IMF bailout – The Core IAS

IMF bailout

Context: The International Monetary Fund (IMF) executive board approved a nearly $3 billion bailout plan for Sri Lanka last week, of which about $333 million was to be disbursed immediately to alleviate the country’s humanitarian crisis.

What is IMF bailout?

In a general sense, a bailout means extending support to an entity facing a threat of bankruptcy

When do countries ask for it?

Countries seek IMF bailouts when:

  • They are facing macroeconomic risks
  • Currency crises and need assistance to meet external debt obligations
  • To buy essential imports and push the exchange value of their currencies.

When do such situation occurs?

  • According to the IMF website, inappropriate fiscal and monetary policies, which can lead to large current account and fiscal deficits and high public debt levels; an exchange rate fixed at an inappropriate level, which can erode competitiveness and result in the loss of official reserves, and a weak financial system, which can create economic booms and busts are among factors that lead to economic crises. Political instability and weak institutions also can trigger crises, as can insolvent financial institutions.

Scenario in Pakistan & Srilanka

  • Both Sri Lanka and Pakistan witnessed a sharp rise in domestic prices and the exchange value of their currencies plunged. Currency crises are usually the result of mismanagement of the currency by its central bank. Sri Lanka’s economic crisis can also be partly contributed to bad timing, as it saw a fall in the flow of US dollars into the country due a decline of foreign tourists during the Covid-19.

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About IMF

  • The IMF was set up in 1945 with the aim to bring about international economic coordination to prevent competing currency devaluation by countries trying to promote their own exports. It later went on to become a last resort lender for countries facing severe economic crises.

How IMF bailout is provided

  • The IMF lends money to the economies in peril in the form of Special Drawing Rights (SDRs), which is a basket of five currencies — US dollar, Euro, Chinese Yuan, Japanese Yen and British Pound. It can be executed in the form of loans, cash, bonds, or stock purchases.
  • The lending is done through programs designed according to purpose. According to the IMF, these include standby arrangement, standby credit facility, extended fund facility, extended credit facility, rapid financing instrument, rapid credit facility, flexible credit line, short term liquidity line, precaution and liquidity line, resilience and sustainability facility, staff monitored program, policy support instrument and policy coordination instrument.

Five steps of IMF lending

  1. First, a member country in need of financial support makes a request to the IMF.
  2. Then, the country’s government and IMF staff discuss the economic and financial situation and financing needs.
  3. Typically, a country’s government and the IMF agree on a program of economic policies before the IMF lends to the country. In most cases, a country’s commitments to undertake certain policy actions, known as policy conditionality, are an integral part of IMF lending.
  4. Once the terms are agreed upon, the policy program underlying an arrangement is presented to the IMF’s Executive Board in a “Letter of Intent” and detailed in a “Memorandum of Understanding.” The IMF staff makes a recommendation to the Executive Board to endorse the country’s policy intentions and offer financing. This process can be expedited under the IMF’s Emergency Financing Mechanism.
  5. After its Executive Board approves a loan, the IMF monitors how members implement the policy actions underpinning it. A country’s return to economic and financial health ensures that IMF funds are repaid so that they can be made available to other member countries.

What are the conditions applicable to an IMF bailout?

  • Among the conditions laid down for a country seeking financial assistance from the IMF could be certain structural reforms, such as fiscal transparency, tax reforms and reforms in state-owned enterprises. Critics say these reforms can be tough on the public and may be driven by a geopolitical influence, since they are often decided by officials of various countries.
  • Proponents say these conditions are necessary to ensure successful lending by the IMF, as countries with policies that stem economic growth and stability would not be able to pay back their debts.
  • Conditions for IMF lending also relate to macroeconomic variables, like monetary and credit aggregates, international reserves, fiscal balances, and external borrowing, as per the IMF.

Pros and cons

  • An IMF bailout ensures the survival of a country amid economic turmoil, also ensuring that essential industries and economic systems remain up and running. The IMF can also provide technical expertise to the affected country on how to implement reforms to strengthen the economy and institutions
  • On the downside, the IMF’s conditions can result in reduced government spending and higher taxes, measures which have been historically unpopular with the people and often resulted in public unrest. It can also create a sense of dependency on external funding, while also harming the country’s reputation in the eyes of investors.

Where does IMF get its money?

  • IMF funds come from three sources: member quotas, multilateral and bilateral borrowing agreements. Quotas are the IMF’s main source of financing, wherein each member of the IMF is assigned a quota, based broadly on its relative position in the world economy.
  • The IMF’s current total resources of about SDR 977 billion translate into a capacity for lending of about SDR 713 billion (around US$1 trillion).
  • Besides members of the Paris Club of creditor nations such as the United States, France and Japan, other lenders include China, India, Saudi Arabia, South Africa and Kuwait.

Delays in funding approval worry nations in need

  • IMF funding is often the sole financial lifeline available to countries in a debt crunch, and key to unlocking other financing sources, with delays putting pressure on government finances, companies and populations.
  • Sri Lanka waited for over 180 days to finalize a bailout after a $2.9 billion September staff level deal while Ghana, having defaulted on its overseas debt in December following a preliminary IMF deal, has yet to get board approval 80 days later. For countries such as Sri Lanka facing shortages of food, fuel and medicines as well as painful reforms to alleviate a debt crisis after years of economic mismanagement, the delays can be devastating.
  • This compares to a median of 55 days it took low- and middle-income countries over the last decade to go from preliminary deal to board sign-off, according to public data from over 80 cases compiled by Reuters.
  • These delays have been caused by a number of reasons, but debt experts mainly point to the fact that China is still reluctant to offer debt relief in comparable terms with other external creditors. Beijing is the largest bilateral creditor to developing nations, extending $138 billion in new loans between 2010 and 2021, according to World Bank data.
  • An IMF spokesperson said it was a “very small number of countries” that suffered “significant delays,” acknowledging this was in particular where there was a need to restructure debt owed to official bilateral lenders.

Source: Indian Express

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