However good the IMF’s surveillance process and the economic policies governments implement, it is unrealistic to expect that crises will never occur. Indeed, a dynamic market economy will tend to face occasional crises—and the IMF’s role is then to help mitigate their impact and shorten their duration through its policy advice and financial support and also to try to prevent the crisis from spreading to other countries. This has sometimes required the commitment of substantial resources by the IMF. In most cases, this investment has paid off. For example, the IMF’s loan of $21 billion to Korea in December 1997 was very large by any standards. But it helped restore financial stability by early 1998 and strong growth the following year. And Korea repaid the IMF ahead of schedule. That was a case where large-scale support was appropriate and successful. The IMF played a similar role in Brazil in 1998 and Turkey in 2001.
Why do economic crises occur?
Bad luck, bad policies, or a combination of the two may create balance of payments difficulties in a country—that is, a situation when the country cannot obtain sufficient financing on affordable terms to meet net international payments. In the worst case, the difficulties can build into a crisis. The country’s currency may depreciate at a rate that destroys confidence in its value, with disruptive and destructive consequences for the domestic economy, and the problems may spread to other countries.
The causes of such difficulties are often varied and complex. But key factors have included weak domestic financial systems, large and persistent fiscal deficits, high levels of external debt, exchange rates fixed at inappropriate levels, natural disasters, and armed conflicts.
Some of these factors can directly affect a country’s trade account—reducing exports or increasing imports. Others may reduce the financing available for international transactions—for example, by causing investors to lose confidence in their investments in a country, leading to massive asset sales and a sudden departure of capital overseas, or “capital flight.”
How IMF lending helps
IMF lending seeks to give countries breathing room while they implement policies of adjustment and reform aimed at resolving their balance of payments problems and restoring conditions for strong economic growth. These policies will vary depending on the country’s circumstances, especially the root causes of the problems. For instance, a country facing a sudden drop in the price of a key export may simply need financial assistance to tide it over until prices recover and to help ease the pain of an otherwise sudden and sharp adjustment. A country suffering from capital flight needs to address whatever problems led to the loss of investor confidence: perhaps interest rates that are too low, an overvalued exchange rate, a large government budget deficit, a debt stock that appears to be growing too fast, or an inefficient and poorly regulated domestic banking system.
“Before a member country can receive a loan, the country’s authorities and the IMF must agree on the appropriate program of economic policies.”
Before a member country can receive a loan, the country’s authorities and the IMF must agree on an appropriate program of economic policies (see Conditionality, page 23).
In the absence of IMF financing, the adjustment process would be more difficult. For example, if investors do not want to buy any more of a country’s government bonds, its government has no choice but to reduce the amount of financing it uses—by cutting its spending or increasing its revenues—or to finance its deficit by printing money. The “belt tightening” involved in the first case would be greater without an IMF loan. And, in the second case, the result would be inflation, which hurts the poor most of all. IMF financing can facilitate a more gradual and carefully considered adjustment.
The policy advice provided by the IMF, including on the formulation of policy programs to be supported by IMF loans, is tailored to a country’s circumstances. In recent years, the largest number of loans has been made through the Poverty Reduction and Growth Facility (PRGF), which provides low-income countries with loans at below-market interest rates and over relatively long time horizons (repayable over 5½-10 years). However, the largest amount of funds is provided through Stand-By Arrangements, which charge market-based interest rates on loans (usually for 12-18 months, repayable over 3¼-5 years) to assist with short-term balance of payments problems (see pages 24-25).
The IMF provides other types of loans as well, including emergency assistance to countries that have experienced a natural disaster or are emerging from armed conflict.
Resolving external debt crises
Some balance of payments difficulties arise because countries amass debts that are not sustainable—that is, they cannot be serviced under any feasible set of policies. In these circumstances, a way must be found for a country and its creditors to restructure the debt. This may involve some easing of the repayment terms, like an extension of maturities and/or an agreed reduction in the face value of the debt.
Together with the World Bank, the IMF has been working to reduce to sustainable levels the debt burdens of heavily indebted poor countries under the enhanced Heavily Indebted Poor Countries (HIPC) Initiative, introduced in 1996 and enhanced in 1999. So far, 27 countries have been approved for debt service relief provided by the Fund and the Bank, other multilateral institutions, and other (mostly official) creditors.
More recently, the IMF has been working to help improve the sovereign debt restructuring process between countries and their private creditors:
The IMF has been encouraging member countries to include collective action clauses (CACs) in new international sovereign bonds to facilitate a restructuring of sovereign debt when, in extreme circumstances, it may be needed to resolve financial crises. CACs in bonds issued under New York law have now become commonplace, much sooner than many people had anticipated. Several emerging market countries are now including CACs in their sovereign bonds. It is, however, too soon to evaluate the contribution such clauses can make to improving the orderly resolution of debt crises.
The IMF is also supporting private sector efforts to formulate a voluntary code of conduct to provide guidance to debtors and creditors in their negotiations.
In addition to these efforts, during 2001-02, the Fund’s management sought to advance a formal treaty-based framework—the Sovereign Debt Restructuring Mechanism, or SDRM. Although the framework did not attract the requisite political support to move forward, those efforts did much to improve understanding of the impediments to timely and effective debt restructuring and gave new impetus to complementary approaches, especially CACs and a code of conduct.