Understanding IMF Bailouts
Context:
- The International Monetary Fund estimates that Sri Lanka’s ailing economy will get a $3 billion bailout. Pakistan is also undergoing a serious economic crisis marked by a weakening currency and rising prices, and IMF representatives are negotiating a $1.1 billion bailout proposal with the country.
The IMF:
- With its headquarters in Washington, D.C., the International Monetary Fund (IMF) is a key United Nations financial institution and a global financial organisation. The IMF was established in 1945 as a result of the Bretton Woods conference.
- Back then, the IMF’s principal purpose was to encourage global economic cooperation in order to dissuade countries from weakening their own currencies in an effort to stimulate exports. In the end, the IMF evolved into a lender of last choice for governments of countries facing significant currency issues.
Why do nations ask for IMF bailouts?
- Severe macroeconomic risks compel nations to request IMF help, most frequently in the form of a currency crisis. For instance, the cost of living in Pakistan and Sri Lanka both increased quickly, but the value of their currencies in relation to the dollar fell precipitously.
- Such monetary crises are generally the consequence of the nation’s central bank gravely mismanaging its currency, frequently with the covert assistance of those in power. To fund populist spending, governments may force central banks to create new money out of thin air. Such spending eventually causes a rapid rise in the money supply as a whole, which in turn raises prices across the board and depreciates the value of the currency.
- People may become hesitant to accept a currency in exchange for goods and services, which could damage public trust in the currency and have a detrimental effect on economic activity. Investors from outside the country can also be reluctant to put money into a country where currency values fluctuate erratically.
- Several countries are forced to seek assistance from the IMF under such circumstances in order to fulfil their external debt and other obligations, pay for essential imports, and support the value of their currencies.
- A country’s domestic economic policies can also have a detrimental effect on its currency and foreign exchange reserves. For instance, an economic policy that threatens output may affect a country’s ability to garner the essential foreign funds for its existence.
- Bad luck might also result in a crisis. In Sri Lanka’s case, fewer foreign travellers led to a significant decrease in the amount of US dollars entering the nation.
How does the IMF help countries?
- In essence, the IMF provides loans to suffering nations that request its assistance, typically in the form of special drawing privileges (SDRs). The five currencies that make up the SDR basket are the US dollar, the euro, the Chinese yuan, the Japanese yen, and the British pound.
- The IMF finances its lending to failing economies by utilising a number of financing programmes, such as the extended credit facility, flexible credit line, stand-by agreement, etc. The bailout nations may use the SDRs in a number of ways, depending on their particular situation.
- Pakistan and Sri Lanka both urgently want American funding to cover import costs and pay off their foreign debt. So, it is likely that they will use any funds they get from the IMF to address these urgent issues.
IMF bailout funding Does it have any restrictions?
- Prior to making any financial loans to a country, the IMF typically places conditions on it. For instance, in order to get IMF money, a country may need to agree to the implementation of particular structural reforms.
- Debate has been sparked by the IMF’s conditional loans since many individuals believe these requirements are too onerous for the common public. Others contend that international politics has an impact on the IMF’s financing decisions, which are decided by representatives chosen by various states.
- However, advocates of the IMF’s lending policies argue that in order for loans to be successful, a number of criteria must be satisfied. To begin with, countries that need IMF bailouts frequently find themselves in financial difficulty as a result of political decisions that turned out to be detrimental to stability and economic expansion. Hence, if the nation’s crisis-causing actions are not modified, it might not be wise for the IMF to offer financial help. Hence, for instance, the IMF may ask a country with high price inflation to guarantee the independence of its central bank.
- Corruption is a distinct issue. Lending by the IMF to unstable economies may out to be a pointless endeavour as a result of the poor institutions and high levels of corruption in these economies. In other words, the likelihood that these countries will misuse the rescue monies is high.
Conclusion:
- The IMF’s stated mission is to “work to develop global monetary cooperation, secure financial stability, ease trade between nations, promote high employment and sustainable economic growth, and alleviate poverty worldwide.” The (implied) goal of governments and central banks should be to make sure that their country has macroeconomic stability such that an IMF bailout is never required.
