Establishment and Goals of the IMF
IMF was established during the Bretton Woods conference in 1945 for the purpose of creating a new world economic order. Article I of the IMF Articles of Agreement states the main goals of the financial institution:
- Provide consultation and collaboration on international monetary problems and project in order to promote international cooperation
- Maintain high levels of employment and real income, to encourage the development of the productive resources of all members
- Promote exchange stability and to avoid competitive exchange depreciation
- Establish a multilateral system of payments and to eliminate foreign exchange restrictions
- Temporary funding to correct balance of payments
The IMF pursues these goals using the following lending channels:
Low-income countries borrow at a concessional interest rate through:
- Poverty Reduction and Growth Facility (PRIGF)
- Exogenous Shocks Facility (ESF)
Other countries borrow at non concessional interest rate through:
- Stand-By Arrangements (SBA) designed for middle-income countries to help address short-term balance of payments problems.
- Flexible Credit Line (FCL) is for countries with strong fundamentals and policies. It is useful for crisis prevention purposes. These disbursements are not conditioned on implementation of specific policies as happens under the SBA.
Extended Fund Facility was established to help countries address longer-term balance of payments problems requiring fundamental economic reforms.
At the end of October, the three countries that using the new Flexible Credit Lines most are Mexico and Poland (1000% of quota), Colombia (900%). Five major countries which are benefiting from nonconcessional arrangements (on August 6, 2009) are Latvia (1200% of quota), Iceland (1190%), Romania (1111%) Hungary (1015%) and Ukraine (802%)
Shift in Lending practices following Asian Crisis of 97-98: Less Conditionality
Comparing the policies of IMF lending in the Asian Crises and the recent financial crises provides an example of a great paradigm shift. The Asian Crises in the late 90’s saw some major emerging economies such as Thailand, Indonesia, South Korea, Philippines and Malaysia suffering with permanent currency devaluations, massive number of bankruptcies, real estate busts, high unemployment, and social unrest. The IMF created a series of bailout packages to restore stability to the affected economies. However, the IMF's support was conditional on economic reforms influenced by neoliberal economic principles which required these countries to:
- Reduce of budget deficits
- Allow insolvent banks and financial institutions to fail
- Aggressively raise interest rates
- Administer IMF funded capital “rationally”
- Supervise all financial activities (Noland: 98-103)
In principle, the condition for IMF support was that the financial systems in the crises economies had to be transparent and work on similar lines as in the industrialized economies. IMF came under heavy criticism from economists around the world for its stringent lending conditions and its failure in achieving the objective it had set out to stabilize the economies.
In combating the recent financial cries, the IMF has enacted what amounts to a major swing in policy. In the financial crises, the IMF sharply increased the resources to lend through increased funds made available by the G-20 nations. The IMF’s lending capacity is being increased to USD 750 billion (The Economist, 2009). IMF conducted a major overhaul of how it lends money by offering higher loan amounts and tailoring loan terms to countries’ circumstances. Financing provided by the IMF was used more to meet the funding needs of the private sector , the government, not merely to support central bank reserves.
The IMF Moral Hazard Debate
The reasoning behind a “moral hazard” for IMF lending is usually advanced as follows: a developing country accumulates large amounts of debt (from private sources), runs into to repayment difficulties for one reason or another, traditional capital markets dry up, the IMF steps in, private lenders are paid in full, and the IMF gets left holding the loans (Rogoff 2002). The major contributors to the IMF are industrialized nations and the funds provided come at the expense of their taxpayers. Thus, it is at their expense that the developing county is bailed out. Since the IMF is in the business of preventing government default on its external debts, these developing countries may change the behavior towards a higher appetite for risk. Hence, a “moral hazard”.
Loan default rates have actually been quite low. With the exception of Argentina in 2001, which defaulted on its IMF loans of around USD 140 billion (BBC news 2003). If the majority of IMF loans get repaid then it favors the argument of little or no moral hazard.
The 2008 Financial crisis has caused more countries to look towards the IMF for emergency funds. This includes emerging countries from Eastern Europe including Ukraine which received $16.5 billion, Hungary $25.1 billion (Pan 2008), Iceland $2 billion (Associated Press, 2008), Latvia €1.7 billion (Conway 2008), among others. These countries had varying financial structure and positions, some heavily indebted (Ukraine, Latvia) others with massive fiscal deficits (Ukraine, Hungary), shaky financial systems (all), and export led growth (all except Iceland). This level of lending reignites the concerns of moral hazard.
Despite calls for relaxation – conditionality seems to be more directed towards specific reforms and in practice still quite restricting (see previous section). Conditionality reduces the risk of moral hazard by tying those conditions to funding. For Latvia, the IMF has considerable control over fiscal policies that help to guarantee loan repayment which is backed in the letter of intent by Latvia: “we are committed to containing external and fiscal imbalances” (IMF, 2009).
A final argument is that since private capital sources make losses when a country is in financial distress, there must be bounds on their risky behavior. In Iceland for example, the “crisis led to the collapse of Iceland’s three main banks, accounting for around 85 percent of the banking system” (IMF 2008:1). The result led to a government “restructuring” (IMF 2008:1) that incurred massive government debt. While this shows that private funding does pay for some of the costs due to their risky behavior, the fact that the government stepped in to pick up the bill, transfers the costs to the Icelandic taxpayers. The subsequent IMF loan transfers responsibility to the donor countries. This leads to a mixed conclusion, which needs more time to play out. Will Icelandic banks behave more conservatively? Or will they take advantage of IMF loan by engaging in further risky behavior?