International Monetary Fund and International Financial System

An Exposition

Dr. Sukumar Nandi Indian Institute of Management Lucknow

Purposes of the IMF and The World Bank
 The International Monetary Fund (IMF) maintains international monetary cooperation among its members The World Bank aids in the development and reconstruction of it members

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IMF Briefing
 Exchange rate stability, balance of payments disequilibrium, and growth of international trade 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".  By sharing economic policies the system of buying and selling currencies would be stable

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World Bank Briefing
Made up of 5 different organizations      International Bank for Reconstruction and Development (IBRD) International Development Association (IDA) International Finance Corporation (IFC) Multilateral Investment Guarantee Agency (MIGA) International Center for the Settlement of Investment Disputes (ICSID)

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History behind the IMF and World Bank  After the Great Depression in the 1930s there was a need for an organization to create a system for exchange rate stability  Uncertainty of the value of paper money (no longer used the gold standard)  Countries faced difficulties in trade related monetary payments in the absence of stable and well-accepted international currency

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The Interwar Years, 1918-1939
 With the eruption of WWI in 1914, the gold standard was suspended.  The interwar years were marked by severe economic instability.  The reparation payments from Germany led to episodes of hyperinflation in Europe.  The German Hyperinflation  Germany’s price index rose from a level of 262 in January 1919 [ pre-war =100] to a level of 126,160,000,000,000 in December 1923 (a factor of 481.5 billion).
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Bretton Woods Conference
 Countries’ economies affected by WWII

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need for reconstruction in well-developed nations need for development in the lesser developed nations

1940s proposals for monetary system by Harry Dexter White (U.S.) and John Keynes (UK)

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establish the value of each currency eliminate restrictions and certain practices on trade assistance for post-war reconstruction

Bretton Woods Conference, New Hampshire, July 1944 with delegates of 44 nations

final negotiations of the IMF and the World Bank took place

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Bretton Woods Agreement 1944
 In July 1944, 44 representing countries met in Bretton Woods, New Hampshire, USA, to set up a system of fixed exchange rates.  All currencies had fixed exchange rates against the U.S. dollar and an unvarying dollar price of gold ($35 an ounce). It intended to provide lending to countries with current account deficits. It called for currency convertibility. Two main Institutions were created : (a) International Monetary Fund (b) International Bank for Reconstruction and Development

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International Monetary Fund
  IMF

The International Monetary Fund was devised 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.

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IMF
Goals and Structure of the IMF  The IMF agreement tried to incorporate sufficient

flexibility to allow countries to attain external balance without sacrificing internal objectives or fixed exchange rates. Two major features of the IMF Articles of Agreement helped promote this flexibility in external adjustment:  IMF lending facilities  IMF conditionality is the name for the surveillance over the policies of member counties who are heavy borrowers of Fund resources.  Adjustable parities
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Purposes of the IMF
Articles of Agreement of the IMF

i) promote international monetary cooperation
ii) expansion and balanced growth of international trade iii) promote exchange rate stability iv) help establish multilateral system of payments and eliminate foreign exchange restrictions v) make resources of the Fund available to members when in need vi) Shorten the duration and lessen the degree of disequilibrium in international balances of payments
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Where the IMF gets its money
 Most comes from the quota subscriptions  the money each member contributes when joining the IMF General Arrangements to Borrow (1962)  line of credit set up with several governments and banks throughout the world

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Special Drawing Right (SDRs)
 SDR is an invented currency [ Robert Triffin, suggestions to augment world liquidity ]  its value is based on the worth of the world’s five major currencies US Dollar, French Franc, Pound Sterling, Japanese Yen, Deutsche Mark [ now four]

Countries add SDRs to their holdings of foreign currencies  keep available for need of payments that must be made in foreign exchange

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Organization of IMF
 Board of Governors  Each member country appoints one Governor and and Alternate Governor  Executive Board  24 Executive Directors which are representatives for the members  Managing Director  the chairman of the Executive Board

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 Governors spend most of their time dealing with their own countries  report their countries’ plans to their representatives  only meet with entire IMF board once a year  Executive Board oversees the economic policies of the members  holds meetings three times a week  Managing Director heads the IMF staff of about 2,600 people  traditionally held by a European
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Power among the members
 Size of the quotas determine voting power  IMF decides on the quota for each member  richer countries have larger quota  US having largest economy provides 18% of the total quota (about $35 billion)  US has largest voting power (18% or 26,5000)

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Members with largest quotas

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More on quotas
  Quotas are reviewed every 5 years by the IMF Quotas also determine how much each member can borrow from the IMF when in need of aid On April 28, 2008, the Board of Governors of the International Monetary Fund (IMF) adopted far-reaching reforms of the institution's governance structure (IMF Resolution 63-2).

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IMF Resolution 63-2, 2008
 The Resolution proposes an amendment of the IMF's Articles of Agreement, which will enhance the voice and participation of low-income countries through (i) a tripling of basic votes—the first such increase since the IMF's creation in 1944, (ii) a mechanism that will keep constant the ratio of basic votes to total voting power in the IMF going forward and
(iii) provisions enabling each of the two Executive Directors representing African constituencies to appoint an additional Alternate Director.

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IMF Quota position in 2010 [ percent of total]
United States Japan Germany France United Kingdom 17.071 6.118 5.978 4.935 4.935

China 6/
Italy Saudi Arabia Canada Russia

3.718
3.242 3.210 2.927 2.732

India Netherlands Belgium Brazil Spain

1.911 2.372 2.116 1.395

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1.401

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When is a country in need ?

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A country in severe balance of payments adjustment for import-export gap and/or servicing foreign debt [ e.g. Mexico in 1982, India in 1989]
A country that had not taken in enough foreign currency to pay the other countries for what they have bought  spends more money than it takes in IMF will lend foreign exchange to that member  hoping to stabilize its currency which will strengthen its trade

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How much money a member can borrow from the IMF
 25% of the country’s quota may be used  If this is not sufficient, then members can borrow up to 3 times the amount of its quota  present plans for reform to Executive Directors  If these plans are sufficient for the Executive Directors, the IMF grants the member a loan

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World Bank
Made up of 5 different organizations

   

International Bank for Reconstruction and Development (IBRD) International Development Association (IDA) International Finance Corporation (IFC) Multilateral Investment Guarantee Agency (MIGA) International Center for the Settlement of Investment Disputes (ICSID)

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International Bank for Reconstruction and Development
 Founded in 1944 at the Bretton Woods Conference  to finance the reconstruction of countries affected by WWII  To help with development of impoverished nations World Bank’s central institution 181 member countries Lends to countries with relatively high per capita incomes Money is used for:  development projects (i.e. highways, schools)  programs to help governments change the way they manage their economies Provides technical assistance in projects
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International Development Association
 Established in 1960  assist the poorest developing countries lends to countries with annual per capita incomes of about $800 or less  It’s loans are knows as “credits” 161 members

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International Finance Corporation
 Established in 1956, IFC is the largest multilateral source of loan and equity financing for private sector projects in the developing world. It promotes sustainable private sector development primarily by: Financing private sector projects and companies located in the developing world.

Established also to reduce poverty and improve people's lives in an environmentally and socially responsible manner ( 181 UN members and Kosovo) finances private sector investments, mobilizes capital in international financial markets, and provides technical assistance and advice to governments and businesses provides both loan and equity finance for business ventures in developing countries
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Multilateral Investment Guarantee Agency
  Established in 1988 helps developing countries attract foreign investment  provides investment marketing services and legal advisory services to its members 152 members

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International Center for the Settlement of Investment Disputes
 Established in 1966 to promote increased flow of international investment  Provides facilities for the reconciliation of disputes between governments and foreign investors  131 members

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Where the IBRD gets its money
 through the sale of its bonds in international capital markets  Members’ subscriptions to its capital stock  only 10% of the subscriptions is used by the Bank

 “Callable Capital”  portion of the subscriptions that the Bank borrows  the Bank charges a rate of interest rate on its loans to pay this back
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Where the IDA gets its money
  Mostly from governments’ voluntary contributions Replenishments  additional contributions which are needed every few years

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Differences between the IBRD and the IDA
 IBRD charges an interest rate on loans  loans must be repaid within 15-20 years with a 5 year grace period  IDA does not charge an interest rate, only a 0.75% service charge  repayment period is 30-45 years with a 10 year grace period

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Asian Crisis
 Financial crisis broke out in Asia in 1997  large declines in currencies, stock markets, and other asset prices It affected emerging markets outside of Asia IMF arranged programs of economic stabilization and reform with Indonesia, Korea, and Thailand

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IMF’s Actions
 Temporary tightening of monetary policy  correct the weaknesses in the financial system  remove features of the economy that were impediments to growth  assist in reopening lines of external financing  maintaining a sound fiscal policy

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