International Monetary Fund: A Closer Look

The International Monetary Fund (IMF) is often in the news. Every now and then some countries approach the IMF when they need funding to save their failing economies. Almost every educated person on earth has heard about the IMF. Also, everybody thinks that the IMF is a global institution with almost unlimited access to money. However, that is not the case.

Even though the IMF is a famous institution, very few people actually know where the fund raises its money from. In this article, we will list and explain the various sources of funding available to the IMF.

Sources of Funding

• Quotas: Quotas are the main source of IMF funding. Quotas can be thought of as being a subscription fee. Every country that joins the IMF is supposed to subscribe to a quota. This means that the country has to agree to pay periodic payments to the International Monetary Fund.

  The fund uses a complex formula to calculate what the quota of a new member should be. This formula has many factors such as GDP, openness to foreign markets and foreign exchange reserves.

  For the purpose of this calculation, the GDP is weighted to ensure that the calculation takes into account the difference between exchange rates. Once the number is derived, a dispersion formula is used to ensure that any member does not have to pay too much compared to other members.

  The quota also determines the influence of a member in the organization. Generally, the quota is proportionate to the economic stature of a given country. This is the reason why at the present moment, the United States holds the biggest quota whereas a small nation called Tuvalu holds the smallest quota. These quotas form the primary and most important source of funding for the International Monetary Fund (IMF)

• Borrowing Arrangements: Sometimes the IMF has to give out more in loans than it has taken in, in the form of quotas. This is why IMF needs to have special borrowing arrangements with many nations.

  Sometimes a group of nations forms a syndicate in order to give a loan. On the other hand, the International Monetary Fund also has one to one agreements with several nations. These loan arrangements form the second and third line of defense for the world financial system.

How The IMF Lends Money?

It is important to distinguish between the lending done by the World Bank and the one done by the International Monetary Fund. To the untrained observer, they are both loans from international agencies. However, there is a big difference. World Bank lends to countries for individual projects. The lending is based on the viability of the individual project. The country need not be in a crisis in order to get a loan from the World Bank.

The International Monetary Fund, on the other hand, almost exclusively gives loans to nations which are in crisis. The loans are only given to correct the balance of payments problems being faced by the entire country. The IMF does not take into account the situation of individual provinces or cities.

The problem with IMF loans is that they are almost always given to high-risk borrowers. Countries which are about to go bankrupt borrow money from the IMF. Hence, IMF needs a mechanism to ensure that its funds are paid back. The IMF does this by using two methods.

• Firstly, IMF never pays out all the funds at once. The disbursement is done in small installments. Each successive installment is bigger than the earlier one. This is done to ensure that only countries that are using the funds appropriately are paid more money. It is the IMF’s jobs to ensure that there are structural changes in the economy. The IMF does this by monitoring the use of funds and abandoning further loans if the country does not use the funds appropriately.
• Secondly, IMF starts interfering with the way the country manages its finances. This means that the IMF has a look at the finances to figure out which expenses are important and which can be eliminated. The use of IMF funds by any country almost certainly means that the government is going to increase taxes. It also means that the welfare handouts being given by the government are about to reduce.

Criticisms of the IMF

The IMF is often criticized for converting third world countries into loan addicts. Also, some of the austerity measures that are usually suggested by the IMF are inhumane. Often, these measures include privatization of basic infrastructure facility like water, electricity and so on. Once this privatization occurs, the price of these facilities is increased exponentially. The end result is that the standard of living of the people in that country is compromised.

The bottom line is that it is true that the IMF has been accused of loan sharking on several occasions. However, in the absence of the IMF, there would be no way to help failing economies rectify their errors and come back on track. It is a necessary evil which bears the brunt of being the disciplinarian which has to enforce a painful transformation process.