4. INTRODUCTION 1¢ history of world economic co- igerson isthe creation ofthe International Monetary gripiefly called IMF. The IMF was organised in fut and_commenced operations in March, 1947 “The fundamental object of the IMF was the avoidance ive devaluation and exchange control that ‘landmark in th of competi fad characterised the era of 1930s. It was set up to Mminister a “code of fair practice”. in the field of short-term loans to member deficits in their balance weet these payments latign exchange and to make aaions experiencing temporary di payments, to enable them to m without resorting to devaluation or exchange control, while at the same time following international policies to maintain domestic income and employment at high lwels. Thus, basically there are three general objectives the IMF: (I) the elimination or reduction of existing aachange controls, (ii) the establishment and maintenance of currency convertibility with stable exchange rates, and li) the widest extension of multi-lateral trade and Dayments, In essence the Fund is an attempt to achieve the ‘ternal or international advantages of gold standard Sam wthout subjecting nations 10 i nteral daevan ee dal the same time maintaining the internal advantages P2per standard while bypassing its external disadvantages The following are the major functions of the IMF: 1. It functions as a short-term credit institution: 2. provides a machinery for the ordery adjustments of exchange rates. It is a reservoir of the curres member countries from which @ can borrow the currency of ol i ncies of all the bporrower nation ther nations. “7 THE IMF AND THE PROBLEM OF INTERNATIONAL LIQUIDITY in foreign exchange. ineing current tions. loans for fina’ roads» machinery fr ateting sometimes the par value of the currency of a member orderly adjustment of exchange rates, ‘and maintenance of high levels ‘of employment and resources of all member nations. to the UNO. IMF's constitution represents a departure Moreover, the contributed quota of a country determines its borrowing rights and voting strength. India being ‘one of the largest quota-holders (600 n dollars) hhas the honour of having a permanent seat on the Board of Executive Directors. Each member nation of the IMF is required to subscribe its quota partly in fon mut cote gold eal fo 25 ee aid ta noln’s oun currenoy la generally pet ae 4. Nisa However, it grants transactions only an 6sz 0 the form of deposit balance in favour of the IMF held in the nation’s central bank. Thus, the Fund gets @ pool of foreign currencies to lend, together with gold enables it to acquire additional amounts of currencies, whenever its intial supply of some currencies becomes depleted. The lending operations of the Fund technically take the form of sale of currency. Any member nation running short of foreign currency may buy the required currency from the Fund, paying for it in its own currency Since each member contributes gold to the extent of 25 per cent of its quota, the Fund freely permits a member to draw up to the amount ofits gold contribution, Additional drawings are permitted only after certain careful and strict scrutinies. Since the purpose of the Fund is to make temporary and long-term loans, it expects repayment of loans within 3 to 5 years. ‘The Fund has also laid down provisions relating to exchange stability. At the same time, the Fund started functioning, members were required to declare the par values of their currencies in terms 6f gold as a common denominator or in terms of U.S. dollar. Thus, under IMF arrangements, gold, retains its role in determining the relative values of currencies of different nations. And once the par values of different currencies are fixed, it is quite easy to determine the exchange rate between any two member nations. However, if at any time a member country feels there is a fundamental disequilibrium in its balance ‘of payments position, it may propose a change in the par value of its curency, Le, its devaluation. But devaluation is allowed or even advised by the IMF for the purpose of correcting a fundamental disequilibrium and not for undue competition or for other advantages. Thus, the decision to devalue should not be taken unilaterally by the member concerned, but only after consultation with the Fund, The Fund has also laid down that member countries should not adopt a system of multiple exchange rates. That is to say, there should not be two or mote rates between the currency of one member country and that of any other member country. This was necessary to prevent countries deviating from the pr ‘exchange rates. Secondly, it was laid down that a member country should not purchase or sell gold internationally at prices other than those indicated by the par values. In essence, these provisions were laid down in order to secure the chief advantage of the gold standard system, viz., exchange stability. At the same time, the exchange rates are not rigidly fixed as in the case of gold standard and exchange depreciation or devaluation is permissible only for correcting a fundamental disequilibrium in the balance of payments of a country. Similarly, > MONEY, BANKING, INTERNATIONAL TRADE AND PUBLIC FINANCE the Fund may ask a member enjoying a persistent sup position to revalue ils currency and set things rine With a view to eliminate or minimise exchange control tacties,:the Fund laid down that there shoule be no restrictions in ordinary trade and other curen transactions. Although the Fund laid down that exchange controls and other restrictions should not be used i normal current transactions, it allows their use at af times to control international capital movernents, especialy capital flights. Moreover, exchange controls are expres permitted in the case of currencies which may be decred “scarce” by the Fund. It is also permitted during te “transition period.” Thus, the elements of exchange control have been incorporated in the provision ofthe Fund In short, the IMF may be described as a bank central banks of different countries, because it collects the resource of the various central banks in the sane way in which a country's central bank collects cah reserves of all the commercial banks, assists them i times of emergency. However, while a central ba can control the credit policy of its member banks, ie Fund cannot control the domestic economic and monet policies of member nations. It only seeks to maitit ‘multiple payments system through an orderly adjusts of the exchange rates. 2, ACHIEVEMENTS OF THE IMF Undoubtedly, the IMF has made a remarkable suceess in most of its principal goals: (1) Itprovided an excellent machinery for consult In international monetary fairs. It serves as an excel! forum for discussions, practically on a day-to-day bss ofthe economic, fiscal and financial polices of men countries with particular reference to their balanct payments impact. The Fund has created a feeling 270" the member countries that their economic proble™ ate not their exclusive concern but ofthe whole interna sosiety (2) The Fund has contributed in certain wai! the expansion of world trade. By providing credit och to member countries, the IMF has reduced the 1 for their imposing import and exchange conto astists the deficit countries to meet their tempt isequilibrium in payments. It also works fo fact ‘multilateral payments and trade, promoting "=" inlemational trade as a whole © (3) Another fundamental object of the ME Ta Promote exchange stability. The measure of © is Stability that the world has witnessed in the INF, is remarkably superior to what was seen 609 ie inter-war period of gold standard regime: U" a“THE IMF AND THE PROBLEM OF INTERNATIONAL LIQUIDITY ip arangements, stable exchange rates de not im i Uachenge rates. IMF's object is to comen ere {1 of stability with flexibility in exchange manmsomnen Sit avoiding competitive exchange demesne “ouing the members to declare the oorreciaons sattonctes fined in terms of gold eran aes [Xen it allows for an orderly adjueimesy ee ange rates when this is needed for torecrne's Uomental disequilibrium in a county's wale iments. The teeent devaluation of the Indian pce 1966) and that of pound sterling was jucthon ty MP (3) Moreover, the Fund has been particularly interested the newly developing counties of the werk eet been liberally assisting them to have « heahthe snce of payments and to maintain monetary stabi nome, In recent years, however, underdeveloped vunties have started looking to the Fund te seoet em in their economic development programmes also, furthermore, most of the new members who have scquied ndependence recently are facing dificult prablems in ‘sanising their monetary, fiscal and exchange systems, © they need a solid basis for thelr economic growth The Fund has been already providing technical ‘sistance to its members in this respect, bul now ils “wily is substantially widened to meet this challenge ln many of these countries, the Fund's experts have tisted in the formulation of appropriate monetary, Wgel and exchange polices in the implementation of isation programmes. 3. THE PROBLEM OF INTERNATIONAL LIQUIDITY vig ght? Problem of international li widity is associated Sitsrtin csc pment ete men dec’ Connection with international trade in goods betwerriS€$ and also in connection with capital movernents Seren county aaateysestona tay atest te sence ec net _ 8 imbalances in international payments. In are form, thus, international quid i comprised Reserves that are available in the monetary authorities nt Countries for meeting international disbursements. ng act the present international monetary order, ante member Couns he" ne "ken ae °f the international liquidity structure are ‘Sold reserves with the national monetary authorities 2 patentral banks — and with the IMF. &, Dollar reserves of countries ater than the USA Sterling reserves of countries other than the 573 should be noted that items (2) and (3) are regarded’ as key currencies of the world and their reserves held by member countries constitute the respective liabilities of the USA. and the UK. More recently, Swiss fran and German marks also have been regarded as “key 4. IMF tranche position which represents the “drawing potential” of the IMF members. 5. Credit arrangements (bilateral and multi-lateral credit) between countries such as “swap agreements’ and the “Ten” of the Paris Club. Of all these components, however, gold and key currency like dollar today assume greater significance in cetermining the international liquidity of the world Broadly speaking, the problem of international liquidity has two aspects: quantitative and qualitative. The quantitative aspect of the problem relates to the adequacy of international liquidity. The qualitative aspect of the problem pertains to the nature and composition of international reserves for liquidity. A major source of worry in maintaining international economic relations is the quantitative aspect of the problem of international reserves. It is generally feared that in future there is likely to arise a shortage of international liquidity. It is regarded that there is no guarantee that the present international monetary provide an increase in the supply of quantity of international reserves international monetary system is going to boy inadequate for the world's Tutuse meats under the present ‘tremely existing system of international monetary te under the shar bound isle sie monetary mechansae to emerge a liquidity gap, “inadequaney", posing 9 serious problem of international liquidity In its qualitative aspect, the problem is related to the use ofthe dollar and sterling as reserve components The US. dollar and the pound sterling ate the prinelpal reserve currencies or “key currencies” because of thelr role as the major trading currencies for carrying out a large number of international trade and investment transactions, However, since World War Il, the world's international payments system has received its maln support from the willingness of the world to hold dollar and use it as an international currency. Thus, today, dollar supply plays a pivotal role in determining the total reserves for intemational liquidity. In the composition of international liquidity, we now find that gold and dollar plus sterling — key currencies — are the major components. But, since gold cannot be Increased very ruich the requirements of growing international reserves may be sought to be met by Increasing the supply of key currencies. Now, if currencies form an increasing part of international reserves, this implies an increase in relation to their gold stock of the liquid abilities of the countries whose currencies are held as reserves by other countries. But, should these liquid labilities grow beyond the gold reserves owned by the reserve currency countries, confidence may be seriously weakened in their continued ehility to maintain the par values of their currencies and the stability of the International payments system may be undermined, This isthe precise situation which confronts the U.S. dollar today. As a matter of fact, the U.S. balance of payments deficits con capital account have added to the world’s reserves, but its recent deficits have created a sense of insecurity about the future. Since 1959, the U.S. balance of payments has turned adverse and she has been losing gold. This loss of her gold was temporarily halted by the sale of gold by the USSR and later by the restoration of confidence through bilateral “swap” credit agreements and stand: bby drawing arrangements with the IMF. However, there 's a fear that if the situation is not substantially improved, European countries which have been accumulating dollars only as an act of persuasion, may any time start converting them into gold. If this happens, the USA. might lose large quantities of gold and the dollar might have to go off the gold link as the £ (pound). Sterling was forced off the gold standard on September 21, 1931 In fact, confidence in dollar is weakening with a decline vn American gold holdings. Thus, there is the international liquidity dilemma, Under the present monetary set up, an increase in the ipply of wtemabional liquidity commensurate with ineweased anid for lquidity due to the expanding workd trade been dependent on the USA's sminuing deficits in ats balance MONEY, BANKING, INTERNATIONAL TRADE ANO PUBLIC FINANCE persistent deficits In USA's balance ‘ort that involve accumulating dollar European countries may disincine hele International reserves In the form of dollars. They may start converting thelr dolar eserves Into gold. This may precipitate o crlsis in the European dollar market. This erisis may further reduce United States gold holdings which In turn may generate Tack of confidence In the stability of the gold value of the dollar. It may further accelerate a rush for gold. To avold this danger, the balance of payments deficit of the USA has to be reduced, And if she reduces this Gelieit, to that extent world's liquidity reserves will also be depleted under the present International monetary system, Another repercussion Is that when the United Slates will reduce its grants of loans to newly-developit ‘countries in order to Improve her balance of payments, these countries will also have to make undesirable cuts In thelr development programmes. The problem of bridging tho gap in the US balance of payments is, thus, interlinked with the problem of international liquedity. 4, IMF AND INTERNATIONAL LIQUIDITY The IMF duly recognised that the international monetary system cannot consist of fixed arrangements expected to be suitable for ever. Accordingly, suitable changes in the policies and operations of the Fund are directed towards meeting the financial requirements of the dynamic world economy. ‘The IMF provides short-term financial assistance to Its members to meet seasonal balance of payments deficits, as well as emergency situations With a view to enable the Fund to achieve its objectives more effectively, the Executive Directors o! the IMF recommended in 1958 an increase of 50 per cent in the quotas of the members, with additional increases for certain members. As a result of the increas? in the quotas of the member countries, the resources of the Fund were increased considerably. Thus. he ability of the Fund to meet the increasing liquidi!y requirements of its members was enhanced. Hence: al present there seems to be no “inadequacy” problems as such, In order to make the Fund's resources readily avalable to its members, the following important changes hav been made in its procedures for giving accommodation to member countries: (0) Gold tranche policy. in 1952, the Fund laid down this policy under which a member oul draw on the Fund virtually at will o the exter! of the gold tranche position with the Fur! of payments. But of payments of the reserves with the the latter to keep a- ‘THE IMF AND THE PROBLEM OF INTERNATIONAL LIQUIDITY owers. Since 1952, in order to promote greater 0) Waits facilities, the Fund has in practice ust Jasingly waived the limitation of Grawig iercess of 22 per cent of a member's quota iP gay 12-month duration ,) Stand-by arrangements. Since 1952, a new procedure of drawing called stand-by arrangement vas devised by the Fund. Under this scheme, once a request for assistance had been approved, ‘2 member is authorised to draw the specified limit of foreign exchange from the Fund within a specified period without further application to the Fund. liv) Liberal credit policy. In its credit policy also the Fund shows a liberal attitude to member's requests for transactions within the first tranche if they make reasonable efforts to solve their problems. However, requests for drawings beyond the first credit tranche require substantial justification. __ ln December, 1961, the Fund took a decision on ® General Arrangement to Borrow (G.A.B.), according hich the Fund has been authorised to borrow ‘ovlementary resources under Article VIlof the Agreement. object of the Agreement is to “enable the IMF to ssuiter® effectively its role in the international monetary ‘agg’ the new conditions of widespread convertibility, ia greater freedom for short-term capital movement.” eunctal amount of such supplementary resources is ini ant t© $ 6.2 billion. The Agreement provides lor ynegeauest for drawing by participant countries doaite@uPPlementary resources are required will opeilth according to the Fund's established policies “repetatlonal practices with respect to the use of in Hot the Agreement enables the Fund to mobilise ati !€ additional resources in defence of the tional Monetary system. It has increased both ‘iquidity and the resiliency of the monetary tg. Al teh® Benefit of all atid #S6 changes are made in order {0 increase cations Ne Fund to meet the increasing need of abt. becal, €@8erVe requirements of the world. No ingt®4ure g¢'@, Of these changes in the policies and ‘nati Of the Fund in ato ‘und’s working, the 2a preset has been maintained satisfactory itself get Petiod, The IMF has tried its best to Oy. Hoyine dynamic requirements of the world tive gr’e¥er, from the viewpoint of a long-term feebbing cod With the growing needs of the newly- lpn 0 PAtries for long-term foreign capital for enP ment, for long-term foreign capi Rt ing PUPOSE, many are of the opinion that i ui and “i ‘atte ormt® liquigite sonal monetary system cannot provide me ' in the future, and that it needs substantial “Organisation in this respect. o 575 5. SPECIAL DRAWING RIGHTS em mas The post-war international monetary system val a be characterised as the “currency reserve standard.” wherein the U.S, dollar has been serving as a res he fifties. But, due asset as good as gold, at least, till t! t, due to the shaky position of the US dollar and other reason: such as speculation in gold, chaos in Euro-dollar market etc, tht system faced acute problems of internationa liquidity ike balance of payments difficulties, inadequate growth of monetary reserves and fragility of the go! exchange standard. Economists have visualised three aspects, liquidity adjustment and confidence, as the problems of international liquidity. To solve these, a reform in the existing international monetary system was regarded inevitable. Many proposals and plans (as has been seen in the preceding section) had been suggested to evolve some alternative system to get rid of the difficulties faced by the existing system. Unier this scheme, the IMF is empowered to grant member governments special drawing rights (SDRs) on a specified basis, subject to ratification. SDRs are regarded as international reserve, allocated annually by the collective decision of participating members in the Fund. Possession of SDRs entitles a country to obtain a defined equivalent of currency from other participeting countries and enable it obligations towards the General A The creation of SDRs is, thus, the resources available to IMF their temporary foreign exchange difficulties atten puting any adaltional strain on the IMF resources, Sisiat ate, thus, a method of supplementing the exctee's assets in the international liquidite, ae A precise mechanism has bee implementation of the SDI to discharge certain count of the Fund. » intended to increase members to overcome n evolved in ti scheme. Under tie neh Peeding convertible foreign eMPPly to the Fund for tee to the limit of allocated amet aa an application, the Fund woule (say country Il), whose balan, reserve position are sutficie, “designated country” — to meet the fore; needs of country |. Then country T corel designated country” (country Il} ray total net amount equal Went alated 10 the designated ‘conn point, suppose country | has hae uot 1,000 units and the sgeseen, allocated as been allotted a quota ‘ county 1 seeks converse ago 2:900 units, for which. country Il has SoG Fund. So, country I has to ayse 0 holdings and give them to country Il in exchange for an equivalent amount of convertible foreign exchange Country I thus becomes a debtor and country Ila creditor country. The debtor country has to pay interest at 1.5 Per cent per annum on the unit surrendered to the creditor country, It must be noted that the designated country cannot be added to provide foreign exchange for the SDR units in excess of twice the quota of SDRs allotted to it (i.e., 1,500 x 2 = 3,000 units in our illustration) In case, the requirement of a country exceeds twice the amount allotted to a designated country, some other countries along with this country will have to be designated to meet the total requirements. 6. FEATURES OF SDR SCHEME ‘The salient features of Special Drawing Rights Scheme are as follows: 1. The creation of Special Drawing Rights (SDRs) is essentially similar to the concept of credit creation which central banks undertake in their countries to supplement the resources of the banking system to meet the monetary requirements — the liquidity need of the country. The SDRs scheme is an extension of the same principle. In fact, basically, the idea of SDRs is drawn from the popular Keynesian plan of creation ‘of ICU and Bancor currency. 2. The scheme proposes that the allocation of SDRs is to be made on the basis of the quotas held by the individual member countries, 3. SDRs have been created under’a Special Drawing ‘Account (SDA) with the IMF. The resources of the new account, SDA, are created by an agreement amongst members as to the percentage of the existing resources (quotas) with the IMF to be formed into SDRs. At the Paris Conference on July 24, 1969, the Group of Ten, however, recommended that some $ 3,500 milion worth ‘of SDRs be created in the beginning year and $ 3,000 million in each of the two succeeding years. 4. With the introduction of the SDR scheme, thus, the accounts of the IMF are divided into: (i) the General Account, and (i) the Special Drawing ‘Account. The General Account deals with the ‘ordinary transactions of the IMF relating to subscriptions, towards quotas, drawings, purchases, payment of charges, etc. the SDA conducts the SDR transactions. 5. The scheme proposes that the Special Drawing Rights would be a sort of gold paper. Thus, 10. WL 2 MONEY. BANKING, INTERNATIONAL TRADE ANO PUBLIC FINANCE the value of the SDRs is fixed in gold ay the existing scheme, the unit value cf spy is expressed in terms of gold equal to 0.44 gram of fine gold for one U.S, dollar pricy ‘August, 1971, With effect from February is 1973, an SDR is equivalent t0 $1.2. The aly, cof SDR being fixed, it has to be mainaine, by the member participants The scheme, thus, envisages a pure fiduciy reserve creation. It provides for regularly creating SDRs in the IMF which the member counts would accept as reserves and use forthe setemen of international payments. The SDRs have been, thus, aptly described as “Paper Gold’. Thee paper gold reserves are expected to fil te gap of deficiency in international liquidity esting from a mere rise of 2.5 percent in word money reserves against the expansion in internation! trade at 8 per cent per annum. The SDRs themselves are not international mor SDRs ae just lke coupons which can be exchanged for currencies required by the holder of Ss for making international payments. Furthe, SDR transactions are carried out through ets in the SDA books of the IMF. Under the new scheme, the central bars ¢! the member countries of the IMF will hld S0® as their reserves along with gold and key cunenss However, the participants are required to prowl their currency in exchange for SDRs when ‘upon to do so, the purpose being that counts ‘would provide the requisite backing of real rou to the SDRs. Ithas been statutorily laid down that due rst would be exercised in the creation of in order to maintain people's confidence * it ‘The SDRs allocated to the Fund membe transferable assets under the designation by the IMF, subject to certain limits of hols Thus, itis obligatory on the part ofthe partial countries to accept drawing rights from Fut members in exchange for the equal #0 of convertible currency. This obligation, howe cannot exceed twice a country’s allocate Under the scheme, the use of SDRs would oi, imply a reduction in the reserves of the country, while thie other participating Our) which are receiving drawing rights in into, settlements would accumulate their SDR MO gt It is proposed that a modest rate of im will be paid in SDR on holdings of such Rights. sat> The scheme provides that the decur ve and accumulation of SDRs would place within the Special Drawing Acco Over a five-year period, a country sha use more than 70 per cent of its average cumulative allocation. 13. Further, members using SDRs wou obligation to reconstitute their position in .« with the principle which is to take in the amount and duration of its use. The > of reconstitution is assumed to be ver a enforce the “circularity” of the SOF *g its inernee scheme seeks to reconstitute “ational li a duidity structure, it aims at ne resent IM ity without causing any Das: F system and its function 7 OR ON