IMF: Objectives, Procedures of Borrowing and Repayment

The International Monetary Fund (IMF) is an international organization that oversees the global financial system by following the macroeconomic policies of its member countries, in particular those with an impact on exchange rates and the balance of payments. It also offers financial and technical assistance to its members, making it an international lender of last resort. Its headquarters are located in Washington, D.C., USA.

The IMF describes itself as "an organization of 185 countries, working to foster global monetary cooperation, secure financial stability, facilitate international trade, promote high employment and sustainable economic growth, and reduce poverty". The present Managing Director Dominique Strauss Kahn of France.

After the First World War, every country imposed trade restrictions, exchange controls and resorted to exchange appreciation in order to encourage exports. There was a decline in the world trade. In order to end this international economic and political crisis and furhter ease the tension, 44 nations assembled at the United Nations Monetary and Financial Conference in the Mount Washington Hotel at Bretton Woods, New Hampshire (USA) from July 1 to July 22, 1944.

The IMF was formally organized on December 27, 1945, when the first 29 countries signed its Articles of Agreement. The statutory purposes of the IMF today are the same as when they were formulated in 1944. It started functioning from March 1, 1947.

Objectives of IMF:
1) International Monetary Cooperation. To promote international monetary cooperation by providing a convenient forum for member nations to get together and provide means to strengthen out international monetary problems.
2) Stability in Foreign Exchange Rates. To fix parity rate of currencies and bring the members closer to a regime of stable exchange rates.
3) Elimination or Reduction of Balance of Payments Disequilibrium. To assist members in overcoming short-run disequilibrium in balance of payments (BOPs) by lending the required foreign currencies on specified terms and conditions.
4) Promotion of International Trade. To provide technical guidance and consultation to members for facilitating orderly growth of world trade and economic cooperation.
5) Establishment of a Multilateral Trade and Payments System. To replace the old bilateral trade agreements which obstructed world trade by a system of multilateral trade and payments sytem.
6) Balanced Economic Growth. To contribute to the promotion of rising level of employment, particularly in backward nations.


Membership:
Membership of the IMF is voluntary. But withdrawal of membership may be voluntary or compulsory.

Quota:
After becoming a member, a country is assigned a quota of subscription (membership fee), which determines its voting power and its drawing rights.

A subscription quota is fixed on the basis of the economic importance of the members, such as its exports, imports, GDP and gold and foreign exchange reserves. 25% of that amount of subscription is to be paid in the form of gold or US dollar and the remaining 75% amount in terms of domestic currency of the country concerned. The former part is called gold tranche (slice) and the latter is called credit tranch (credit in the sense that this part is to be paid in gold or US dollars later on).

The quota amount is revised from time to time (normally once in five years). India’s subscription was the fifth largest at the beginning (1947), but her current position is eleventh, with 4158.2 million SDR quota amount, which is 2.44% of the total subscription amount of the Fund. (The table is kept here for reference purpose.)

Table showing the top 21 member countries:

IMF Member Country
Quota: Millions of SDRs
Quota: Percentage of Total

Australia
3236.4
1.49
Belgium
4605.2
2.12
Brazil
3036.1
1.4
Canada
6369.2
2.93
China
8090.1
3.72
France
10738.5
4.94
Germany
13008.2
5.99
India
4158.2
2.44
Italy
7055.5
3.25
Japan
13312.8
6.13
Korea
2927.3
1.35
Mexico
3152.8
1.45
Netherlands
5162.4
2.38
Russian Federation
5945.4
2.74
Saudi Arabia
6985.5
3.21
Spain
3048.9
1.4
Sweden
2395.5
1.1
Switzerland
3458.5
1.59
United Kingdom
10738.5
4.94
United States
37149.3
17.09
Venezuela
2659.1
1.22
Remaining 165 countries
60081.4
29.14


Lending Operations:
IMF caters to the short run loan requirements of member countries. The resources of the Fund consists of gold and specified quantities of currencies of the member countries in the form of quota subscription. A member facing temporary BOPs problem could borrow the required currency or currencies from the Fund.

Restrictions on borrowing as per original rule:
Borrowing may be only for temporary duration, not more than five years to adjust short run current payment difficulties in BOPs.
The capacity to borrow of the member nations is in proportion to their respective quota subscription.
A country cannot borrow more than 25% of its quota in any one year, by paying equivalent domestic currency at declared parity rate to the IMF.
No member country could borrow to an extent which would cause the Fund’s holdings of currency of that country exceed 200% of the debtor country’s quota. (This rule is discretionary and could be relaxed in exceptional cases.)
Currency borrowed from the Fund cannot be used for affecting capital transfer from one country to another.

Conditions of borrowing:
The conditions of borrowing refer to set of conditionalities which the IMF intends to apply to the borrowing nations for ensuring a high degree of economy in performance and of policies of the borrowing country. Therefore, the Executive Board of IMF prescribes certain specific guidelines and conditions which the recipient country is expected to fulfil for securing financial accommodation for correcting BOPs deficit. These guidelines are –
The recipient country is required to undertake such tax reforms as provide incentives to the producers to step up domestic production and export.
It is required to reduce/remove controls on prices so that favourable conditions are created in the economy for increasing production and export.
The prices of products of public sector enterprises should not be administered as these would entail loss in efficiency for the undertakings.
Artificial supports such as subsidies should be eliminated wherever possible.
Borrowing country should take appropriate steps for export promotion.
Investment programme of the country should be production oriented.

Repayment:
The borrowing country will have to repay the dollar loan or in other words, repurchase its own excess over-quota currency by paying dollar or gold or other approved hard currencies so that the debtor country’s currency with the IMF reaches 75% of quota again. Except for the gold tranche, the Fund charges an interest on borrowing on sliding scale, which rises steeply with the rise in the excess holdings of the borrower’s currency.


[An example to illustrate the borrowing and repayment procedures:

Suppose the exchange rate is $ 1 = Rs 10.
Suppose India is required to pay Rs 1000 as subscription quota. Of this, Rs 250 is in gold/dollars and Rs 750 in Indian currency.
According to rules, India can borrow upto 200% of its quota, i.e. Rs 2000 (which is the ceiling).

Borrowing: Suppose India needs a short term loan of $125 to tide over BOPs problem. ( Note: With $100 = Rs 1000 quota, India cannot borrow more than $125).
So India has to deposit equivalent amount in Indian currency with the Fund i.e Rs 1250. ($1=Rs 10, $125=Rs1250).
This will raise Indian currency with the Fund to Rs 2000. (Rs 750 in credit tranche + Rs 1250 deposited for borrowing $125).
IMF then lends India $125. For the first 25% of quota, there is no interest charged. The rate of interest charged for excess holding of borrower’s fund goes on rising at a sliding rate.

Repayment: Now India has Rs 1250 in excess of its quota in Rupee with the Fund. So India will have to repurchase this with gold/ dollars or any hard currency. Thus the dollar loan of $125 is paid back along with whatever interest rate that IMF charges.


An interesting digression: If some nation borrows currency of a particular nation, then the borrowing capacity of the lender nation rises.
Suppose, as in the previous example, India borrows $125 and in exchange kept Rs 1250 with the Fund, increasing Indian rupee to Rs 2000 with the Fund.
Now suppose Bangladesh is in need of Indian rupee and borrows Rs 100 from the Fund. So Indian rupee with the Fund becomes Rs 1900 (Rs 2000-100). This makes it possible for India to borrow another $10 (=Rs100) from the Fund, because Bangladesh’s borrowing has reduced its borrowing extent to 190% from 200% and so it can borrow another 10% ($10 in this example) again.
While repaying, India has to repurchase only Rs 1150 (Rs 1900-750) back. While borrowing India kept Rs 1250 initially (borrowed $125), now it can buy back only Rs 1150 or pay back only $115 to the Fund. This has been possible because Bangladesh borrowed Rs 100 from the Fund. As for Bangladesh, it will repay the Rs 100 loan in the usual procedure.]