Ch 5: The Functions of the IMF & the World Bank

1. Ch 5: The Functions of the IMF & the World Bank Ref: separate handout By Sandra Blanco & Enrique Carrasco

2. Introduction • The International Monetary Fund (IMF) and the International Bank for Reconstruction (IBRD) are together known as the Bretton Woods Institutions (BWIs) because they originated from a meeting of world leaders at Bretton Woods in New Hampshire, USA in 1944. • Background of World War II: the focus of the global leaders was on global monetary system through stability with growth. Thus IMF negotiations took most of the foregrounds of Bretton Woods. The IBRD came somewhat later. IMF started functioning in 1947 but IBRD in 1950 • IBRD is the forerunner of today’s World Bank. But actually, there is no organization called World Bank. What we have is WB Group

3. A. Background: The rough road to Bretton Woods • The purpose of the Bretton Woods Conference in New Hampshire was to prevent the recurrence of the inter-war period (1918-1939) chaos which was marked by high inflation, restrictions on international trade and payments, speculation in foreign exchange market, sharp movements in foreign exchange reserves and sharp drops in economic activities.

4. A.1 Gold Exchange Standard replaced Gold Standard • The founders of IMF agreed upon a “gold exchange standard” to achieve stability and economic growth. The prevailing Gold Standard as a global monetary system. Still they retained the basic principle of Gold Standard. • Let us see how the Gold Standard operated automatically and what was its loopholes.

5. A.1 Gold Exchange Standard replaced Gold Standard • Gold Standard prevailed during 1870 and 1914, whereby central banks needed to keep adequate stocks of gold as “reserves”. • The international monetary system required that each unit of a country’s currency represented a certain weight of gold. • Central Banks were required to keep an ‘official parity’ between country’s currency and stock of gold.

6. A.1 Gold Exchange Standard replaced Gold Standard • The objective of the gold standard was to encourage countries to maintain sound economic policies. • In theory, the gold-standard was supposed to operate automatically with little government intervention. If they failed to do so, gold would flow out and set in chain reaction to restore gold balance. • However, in reality the “rules of the game” did not work smoothly as countries frequently violated the rules.

7. A.1 Gold Exchange Standard replaced Gold Standard • During the inter-war period countries pursued policies that led to international economic chaos and war. • After world war I the European nations found it difficult to maintain the gold standard. • Commodity prices soared up and there was shortage of gold and currencies.

8. A.1 Gold Exchange Standard replaced Gold Standard • In order to make exports cheaper countries began to devalue their currencies, one by one. • There were “competitive devaluations” that availed no advantage. • As countries started to put up trade restrictions, there was a sever drop in global economic activity.

9. A2. Interwar Chaos and Crises • World War I, debt crisis, reserves depleted, Gold Standard could not be sustained. • Commodity prices soared, inflation, stock market crashed in 1929, Great Depression • Country after country devalued currencies in order to make exports cheaper.

10. B. Creation of IMF and the World Bank • The founders of the Bretton Woods Institutions (BWIs) were preoccupied with avoiding repetition of the inter-war problems. • They wanted to: • accomplish economic prosperity that would lead to peaceful relations • change floating exchange rates • avoid competitive devaluations & trade restrictions

11. B. Creation of IMF and the World Bank • Although the gold standard was stable, the negative aspects of it dissuaded the BWIs founders from adopting it. • The founders preferred a fixed exchange rate system tied to gold that would promote important domestic goals such as full employment and price stability.

12. B.1 Negotiations over Creation of World Bank and IMF • The Bretton Woods Conference held in New Hampshire during the summer of 1944 had the following aspects: • The negotiations over the creation of the IMF focused on technical issues relating to international monetary affairs. • Most of the discussions related to figuring out how the IMF would operate, and little time was devoted to discussing the plight of “developing countries”.

13. C. The founders of the BIWs did not address “development” • Most of the discussions related to figuring out how the IMF would operate, and little time was devoted to discussing the plight of “developing countries”. • An international clearing union (ICU) was proposed that would issue a new form of international money called “bancor” and monitor lending from one country to another. • The US representative proposed for an international organization called the Stabilization Fund (SF).

14. C. The founders of the BIWs did not address “development” • There were disagreements between the two most powerful countries, UK and USA. • UK was not prepared to accept a plan based on a fixed exchange rate system. • A series of compromises led to the creation of an international organization called International Monetary Fund, that closely resembled the plan proposed by USA.

15. C. The founders of the BIWs did not address “development” • The World Bank preparatory work and negotiations at the conference reflected only a peripheral concern for “development”. • “Development” was not the primary concern at the Bretton Woods Conference, and creating the World Bank was an afterthought. • The main point of contention was whether “development” or reconstruction would be the World Bank’s priority. • The developing countries were more interested in the formation of the World Bank than the IMF.

16. D. The IMF’s Functions and Structure • The IMF charter originally established adjustable par values for the currencies of member countries. • The IMF charter originally set up a system of fixed exchange rates in order to address the problems of the inter-war period. • The system was referred to as a gold exchange standard. • However, this system placed great strains on countries as they tried to defend the par values.

17. D. The IMF’s Functions and Structure • The IMF’s “lending” facilities help member countries make adjustments to restore balance of payments equilibrium. • The founders built flexibility into the system in various ways. • They prepared a method for gaining resources through the member’s quota subscriptions.

18. D. The IMF’s Functions and Structure • Each member’s quota subscription is determined by the size of the member’s economy and the importance of its currency worldwide. • The loans from the Fund’s General Resources Account can be used for any purpose relating to general balance-of-payments support.

19. D. The IMF’s Functions and Structure • Member countries have automatic access to a portion of the Fund’s resources, called the “reserve tranche”. • As the amount of loan moves into the “first credit” followed by “upper credit”, the IMF imposes conditions on the use of the funds – known as “conditionality”. • Conditionality refers to the explicit commitment by the member country to implement remedial measures in return for IMF assistance.

20. D. The IMF’s Functions and Structure • Drawings in the upper credit trances typically are associated with 12-18 month “stand-by-arrangements” or “extended fund facility” for 3-4 years. • In additions to drawings from the General Resources Account, the Fund has established a number of other lending “facilities” designed to specific problems”: such as the Extended Credit Facility (concessional loans for poor countries experiencing protracted balance of payments problems - this facility succeeds the Poverty Reduction and Growth Facility), the Standby Credit Facility (provides financial assistance to low-

21. D. IMF Functions: Lending • income countries with short-term balance of payment needs), and the Rapid Credit Facility (provides rapid financial assistance with limited conditionality to low-income countries with an urgent need to balance payments). • Except for the Supplementary Reserve Facility, the IMF uses the quotas to determine how much a member country may borrow under a facility.

22. D. The IMF’s Functions and Structure: Surveillance • Today the IMF engages in surveillance over the exchange rates of member countries. • After the Bretton Woods system collapsed, the IMF’s charter was amended to allow member countries to choose their own exchange rate systems.

23. D. The IMF’s Functions and Structure : Surveillance • Article IV gives the IMF broad powers of two types of surveillance: • Bilateral surveillance through annual “Article IV consultations” with member countries • Multilateral surveillance that focuses on economic and policy spillovers between countries • The IMF then passes on its feedback to individual member nations.

24. D. The IMF’s Functions and Structure • The IMF has encouraged members to make their domestic currencies “convertible” – i.e. freely exchangeable for foreign currencies. • By virtue of Article VIII, member countries agree not to impose restrictions on payments & transfers relating to the current account.

25. D. The IMF’s Functions and Structure: Compliance • The Fund has several ways of assuring compliance with its rules and policies. • Conditionality enables the IMF to withhold funds if a member country does not comply with loan conditions. • Member countries may be shut out of the international capital markets by violating the rules & policies.

26. D. The IMF’s Functions and Structure: Compliance • The Fund can prohibit a member country from using the General Resources Account. • The IMF can kick the country out of the organization (as Czechoslovakia was forced to leave in 1954). • Through collaboration and consultation, the Fund tries to persuade and cajole countries into complying with rules and policies.

27. D. The IMF’s Functions and Structure: Technical Assistance • The IMF provides countries with assistance regarding technical issues. • IMF also provides technical assistance to its member countries. • It provides assistance in the areas of fiscal policy, monetary policy, banking, institution-building, financial legislation, and statistics.

28. D. The IMF’s Functions and Structure • The structure of the IMF. • Two main organs within the IMF are: • The Board of Governors • The Executive Board • The Board of Governors, consisting of representatives from each member country, meet annually to serve on two important committees: • The International Monetary & Financial Committee • The Development Committee

29. D. The IMF’s Functions and Structure • Day-to-day operations are managed by the Executive Board, consisting of twenty-four Executive Directors. • The Board meets three days each week. • IMF staff is also subdivided into a number of regional and functional departments.

30. E. The Functions & Structure of the World Bank Group • The World Bank consists of the International Bank for Reconstruction and Development (IBRD) and the International Development Association (IDA). • The IDA provides concessional loans to the very poor countries that cannot afford the IBRD loans.

31. E. The Functions & Structure of the World Bank Group • There are three other independent entities associated with IBRD and IDA: • The International Finance Corporation (IFC) • The International Center for Settlement of Investment Disputes (ICSID) • The Multilateral Investment Guarantee Agency (MIGA) • These five together are known as the World Bank Group.

32. E. The Functions & Structure of the World Bank Group • Although the IMF and the IBRD seem like very similar institutions, formally they differ in fundamental ways: • Both are multilateral institutions whose charters call for weighted voting; both also focus on economic matters in member countries. • Only countries that are members of the IMF can become members of the IBRD.

33. E. The Functions & Structure of the World Bank Group Comparison between IMF and IBRD • Richer countries own a greater share of both the IBRD & the IMF, and have more voting powers. • Both institutions focus on economic matters. • The IMF traditionally engaged in short-term balance-of-payments lending to help establish policies that would stabilize overheated economies. • The Bank, in contrast, traditionally funded longer-term projects designed to promote economic growth.

34. E. The Functions & Structure of the World Bank Group • The IBRD, however, is an investment bank that intermediates between investors, who buy the Bank’s bonds, and developing countries, which borrow from the Bank. • IMF is primarily an institution overseeing an orderly international monetary system. • The primary function of the IBRD is to engage in multilateral development financing.

35. E. The Functions & Structure of the World Bank Group • The IBRD’s lending stresses market-based economic development and poverty reduction. • The IBRD initially focused on project lending, concentrating on investment in physical capital in developing countries. • The IBRD’s lending concentrated on developing a country’s infrastructure, like building electric power plants & implementing transportation projects.

36. E. The Functions & Structure of the World Bank Group Evolution of IBRD Functions: • In the 1960s and 1970s the IBRD began to focus on investing in human capital. • The IBRD shifted its focus from investment primarily in physical capital to investment in “human capital”. • In 1970, under the presidency of Robert McNamara, the IBRD and IDA lending stressed poverty alleviation in order to promote distributional equity along with economic growth. • Today, the IBRD (& the IDA) continue to invest in human capital.

37. E. The Functions & Structure of the World Bank Group Evolution of IBRD Functions: • The debt crisis of the 1980s prompted the IBRD to make market-based adjustment loans. • Most of the IBRD development activities fall under “investment lending” category. • The Bank also provides “adjustment lending” to support fundamental economic & financial policy changes. • This type of lending emerged with the onset of the debt crisis of the 1980s.

38. E. The Functions & Structure of the World Bank Group Evolution of IBRD Functions: • In the 1990s the Bank tried to improve its responsiveness while stressing the poverty alleviation and corruption reduction. • In response to criticisms, the Bank has formed an Inspection Panel to monitor the Bank’s compliance with its own policies. • The Heavily Indebted Poor Countries (HIPC) Debt Initiative, opened in 1996, enables poor (mainly African) countries to reduce their debt to multilateral, Paris Club, and other official bilateral & commercial creditors.

39. E. The Functions & Structure of the World Bank Group Evolution contd.. • In an effort to fight corruption, the World Bank started its anti-corruption campaign in 1997 in Eastern Europe and Central Asia. • The Bank focuses on five key elements: • Increasing political sustainability • Strengthening civil society participation • Creating a competitive private sector • Developing institutional restraints on power, including a strong & independent judiciary • Improving public sector management

40. E. The Functions & Structure of the World Bank Group Other Members of WB Group: • The IFC, MIGA, and ICSID help mobilize the private sector. • The IFC formed in 1956 and it promotes private sector investment in poor countries, by providing long-term market-priced loans and equity financing for private sector projects. • The MIGA is an investment insurance agency, established in 1988, that encourages foreign direct investment in developing nations, by providing guarantees against political risks.

41. E. The Functions & Structure of the World Bank Group • The purpose of the ICSID is to promote increased flows of international investment by providing a forum outside the host state for settlement of investment disputes. • Although the World Bank Group tries to facilitate foreign private investment, many believe that the benefits of investment does not benefit the society as whole. • In fact, many believe foreign investment frequently increases the gap between the rich and the poor.

42. E. The Functions & Structure of the World Bank Group • The structure of the IBRD and other World Bank group organizations. • Like the IMF, the IBRD is comprised of a Board of Governors and a Board of Executive Directors. • The Board of Executive Directors has 24 members who meet once or twice weekly. • Voting power is based on the proportional size of each nation’s shareholding within the Bank. • The other World Bank Group organizations have a parallel structure.