Working of International Monetary Fund (IMF)

Recommended Reading: International Monetary Fund (IMF)

1. Financial Resources:

IMF’s resources mainly come from two sources Quotas and Loans. The capital of the Fund includes quotas of member countries, amount received from the sale of gold, General Arrangements to Borrow (GAB), New Arrangements to Borrow (NAB) and loans from members nations.

Quotas and Loans and their Fixation: The Fund has 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 its drawing rights. The country will be assigned with an initial quota in the same range as the quotas of existing members that are broadly comparable in the economic size and characteristics.  At the time of the formation of the IMF, each member is required to pay its subscription in full or on joining the Fund – of which 25 percent of its quota in gold/SDR/widely accepted currencies such as USD/ Euro/Yen/UK Pound and the rest in their own currencies. In order to meet the financial requirements of the Fund, the quotas are reviewed every five years and are raised from time to time. Loans from members and non-members constitute another major source of funds for the IMF. Since 1980 IMF has been authorized to borrow from commercial capital markets too. Quotas are denominated in Special Drawings Right , which is the IMF’S Unit of account. IMF has a weighted voting system . the larger a country’s Quota in the IMF (determined broadly by its economic size) the more the vote the country has, in addition to its basic votes of which each member has an equal number.

2. Fund Borrowings:

Besides performing regulatory and consultative functions, the Fund is an important financial institution. The bulk of its financial resources come from quota subscriptions of member countries. Besides, it increases its funds by selling gold to members. While Quota subscriptions of member countries are its major source of financing, the IMF can activate supplementary borrowing arrangements if it believes that resources might fall short of the members’ needs. Through the General Arrangements to Borrow (GAB) and the New Arrangements to Borrow (NAB), a number of member countries and institutions express their readiness to lend additional funds to the IMF. GAB and NAB are credit arrangements between IMF and group of members and institutions to provide supplementary resources of up to US$54 billion to cope with the impairment of the international monetary system or deal with an exceptional situation that poses threat to the stability of the system. The GAB enables the IMF to borrow specified amount of currencies from 11 developed countries or their Central Banks under certain circumstances at market related interest rates. Whereas the NAB is a set of credit arrangement   between the IMF and 26 Members and Institutions. The NAB is the first and principal resource in the event of a need to provide supplementary resources to the IMF.

Commitments from individual participants are based predominantly on relative economic strength as measured by the IMF Quotas. Like other financial institutions IMF also earns income from the interest charges and fees levied on its loans.

4. Fund Lending:

The Fund has a variety of facilities for lending its resources to its member countries. Lending by the Fund is linked to temporary assistance to members in financing disequilibrium in their balance of payments on current account. Reserve tranche and Credit tranche facilities are two basic facilities available for meeting BOP deficits.
Reserve tranche: Every member country is entitled to borrow without any conditions a part of its Quota (i.e., the subscription paid by the member country to the IMF). If a member has less currency with the Fund than its quotas, the difference is called Reserve tranche. It can draw up to 25 percent on its reserve tranche automatically upon representation of the Fund for its balance needs. It is not charged on any interest on such drawings, but is required to repay within a period of three to five years.

Credit Tranche: A member can draw further annually from balance quota in 4 installment up to 100% of its quota from credit tranche. Drawings from credit tranches are conditional because the members have to satisfy the Fund adopting a viable programme to ensure financial stability.

Other Credit Facilities:

  • Buffer Stock Financing Facility (BSFF): It was created in 1969 for financing commodity buffer stock by member countries. The facility is equivalent to 30 percent of the borrowings member’s quota.
  • Extended Fund Facility (EFF): It is another specialized facility which was created in 1974. Under EFF, the Fund provides credit to member countries to meet their balance of payments deficits for longer periods, and in amounts larger than their quotas under normal credit facilities.
  • Supplementary Financing /Reserve Facility (SFF/SRF): It was established in 1977 to provide supplementary financing under extended or stand-by arrangements to member countries to meet serious balance of payments deficits that are large in relation to their economies and their quotas.
  • Structural Adjustment Facility (SAF): The Fund setup SAF in March 1986 to provide concessional adjustment to the poorer developing countries.
  • Enhanced Structural Adjustment Facility (ESAF): The EASF was created in December 1987 with SDR 6 billion of resources for the medium term financing needs for low income countries. The objectives, eligibility and basic programme features of this facility are similar to those of the SAF.
  • Compensatory & Contingency Financing Facility (CCFF): The CCFF is created in August 1988 to provide timely compensation for temporary shortfalls or excesses in cereal import costs due to factors beyond the control of the member and contingency financing to help a member to maintain the momentum of Fund-supported adjustment programmes in the face of external shocks on account of factors beyond its control.
  • Systematic Transformation Facility (STF): In April 1993, the IMF established STF with $6billion to help Russia and other Central Asian Republics to face balance of payments crisis.
  • Emergency Structural Adjustment LOAN (ESAL): The Fund established ESAL facility in early 1999 to help the Asian and Latin American countries inflicted with the financial crisis.
  • Contingency Credit Line (CCL): The CCL was created in 1999 to protect fundamentally sound countries from the contagion of financial crisis occurring in other countries, rather than from domestic policy weaknesses.
  • Poverty Reduction and Growth Facility (PRGF) and Exogenous Shock Facility (ESF): These are concessional lending arrangements to low income countries and are unpinned by comprehensive country –owned strategies, delineated in their Poverty Reduction Strategy Papers (PRSP). In recent years PRGF has accounted for the largest number of IMF loans. The interest levied on these loans is 0.5% only and the repayment period is over 5-10 years.
  • Stand- By Agreements (SBA): SBA is designed to help countries having deficit BOP with an extended repayment period of 2 to 4 years. Under Stand-By and Extended Arrangements a member can borrow up to 100% of its quota annually and 300% cumulatively.

5. Exchange Rate:

The original Fund Agreement provided that the par value of each member country was to be expressed in terms of gold of certain weight and fineness or US dollars. The underlining idea was to create a system of stable exchange rates with ordinary cross rates. But the Fund was obliged to agree to changes in exchange rates which did not exceed +/- 1 percent of the initial par value. A further change of +/- 1 percent required the permission of the Fund.

6. Other Facilities:
The IMF advices its member countries on various problems concerning their BOP and exchange rate problems and on monetary and fiscal issues. It sends specialists & experts to help solve BOP and exchange rate problems of member countries.

The Fund has setup three departments to solve banking and fiscal problem of member countries:

  • There is the Central Banking Service Department which helps member countries with the services of its experts to run and manage their central banks and to formulate banking legislation.
  • The Fiscal Affairs Department renders advice to member countries concerning their fiscal matters.
  • The IMF institutes conducts short-term training courses for the officers of member countries relating to monetary, fiscal, banking and BOP policies.