- The International Monetary Fund (IMF) has agreed to provide $3 billion to Pakistan in badly needed relief to help bail out the impoverished country’s ailing economy.
Mandate of IMF
- The IMF was set up in 1945 out of the Bretton Woods conference. The primary goal of the IMF back then was to bring about international economic coordination to prevent competing currency devaluation by countries trying to promote their own exports.
- Eventually, the IMF evolved to be a lender of last resort to governments of countries that had to deal with severe currency crises.
Why do nations seek an IMF bailout?
- Countries seek help from the IMF usually when their economies face a major macroeconomic risk, mostly in the form of a currency crisis.
- For instance in the case of Sri Lanka and Pakistan, both countries have witnessed domestic prices rise rapidly and the exchange value of their currencies drop steeply against the U.S. dollar.
- A rapid, unpredictable fall in the value of a currency can destroy confidence in said currency and affect economic activity as people may turn hesitant to accept the currency in exchange for goods and services. Foreigners may also be unwilling to invest in an economy where the value of its currency gyrates in an unpredictable manner.
- In such a scenario, many countries are forced to seek help from the IMF to meet their external debt and other obligations, to purchase essential imports, and also to prop up the exchange value of their currencies.
How does the IMF help countries?
- The IMF basically lends money, often in the form of special drawing rights (SDRs), to troubled economies that seek the lender’s assistance.
- SDRs is a reserve created by the IMF. The member countries have to contribute to this account in proportion to their IMF quota.
- SDRs simply represent a basket of five currencies, namely the U.S. dollar, the euro, the Chinese yuan, the Japanese yen, and the British pound.
- Also called “paper gold”, an SDR is neither paper nor gold but an accounting entry. It is a potential claim on the freely usable currencies of IMF members.
- Holders of SDRs can obtain these currencies in exchange for their SDRs in two ways: first, through the arrangement of voluntary exchanges between members; and second, by the IMF designating members with strong external positions to purchase SDRs from members with weak external positions.
- The IMF carries out its lending to troubled economies through a number of lending programs such as the extended credit facility, the flexible credit line, the stand-by agreement, etc.
- Countries receiving the bailout can use the SDRs for various purposes depending on their individual circumstances. Currently, both Sri Lanka and Pakistan are in urgent need for U.S. dollars to import essential items and also to pay their foreign debt. So any money that they receive from the IMF is likely to go towards addressing these urgent issues.
Are there any strings attached to an IMF bailout?
- It should be noted that the IMF does not lend for specific projects. Instead, the IMF provides financial support to countries hit by crises to create breathing room as they implement policies that restore economic stability and growth. It also provides precautionary financing to help prevent crises.
- The IMF usually imposes conditions on countries before it lends any money to them. For example, a country may have to agree to implement certain structural reforms as a condition to receive IMF loans.
- The IMF’s conditional lending has been controversial as many believe that these reforms are too tough on the public. Some have also accused the IMF’s lending decisions, which are taken by officials appointed by the governments of various countries, to be influenced by international politics.
- Supporters of the IMF’s lending policies, however, have argued that conditions are essential for the success of IMF lending.