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Essay on Imf
| Date: |
04-02-99 1:36pm |
| Subject: |
Business |
| Word Count: |
2210 |
| Page Count: |
8.84 |
Imf
Introduction:
We are all aware of the enormous difficulty that the Asian countries have been having in regard to their economies having large trade deficits and the devaluation of their currencies. Asia’s crisis was classified as “The Great Asian Slump that is for the record books” (“Saving Asia it’s time to get radical,” 75) making the Latin America’s crisis of 1995 look like a minor wobble.
Hong Kong announced that its economy shrank 2.8% in the first quarter of 1998. Economist forecast Indonesia’s GDP to fall an overwhelming 15.1% this year. Comparing that to Americas worst post war recession when the economy shrank 2.1% (“Saving Asia, It’s time to get radical,” 75). This record-breaking crisis has had an enormous effect on our economy as well, and had to be handled as quickly and as painlessly as possible.
Therefore, the IMF had to step in and advise the nations on stabilizing their economies by restoring confidence in the currencies. As well as making their currencies look more attractive, which demanded increased interest rates, among many other actions that the IMF implemented.
However, there are always individuals who are for and against any actions taken in an attempt to resolve a certain predicament. As anywhere else, here we also find that there are some who feel that IMF did a very poor job at providing the right treatment for the ‘wound’, and yet others who content that IMF did the best that it could and in fact helped the “ailing tigers”.
A Brief History of the IMF
In July 1944 the United Nations Monetary and Financial Conference met at Bretton Woods, New Hampshire, to find a way to rebuild and stabilize a world economy that had been severely devastated by World War II. One result of the conference was the founding of the International Monetary Fund (IMF) through the signing of its Articles of Agreement by 29 countries.
The stated purposes of the IMF were to create international monetary cooperation, to stabilize currency exchange rates, to facilitate the expansion and balanced growth of international trade, and to make its general resources temporarily available to its members experiencing balance of payments difficulties under adequate safeguards. There were 143 member nations in the IMF in the early 1980s. Most of the Communist countries, including the Soviet Union, did not join; and, of the Western nations, Switzerland has not participated (Compton’s Interactive Encyclopedia, 1996). However there are now 182 members (www.imf.com, last updated August ‘98).
(www.imf.org)
On joining the IMF, each member country contributes a certain sum of money called a quota subscription, as a sort of credit union deposit.
(www.imf.org)
IMF appraises its members' exchange rate policies within the framework of a comprehensive analysis of the general economic situation and the policy strategy of each member. “The IMF fulfills its surveillance responsibilities through: annual bilateral Article IV consultations with individual countries; multilateral surveillance twice a year in the context of its World Economic Outlook (WEO) exercise; and precautionary arrangements, enhanced surveillance, and program monitoring, which provide a member with close monitoring from the IMF in the absence of the use of IMF resources” (www.imf.org).
Total Fund Credit and
Outstanding
(SDR billions; end of August 1998)
------------------------------------------------------------------------
World62.8 Africa7.1 Asia22.6 Europe19.8 Middle East0.5 Western Hemisphere12.8
(www.imf.org)
Furthermore, to achieve its goals, the Bretton Woods Conference stated a number of conditions with which member nations were required to comply. Each nation agreed to establish a par value for its currency; that is, the value of a unit of its currency would be fixed in relation to the dollar or to gold. This would prevent great fluctuations of national currencies in relation to each other. This part of the agreement was abandoned in 1971, when the United States removed the dollar from the gold standard. Currencies have since been allowed to float in value in relation to each other and in relation to the conditions of the world economy.
Member nations also agreed upon the principle of currency convertibility. Thus, if one nation owned the currency of another, it would be able to sell it back at par value.
(www.imf.org)
A third agreement was that member governments would contribute to the operating funds of the IMF according to the volume of their international trade, national income, and their international reserve holdings. Part of the contribution is in gold, the remainder in the nation's own currency. A nation may borrow funds against the gold portion of its contribution if it encounters financial difficulties due to an unfavorable balance-of-payments situation.
The IMF has other devices to assist members in balance-of-payments difficulties. The Standby Arrangements adopted in 1954 enable nations to negotiate lines of credit in anticipation of current needs. The General Arrangements to Borrow, instituted in 1961, provide standby credit for emergencies. The Compensatory Financing of Export Fluctuations, introduced in 1963, enables developing countries to cope with sudden drops in export receipts without injuring the country's economy through currency exchange restrictions.
The IMF makes its financial resources available to member countries through a variety of financial windows. Except for the Enhanced Structural Adjustment Facility (ESAF) drawings, which are loans and not purchases of other members’ currencies, members benefit themselves of the IMF’s financial resources by purchasing (drawing) other members' currencies or SDRs with an equivalent amount of their own currencies. The IMF levies charges on these drawings and requires that members repay their own currencies from the IMF over a specified time.
(www.imf.org)
The Origin of the Crisis
The forthcoming of the crisis was for the most part unexpected due to the previously seen decades of outstanding economic performance in Asia. Nevertheless, the crisis unfolded rather rapidly and many place the blame on the weakness of the financial systems and governance. The combination of inadequate financial sector supervision, poor assessment and management of financial risk, and the maintenance of relatively fixed exchange rates led banks and corporations to borrow large sums of international capital. However, vast inflows can quickly become huge outflows. “The five worst affected Asian economies (South Korea, Indonesia, Thailand, Malaysia, and the Philippines) received $93 billion of private capital in 1996. In 1997, you saw an outflow of $12 billion. This shift of $105 billion in one year was the equivalent of 11 percent of their combined gross domestic product. (“ A fix for the world markets”, 30)”
Although private sector expenditure and financing decisions led to the crisis, governance issues played a major role. Limited transparency, meaning lack of availability of fiscal accounting and economic data has made it very difficult for investors to obtain the information needed for investment expenditures.
In addition to the issues listed above, what furthermore intensified the crisis was the fact that the nations seeing all of elements that are comprising the crisis occur in their economies have lost confidence in their currencies and the financial institutions. However, what turned this bad financial situation into a catastrophe was the loss of confidence that turned into self-reinforcing panic.
Although, the world was shocked at the intensity of the crisis they - meaning the United Nations, the IMF and the affiliated countries began getting involved in order to start the recovery process as soon as possible. This aided Asia’s troubled markets from spreading their ‘virus’ onto the nearby, vulnerable markets and then to the apparently unconnected markets.
What did the IMF do?
Assessing the complex situation on the matter, the IMF had formulated a few propositions to help reestablish confidence in the affected countries. They are as follows:
· A temporary tightening of monetary policy to evoke exchange rate depreciation.
· Begin structural reforms to remove features of the economy that had become impediments to growth (such as monopolies, trade barriers, and nontransparent corporate practices).
· Initiating the reopening and / or maintaining lines of external financing.
· Maintenance of a sound fiscal policy, through the provision for rising budgetary costs of financial sector restructuring.
Provided these factors the Asian counties should have been on their way to recovery. However, we have only begun to see slight improvement on their part, thus posing a question: How effective is the prescribed treatment?
Arguments for the actions taken by the IMF
There are three major criticisms that Martin Feldstein, a former presidential economist, makes of the International Monetary Fund’s remedies for the Asian crisis (“Refocusing the IMF,” 1998). First, he argues that IMF uses the same old type of medicine, inappropriately dispensed throughout the nations. Second, he contends that the IMF went beyond it’s essential task by including structural elements in the program, the essential task being the correcting the balance of payments. Finally, he is troubled by the bailout issue – referring to the fact that IMF provides a safety net and countries are not as concerned with taking excessive risk because they know that IMF will be there to bail them out.
Stanley Fischer, who is first deputy managing director of the International Monetary Fund, addresses the three issues troubling Feldstein. Fischer contends that there could not possibly be the same method used for the nations that are in need of help. He says that the countries requesting assistance are different in the size of their current account deficit and the stages of crisis they are in. Therefore, the design of the programs reflected each individual country.
When the countries approached the IMF, Thailand and South Korea had very low reserves and the Indonesian rupiah was extensively depreciated. So, the IMF had to restore confidence in their currencies prier to the attempt of fixing any other problems. This could have only been achieved through the increase of interest rates temporarily, in order to make their currencies look more appealing. Even if the higher interest rates would make the situation with weak banks and corporations more complex. However, when confidence would be restored the interest rates can be lowered to the normal level.
As in regard to Feldstein’s criticism of the structural elements incorporated into the reform programs, they were vital for the Asian financial sector. Due to the fact that the underling problems stemmed from the weakened financial institutions and complicated nontransparent relations among government and corporations, IMF had to include structural reforms. Otherwise the IMF would have only addressed the balance of payment problem by landing money, it would not have been effective since the underling aspects were not considered.
Responding to Feldstein’s third critique, Fischer addresses the issue of bailouts. Feldstein claims that countries may take an excessive risk knowing that IMF will bail them out if things go bad. Fischer says that to think that policymakers pursue risky courses of action because they anticipate that IMF safety net will catch them is far-fetched. Countries avoid going to the Fund, since historical precedence has shown that policymakers whose countries end up in trouble do not do well politically. Therefore, this proves that countries do not do take unwise actions merely because they believe that there will be a safety net to catch them.
What could have been done differently to contain the crisis?
Some countries believed that the remedies put forth by the IMF were inadequate because Asian governing methods and economies are very different from ours. And furthermore Asia would have done better if an internal Monetary Fund was formulated. In August 1997 Japan proposed an Asian Monetary Fund to deal with the crisis. It secured pledges of $100 billion mostly from itself, China, Hong Kong, Taiwan, and Singapore (“The resources lie within,”19).
Most importantly Asians save a lot of their income compared to western countries and households do most of the saving. Domestic savings run about twice the American rate. Households put their savings in to low risk banks as opposed to Americans who use their savings to finance households’ own investment in housing. Therefore, the resources to begin the initial healing process may essentially lie within.
Moreover, the Asian Monetary Fund would build on Asia’s saving surplus, and foreign exchange reserves. Where would the AMF get the resources to do this you may think? The AMF would have financing from the subscribed governments. The fact that they were able to secure $100 billion rapidly manifests that sizable sums are in prospects.
Nevertheless the AMF never came to existence due to United States Treasury’s disapproval of Japan’s proposal.
Conclusion
Looking retrospectively, we can contemplate the procedures that were done and theories what should have been done differently. However, what’s done is done and we can only examine the origin of the crisis and it’s development in an attempt to prevent another one from occurring.
You may agree or disagree with the specific measures that IMF has implemented, but we really do not know would it have been better if other measures were utilized or if the IMF did not intervene at all. Asia’s economies seem to be slowly coming out of the “intensive care”. The exchange rates of all the crisis economies have strengthened from their lows, which were reached in January 1998. While the Indonesian rupiah remain deeply depreciated, it too has recovered significantly from the low it reached in June 1998. In addition to that, interest rates in Korea and Thailand have declined remarkably since January as currency pressures have eased (www.imf.org).
Even though the crisis is not completely resolved there is evident progress. The IMF has already drawn lessons from the crisis on how to strengthen the international financial system and the importance of a sound macroeconomic policy framework, and the dangers of unsustainable large current account deficit.
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