Sunday, October 26, 2008

IMF and International Liquidity Problem

International Liquidity is the sum total of international reserves of all the nations participating in the world monetary and trading system. The term ‘International Liquidity’ comprises all those financial resources and facilities which are available to monetary authorities of member nations for financing the deficits in their international balance of payments. The various components of international liquidity are: (i) Gold held by Central Banks (gold held by private individuals is not included), (ii) Foreign currencies held by Central Banks, (iii) Borrowing facilities available from the IMF under different schemes, (iv) Special Drawing Rights first introduced in 1970 by IMF as an international monetary asset and (v) A country’s borrowing capacity in the international money market.

The problem of international liquidity is concerned with the imbalances in the demand for and supply of international liquidity. International liquidity shortage leads to recession in the world economy, whereas international liquidity surplus tends to have an inflationary impact on international economy. Solution to the problem relates to attempts at balancing supply and demand for international liquidity.

In case all the countries have equilibrium in their balance of payments (BOPs), there can be no problem of international liquidity. Secondly, if the national currencies of all the countries become fully convertible, and freely acceptable in international payments, no shortage of international liquidity can arise. Thirdly, if all the deficit countries are allowed to have an unlimited and unconditional access to borrowing and trading, there would have been no problem of international liquidity.

The liquidity problem has two aspects: qualitative and quantitative.

The Qualitative Aspect of the problem refers to the nature and composition of international reserves. In the composition of international liquidity, gold and reserve currencies (mainly dollar after World War II) play a dominant role. But since gold reserves cannot be increased much, growing international liquidity requirements are to be met by increasing reserve currency holdings. This means creating BOPs deficits in the reserve currency’s country (USA), if the other nations tend to accumulate the reserve currency. This leads to the confidence problem.

Quantitative Aspect: Although the international liquidity reserves had expanded from $48 billion to nearly $800 billion during 1950-88, yet it is too small in comparison with the expanding world trade. The reasons for the shortage of international liquidity are the following:
Payments deficits: BOPs deficits of all nations except Japan, Germany, Switzerland, Belgium and OPEC. This problem was aggravated by oil crisis of 1970s. The deficit of non-oil producing countries has increased by 4 times during 70s and early 90s.
Redistribution of international reserves: The international reserves are distributed more favourably to the DCs. International reserves are flowing away from USA amd developing nations since 1960s to countries like France, Germany, Italy, Belgium, Scandinavian nations, Japan, Switzerland etc.
Attitude of the DCs: The DCs are not reducing their BOPs surpluses by buying from the LDCs. They allege that the LDCs are responsible for this crisis. Their problems of international liquidity has arisen due to mismanagement of their economies, extravagant public expenditure, unproductive wasteful expenditure, over ambitious social and economic goals and trying to do too many things at the same time.
Little access to markets of DCs: LDCs have very little access to the markets of the DCs. They are putting tariff walls against the imports of developing nations. The DCs are forming economic unions imposing high common external tariff.

If satisfactory arrangements are not made to overcome the problem of shortage of international liquidity, both rich and poor countries tend to suffer in the long run. The problem of international liquidity forces LDCs to resort to import restrictions, exchange controls, devaluation, restrictions on capital flows etc, which adversely affects the DCs as well.

Many proposals have been made to solve the problem of international liquidity. The IMF contributes to international liquidity in two ways: by providing (a) conditional liquidity and (b) unconditional liquidity.

(a) Conditional Liquidity. The IMF provides conditional liquidity under its various lending schemes. The credit provided to its members is generally subject to certain conditions. Most of the IMF loans require an adjustment programme to be undertaken by the member nation for improving its BOPs position. Moreover, funds from the IMF under agreed conditions increases the member’s access to international capital market.

Important credit facilities by IMF are:
Basic Credit Facility
Extended Fund Facility
Compensatory Financing Facility
Buffer Stock Facility
Supplementary Financing Facility
Trust Fund
Structural Adjustment Facility etc.

In order to make the resources easily and more adequately available, the IMF has been introducing various procedural changes from time to time.

(b) Unconditional Liquidity. The supply of unconditional liquidity takes the form of reserve assets that can be used for BOPs financing. The IMF provides unconditional liquidity through the allocation of Special Drawing Rights (SDRs), and also in the form of reserve positions in the Fund. Member nations can use their holdings of SDRs and reserve positions in the Fund to finance their BOPs deficits without having to enter into policy commitments with the Fund.

1 comment:

Unknown said...

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