Print Friendly, PDF & Email

Understanding IMF bailouts

GS Paper 2

 Syllabus: Important International Institutions, agencies and fora – their Structure, Mandate

 

Source: TH

 Context: The International Monetary Fund (IMF) confirmed a $3 billion bailout plan for Sri Lanka’s struggling economy and is also in negotiations with Pakistan for a $1.1 billion bailout plan.

 

Background:

  • The IMF was set up in 1945: as an outcome 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?

  • Central banks mismanagement → forced by governments (populist spending) → create fresh money → rapid rise in the money supply → prices rise → exchange value of the currency drops → destroy confidence in the currency.
  • A country’s domestic economic policies (that imperil productivity) can also have an adverse impact on its currency’s exchange rate and foreign exchange reserves.
  • Bad luck can also contribute to a crisis. For example, a decrease in foreign tourists visiting Sri Lanka led to a steep fall in the flow of U.S. dollars into the nation.
  • In such a scenario, many countries (facing a major macroeconomic risk/currency crisis) are forced to seek help from the IMF to meet their external debt and other obligations, to purchase essential imports, etc.

 

How does the IMF help countries?

  • The IMF basically lends money, often in the form of special drawing rights (SDRs), to troubled economies through a number of its lending programs such as the
    • The extended credit facility,
    • A flexible credit line,
    • Stand-by agreement, etc.
  • 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.
  • Countries can use the SDRs for various purposes depending on their individual circumstances.

 

Strings attached to an IMF bailout:

  • The IMF usually imposes conditions on countries before it lends any money to them.
  • For example, a country may have to implement certain structural reforms as a condition to receive IMF loans.

 

The Pros and Cons of IMF’s conditional lending :

Cons Pros
●       Too tough on the public

●       Influenced by international politics

●       Essential for the success of IMF lending

●       Throwing money without reforming policies that caused the crisis/corruption does not make sense

●       Ensures independence of its central bank

 

The 1991 Indian economic crisis:

●       It resulted from a balance of payments deficit due to excess reliance on imports and other external factors.

●       The Government of India’s immediate response was to secure an emergency loan of $2.2 billion from the IMF by pledging 67 tons of India’s gold reserves as collateral security.

●       The crisis paved the way for the liberalisation of the Indian economy, since one of the conditions stipulated in the World Bank and IMF loan (structural reform), required India to open its economy.

 

Insta Links: IMF

 

Mains Links:

The World Bank and the IMF, collectively known as the Bretton Woods Institutions, are the two inter-governmental pillars supporting the structure of the world’s economic and financial order. Superficially, the World Bank and the IMF exhibit many common characteristics, yet their role, functions and mandate are distinctly different. Elucidate. (UPSC 2013)

 

Prelims Links: (UPSC 2019)

In the context of India, which of the following factors is/are contributors to reducing the risk of a currency crisis?

  1. The foreign currency earnings of India’s IT sector
  2. Increasing the government expenditure
  3. Remittances from Indians abroad

Select the correct answer using the code given below.

  1. 1 only
  2. 1 and 3 only
  3. 2 only
  4. 1, 2 and 3

 

Ans: 2