International financial System:

IMF and World Bank

 Issues covered
• The relationship between international trade
and finance
• International Monetary Fund (IMF): Its role in
trade financing
• World Bank: developmental infrastructure for
trade facilitation
• Global financial and debt crises: impacts on
trade financing
 Relation between international trade and
finance
• International trade does not take place on the basis of
national currency, it takes place with international
currency. Therefore international money market is
inseparably linked to the total volume of trade.
• A sound, stable, credible and dependable money
market is required for maximising the trade.
• Balance of payment (BoP) problem of a country
disables it to engage in international trade.
How does IMF facilitate international trade
financing
• IMF is the gatekeeper for earning and spending of
foreign currency.
• It is primarily a stabilising, often called a balance
of payments, institution. It plays a role to assist a
country that encounters BoP problem.
• IMF is the lender of the last resort.
• IMF is responsible for international monetary
cooperation towards creating a stable international
payment system for trade and investment.
 IMF as an organization

• The Bretton Woods Conference created two permanent

financial organizations, International Monetary Fund and the
International Bank for Reconstruction and Development, both
designed to have universal membership , based on
contribution of resources by all members.
• The World Bank would be devoted long-term economic
development, first to reconstruction of countries ravaged by
the war, then to development of countries not yet in the
economic mainstream.
• The IMF would enable states to achieve financial stability
with growth, by making its resources available to them for
purposes consistent with the Articles of Agreement.
 IMF and its Status
• The IMF is the central international financial institution
responsible for international monetary collaboration.
• It is an intergovernmental institution that serves all
developed, developing and least-developed countries.
• Its membership is open to all independent states,
possessing full autonomy of their external relations,
agreeing to the terms and conditions of membership, and
willing to fulfil the obligations under the Articles of the
Agreement of IMF.
• Specialized Agency of the UN and has international legal
personality.
 What is BoP crisis ?
• A country is said to have BoP crisis when it
persistently earns less (through export) and
spends more (through import) and falls in
deficit
• The ideal situation is maintaining equilibrium
between earning and spending.
 Causes of Bop crisis
• Higher level of import
• Steep fluctuation of currency
• Political unrest
• Socio-economic unrest
• Rampant corruption/money laundering
• Unproductive expenditure
 Bop crisis and role of IMF
• IMF has two major functions: (1) to create stable
international payment system by fixing exchange
rate; and (2) to supply short term loan to
members suffering from BoP problems.
• The objective of IMF short term foreign currency
loan to a country is to overcome BoP problems
and help it to stay in international trading.
• IMF’s loan is conditional.
 Lending

• A member can seek and receive IMF’s

loans provided that
- It is encountering difficulties in financing a
deficit in its balance of payments;
- Its foreign currency reserve is dwindling ;
- Its balance of payments deficit is
temporary one; and
- It has short –or medium term stabilization
programme for BoP adjustments.
 How is this loan administered ?
• IMF loan is like swapping a country’s national currency with international
currency ( a member purchases requisite amount of foreign currency from
IMF with its own national currency).
• Loan is given by SDR, IMF currency exchangeable with five key currencies
( USD, yen, pound, Chinees remenbi, and Euro).
• Loan is given through tranche system, that means in four instalments which
is released with conditionality.
• The amount of loan is determined by the quota of that member, not on the
basis of its need.
• On the basis of a country’s contribution, it is given certain number of
shares. One IMF share is equivalent to 100,000 SDR. A country by virtue of
IMF membership gets 250 shares, and its rest of 250 shares it has to buy.
• The borrowing is not need based , it is share-based. The more share a
country has, it can borrow more money.
 Continued….
• Reserve Tranche: A member is entitled to borrow this 25 per
cent of its quota merely by placing a request. It does not attract
any conditions and requires no more than an economic policy
statement demonstrating the member’s intention to its payments
problem.
• Credit Tranche:
- the loan under this tranche is much harder
- The quota is segmented into four tranche, first tranche does not
require compliance with prescribed economic performance or
conditionality.
- any loan beyond this first tranche requires review of
performance criteria and conditionality.
 To be continued…
• Under special circumstances , in case of loan of first tranche,
the IMF may require such a member to adopt and implement
certain economic policies .
• At the end of each tranche, the IMF reviews the economic
performance of the borrowing member at the previous quarter
or tranche to ensure that agreed balance of payments
adjustment programmes are being followed.
• Subsequent drawing of instalments is discontinued should the
member’s performance be found to be unsatisfactory.
 IMF Decision making procedure

• IMF relies in decision-making on weighted and qualified majority voting

system. The voting strength of a member is equal to its quota which is set
on the basis of its subscription to the IMF resource pool.
• The voting strengths of members are not equal but vary substantially on
the basis of the share of stock they hold.
• Each member receives a base voting strength of 250 votes regardless of the
amount of its contribution to the IMF resource pool.
• IMF issues shares , each worth SDR 100.000 which makes a real
difference as each share creates one additional vote.
• In another words, the voting strength of a member is directly
proportional to its contribution to the IMF resource pool.
• Decisions are made by specified majority votes. For
substantive matters such as granting loans, changing the quota
for a member or structure of the IMF, a majority of 85% of
votes is required. For procedural matters a majority of 60% of
votes is required.
• A 70 per cent majority is required to decide on comparatively
minor issues such as changing the loan interests or charges.
• US itself has 17% voting right and therefore, virtually it
enjoys veto power with respect to decision-making in
substantive matters requiring 85% of the total votes.
 Continued….
• In reality the decision-making process is dominated
by those contributing more to the IMF resource pool.
Developing countries, thus, have no control over
decision-making.
• The decision-making process is premised exclusively on the
principle that members contributing more should have greater
control over the decision-making process.
 Conditionality of IMF loans
• Conditionality refers to the supervision of borrowers’
economic policies and austerity measures. It is
something that includes certain corrective economic
policies and measures that IMF consider imperative
for prospective borrower
• It therefore prefers demand management
policy/technique by controlling and limiting the level
of demand to a point that reduces government deficit
to service its external payments.
• This demand management measures include one or
combination of the following:
- control over money supply
- restrictions on credit
- reduction in budget deficit by cutting expenditure on
public health, education and by eliminating subsidies
- removal of restrictions on trade and capital
movement, and
- promotion of foreign investment.
 Objectives of conditionality
• To recover its payments back
• To save borrowers economy from absolute mismanagement
• To facilitate or force the borrower country to balance its book
to overcome BoP problem within the stipulated loan period
• It is intended to ‘help a member to overcome its balance-of-
payments problem, avoid to temptation to resort to measures
detrimental to itself or to the general welfare, and help it to
achieve and maintain a sustainable balance-of-payments
position over a reasonable period of time.
 Benefits of conditionality

• Positive aspects of conditionality for debtor country

are that
-it provides a mechanism by which IMF can protect
its resources by ensuring that debtors are able to
repurchase obligations.
- it offers the IMF’s valuable services of evaluating
debtor’s plans for progress towards adjusting balance
of payments.
 To be continued…
- it restores the status of debtors with respect to their
creditworthiness that facilitates access to private loan loans.
- renders debtors to become more outward oriented and
liberalized and less protectionist in their trade policies and
practice, and
- serves as a scapegoat for debtors in introducing tough and
painful austerity measures for speedy economic reforms which
are otherwise difficult to implement due pressures brought to
bear by various lobby and public advocacy group.
 Disadvantages of conditionality

• Obsessive doctrinism
• Emphasis on trade liberalization
• Devaluation of currency
• Anti-inflationary measures ( cuts to public sector mean unemployment, loss of
social security, reduction of subsidies for basic foods, public transport, health services
and education. This causes social inequalities and mass of people to fall below the
subsistence level.)
• Socio-political costs ( the policy is devoid of socio-political consciousness)
• Minimum penalty for non-compliance ( reasons for non-compliance : it creates higher
impoverishment than a debtor government can politically digest and IMF can cover only
a small portion of deficits in developing countries.)
• Lack of control over external factors ( role of arbitrator and policy)
• Discriminatory conditionality
 What is the BoP in trade terms ?

• BoP as trade remedy gives a WTO member country a short term option to
impose restrictions on foreign products.
• Article 11 ( GATT/WTO) : Prohibition of quantitative restrictions
• Art. 12 ( as an exception) applies to all WTO member either developed or
developing.
• Art.18 only applicable to developing and least developed member
countries.
• WTO General Council is the higher authority to determine BoP crisis and
the provisions of quantitative restrictions and easing procedure.
• Easing must be corresponding to the improvement or in proportion to the
improvement of the BoP problem.