Friday, May 25, 2007

Understanding IMF Loans

I was asked a couple of days ago by one you to explain the import of this statement found on IMF’s web site.

"Technically, countries do not receive loans from the IMF -- they "purchase" foreign exchange from the IMF's reserve assets, paying with their own currency. The loan is considered repaid when the borrower "repurchases" its currency from the IMF in exchange for reserve assets."

You should know that the mandate of IMF and the World Bank are totally different. Many a time even the institutions themselves are confused as one entity.

The IMF is not a development institution. It does not and cannot, provide loans to help poor countries build their physical infrastructure, diversify their export or other sectors, or develop better education and health care systems. This is the job of the World Bank and the regional development banks.

The IMF makes financing temporarily available to member countries to help them address balance of payments problems—that is, when they find themselves short of foreign exchange because their payments to other countries exceed their foreign exchange earnings. Its loans are intended to help its members tackle balance of payments problems, stabilize their economies, and restore sustainable economic growth. Unlike the World Bank and other development agencies, the IMF does not finance projects. In most cases, IMF loans provide only a small portion of what a country needs to finance its balance of payments. But, because IMF lending signals that a country's economic policies are on the right track, it reassures investors and the official community and helps generate additional financing. Thus, IMF financing can act as a catalyst for attracting funds from other sources.

The ‘loan’ advanced by IMF to a member country is in the form of SDRs – Special Drawing Rights (an instrument which was introduced in 1969). A country that is advanced loans by IMF is given these SDRs (in exchange for its own currency) with which the country buys the required foreign currency to tide over its balance of payment crisis. When the country comes out of the balance of payment crisis, it surrenders these SDRs and gets back its currency. Hence the statement that IMF does not actually given any ‘loan’ but only a facility in the form of SDRs.

The basic purpose of IMF:

The IMF's primary purpose is to ensure the stability of the international monetary system—the system of exchange rates and international payments that enables countries (and their citizens) to buy goods and services from each other. To maintain stability and prevent crises in the international monetary system, the IMF reviews national, regional, and global economic and financial developments. It provides advice to its member countries, encouraging them to adopt policies that foster economic stability, reduce their vulnerability to economic and financial crises, and raise living standards, and serves as a forum where they can discuss the national, regional, and global consequences of their policies.

And it provides technical assistance and training to help countries build the expertise and institutions they need for economic stability and growth.