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The Workings of the IMF

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The IMF and its sister organisation the World Bank were initiated at the town of Bretton Woods in New Hampshire in the USA in 1947 in response to the economic circumstances that had developed prior to the 2nd World War. Countries were engaging in damaging trade disputes fought out using competitive devaluation and protectionism.

Originally the IMF was set up to perform three basic functions:

oversee a system of fixed and adjustable exchange rates
promote currency convertibility to facilitate world trade
act as a lender of last resort to countries experiencing short term balance of payments problems

In 1971 the fixed exchange rate system collapsed and it saw a broadening of its functions to also include supervising of member countries economic policies and problems.

How does the IMF work?

Each member pays a subscription or quota to the fund in gold reserves or their own currency. The more it contributes the more it can borrow in times of need. In addition, the amount a country contributes determines the number of votes it has and thus the amount of control it has over IMF policy, thus the United States has 70 times the voting power of Zambia. The fund's total quota in 2005 was $327 billion. Members of the IMF can borrow from the fund on a wide range of terms. It should be noted that its quotas are now less than 2% of world trade and no major industrial economy has borrowed from it since the 1970s. Its main clients are the Less Developed Countries (LDCs) and the transition economies.

Borrowing countries can borrow back their initial quota on a no strings attached basis. However, if the country needs more they can borrow up to three times their quota. If they borrow above their quota they have to agree to certain conditions. These conditions are outlined in a structural adjustment programme or SAP. The more they borrow the tougher the conditions.

There are four main types of loans

Stand-by Arrangements (SBA)
These are loans to countries experiencing short-term balance of payments problems. The loan is at the market rate of interest and for 3-5 years. Surcharges apply to high access levels.
Compensatory Financing Facility (CFF)
The financial terms are the same as those applying to the SBA but with no surcharge. The CFF was established in 1963 to assist countries suffering from fluctuating world commodity prices.
Extended Fund Facility (EFF)
These provide balance of payments support over a longer period (4-10 years) and for large amounts.
Supplemental Reserve Facility (SRF)
Large scale, short-term loans (2-2½ years) with a 3-5% surcharge to emerging market economies that experience massive outflows of capital due to sudden loss of market confidence.

Loans are often made in the form of Special Drawing Rights or SDRs. In the 1960s and 70s there was a shortage of internationally acceptable liquid assets and so the member governments of the IMF empowered the fund to create an artificial world liquid asset that could be accepted in payment for debt. Now about 2% of world reserves are made up from SDRs.

Although the IMF accounts for only about 5% of assistance to Sub Saharan Africa it is still seen to exert a great deal of influence. Failure to adhere to the conditions of the Structural Adjustment Programmes will affect the sources of future funds from other organisations such as the World Bank and other multilateral donors.

It should not be forgotten that the flow of funds occurs both ways. The loans and assistance made to LDC countries must be repaid. In 1997 Sub Saharan countries repaid 300 million more that it received in new loans. The burden of these debt repayments and the tough conditions required by the SAPs take their toll on the development and the reduction of poverty.

In 1996, the IMF and the World Bank launched the Highly Indebted Poor Countries (HIPC) Initiative to create a framework for all creditors, including multilateral creditors, to provide debt relief to the world's poorest and most heavily indebted countries, and thereby reduce the constraint on economic growth and poverty reduction imposed by the debt build-up in these countries. The Initiative was modified in 1999 to provide three key enhancements:

Deeper and Broader Relief: more countries became eligible for debt relief and some countries became eligible for greater relief
Faster Relief: permitted countries to receive interim debt relief faster
Stronger Link Between Debt Relief and Poverty Reduction: Freed resources were to be used to support poverty reduction strategies developed by national governments

Next issue - The Structural Adjustment Policies of the IMF >>