Context: Bangladesh has sealed a bailout agreement with IMF to boost its cash strapped economy.
Reasons for seeking Bailout from IMF
- Balance of Payment crisis: A nation may seek a bailout when it faces a deficit in its balance of payments, which includes trade imbalances, a shortage of foreign exchange reserves, and difficulties in meeting external debt obligations. It can be a result of political instability, populist measures such freebies etc.
- Unsustainable Debt: When a country accumulates unsustainable levels of debt, it may become unable to service its debt obligations, potentially leading to default. E.g., Sri Lanka and Pakistan.
- External shocks: Natural disasters, global economic crises, or other external shocks like pandemic (COVID-19) can severely affect a country’s economic stability. E.g., Bangladesh following the Russia Ukraine war its dollar reserves have shrunk by more than 1/3rd due to costly oil imports.
- Currency depreciation due to inappropriate monetary & fiscal policies. E.g., overly expansionary monetary policies, such as printing excessive money or keeping interest rates too low for too long, can lead to high inflation and exchange rate instability.
IMF helps countries in following ways
- It basically lends money, often in the form of special drawing rights (SDRs), to troubled economies that seek the lender’s assistance.
- 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.
- Currently, Bangladesh is in urgent need for U.S. dollars to import essential items such as fuel and also to pay their foreign debt.
Conditionalities of IMF Bailout
- Reducing government borrowing – Higher taxes and lower spending
- Higher interest rates to stabilise the currency.
- Structural adjustment such Privatisation, deregulation of certain sectors.
Issue with IMF conditions
- The policies of structural adjustment and macroeconomic intervention can make difficult economic situations worse.
- For instance, in the Asian crisis of 1997, countries such as Indonesia, Malaysia and Thailand were required by the IMF to pursue tight monetary policy (higher interest rates) and tight fiscal policy to reduce the budget deficit and strengthen exchange rates. However, these policies caused a minor slowdown to turn into a serious recession with very high levels of unemployment.
Does the IMF charge for its loans?
All IMF members have access to financial support through the General Resources Account (GRA), which is subject to various charges. These charges are designed to cover the operational costs of the IMF and support its activities, including those related to providing policy advice and capacity development to member countries.
- The IMF is an independent international organization.
- It is a cooperative of 190 member countries, whose objective is to promote world economic stability and growth.
- It was originally created in 1945 as part of the Bretton Woods agreement, which attempted to encourage international financial cooperation by introducing a system of convertible currencies at fixed exchange rates.
- The member countries are the shareholders of the cooperative, providing the capital of the IMF through quota.
- It is one of several autonomous organizations designated by the United Nations (UN) as “Specialized Agencies,” with which the UN has established working relationships.
- It is a permanent observer at the UN.
- Its headquarters is in Washington DC.
- The IMF began its operations in 1947, and France became the first country to draw funds from the IMF in 1947.
- Membership of the IMF is compulsory to be part of the International Bank for Reconstruction and Development (IBRD or World Bank).
IMF’s lending provisions
- Extended Fund Facility: It provides financial assistance to countries facing serious medium-term balance of payments problems because of structural weaknesses that require time to address.
- Extended credit Facility: It provides medium-term financial assistance to low-income countries (LICs) with protracted balance of payments problems.
- Rapid Financing Instrument: It provides prompt financial assistance to any IMF member country facing an urgent balance of payments need. It is one of the facilities under the General Resources Account (GRA) that provide financial support to countries, including in times of crisis.
- Rapid Credit Facility: It provides fast concessional financial assistance to low-income countries (LICs) facing an urgent balance of payments need.
- Flexible Credit Line: It is designed to meet the demand for crisis-prevention and crisis-mitigation lending for countries with very strong policy frameworks and track records in economic performance.
- Resilience and Sustainability Facility: It provides affordable long-term financing to countries undertaking reforms to reduce risks to prospective balance of payments stability, including those related to climate change and pandemic preparedness.