structural reforms such as
privatization, fiscal reforms, financial sector reforms, trade refo rms, central
bank independence, etc. These were more intrusive than prior Fund
conditionality the canonical example of what generally came to be viewed as
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excess being the 140 or so conditions imposed on Indonesia in 1998 including
measures dealing with reforestation programs, disbanding the clove monopoly,
and introducing a micro-credit scheme.Whether all these conditions were really
needed, or whether the Fund was freer with conditionality because its largest
shareholders did not ever anticipate borrowing is something that can again be
debated for a long time. What is true is that even though the Fund has taken
important steps to streamline conditionality as exemplified by the recent
program with Brazil the fear of excessive conditionality persists.
Most recently, some emerging markets have built up their foreign reserves
to such an extent that they are unlikely to need Fund resources at least in the
short term. Given the precedent set by the industrial countries, these "advanced"emerging markets are not keen to be seen heeding Fund advice, though many of
them value it privately. Unfortunately, paying attention to the global community
is seen as weakness today rather than responsible global citizenship.
This development of IMF is particularly pernicious for a number of
reasons. Unlike industrial countries, these advanced emerging markets still have
structural vulnerabilities which are currently papered over by the excellent
global economic condition. After all, with the United States r unning a huge
current account deficit, it becomes easier for many emerging markets to run
current account surpluses, and reduce their external borrowing. Similarly, fiscal
surpluses are easier to run when buoyant export revenues provide easy -to-
collect taxes. The times will change, though not necessarily soon, and while
emerging markets are trying to use current conditions to reduce their
vulnerabilities, it can expected that many will continue to benefit tremendously
from Fund surveillance. They may well n eed Fund resources in the future.
Many of the member countries are now significant players in the world
economy, who affect each other, as well as the rest of the world. They could
play a valuable role in the multilateral dialogue their collective will could be
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a powerful force in reforming multilateral form, but it is not being asserted,
partly because they have diverse interests. Equally problematic, industrial
countries are only slowly, too slowly in my view, figuring out that their groups
need to be reformed the smallest countries are a particular drag here because
any reform that includes new members is likely to leave them out. Moreover,
industrial countries have gotten used to domestic policy independence. The
member countries need to realize that if they want the advanced emerging
markets to alter their policies to further the common interest, they themselves
have to accept some multilateral constraints on their policies.
The ebbing spirit of internationalism is not felt only by the IMF. More
generally, it seems to that the rapidity with which the private sector hasembraced globalization worries citizens. Some governments see their role
increasingly as slowing this process, extracting political mileage by pandering
to vociferous interest groups obstructing change, rather than educating citizens
to accept it. Economic patriotism is protectionist old wine in a mislabelled new
bottle, but it is all the more dangerous in a world where multilateral dialogue is
becoming so critical. The beggar-thy-neighbour policies being contemplated by
some countries on the capital account -shielding large swathes of their own
economy from corporate takeovers while encouraging their own companies to
take advantage of the continued openness of o thers deserves to be roundly
condemned. If not stopped immediately, these policies will only spread, with
action breeding reaction.
It is amidst this background of diminishing multilateral dialogue that
calls are being made to reform the Fund. Part of the Fund's response to its
largest shareholders has to be, "Physician, heal thy self". But the larger part of
the Fund's response has to be to find ways to re -engage all of its member
countries.
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FUND SURVELLIENCE OF FLOATING EXCHANGE RATES
IMF surveillance that is its periodic monitoring of a country's economic
policies focuses on two related issues: the sustainability of a country's
policies and their external effects. While the exchange rate is at the heart of the
IMF's mandate for surveillance, the level of the exchange rate (and its departure
from some notion of equilibrium), is just one of the gauges of the
appropriateness of policy.
In the past, one hurdle used to be that countries simply did not have
the high quality personnel or the wealth of data and country experience the
Fund staff had. Increasingly, though, our member countries recruit officials with
qualifications comparable to those of Fund staff, and have access to the same
databases that the Fund uses. While they do not usually have the wealth of
cross-country experience we have, countries do talk to one another.
But as important as the quality of analysis is impartiality. This is where the
Fund still has an important advantage.
Example: Politicians need to be re-elected. This shortens their policy horizonsand increases their incentive to take on long -dated risks with short-dated
returns. Growth before elections is much valued, growth after elections is highly
discounted. Inflicting pain on current generations, especially those who are
vocal and vote, in order to ease the way for future generations, is especially
difficult. Unfortunately, future generations do not have a voice, and not all the
electorate see the consequences of myopic policies. Populism is ind eed popular!
Lack of sustainability as politicians follow will fully myopic policies is why so
many countries have had to borrow from the Fund in the past, and why so many
emerging markets have got into trouble in the past decade. Foreign investors are
willing to finance unsustainable spending for a while they give you a long
rope to hang yourself, but when the drop finally comes, it is quick and
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extremely painful.
Sustainability could be a domestic matter. It is because unsustainable
policies will eventually require outside (Fund) financing, or force costly
adjustment on other countries, that the Fund, representing the global
community, has a legitimate interest. And in matters of unsustainability,
emerging markets are not the only offende rs.
Consider the United States, which is running a current account deficit
of 6.5 percent of GDP meaning it spends far more than it saves in the
process absorbing nearly 70 percent of world external savings. Any industrial
country running such a large deficit becomes reliant on the mood of foreign
investors not so much because foreign investors will inflict a "sudden stop" butbecause they are likely, at some point, to start demanding a much higher
premium for continuing to finance. Thus far they have not, not even pricing in
the eventually needed real dollar depreciation, perhaps another example of the
long rope markets provide.
When they cut back on spending, the effect on U.S. output may well
be limited under some scenarios, especially if the spending slowdown is
accompanied by interest rate cuts and excha nge rate depreciation. This is why
the Fund has been so vocal about the problem of global current account
imbalances, and the need for the United States to increase sav ings in a measured
way.
Moreover, the counterpart of the U.S. deficit, the current account
surpluses and reserve build-up that have so fortified emerging markets, are also
unsustainable. When the deficit shrinks the surpluses will shrink this is
simply a matter of adding up. The question every country has to ask itself is
"Am I prepared for the day the U.S. consumer finally decides to hang up the
shopping bag and save?"
It is concerns about sustainability and external effec ts that motivate
the Fund's advice to China. China is becoming overly reliant on external
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demand. Its exchange rate policy distorts the pattern of investment even while
weighing on consumption, and prevents the central bank from using interest
rates as an effective tool of policy. While corporate and financial sector reform
is probably key to medium-term sustainability in China, allowing exchange rate
appreciation must be an integral part of the strategy.
Ultimately, adjustment of the global imbalances will be a good thing,
for it does seem against the natural order for countries with massive
development needs to finance the asset price booms and the under -saving of
rich countries (leaving aside the distortionary exchange intervention and
demand compression that underlies some of the reserve build -up). Nevertheless,
there are those who question the need for any concern about imbalances, giventhat they have been financed so long. After all, the US was running a large
current account deficit in the late 1980s, and that imbalance r esolved itself
smoothly.
There is need for concern. For one, the benign global financing
conditions appear to be turning so the recent past need not say much about the
future. More important, the U.S. current account deficit is twice the size of what
it was in the 1980s even with increasing economic integration, there is a
limit to how much a country can depend on the outside world. Since adjustment
is inevitable, would it not be better for each country to commit to a medium.
IMF's mandate to monitor these imbalances and to work together to
narrow them. In particular, the Managing Director has called for a new modality
called "multilateral consultations", which will recognize the multilateral nature
of these imbalances and bring together key countries for a dialogue whenever
deemed necessary.
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IMF INSURANCE
To provide a better forum for multilateral dialogue is an essential step to re -
engage the major players. Equally important if the Fund can convince advanced
emerging markets that they still have much to gain by listening to the Fund,
these countries are drawn back to the Fund. In turn, this makes the Fund a more
interesting place for industrial economies to engage in multilateral dialogue.
It is believed that insurance is a key to re-engagement. Many argued
earlier that the advanced emerging markets s till have vulnerabilities such as
underdeveloped financial sectors that are being papered over by massive
reserve holdings.
It has been suggested by IMF that, the underlying imbalances driving
the reserve build-up may reverse in the future. As the reserves of advanced
emerging markets fall, they may well want to re -engage with the Fund, but on
their own terms. They are being open to some kind of insurance from the Fund,
but are to be wary of the creditor-biased conditionality that they believe
accompanies it. Some industrial countries do not want to offer automatic access
for fear of encouraging lax policies or moral hazard.
A PROPORSAL FOR FUTURE FUND "INSURANCE" TO
EMERGING MARKETS.
Let me speculate on what a potential solution could be. The more automatic
access a country wants to financing in case of crisis, the more pre -screening is
necessary. One way to offer this is to condition a country's automatic access to
Fund financing on the quality of its policies, as determined by regula r Fund
surveillance. If a country's policies are judged to be sensible, its access to
automatic financing in case it is hit by an unexpected shock improves. Access to
automatic financing then becomes a precise, meaningful, and continuous signal
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of a country's policies. Precise because it is a number, meaningful because it
implies automatic access, and continuous because it is constantly updated based
on a country's policies. Such a system of "ex ante" conditionality would give
countries added incentive to stay on the straight and narrow, even outside
normal Fund programs.
Industrial countries may be reluctant to provide financing for such a
scheme. But there may be ways of minimizing the call on their purse. The range
of innovative possibilities that would give advanced emerging markets more of
a say over Fund policies, a greater role in financing, and more attractive
insurance facilities from the Fund, is large and is well worth further
examination. For instance, one extreme would be simply being a more global
version of the Chiang Mai initiative, where countries offer to l end reserves to
each other, mediated by the Fund. Some initial drawing level would be
automatic, but more would require an IMF program.
At the other extreme would be a more formal pooling of country
reserves within the Fund, as part of a new insurance facility that would offer far
more automatic access in times of trouble in return for more ex ante
conditionality. The Managing Director has indeed called for an examination of
the possibilities in his strategic review. With advanced emerging markets more
engaged, perhaps industrial countries will also see more value in the Fund as a
forum for dialogue and the spirit of internationalism will be rekindled once
more.
SUPPORT OF MILITARY DICTATORSHIP
The role of the Bretton Woods institutions has been controversial since the
late Cold War period, due to claims that the IMF policy makers
supported military dictatorships friendly to American and
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International Monetary Fund (IMF) get involved in many problems
of members countries and try to sort out the problem related, it played a crucial
role in Kenya. IMF got involved in the country; the Kenyan central bank
oversaw all currency movements in and out of the country. The IMF mandated
that the Kenyan central bank had to allow easier currency movement. The
adjustment resulted in very huge foreign investment in the country which before
was working in huge deficit problem was then; due to intervention of IMF got
somewhat out of problem.
In 2006, an IMF reform agenda called the Medium Term Strategy
was widely endorsed by the institution's member countries. The agenda includes
changes in IMF governance to enhance the role of developing countries in the
institution's decision-making process and steps to deepen the effectiveness of its
core mandate, which is known as economic surveillance or helping member
countries adopt macroeconomic policies that will sustain global growth and
reduce poverty.
On June 15, 2007, the Executive Board of the IMF adopted the 2007
Decision on Bilateral Surveillance, a landmark measure that replaced a 30 -year-
old decision of the Fund's member countries on how the IMF should analyse
economic outcomes at the country level. From IMF view the global scenario is
changing and it is trying to change the situation and has started analysing
countries from single country level.
It is this: Even as the world has become more interconnected
through trade and finance, even as the Fund's members have become more
successful, the spirit of cooperation that prevailed amongst the members at the
time of the founding of the Fund seems to have waned.
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SUBSCRIPTION AND QUOTAS
What emerged largely reflected U.S. preferences: a system of subscriptions
and quotas embedded in the IMF, which itself was to be no more than a fixe d
pool of national currencies and gold subscribed by each country as opposed to a
world central bank capable of creating money. The Fund was charged with
managing various nations' trade deficits so that they would not produce
currency devaluations that would trigger a decline in imports.
The IMF is having as much as fund, composed of contributions of
member countries in gold and their own currencies. The original quotas were to
total $8.8 billion. When joining the IMF, members are assigned " quotas"reflecting their relative economic power, and, it is as a sort of credit deposit,
were obliged are to pay a "subscription" of an amount commensurate to the
quota. The subscription is to be paid 25% in gold or currency convertible into
gold (effectively the dollar, which was the only currency then still directly gold
convertible for central banks) and 75% in the membe r's own currency.
Quota subscriptions are to form the largest source of money at the
IMF's disposal. The IMF set out to use this money to grant loans to member
countries with financial difficulties. Each member is then entitled to withdra w
25% of its quota immediately in case of payment problems. If this sum should
be insufficient, each nation in the system is also able to request loans for foreign
currency.
TRADE DEFICITS
In the event of a deficit in the current account, Fund members, when short of
reserves, are be able to borrow foreign currency in amounts determined by the
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size of its quota. In other words, the higher the count ry's contribution was, the
higher the sum of money it could borrow from the IMF.
Members are required to pay back debts within a period of 18
months to five years. In turn, the IMF embarked on setting up rules andprocedures to keep a country from going too deeply into debt year after year.
The Fund exercises "surveillance" over other economies for the U.S.
Treasury in return for its loans to prop up national currencies.
IMF loans are not comparable to loans issued by a conventional
credit institution. Instead, they are effectively a chance to purchase a foreign
currency with gold or the member's national currency.
The IMF is designed in such a way to advance credits to countries
with balance of payments deficits. Short -run balance of payment difficulties
would be overcome by IMF loans, which would facilitate stable currency
exchange rates. This flexibility meant a member stat e would not have to induce
a depression to cut its national income down to such a low level that its imports
would finally fall within its means. Thus, countries are to be spared the need to
resort to the classical medicine of deflating themselves into drasticunemployment when faced with chronic balance of payment s deficits.
The IMF sought to provide for occasional discontinuous exchange -
rate adjustments (changing a member's par value) by international agreement.
Member nations were permitted to adjust their currency exchange rate by 10%.
This tended to restore equilibrium in their trade by expanding their exports and
contracting imports. This would be allowed only if there was a fundamental
disequilibrium. A decrease in the value of a country's money was called
devaluation, while an increase in the value of the country's money was called
a revaluation.
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GROWTH OF INTERNATIONAL CURRENCY MARKETS
Another aspect of the internationalization of banking has been the emergence of
international banking consortia. Since 1964 various banks had formed
international syndicates, and by 1971 over three quarters of the world's largest
banks had become shareholders in such syndicates. Multinational banks can and
do make huge international transfers of capital not only for investment purposes
but also for hedging and speculating against exchange rate fluctuations. These
new forms of monetary interdependence made possible huge capital flows.
TECHNICAL ASSISTANCE
The IMF shares its expertise with member countries by providing technical
assistance and training in a wide range of areas, such as central banking,
monetary and exchange rate policy, tax policy and administration, and
official statistics. The objective is to help improve the design and
implementation of members' economic policies, including by strengthening
skills in institutions such as finance ministries, central banks, and statistical
agencies.
The IMF has also given advice to countries that have had to re
establish government institutions following severe civil unrest or war.
In 2008, the IMF embarked on an ambitious reform effort to enhance the
impact of its technical assistance. The reforms emphasize better prioritization,
enhanced performance measurement, more transparent costing and st ronger
partnerships with donors.
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Beneficiaries of technical assistance
Technical assistance is one of the IMF's core activities. It is concentrated in
critical areas of macroeconomic policy where the Fund has the greatest
comparative advantage. Thanks to its near-universal membership, the IMF's
technical assistance program is informed by experience and knowledge
gained across diverse regions and countries at different levels of
development.
About 80 percent of the IMF's technical assistance goe s to low- and
lower-middle-income countries, in particular in sub-Saharan Africa and Asia.
Post-conflict countries are major beneficiaries. The IMF is also providing
technical assistance aimed at strengthening the architecture of the
international financial system, building capacity to design and implement
poverty-reducing and growth programs, and helping heavily indebted poor
countries (HIPC) in debt reduction and management.
Types of technical assistance
The IMF's technical assistance takes different for ms, according to needs,
ranging from long-term hands-on capacity building to short -notice policy
support in a financial crisis. Technical assistance is delivered in a variety of
ways. IMF staff may visit member countries to advise government and
central bank officials on specific issues, or the IMF may provide resident
specialists on a short- or a long-term basis. Technical assistance is integrated
with country reform agendas as well as the IMF's surveillance and lending
operations.
The IMF is providing an increasing part of its technical assistance
through regional centres located in Gabon, Mali, and Tanzania for Africa; in
Barbados for the Caribbean; in Lebanon for the Midd le East; and in Fiji for
the Pacific Islands. As part of its reform program, the IMF is planning to
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open four more regional technical assistance centres in Africa, Latin America,
and central Asia. The IMF also offers training courses for government and
central bank officials of member countries at its headquarters in Washington,
D.C., and at regional training centres in Austria, Brazil, China, India,
Singapore, Tunisia, and the United Arab Emirates.
Partnership with donors
Contributions from bilateral and multilateral donors are playing an
increasingly important role in enabling the IMF to meet country needs in this
area, now financing about two thirds of the IMF's field delivery of technical
assistance. Strong partnerships between recipient countries and d onors enable
IMF technical assistance to be developed on the basis of a more inclusive
dialogue and within the context of a coherent development framework. The
benefits of donor contributions thus go beyond the financial aspect.
The IMF is currently seeking to leverage the comparative
advantages of its technical assistance to expand donor financing to meet the
needs of recipient countries. As part of this effort, the Fund is strengtheningits partnerships with donors by engaging them on a b roader, longer-term and
more strategic basis.
The idea is to pool donor resources in multi-donor trust funds that
would supplement the IMF's own resources for technical assistance while
leveraging the Fund's expertise and experience. Expan sion of the multi-donor
trust fund model is envisaged on a regional and topical basis, offering donors
different entry points according to their priorities. The IMF is planning to
establish a menu of seven topical trust funds over the next two years,
covering anti-money laundering/combating the financing of terrorism; fragile
states; public financial management; management of natural resource wealth,
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public debt sustainability and management, statistics and data provision; and
financial sector stability and development.
Technical assistance benefits to low-income countries
Technical assistance is one of the benefits of IMF membership. About 85
percent of IMF technical assistance goes to low and lower -middle income
countries. Post-conflict countries are also major beneficiaries. Apart from the
immediate benefit to recipient countries, by helping individual countries
reduce weaknesses and vulnerabilities, technical assistance also contributes to
a more robust and stable global economy.
Further, technical assistance provided to emerging and
industrialized economies in select cutting -edge areas helps provide traction to
IMF policy advice, and keeps the institution up -to-date on innovations and
risks to the international economy.
Integration of technical assistance with IMF surveillance and
lending
Technical assistance contributes to the effectiveness of the IMFs surveillance
and lending programs, and is an important complement to these other core
IMF functions. Specialized technical assistance from the IMF helps build
capacity in countries for effective policymaking, including in support of
surveillance or lending operations.
Conversely, surveillance and lending work results in policy and
other experiences that further inform and s trengthen the IMFs technical
assistance program according to international best practices. In view of these
linkages, achieving greater integration between technical assistance,
surveillance, and lending operations is a key priority for the IMF.
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Technical assistance covers core areas of IMF expertise
The IMF provides technical assistance in its areas of core expertise:
macroeconomic policy, tax policy and revenue administration, expenditure
management, monetary policy, the exchange rate system, financial sector
sustainability, and macroeconomic and financial statistics. In particular, efforts
in recent years to strengthen the international financial system have triggered
additional demands for IMF technical assistance.
For example, countries have asked for help to address financial sector
weaknesses identified within the framework of the joint IMF-World
Bank Financial Sector Assessment Program; adopt and adhere to
international standards and codes for financial, fiscal, and statistical
management; implement recommendations from off-shore financial centres
assessments; and strengthen measures to combat money laundering and the
financing of terrorism.
At the same time, there is a continuing demand for technical
assistance to help low-income countries build capacity to design and implement
poverty-reducing and growth programs, and to help heavily indebted poor
countries undertake debt sustainability analyses and manage debt -reduction
programs. The IMF also contributes actively to the Integrated Framework for
trade-related technical assistance, which aims to assist lo w-income countries
expand their participation in the global economy. The recipient country is fully
involved in the entire process of technical assistance, from identification of
need, to implementation, monitoring, and evaluation .
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Technical assistance delivery takes a regional approach
The IMF delivers technical assistance in various ways. Depending on the nature
of the assignment, support is often provided through staff missions of limited
duration sent from headquarters, or the placement of experts an d/or resident
advisors for periods ranging from a few weeks to a few years. Assistance might
also be provided in the form of technical and diagnostic studies, training
courses, seminars, workshops, and on-line advice and support.
The IMF has increasingly adopted a regional approach to the
delivery of technical assistance and training. It operates seven regional technical
assistance centresin the Pacific; the Caribbean; East, West and Central
Africa; the Middle East; and in Central America. The latter was opened in May
2009, and the IMF is planning to open three additional regional centres in
Central Asia, and two further centers in Africa. In addition to training offered at
the IMF Institute in Washington D.C., the IMF also offers courses, workshops,
and seminars for country officials through a network of seven regional training
institutes and programs, and in the context of the regional technical assistance
centers.
The regional centers will be complemented by technical assistance
financed through topical trust funds. The f irst such fund started operations in
May 2009, concentrating on building capacity in connection with anti -money
laundering and combating the financing of terrorism. Further trust funds are
planned, including on tax administration and policy, managing natur al resource
wealth, fiscal management, sustainable debt strategies, financial stabilitystatistics, and training in Africa.
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Donors play a large role in financing technical assistance
Technical assistance accounts for about one-fifth of the IMFs operating budget.
It is financed by both internal and external resources, the latter comprising
funds from bilateral and multilateral donors. Such cooperation and resource
sharing with external donors has a few benefits: it leverages the internal
resources available for technical assistance; helps avoid duplication of advice by
different donors, and strengthens collaboration with donors and other technical
assistance providers.
Bilateral donors to the IMFs technical assistance and training
program include Australia, Austria, Belgium, Brazil, Canada, China, Denmark,
Finland, France, Germany, India, Italy, Japan, the Republic of Korea, Kuwait,
Luxembourg, Mexico, the Netherlands, New Zealand, Norway, Oman, Qatar,
Russia, Saudi Arabia, Singapore, Spain, Switzerland, the United Kingdom, and
some beneficiary countries.
Multilateral donors include the African Development Bank, the Arab
Monetary Fund, the Asian Development Bank, the Caribbean Development
Bank, and the Central American Bank for Economic Integration, the European
Commission, the European Investment Bank, the Inter-American Development
Bank, the Islamic Development Bank, and the United Nations Development
Program (UNDP). In FY 2009, external financing accounted for more than two-
thirds of IMF technical assistance field delivery.
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STEPS TAKEN BY INTERNATIONAL MONETARY FUND
The IMF is the principal institution of global economic governance positioned
to help deal with the current economic and financial crisis. Fortunately, the
Funds legitimacy and relevance has been changing in recent years specifically
from 1990s. Moreover, even in the best of circumstances, the Fund is as
successful as its principal members want it to be.
(A)In the near term, the Fund :
(a) Lend help to countries that have been adversely affected by the crisis,
(b) Help to establish an agreed approach to global economic and
financial recovery, and
(c) Monitor the implementation of national economic and financial
policies, in particular exchange-rate policies, to minimize the negative,
spill over effects of one countrys policies on other countries.
(B)In the longer term, the Fund should step up its surveillance of nationalfinancial systems and the global system and help to develop a better
framework for macro prudential supervision. The macro prudential
supervision can be defined as a concern for the influence of financial
system developments on the global economy and system.
THE DRAWBACK OF INTERNATIONAL MONETARY FUND
The IMF was emerged also to play a major role in helping the so-called
transition countries of Eastern Europe and the former Soviet Union to adopt
market oriented economic systems.
Despite substantial continued, overall success over the past
three decades, three problems emerged:
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(1)A countrys adoption of economic adjustment programs in connectionwith IMF financial assistance is politically controvers ial.
(2)The private sector came to play the dominant role as the source ofinternational capital flows, and global surveillance and supervisory
systems failed to keep pace with many of the resulting implications for
the countries attracting the inflows.
(3)The governance of the IMF continued to be dominated by the majorindustrial countries, in particular the United States and the European
countries, which undermined the legitimacy o f the institution in a
changing world.
The IMF has evolved with the globalization of our economies, but not as fast assome would prefer. A fresh reform effort was begun four years ago, but there
was little sense of urgency given the benign global economic and financial
conditions that generally persisted until the middle of last year.
Major financial institution around the world and government after the
global financial crisis in 2007-2009 argued that the IMF no longer had a major
role to play as a lender or in helping to guide the global economy a nd financial
system. The major IMF credit outstanding peaked (on an end-of-year basis) at
almost $100 billion at the end of 2005, but had declined to about $10 billion by
the end of September 2008.
One consequence is that the package of IMF reforms that was agreed
in the spring of 2008, after years of contentious discussions, was modest at best.
Due to this drawback of IMF there was a major problem created to the world,
the IMF gifted us The Global financial Crisis of 2007-2009. This till date some
were has an effect on the international financial system and has dropped the
majority countries around the world.
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Impact on access to food
A number of civil society organizations have criticized the IMF's policies for
their impact on peoples' access to food, particularly in developing countries. In
October 2008, former US President Bill Clinton joined this chorus in a speech
to the United Nations World Food Day, which criticized the World Bank and
IMF for their policies on food and agriculture:
We need the World Bank, the IMF, all the big foundations, and all the
governments to admit that, for 30 years, we all blew it, including me w hen I was
President. We were wrong to believe that food was like some other product in
international trade, and we all have to go back to a more responsible andsustainable form of agriculture.
Former US President Bill Clinton, Speech atUnited Nations World Food
Day, October 16, 2008
Impact on public health
In 2008, a study by analysts from Cambridge and Yale universitys published
on the open-access Public Library of Science concluded that strict conditions on
the international loans by the IMF resulted in thousands of deaths in Eastern
Europe by tuberculosis as public health care had to be weakened. In the 21
countries to which the IMF had given loans, tuberculosis deaths rose by 16.6%.
In 2009, a book by Rick Rowden titled, The Deadly Ideas of
Neoliberals: How the IMF has Undermined Public Health and the Fight Against
Aids, claimed that the IMF's monetarist approach towards prioritizing price
stability (low inflation) and fiscal restraint (low budget deficits) was
unnecessarily restrictive and has prevented developing countries from being
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able to scale up long-term public investment as a percent of GDP in the
underlying public health infrastructure. The book claimed the consequences
have been chronically underfunded public health systems, leading to dilapidated
health infrastructure, inadequate numbers of health personnel, and demoralizing
working conditions that have fuelled the "push factors" driving the brain drain
of nurses migrating from poor countries to rich ones, all of which has
undermined public health systems and the fight against HIV/AIDS in
developing countries.
Impact on environment
IMF policies have been repeatedly criticized for making it difficult for indebted
countries to avoid ecosystem-damaging projects that generate cash flow, in
particular oil, coal and forest-destroying lumber and agriculture
projects. Ecuador for example had to defy IMF advice repeatedly in order to
pursue the protection of its rain forests, though paradoxically this need was
cited in IMF argument to support that country. The IMF acknowledged this
paradox in a March 2010 staff position report which proposed the IMF Green
Fund, a mechanism to issue Special Drawing Rights directly to pay for climate
harm prevention and potentially other ecological protection as pursued
generally by other environmental finance.
While the response to these moves was generally positive possibly
because ecological protection and energy and infrastructure transformation are
more politically neutral than pressures to change social policy. Some expertsvoiced concern that the IMF was not representative, and that the IMF proposals
to generate only 200 billion dollars/year by 2020 wit h the SDRs as seed funds,
did not go far enough to undo the general incentive to pursue destructive
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projects inherent in the world commodity trading and banking systems -
criticisms often levelled at the WTO and large global banking institutions.
In the context of the May 2010 European banking crisis, some
observers also noted that Spain and California, two troubled economieswithin Europe and the US respectively, and also Germany, the primary and
politically most fragile supporter of a Euro currency bailout would benefit from
IMF recognition of their leadership in green technology, and directly
from Green-Fund generated demand for their exports, which might also
improve their credit standing with international bankers.
Criticism from free-market advocates
Typically the IMF and its supporters advocate a monetarist approach. As such,
adherents of supply-side economics generally find themselves in open
disagreement with the IMF. The IMF frequently advocates
currency devaluation, criticized by proponents of supply-side economics
as inflationary. Secondly they link higher taxes under " austerity programmes"
with economic contraction.
Complaints have also been directed toward the International Monetary
Fund gold reserve being undervalued. At its inception in 1945, the IMF pegged
gold at US$35 per Troy ounce of gold. In 1973, the Nixon administration lifted
the fixed asset value of gold in favour of a world market price. This need to lift
the fixed asset value of gold had largely come about because Petrodollars
outside the United States were worth more than could be backed by the gold
at Fort Knox under the fixed exchange rate system. Following this, the fixed
exchange rates of currencies tied to gold were switched to a floating rate, also
based on market price and exchange.
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FINANCIAL CRISIS OF 2007-2009
The financial crisis of 2007 to the present was triggered by a liquidity shortfall
in the United States banking system. It has resulted in the collapse of large
financial institutions, the bail out of banks by national governments, and
downturns in stock markets around the world. In many areas, the housing
market has also suffered, resulting in numerous evictions, foreclosures and
prolonged vacancies. It is considered by many economists to be the
worst financial crisis since the Great Depression of the 1930s.
It contributed to the failure of key businesses, declines in consumer
wealth estimated in the hundreds of billions of U.S. dollars, substantial financial
commitments incurred by governments, and a significant decline in economic
activity. Many causes have been suggested, with varying weight assigned by
experts. Both market-based and regulatory solutions have been implemented or
are under consideration, while significant risks remain for the world
economy over the 20102011 periods.
THE MAIN CAUSE OF FINANCIAL CRISIS
The collapse of the housing bubble, which peaked in the U.S. in 2006, caused
the values of securities tied to real estate pricing to plummet thereafter,
damaging financial institutions globally. Questions regarding bank solvency,
declines in credit availability, and damaged investor confidence had an impact
on global stock markets, where securities suffered large losses during late 2008and early 2009. Economies worldwide slowed during this period as credit
tightened and international trade decline d.
Major financial markets heads argued that credit rating agencies and
investors failed to accurately price the risk involved with mortgage-related
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financial products, and that governments did not adjust their regulatory
practices to address 21st century financial markets. Governments and central
banks responded with unprecedented fiscal stimulus, monetary policy
expansion, and institutional bailouts.
BACKGROUND OF THE CRISIS
The immediate cause or trigger of the crisis was the bursting of the United
States housing bubble which peaked in approximately 20052006. Already-
rising default rates on "subprime" and adjustable rate mortgages (ARM) began
to increase quickly thereafter. As banks began to increasingly give out m ore
loans to potential home owners, the housing price also began to rise. In the
optimistic terms the banks would encourage the home owners to take on
considerably high loans in the belief they would be able to pay it back more
quickly overlooking the interest rates. Once the interest rates began to rise in
mid 2007 the housing price started to drop significantly in 2006 leading into
2007. In many states like California the refinancing became more difficult. As a
result the increase amount of fore closured homes began to rise as well.
Lower interest rates encourage borrowing. From 2000 to 2003,
the Federal Reserve lowered the federal funds rate target from 6.5% to
1.0%. This was done to soften the effects of the collapse of the dot-com
bubble and of the September 2001 terrorist attacks, and to combat the perceived
risk of deflation.
Additional downward pressure on interest rates was created by the
USA's high and rising current account (trade) deficit, which peaked along with
the housing bubble in 2006. Ben Bernanke explained how trade deficits required
the U.S. to borrow money from abroad, which bid up bond prices and lowered
interest rates.
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Bernanke explained that between 1996 and 2004, the USA current
account deficit increased by $650 billion, from 1.5% to 5.8% of GDP.
Financing these deficits required the USA to borrow large sums from abroad,
much of it from countries running trade surpluses, mainly the emerging
economies in Asia and oil-exporting nations. The balance of payments
identity requires that a country (such as the USA) running a current account
deficit also have a capital account (investment) surplus of the same amount.
Hence large and growing amounts of foreign funds (capital) flowed into the
USA to finance its imports.
This created demand for various types of financial assets, raising the
prices of those assets while lowering interest rates. Foreign investors had these
funds to lend, either because they had very high personal savings rates (as high
as 40% in China), or because of high oil prices. Bernanke referred to this as a
"saving glut."
A "flood" of funds (capital or liquidity) reached the USA
financial markets. Foreign governments supplied funds by purchasing
USA Treasury bonds and thus avoided much of the direct impact of the crisis.
USA households, on the other hand, used funds borrowed from foreigners to
finance consumption or to bid up the prices of housing and financial assets.
Financial institutions invested foreign funds in mortgage-backed securities.
The Fed then raised the Fed funds rate significantly between
July 2004 and July 2006. This contributed to an increase in 1-year and 5-
year adjustable-rate mortgage (ARM) rates, making ARM interest rate resets
more expensive for homeowners. This may have also contributed to the
deflating of the housing bubble, as asset prices generally move inversely to
interest rates and it became riskier to speculate in housing. USA housing and
financial assets dramatically declined in value after the housing bubble burst.
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The International Monetary Fund estimated that large U.S. and
European banks lost more than $1 trillion on toxic assets and from bad loans
from January 2007 to September 2009. These losses are expected to top
$2.8 trillion from 2007-10. U.S. banks losses were forecast to hit $1 trillion and
European bank losses will reach $1.6 trillion. The IMF estimated that U.S.
banks were about 60% through their losses, but British and euro zone banks
only 40%.
One of the first victims was Northern Rock, a medium-sized
British bank. The highly leveraged nature of its business led the bank to request
security from the Bank of England. This in turn led to investor panic and a bank
run in mid-September 2007.Over 100 mortgage lenders went bankrupt during
2007 and 2008. Concerns that investment bank Bear Stearns would collapse in
March 2008 resulted in its fire-sale to JP Morgan Chase. The financial
institution crisis hit its peak in September and October 2008. Several major
institutions failed, were acquired under duress, or were subject to government
takeover. These included Lehman Brothers, Merrill Lynch, Fannie Mae, Freddie
Mac, Washington Mutual, Wachovia, and AIG.
WEALTH EFFECTS OF GLOBAL CRISIS
There is a direct relationship between declines in wealth, and declines in
consumption and business investment, which alo ng with government spending
represent the economic engine. Between June 2007 and November 2008,
Americans lost an estimated average of more than a quarter of their collective
net worth. By early November 2008, a broad U.S. stock index the S&P 500 was
down 45% from its 2007 high. Housing prices had dropped 20% from their
2006 peak, with futures markets signalling a 30-35% potential drop. Total home
equity in the United States, which was valued at $13 trillion at its peak in 2006,
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had dropped to $8.8 trillion by mid-2008 and was still falling in late 2008. Total
retirement assets, Americans' second-largest household asset, dropped by 22%,
from $10.3 trillion in 2006 to $8 trillion in mid-2008. During the same period,
savings and investment assets (apart from retirement savings) lost $1.2 trillion
and pension assets lost $1.3 trillion. Taken together, these losses total a
staggering $8.3 trillion. Since peaking in the second quarter of 2007, household
wealth is down $14 trillion.
Further, U.S. homeowners had extracted significant equity in their
homes in the years leading up to the crisis, which they could no longer do once
housing prices collapsed. Free cash used by consumers from home equity
extraction doubled from $627 billion in 2001 to $1,428 billion in 2005 as the
housing bubble built, a total of nearly $5 trillion over the period. U.S. home
mortgage debt relative to GDP increased from an average of 46% during the
1990s to 73% during 2008, reaching $10.5 trillion.
To offset this decline in consumption and lending capacity, the U.S. government
and U.S. Federal Reserve have committed $13.9 trillion, of which $6.8 trillion
has been invested or spent, as of June 2009. In effect, the Fed has gone from
being the "lender of last resort" to the "lender of only resort" for a significant
portion of the economy. In some cases the Fed can now be considered the
"buyer of last resort."
GLOBAL EFFECTS OF FINANCIAL CRISIS
A number of commentators have suggested that if the liquidity crisis continues,
there could be an extended recession or worse. The continuing development of
the crisis has prompted in some quarters fears of a global collapse although
there are now many cautiously optimistic forecasters in addition to some
prominent sources who remain negative. The financial crisis is likely to yield
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the biggest banking shakeout since the savings -and-loan meltdown. Investment
bank UBS stated on October 6 that 2008 would see a clear global recession,
with recovery unlikely for at least two years. Three days later UBS economists
announced that the "beginning of the end" of the crisis had begun, with the
world starting to make the necessary actions to fix the crisis: capital injection by
governments; injection made systemically; interest rate cuts to help borrowers.
The United Kingdom had started systemic injection, and the world's
central banks were now cutting interest rates. UBS emphasized the United
States needed to implement systemic injection. UBS further emphasized that
this fixes only the financial crisis, but that in economic terms "the wo