When counties face financial crisis due to domestic or external factors, they often take recourse from the International Monetary Fund (IMF). IMF provides lending support to countries facing Balance of payment problems, fiscal crisis due to debts or financial crisis stemming from insolvent financial instituions.
IMF lending gives countries breathing room to adjust policies in an orderly manner, paving the way for a stable economy and sustainable growth. In the process, the fund offers various types of loans that are tailored to countries’ different needs and specific circumstances. Some of the lending tools of IMF are:
- Rapid Credit Facility (RCF): To deal with the urgent BoP Crisis on account of price rise, disasters etc.
- Stand-by Credit Facility: Short-term loans for less than 3 years. It is the main lending tool of the IMF.
- Extended Credit Facility: Long term loans for more than 3 years and less than 5 years.
However,
- Many of the economic reforms the IMF required as conditions for its lending—fiscal austerity, high interest rates, trade liberalization, privatization, and open capital markets—have often been counterproductive for target economies.
- With the increasing growth and economic size of EMDEs, there has been a growing dissatisfaction with the distribution of quotas and voice in IMF governance.
As a result, most of the emerging economies are making alternative arrangements like:
- Accumulation of forex reserves: Most of the emerging economies have started accumulating huge forex reserves to insulate themselves from any global financial crisis.
- Bilateral Currency Swap agreements: A bilateral currency swap agreement is an exchange of currencies between two countries at a fixed exchange rate. India has signed bilateral swap agreements with Japan and Sri Lanka.
Mechanism of Currency Swap agreements: As per the India-Japan agreement,India will be able to borrow in US Dollars or Japanese Yen up to the limit of $75 billion whenever it wants from JapanJapan will be able to borrow in US Dollars or Indian Rupees up to the limit of $75 billion from India.The countries will have to pay interest on the amount actually borrowed.The repayment will be done at an exchange rate which will be fixed at the time of borrowing.
This will eliminate the risk caused due to fluctuations in the exchange rate (also known as FOREX or Foreign exchange risk).
- Regional swap agreements: Regional swap agreements are similar to bilateral agreements but involves multiple countries. They pool their forex resources and use it tide over any BoP crisis of the members. E.g., The European Stability Mechanism of EU countries; Chiang Mai Initiative Multilateralization of ASEAN countries.
The bilateral and regional swap agreements have emerged as a significant alterative to the IMF to provide global financial safety net.
