28 March 2023

Table of Content

What is an IMF bailout, when is it provided to a country, and what are the lending conditions?

GS-2 : Important International institutions, agencies and fora- their structure, mandate.

Recently, the International Monetary Fund (IMF) executive board approved a $3 billion bailout plan for Sri Lanka, with $333 million immediately disbursed to alleviate the humanitarian crisis. Pakistan is being asked by IMF to fulfil commitments from friendly countries on external financing to release $1.1 billion funding held since November, as part of a $6.5 billion bailout agreed in 2019.

The IMF was established in 1945 to prevent competing currency devaluation by countries promoting their own exports and later became a last resort lender for countries facing severe economic crises.

What are IMF bailouts?

• IMF bailouts are financial support given to a country facing macroeconomic risks and currency crises, helping them to meet external debt obligations, buy essential imports, and maintain the exchange value of their currencies.
• Factors that lead to Economic Crisis:

• Inappropriate fiscal and monetary policies
• Fixed exchange rates
• Weak financial systems
• Political instability
• Weak institutions
• Insolvent financial institutions

• Currency crises are usually the result of mismanagement of the currency by its central bank. Domestic prices rise sharply, and the exchange value of their currencies plummet.
• Both Sri Lanka and Pakistan have recently faced economic crises due to a plunge in their exchange value and sharp rise in domestic prices. Sri Lanka's economic crisis was partly due to bad timing as foreign tourists declined during the Covid-19 pandemic.

The Process of Providing an IMF Bailout

• IMF bailout is provided by lending money to economies in need of financial support in the form of Special Drawing Rights (SDRs).

• SDRs consist of five currencies - US dollar, Euro, Chinese Yuan, Japanese Yen and British Pound.
• IMF provides loans, cash, bonds, or stock purchases to countries.

• The lending is done through various programs designed according to purpose, with the purpose of each program varying depending on the country's specific needs, as follows:

• Standby arrangement and standby credit facility provide financial assistance to countries with short-term balance of payments problems.
• Extended fund facility and extended credit facility offer assistance for countries with long-term balance of payments issues.
• Rapid financing instrument and rapid credit facility are designed to provide quick assistance to countries facing urgent balance of payments issues.
• Flexible credit line provides pre-approved access to funds to countries with strong economic fundamentals.
• Short term liquidity line and precautionary and liquidity line are used to prevent financial crises.
• Resilience and sustainability facility supports long-term economic reform efforts.
• Staff monitored program, policy support instrument, and policy coordination instrument offer technical assistance to countries for policy implementation and economic reform.

The IMF lending process involves five steps –

1. A member country in need of financial support makes a request to the IMF.
2. The country's government and IMF staff discuss the economic and financial situation and financing needs.
3. A program of economic policies is agreed upon, and the country makes commitments to undertake certain policy actions, known as policy conditionality.
4. The policy program is presented to the IMF's Executive Board for approval, and the Board endorses the country's policy intentions and offers financing.
5. The IMF monitors the implementation of policy actions and ensures repayment of the loan once the country returns to economic and financial health.

The conditions for an IMF bailout

• Structural reforms, such as fiscal transparency, tax reforms, and reforms in state-owned enterprises, may be required as a condition for financial assistance.

• Critics argue that these conditions can be harsh on the public and influenced by geopolitics.
• Proponents argue that such conditions are necessary to ensure successful lending and repayment of debts.

• Conditions for IMF lending also relate to macroeconomic variables such as monetary and credit aggregates, international reserves, fiscal balances, and external borrowing, as per the IMF.

Pros of IMF bailout

• Helps ensure survival of a country during economic turmoil.
• Helps keep essential industries and economic systems functioning.
• Provides technical expertise to implement reforms to strengthen economy and institutions.

Cons of IMF bailout

• Conditions can lead to reduced government spending and higher taxes, which are unpopular and can cause public unrest.
• Can create a dependency on external funding.
• Can harm the country's reputation in the eyes of investors.

The sources of IMF's funding

• IMF's sources of funds are member quotas, multilateral and bilateral borrowing agreements.

• Quotas, based on a member's position in the world economy, are the IMF's primary funding source.

• Besides members of the Paris Club of creditor nations such as the US, France, and Japan, other lenders include China, India, Saudi Arabia, South Africa, and Kuwait.
• IMF's current resources amount to about SDR 977 billion, with a lending capacity of around SDR 713 billion (around US$1 trillion).

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