IMF and World Bank, Economy Traditional Notes | Study Indian Economy for UPSC CSE - UPSC

IMF

• In the wake of the World War 1, the attempt of many countries in the 1920s and 1930s to return to the old gold system failed miserably. 
• To avoid a repetition of such mistakes, 44 nations assembled at the United Nations Monetary and Financial Conference at Bretton Woods (New Hampshire, USA) from July 12 to 22, 1994. 
• The IMF was established here to promote economic and financial cooperation among its members. The general objective in establishing the IMF was to facilitate the expansion and balanced growth of World trade. 
• The IMF started functioning from March 1947 and has over 150 members.

Objectives

• To promote international monetary cooperation through a permanent institution which provides the machinery for consultation and collaboration in international monetary problems.
• To facilitate the expansion and balanced growth of international trade, and to contribute thereby to the promotion and maintenance of high levels of employment and real income and to the development of the productive resources of all members as primary objective of economic policy.
• To promote exchange stability to maintain orderly exchange arrangements among members, and to avoid competitive exchange depreciation.
• To assist in the establishment of multilateral system of payments in respect of current transactions between members and in the elimination of foreign exchange restrictions which hamper the growth in world trade.
• To lend confidence to members by making the Funds's resources available to them under adequate safeguards, thus providing them with an opportunity to correct maladjustments in their balance of payments without resorting to measures destructive of national or international prosperity.
• In accordance with the above, to shorten the duration and lessen the degree of disequilibrium in the international balance of payments of members.

 Organisation and structure

• The Fund, with headquarters in Washington, USA, consists of a Board of Governors, an Executive Board, a Managing Director, a Council and a staff. 
• The Board of Governors and the Executive Board are decision-making organs. The Board of Governors is at the top. It is composed of one Governor and one Alternate Governor appointed by each member.
• The Board of Governors and the Executive Board together appoint Ad Hoc and Standing Committees.
• The Board of Governors meets annually to review the Fund's working and lay down future policy. Special meetings can be convened by any five members having 25% of the total voting right.
• The Executive Board is the most powerful organ of the Fund. 
• It is in continuous session and meets several times a week. It has 21 members at present. Five Executive Directors are appointed by the five members (USA, U.K. West Germany, France and Japan) having the largest quotas, Saudi Arabia appoints a sixth, since it is one of the two largest contributors to the Fund.
• Fifteen Executive Directors are elected at intervals of two years by the remaining members according to constituencies, roughly on a geographical basis. 
• A Managing Director, elected by the executive directors, is usually politician or an important international official. 
• He is the non-voting chairman of the Executive Board and also the head of the staff.

Quotas

• The fund has a General Account based on quotas allocated to its members. When a country joins the Fund it is assigned a quota that governs the size of its subscription, its voting power and drawing rights. 
• When the IMF was formed, each member was required to pay 25% of its quota in gold or 10% of its net official holdings of gold and US dollars, whichever was less. 
• The remaining 75% was to be furnished in the country's own currency, kept in its central bank. 
• The Fund was delinked from gold in April 1978, and the practice of keeping gold reserves with the Fund has been given up. 
• Now a member country is allowed to maintain the value of its currency and quota in terms of Special Drawing Rights (SDR).
• To meet the financial needs of the Fund, the quotes are reviewed every five years and are raised from time to time. 
• The decisions are taken by a resolution having the majority of 85% of the total voting power of the Fund's members.

Special Drawing Rights (SDR)

• In early 1970, the IMF introduced a scheme for the creation and issued of Special Drawing Rights (SDRs), also known as paper gold. 
• They were created in 1969 through the First Amendment to the Fund’s Articles of Agreement as unconditional reserve assets to influence the   level of world reserves.
• This step was intended to solve the problem of international liquidity. 
• SDRs are allocated to participating members in proportion to their  Fund quotas. The Special Drawing Account looks after this aspect.
• At first, SDRs were drawn by countries as part of their reserves and converted into currencies when they were in BoP difficulties. 
• One SDR was equivalent too .888671 gm gold. which was the value of one U.S. dollar, When, after 1973, the par value system of the Fund was given up and the US dollar and other major currencies were allowed to float, it was decided to stabilise the exchange value of the SDR. 
• Accordingly, the value of the SDR was calculated each day on the basis of a basket of 16 most widely used currencies of the members.
• After the Second Amendment of the Fund's Articles of Agreement in 1978, the SDR became an international unit of account. 
• To facilitate its valuation, the number of currencies in the basket were reduced to five in January 1981, one SDR is revised every five years beginning January 1, 1986. 
• This revision is based on both the values of the exports of goods and services and the balances of their currencies held by other members.
• The SDR is an international unit of account, which is held in the Fund Special Drawing account. The quotas of all currencies in the Fund General Account are also valued in terms of the SDR. 
• As the international monetary asset, the SDR is held in the international reserves of central banks and governments to finance their deficits or surpluses of balance of payments. 
• All transactions by the Fund in the form of loans and their repayments, its liquid reserves, its capital etc, are expressed in the SDR. 
• Many countries are pegging their currencies to the SDR. 
• It has helped many developing member countries to stabilize their external and internal positions and protect their economy from the instability arising in international monetary transactions.

Functions of the fund
Watchdog role

• The Fund is regarded as the guardian of good conduct  in the sphere of balance of payments. It aims at reducing tariffs and other trade restrictions by member countries.
• Article VII of the Charter provides that no member shall, without the approval of the Fund, impose restriction on the making of payments or engage in discriminatory currency arrangements or multiple currency practices. 
• The Fund keeps a watch on the policies being adopted by member countries.
• The Fund also gives technical advice to members on monetary and fiscal policies, conducts research studies and publishes it. It provides technical expertise to member countries facing BoP problems.

Exchange rates  

• The original Fund Agreement provided that the par value of each member country was to be expressed in terms of gold or U.S. dollars. 
• The underlaying idea was to create a system of stable exchange rates with orderly cross rates. 
• Since 1971, these provisions have been changed and the international monetary system has moved from fixed exchange rates to flexible exchange rates. Under the new system, member countries are not expected to maintain and establish par values par values with gold or dollar. 
• The Fund has no control over the exchange rate adjustment policies of member countries, but it is required to lay down principles for the guidance of the members exchange rate policies.

 Lending operations

• The bulk of the financial resources of the Fund for lending come from quota subscriptions of member countries.
• It increase its funds by selling gold to members, borrowing from governments, central banks or private institutions of industrialised countries, the Bank of Private International Settlements, and even from OPEC coduntreis like Saudi Arabia.
• Lending by the Fund is meant as temporary assistance to members in financing disequilibria in their balance of payments on current account.
• If a member has less currency with the Fund than its quota, the difference is called Reserve Finance. It can draw on its reserve trench for its BoP needs automatically, upon representation to the Fund. Such drawings have no interest charge, but must be repaid within three to five years.
• A member can draw further from each of the four credit trenches, 25% of its quota. 
• To meet the reserve BoP problems, the Fund has been gradually raising the limit of borrowings by its members over the years. 
• Now members can draw up to equivalent of 450% of their new quotas on the total net use of the Fund's  resources. In September 1984 the Interim Committee set the borrowing of member countries under the enlarged Express policy at 95 to 115% of its quota each year, up to 280-345% over a three-year period and cumulative limits of 408 to 450%. 
• Borrowings up to this limit are allowed if a member country is making particularly strenuous efforts to correct its BoP disequilibrium and adjust its economy.

Credit Branch

• Compensatory Financial Facility (CFF) was adopted in 1963 and liberalised in 1975 to meet BoP difficulties arising out of temporary shortfalls in export earnings for reasons beyond the control of the member.  
• Such temporary shortfalls in export earnings may be covered by the borrowing member's quota. But the condition is that the member is willing to cooperate with the Fund in an effort to find appropriate solutions for its BoP difficulties.
• Buffer Stock Facility (BSF) was created in 1969 for financing commodity buffer stock by member countries. 
• The facility is equivalent to 50% of the borrowing member's quota. 
• But the member is expected to cooperate with the Fund in establishing commodity prices within the country.
• Extended Financing Facility (EFF) is another specialised facility, created in 1974. Under EFF, the Fund provides credit to member countries to meet their BoP deficits for longer periods, and in amounts larger than their quotas under normal credit facilities, EFF provides credit up to a period of 10 years. 
• It is based on performance criteria and drawings instalments. EFF was extended for ten years with effect from 1981 and is availed of by developing countries. India got a loan of 5.6 billion SDR under this facility for a three-year period beginning November 8,1981.
• Supplementary financing Facility (SFF) was established in 1977 to provide supplementary financing under extended stand-by arrangements to member countries to meet serious BoP deficits that are large in relation to their economies and their quotas. This facility is being extended to low- income developing member countries to reduce the cost of borrowing.

Critical Appraisal of the fund's Working

• The IMF has performed well as an international monetary institution. 
• It has been supplying different currencies to different countries for making adjustments in their BoP over a longer period. Both the developed and developing countries have made extensive use of its resources. 
• It has tried to solve the problem of international liquidity by making suitable amendment to its Articles of Agreement. 
• It has thus proved its flexibility by moving with the changed international economic conditions. 
• The IMF, however, is criticized on the following counts:
  • A conservative attitude : The fund has been conservative always. It has laid down stringent conditions for lending. It charges high interest rates.
  • Conditionality practices : The fund has developed conditionality practices over the last three decades which a country has to fulfil for getting a loan. Before the 1970s, the fund stressed expenditure reduction for meeting BoP disequilibrium. 
• In the 1970s, conditionality included became wider. They included: 
  • the country concerned should do introspection to know the causes of BoP difficulties; and 
  • it should reconsider its economic priorities and their social and political objectives. In March 1979, an additional set of guidelines were laid down to include periodic assessment of the experience of the member country with adjustment programmes financed by Fund resources.
• A secondary role as a monetary agency : The fund has been playing only a secondary role rather than the central role in international monetary relations. 
• It does not provide facilities for short-term credit arrangements. This has resulted in swap arrangements among the central banks of the Group of Ten of the leading developed countries.
• Under these arrangements, these countries exchange each other's currencies and also provide short-term credit to tide over temporary disequlibria in their BoP. Such swap arrangements have led to the growth of Euro-currency market. All this has reduced the importance of the Fund.
• Exchange stability :The fund also failed in its objective of promoting exchange stability and maintaining orderly exchange arrangements among members.
• Foreign exchange restrictions: An objective of the fund has been to eliminate foreign exchange restrictions which hamper the growth in world trade. The fund has not been able to do this.
• The world trade a restricted by is variety of exchange controls and multiple exchange practices.
• Discriminatory policies : The fund has been criticized for discriminating against developing countries and favouring the developed countries. 
• It has become a Rich Counties' Club although the majority of its members are developing countries.

India and the IMF

• India is a founder member of the IMF. It signed the Fund Agreement on December 27, 1945. 
• Till 1970 India's quota in the Fund was the fifth and it had the power to appoint a permanent Executive Director. 
• With the increase in the fund quota after May 1970, the quotas of Japan, Canada and Italy increased ahead of India. 
• Accordingly, India ceased to hold a permanent position as Executive Director.
• India has been one of the major beneficiaries of fund assistance. 
• It has bee getting aid from the various fund agencies fro time to time and has been regularly repaying its debts.
• By virtue of being a member of the fund, India is also a member of the World Bank, from which it has been receiving financial aid for its various development projects. It has been getting advisory help from the fund. A team of four or five economists often visits India. 
• These economists exchange views with Indian officials on India's BoP and exchange rate problems and suggest monetary, fiscal and other measures to solve them. 
• The fund has also been providing short term training courses to Indian personnel on monetary, fiscal, banking, exchange and BoP policies through its Central Banking Service Department, the Fiscal Affairs Department and the IMF Institute.

World Bank

• The International Bank for Reconstruction and Development (IBRD) or the World Bank was established in 1945 under the Bretton Woods Agreement of 1944 to assist in bringing about a smooth transition from a wartime to peacetime economy. It is a sister institution of the IMF. 
• Much of the development assistance of the IBRD is channelised through its associate agency, the International Development Agency (IDA).
• The World Bank performs the following functions:
• It assists in the reconstruction and development of territories of its members by facilitating the investment of capital for productive purpose and encourages development of productive facilities and resources in less developed countries.
• It  promoted private foreign investment. It does this by means of guarantees or participation in loans and other investment made by private investors. When capital is not available on reasonable terms it supplements private investment out of its own resources or from borrowed funds.
• It promotes the long-range balanced growth of international trade and the equilibrium in BoP by encouraging international investment.

Members

• Members of the IMF are members of the World Bank. 
• If a country resigns its membership it is required to pay back all loans with interest on due dates. If the Bank incurs a financial loss in the year in which a member resigns, it is required to pay its share of the loss on demand.
• The Board of Governors is the supreme body. 
• Every member country appoints one Governor and an Alternative Governor is related to the financial contribution of its government.

Capital Structure

• The IBRD started with an authorised capital of $510 billion divided into 1,00,000 shares of $51,00,000. (59,400 million was actually subscribed.) 

Critical Appraisal

• The IBRD has been quite successful in achieving its principal objective of reconstruction and development. 
• It helped in the reconstruction of Europe after its destruction in World War II.
• It has been helping the developed and developing countries alike in the process of growth. 
• Since the 1970s it has been lending more to developing countries not only for infrastructural investment but also for raising their productivity and standard of living.
• World Bank functioning has been criticised on the following grounds:
• High charges : It is argued that the Bank charges a very high rate of interest on loans as also an annual commitment charge on undistributed balances and a front end fee. 
• Now they are no longer fixed arbitrarily at a high level. Still the interest rate continues to be high. 
• Inadequate support : The Bank has also  been criticised for its failure to meet the financial needs of the developing countries fully. 
• Its loans have just touched the fringes of the total capital requirements for their economic and social uplift.
• Faulty lending policy : The bank lending procedure is faulty capacity of the borrowing country before granting a loan. 
• Such  a condition is very harsh and discriminatory for developing countries which are poor and need financial help on a large scale.
• Conditionalities : The introduction of Structural Adjustment Facility (SAF) since 1985 has made IBRD loan terms tighter. 
• The borrowing country is required to follow an action programme set out in the Letter of Development Policies such as open trade, reform in public policies, better planning of public investment, management of public enterprises, etc. 
• The second tranche of SAF is released only after a review of the reform programme that are date-bound.

India and the World Bank

• India is a founder member of the Bank and held a permanent seat on its Board of Executive Directors for a number of year. 
• The Bank has been assisting India in its planned economic development by granting loans, conducting field surveys, giving expert advice, sending missions study teams and training Indian personnel at the EDI. 
• A Chief of Mission represents the Bank at New Delhi.
• India has been the largest receiver of the World Bank assistance since August 1959. 
• The World bank has been assisting India in such projects as development of ports, oil exploration including the Bombay High and gas power project, aircraft, coal, iron, aluminium, fertilisers, railway modernisation, technical assistance, industrial development finance, cooperation etc. 
• The Bank also helped India to solve amicably its river water dispute with Pakistan.
• The Aid India Consortium comprises 14 development countries and six major multilateral Institutions. Member countries include Austria, Belgium, Canada, Denmark, France, Germany, Norway, Sweden, U.K., USA and Switzerland.
• The consortium has been giving aid to Indian for its development plans at the instance of the World Bank.