Institution
Institutions are humanly devised
constraints that structure political,
economic and social interactions
(North, 1991).
Intsitution -2• Informal Constraints: Customs, Traditions,
Codes of Conduct
• Formal Constraints: Constitutions, Laws,
Property Rights
• Eg. Institutions of Free Market Economy are:
Property Rights and Free Competition
• Institutions determine the choice set
– Transaction and Production Costs
International Institutions
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Supra-national
Multi-lateral Agreements
Inter-governmental vs. Non-governmental
International Laws applied
International Financial
Institutions
International Bank for Reconstruction and Development
International Monetary Fund
Two Questions
• What is the role assigned to international
financial institutions?
• How did this role change throughout the years
since Bretton Woods?
The Bretton Woods Rationale
• Lessons from the Great Depression,
• International corporation to avoid repetition
of the “beggar thy neighbour” trade policies
and competitive devaluations,
• Countries devastated by the war required
more investment than could be financed by
domestic savings, therefore official capital
flows became essential for reconstruction and
development
Three Pillars of the Post-War System
• An institution to oversee exchange rate
arrangements and to provide temporary finance
when BoP difficulties did not result from
“fundamental disequilibrium”,
• An institution to enable official capital flows to
facilitate investment where private capital flows
were inadequate,
• An institution to oversee trade relations among
countries and to provide a framework for an open
multilateral trading system.
Bretton Woods - 1945
• Agreed on an institutional framework for
international economic cooperation
• IMF came into existence in Dec., 1945 with the
aims of ensuring exchange rate stability and
encouraging members to eliminate exchange
restrictions.
• 29 members initially, but expanded to 184
countries as of June, 2006.
• Number of members increased esp. In 1960s and
1990s.
Twin Institutions of Bretton Woods
• IMF & IBRD
• Aim => to help rebuilding war-ravaged
countries (i.e. Europe and Japan).
• In 1960s: Newly independent and emerging
nations of Africa, Asia, L. America, Middle
East.
• In 1990s: Transition countries of Central and
Eastern Europe.
IMF & IBRD: Complementary Institutions
• IMF focuses on macroeconomic and financial
sector issues.
• IBRD is concerned mainly with long term
development and poverty reduction
(i.e.infrastructure building)
• Countries must join the IMF to be eligible for
IBRD membership.
IBRD & IMF
• Similar governance structures => shareholder
based,
– Memeber governments are the shareholders of
each institution,
– Shares are in proportion to countries’ economic
importance,
– Votes allocated to each countryare in proportion
to countries’ shareholdings,
– Rich countries possess higher representation.
The IMF -1• Threat: DOMESTIC DEPRESSION and
UNEMPLOYM ENT
– Policies pursued to combat domestic
unemployment,
– Beggar-thy-neighbour policies: shifting effective
demand away from imports onto domestically
produced goods,
• Tarriffs and Quotas on Imports,
• Competitive Devaluations .
– Result: Exporting Internal Imbalances
The IMF -2• Role: To oversee exchange rate relationships in
a fixed but, adjustable exchange rate system.
– Members cannot alter their exchange rates
without approval of IMF,
– It is only possible to alter the exchange rate when
it were determined that there was a “fundamental
disequilibrium” in the BoP,
– When there was no “fundamental disequilibrium”,
countries could borrow from the IMF to tide them
over temporary imbalances.
Pusposes of the IMF are:
(Article 1 of the Articles of Agreement)
• promoting international monetary cooperation;
• facilitating the expansion and balanced growth of
international trade;
• promoting exchange stability;
• assisting in the establishment of a multilateral
system of payments; and
• making its resources available (under adequate
safeguards) to members experiencing balance of
payments difficulties.
Exchange Rate Stability
• Between 1945 – 71, member countries agreed to
keep their exchange rates pegged at rates that
could be adjusted only to correct a fundamental
disequilibrium in the BoP, and only with IMF
agreement.
• In 1971, U.S. Suspended the convertibility of
Dollar into Gold.
• IMF members, since then, are free to choose any
form of exchange arrangement (i.e. Free float,
pegged sys.)
IMF had to develop new initiatives and
reform its policies:
• New members, who are transition countries,
exhibit different needs.
• U.S. abandonement of the par value system.
• Oil price shocks in 1970s.
• Latin American debt crisis in 1980s.
• Crises in emerging financial markets in 1990s.
• Argentina debt default in 2001.
=> Institutional Restructuring!
IMF Activities
• Surveillance
• Lending
• Technical Assistance
Surveillance -1• Surveillance is the regular dialogue and policy
advice that the IMF offers to each of its
members.
• Once a year, IMF conducts in-depth appraisals
of each member country’s economic situation.
• IMF monitors national, global, and regional
economic and financial developments and
advising member countries on their economic
policies.
Surveillance -2• “Multilateral Surveillance” => IMF assessment
on global and regional developments and
prospects:
World Economic Outlook
Global Financial Stability Report
Financial Assistance
• A core responsibility of the IMF is to provide
loans to countries experiencing BoP problems
• A member country may request financial
assistance if it cannot find sufficient financing to
meet its international payments
• Precisely the oil shock of 70s, and the debt crises
of 80s were followed by sharp increases in IMF
lending, transition process in CEE, and the crises
in emerging markets in 90s led to further surges
of demand for IMF resources
Financial Assistance:Process of Lending
• Loan is provided under an “arrangement”
stipulates the specific policies and measures a
country has agreed to implement to resolve its
BoP problem.
• Letter of Intent-Memoranda of Economic and
Financial Policies are prepared by the member
country, and describe the policies that a country
intends to implement in the context of its request
for financial support from the IMF
Financial Assistance
Loan Instruments -1• Various “facilities” are tailored to address the specific
circumstances of diverse members.
1. Poverty Reduction and Growth Facility=>to the poorest
members
2. Exogeneous Shocks Facility
=> Low income countries may borrow at concessional interest
Rates
3. Stand-by Agreements=>short term BoP problems
4. Extended Fund Facility=>BoP related to structural problems
5. Compensatory Financing Facility
=> Non-concessional
Financial Assistance
Loan Instruments -26. Emergency Assistance: To support recovery from
natural disasters and conflicts, in some cases at
concessional interest rates
7. Supplemental Reserve Facility: large loans with
short maturities, to countries going through
capital account crises.
8. Trade Integration Mechanism: to developing
countries, whose BoP suffers from multilateral
trade liberalisation
General Terms of IMF Financial Assistance
-1• All facilities, except PRGF &ESF, are subject to
IMF’s market related interest rates = “rate of
charge” + surcharge
• “Rate of interest rate” is based on SDR and
revised weekly.
• A surcharge can be levied above a certain
threshold to discourage countries from
borrowing large amounts
General Terms of IMF Financial Assistance
-2• The amount that a country can borrow from
the Fund, its “access limit”, varies depending
on the type of loan, but typically it’s the
multiple of the country’s IMF quota.
• “Safeguards” on members’ use of IMF
resources: IMF requires assessment of CB
compliance with desirable practices, i.e.
internal control, financial reporting, auditing
IMF’s Resources
• Most resources for IMF loans are provided by
member countries, primarily through their
payment of quotas.
• Each member of the IMF is assigned a quota,
based broadly on its relative size in the world
economy (i.e. İts GDP, current account
transactions,official reserves), which
determines its contribution to the IMF's
financial resources.
Functions of Quotas
• Subscriptions => financial resources that the
member is obliged to provide to the IMF.
• Voting Power: U.S. has 16.79% of total votes,
Palau has 0.01% of total votes
• Access to Financing
• SDR allocations=>A member’s share of general
SDR allocations is established in proportion to
its quota
What is SDR?
-1• The Special Drawing Right (SDR) was created by
the IMF in 1969 to support the Bretton Woods
fixed exchange rate system.
• A country participating in this system needed
official reserves—government or central bank
holdings of gold and widely accepted foreign
currencies—that could be used to purchase the
domestic currency in world foreign exchange
markets, as required to maintain its exchange
rate.
What is SDR?
-2• The international supply of two key reserve
assets— gold and the U.S. dollar—proved
inadequate for supporting the expansion of
world trade and financial development that
was taking place.
• => the international community decided to
create a new international reserve asset under
the auspices of the IMF.
What is SDR?
-3• In 1973, the Bretton Woods system collapsed
and the major currencies shifted to a floating
exchange rate regime.
• Today the main function of SDR is to serve as
the unit of account of the IMF and some other
international organizations.
SDR Calculation
• Initially, SDR was valued as equivalent to
0.888671 grams of fine gold—which, at the
time, was also equivalent to one U.S. dollar.
• After the collapse of the Bretton Woods
system, the SDR was redefined as a basket of
currencies, consisting of the euro, Japanese
yen, pound sterling, and U.S. dollar.
Borrowing Procedures
• Initial financing of the Fund came from members’ paidin-capital,
• Payments made partly in gold, partly in convertable
currencies, and partly in national currency,
• Members borrow from the Fund in “tranches”, which
were in proportion to their capital subscriptions,
• Access to the first “tranche” was automatic, and equal
to the gold proportion of paid-in-capital,
• Successive increases in “tranches” are subject to
“conditionality.
Technical Assistance & Training -1• The objective is to help improve the design
and implementation of members' economic
policies, including by strengthening skills in
institutions such as finance ministries and
central banks.
Technical Assistance & Training -2• monetary and financial policies (monetary policy
instruments; banking system supervision, and restructuring; foreign management
and operations; clearing settlement systems for payments; and structure
);
• fiscal policy and management (tax and customs policies
development of central banks
and administration, budget formulation, expenditure management, design of
);
• compilation, management, dissemination, and
improvement of statistical data; and
• economic and financial legislation
social safety nets, and management of domestic and foreign debt