The Global Financial Crisis: The Role of the International Monetary Fund (IMF)

The Global Financial Crisis: The Role of the International Monetary Fund (IMF)

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Pr
epared for Members and Committees of Congress

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This report discusses two potential roles the International Monetary Fund (IMF) may have in
helping to resolve the current global financial crisis: (1) immediate crisis control through balance
of payments lending to emerging market and less-developed countries and (2) increased
surveillance of the global economy through better coordination with the international financial
regulatory agencies. This report will be updated as events warrant.

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Whither the IMF? ............................................................................................................................ 1
Immediate Crisis Management.................................................................................................. 3
Reforming Global Macroeconomic Surveillance...................................................................... 5

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Author Contact Information ............................................................................................................ 6

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he current global financial crisis, which began with the downturn of the U.S. subprime
housing market in 2007, is testing the ability of the International Monetary Fund (IMF), in
T its role as the central international institution for oversight of the global monetary system.
Though the IMF is unlikely to lend to the developed countries most affected by the crisis and
must compete with other international financial institutions1 as a source of ideas and global
macroeconomic policy coordination, the spillover effects of the crisis on emerging and less-
developed economies gives the IMF an opportunity to reassert its role in the international
economy on two key dimensions of the global financial crisis: (1) immediate crisis management
and (2) long-term systemic reform of the international financial system.
The role of the IMF has changed significantly since its founding in July 1944. Late in World War
II, delegates from 44 nations gathered in Bretton Woods, New Hampshire to discuss the postwar
recovery of Europe and create a set of international institutions to resolve many of the economic
issues—such as protectionist trade policies and unstable exchange rates—that had ravaged the
international economy between the two world wars. As the global financial system has evolved
over the decades, so has the IMF. From 1946 to 1973, the main purpose of the IMF was to
manage the fixed system of international exchange rates agreed on at Bretton Woods. The U.S.
dollar was fixed to gold at $35 per ounce and all other member countries’ currencies were fixed to
the dollar at different rates. The IMF monitored the macroeconomic and exchange rate policies of
member countries and helped countries overcome balance of payments crises with short-term
loans that helped bring currencies back in line with their determined value. This system came to
an abrupt end in 1973 when the United States floated its currency and subsequently introduced
the modern system of floating exchange rates. Over the past three decades, floating exchange
rates and financial globalization have contributed to, in addition to substantial wealth and high
levels of growth for many countries, an international economy marred by exchange rate volatility
and semi-frequent financial crises. The IMF adapted to the end of the fixed-exchange rate system
by becoming the lender of last resort for countries afflicted by such crises.
Current IMF operations and responsibilities can be grouped into three areas: surveillance,
lending, and technical assistance. Surveillance involves monitoring economic and financial
developments and providing policy advice to member countries. Lending entails the provision of
financial resources under specified conditions to assist a country experiencing balance of
payments difficulties. Technical assistance includes help on designing or improving the quality
and effectiveness of domestic policy-making.
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The current financial crisis represents a major challenge for the IMF since the institution is not in
financial position to be able to lend to the United States or other Western countries affected by the
crisis (with the possible exception of Iceland). The IMF’s total financial resources as of August
2008 were $352 billion, of which $257 billion were usable resources.2 The most the IMF ever lent

1 Such as the Bank for International Settlements, Financial Stability Forum (FSF), and the Organization for Economic
Cooperation and Development (OECD).
2 IMF resources that are considered non-usable to finance IMF operations are (1) its gold holdings, (2) the currencies of
members that are using IMF resources and are therefore, by definition, in a weak balance of payments or reserve
position, (3) the currencies of other members with relatively weak external positions, and (4) other non-liquid IMF
assets.
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in any one year period (the four quarters through September 1998 at the height of the Asian
financial crisis) was $30 billion. The most lent during any two-year period was $40 billion
between June 2001-2003 during the financial crises in Argentina, Brazil, Uruguay, and Turkey.3
The IMF is wholly unequipped to provide by itself the necessary liquidity to the United States
and affected industrialized countries. In addition, the United States and other Western countries,
along with some Middle Eastern oil states, are the primary contributors to IMF resources, and it is
unlikely that these countries would seek IMF assistance. The last time that developed countries
borrowed from the IMF was between1976 and1978, when the United Kingdom, Italy, and Spain
borrowed from the IMF to deal with the aftershocks of the 1973 increase in oil prices.4
Since the financial crises of a decade ago, many emerging market economies, largely in response
to their criticism of the policy conditions that the IMF required of countries receiving IMF loans,
have built up extensive foreign reserve positions in order to avoid having to return to the IMF
should such a crisis occur again.5 From a level of around $1.2 trillion in 1995, global foreign
exchange reserves now exceed $7 trillion. The IMF tabulates that by the second quarter of 2008,
developing countries’ foreign reserves were $5.47 trillion compared to $1.43 trillion in the
industrialized countries.6 This reserve accumulation was driven by increasing commodity prices
(such as oil and minerals) and large current account surpluses combined with high savings rates
in emerging Asian countries.7
Emerging market foreign reserve accumulation fueled by rising commodity prices and large
emerging market trade surpluses, and net foreign direct investment flows has led to a decrease in
demand for IMF lending and a weakening in the IMF’s budget position. IMF lending peaked in
2003 with IMF credit outstanding totaling $110.29 billion. By September 30, 2008, outstanding
IMF loans had decreased by $92.6 billion to $17.72 billion.8 Since the IMF earns income on the
interest paid on its loans, the decrease in demand for IMF’s lending led to a budget shortfall in
2007. The IMF is in the process of seeking authorization from national legislatures to sell a
portion of gold that the IMF holds in reserve to create an investment fund whose profits can be
used to finance IMF operations. Congress is expected to face a vote in FY2009 on whether or not
to authorize this proposal.
The rise of emerging market countries over the past decade, has created new challenges for the
IMF. Many emerging market economies argue that their current stake in the IMF does not
represent their role in the world economy. Several countries, particularly in East Asia and South
America, believe that their new economic weight and status should afford them a larger quota and
a greater voice at the institution. In addition, many poor countries believe that the IMF’s quota
system is prejudiced against them, giving them little voice even though they are the majority of

3Brad Setser, “Extraordinary Times,” Council on Foreign Relations, September 29, 2008. It is worth noting that the
final rescue packages during the Asian crisis totaled many times $30 billion once bilateral assistance was included.
4 Oxford Analytica, “IMF reaffirms role in global economy.” October 15, 2008.
5 Many analysts believe that the tight monetary and fiscal policies that the IMF required of countries accepting IMF
loans accentuated the immediate economic impact of the crisis while having marginal impact on the countries’ long-
term structural reform.
6 IMF Currency Composition of Official Foreign Exchange Reserves (COFER) available at http://www.imf.org/
external/np/sta/cofer/eng/index.htm.
7 Georges Pineau and Ettore Dorruci, “The Accumulation of Foreign Reserves,” European Central Bank, March 2006.
8 Total IMF Credit Outstanding for all members from 1984-2008, available at
http://www.imf.org/external/np/fin/tad/extcred1.aspx.
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the IMF’s borrowers. In response to these concerns, the IMF embarked in 2006 on a reform
process to increase the quota and voice of its emerging market country members.9
While the IMF has struggled to define its role in the global economy, the global financial crisis
has created an opportunity for the IMF to reinvigorate itself and possibly play a constructive role
in resolving, or at the least mitigating, the effects of the global downturn, on two fronts: (1)
through immediate crisis management, primarily balance of payments support to emerging-
market and less-developed countries, and (2) contributing to long-term systemic reform of the
international financial system.
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IMF rules stipulate that countries are allowed to borrow up to three times their quota over a three-
year period, although this requirement has been breached on several occasions where the IMF has
lent at much higher multiples of quota.10 While many emerging market countries, such as Brazil,
India, Indonesia, and Mexico, have stronger macroeconomic fundamentals than they did a decade
ago, a sustained decrease in U.S. imports resulting from an economic slowdown could have
recessionary effects overseas. Emerging markets with less robust financial structures have been
more dramatically affected, especially those dependent on exports to the United States. Increased
emerging market default risk can be seen in the dramatic rise of credit default swap (CDS) prices
for emerging market sovereign bonds. Financial markets are currently pricing the risk that
Pakistan, Argentina, Ukraine, and Iceland will default on their sovereign debt at above 80%.11 On
October 26, the IMF announced a $16.5 billion agreement with Ukraine. On October 27, the IMF
announced a $15.7 billion loan to Hungary. On November 19, the IMF announced a $2.1 billion
loan to Iceland. On November 24, the IMF announced a $7.6 billion loan to Pakistan.12 Other
potential candidates for IMF loans are Serbia, Kazakhstan, Lithuania, Latvia, and Estonia.13
IMF Managing Director Dominique Strauss-Kahn has stressed that the IMF is able and poised to
assist with crisis loans. At the IMF annual meetings in October 2008, Managing Director Strauss-
Kahn announced that the IMF had activated its Emergency Financing Mechanism (EFM) to speed
the normal process for loans to crisis-afflicted countries.14 The emergency mechanism enables
rapid approval (usually within 48-72 hours) of IMF lending once an agreement has been reached
between the IMF and the national government. As noted before, while normal IMF rules are that
countries can only borrow three times the size of their respective quotas over three years, the
Fund has shown the willingness in the past to lend higher amounts should the crisis require
extraordinary amounts of assistance.
A second instrument that the IMF could use to provide financial assistance is its Exogenous
Shock Facility (ESF). The ESF provides policy support and financial assistance to low-income

9 For background, see CRS Report RL33626, International Monetary Fund: Reforming Country Representation, by
Martin A. Weiss.
10 The 1997 package for South Korea was 19 times as large as their quota at the IMF.
11 David Oakley, “Emerging Nations hit by growing debt fears,” Financial Times, October 14, 2008.
12 Information on ongoing IMF negotiations is available at http://www.imf.org.
13 Oxford Analytica, “IMF reaffirms role in the global economy.” October 15, 2008.
14 The EFM was set up in 1995 and has been used on six occasions—in 1997 for the Philippines, Thailand, Indonesia,
and Korea; in 2001 for Turkey; and in 2008 for Georgia.
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countries facing exogenous shocks, events that are completely out of the national government’s
control. These could include commodity price changes (including oil and food), natural disasters,
and conflicts and crises in neighboring countries that disrupt trade. The ESF was modified in
2008 to further increase the speed and flexibility of the IMF’s response. Through the ESF, a
country can immediately access up to 25 % of its quota for each exogenous shock and an
additional 75% of quota in phased disbursements over one to two years.
On October 29, 2008, the IMF announced that it plans on creating a new three month short-term
lending facility aimed at middle income countries such as Mexico, South Korea, and Brazil. The
IMF plans to set aside $100 billion for the new Short-Term Liquidity Facility (SLF). In a
unprecedented departure from other IMF programs, SLF loans will have no policy
conditionality.15
The IMF is not alone in making available financial assistance to crisis-afflicted countries. The
International Finance Corporation (IFC), the private-sector lending arm of the World Bank, has
announced that it will launch a $3 billion fund to capitalize small banks in poor countries that are
battered by the financial crisis. The Inter-American Development Bank (IDB) announced on
October 10, 2008 that it will offer a new $6 billion credit line to member governments, as well as
increase its more traditional lending for specific projects.16 In addition to the IDB, the Andean
Development Corporation (CAF) announced a liquidity facility of $1.5 billion and the Latin
American Fund of Reserves (FLAR) has offered to make available $4.5 billion in contingency
lines. While these amounts may be insufficient should Brazil, Argentina, or any other large Latin
American country need a rescue package, they could be very helpful for smaller countries such as
those in the Caribbean and Central America that are heavily dependent on tourism and property
investments.17
In Asia, where countries were left no choice but to accept IMF rescue packages a decade ago,
efforts are under way to promote regional financial cooperation, so that governments can avoid
having to borrow from the IMF in a financial crisis. One result of these efforts is the Chiang Mai
Initiative, a network of bilateral swap arrangements among east and Southeast Asian countries. In
addition, Japan, South Korea, and China have backed the creation of a $10 billion crisis fund.
Contributions are expected from bilateral donors, the Asian Development Bank (ADB), and the
World Bank.18
Lastly, economic conditions over the past decade have created a new class of bilateral creditors
who could challenge the IMF’s role as the lender of last resort. The rise of oil prices has created
vast wealth among Middle Eastern countries and persistent trade surpluses in Asia have created a
new class of emerging creditors. These countries either have the foreign reserves to support their
own currencies in a financial crisis, or they are a potential source of loans for other countries.

15 “IMF to Launch New Facility for Emerging Markets Hit by Crisis,” IMF Survey Online, October 29, 2008.
16 Bob Davis, “International Groups Offer Latin America More Loans,” Wall Street Journal, October 14, 2008.
17 “Q&A: Central American “Exports, Production, Employment” Hit by Crisis” Inter Press Service News Agency,
October 14, 2008.
18 Malcolm Moore, “Asia Mounts its own Bank Bailout,” The Daily Telegraph, October 15, 2008.
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Ž?˜›–’—?ȱ •˜‹Š•ȱŠŒ›˜ŽŒ˜—˜–’Œȱž›ŸŽ’••Š—ŒŽȱ
In addition to revising its emergency lending assistance guidelines to make the IMF’s financial
assistance more attractive to potential borrowers, there is a role for the IMF to play in the broader
reform of the global financial system. Efforts are underway to expand the IMF’s ability to
conduct effective multilateral surveillance of the international economy. In addition, there are
efforts to increase cooperation with the international financial standard setters as the Financial
Stability Forum (FSF), the Bank for International Settlements (BIS), as well as in various
international working groups such as the Basel Committee on Banking Supervision and the Joint
Forum on Risk Assessment and Capital. The deepening interconnectedness of the international
economy may call for such increased cooperation between the IMF, which performs global
macroeconomic surveillance, and the individual global financial regulatory bodies.
The IMF Articles of Agreement require (Article IV) that the IMF “oversee the international
monetary system in order to ensure its effective operation” and to “oversee the compliance of
each member with its obligations” to the Fund. In particular, “the Fund shall exercise firm
surveillance over the exchange rate policies of member countries and shall adopt specific
principles for the guidance of all members with respect to those policies.” Countries are required
to provide the IMF with information and to consult with the IMF upon its request. The IMF staff
generally meets each year with each member country for “Article IV consultations” regarding the
country’s current fiscal and monetary policies, the state of its economy, its exchange rate
situation, and other relevant concerns. The IMF’s reports on its annual Article IV consultations
with each country are presented to the IMF executive board along with the staff’s observations
and recommendations about possible improvements in the country’s economic policies and
practices.
As the global financial system has become increasingly interconnected, the IMF has conducted
multilateral surveillance beyond two bi-annual reports it produces, the World Economic Outlook
and the Global Financial Stability Report, four regional reports, and regular IMF contributions to
intergovernmental fora and committees, including the Group of Seven and Group of Twenty, and
the Financial Stability Forum. These efforts at multilateral surveillance, however, have been
criticized as being less than fully effective, too focused on bilateral issues, and not fully
accounting for the risks of contagion that have been seen in the current crisis. A 2006 report by
the IMF’s internal watchdog agency, the Independent Evaluation Office (IEO) found that,
“multilateral surveillance has not sufficiently explored options to deal with policy spillovers in a
global context; the language of multilateral advice is no more based on explicit consideration of
economic linkages and policy spillovers than that of bilateral advice.”19 Participants at an October
2008 IMF panel on the future of the IMF reiterated these concerns, adding that many developed
countries have impeded the IMF’s efforts at multilateral surveillance by largely ignoring IMF’s
bilateral surveillance of their own economies and not fully embracing the IMF’s first attempt at
multilateral consultations on global imbalances in 2006. According to Trevor Manuel, South
Africa’s Finance Minister, “one has to start from the fundamental view that if you accept public
policy and you accept the interconnectedness of the global economy, then you need an institution
appropriate to its regulation.”20 Analysts argue, however, that developed countries have long

19 Independent Evaluation Office (IEO) of the IMF, An Evaluation of the IMF’s Multilateral Surveillance, September
1, 2006.
20 Camilla Anderson, “Future Role of IMF Debated As Financial Crisis Takes Toll,” IMF Survey Online, October 16,
2008.
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ignored IMF advice on their economic policy, while at the same time pressuring the IMF to use
its role in patrolling the exchange rate system to support their own foreign economic goals.

ž?‘˜›ȱ˜—?ŠŒ?ȱ —?˜›–Š?’˜—ȱ

Martin A. Weiss

Analyst in International Trade and Finance
mweiss@crs.loc.gov, 7-5407

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