1.
Unit 4. International Monetary System
4. International Monetary System:
The International Financial System
- Reform of International Monetary Affairs
- The Bretton Wood System and the International
Monetary Fund, Controversy over Regulation of
International Finance, Developing Countries'
Concerns, Exchange Rate Policy of Developing
Economies.

2.
The International Monetary Fund (IMF) is an
organization of 189 member countries, each of which
has representation on the IMF's executive board in
proportion to its financial importance, so that the
most powerful countries in the global economy have
the most voting power.
Objective
―Foster global monetary cooperation
―Secure financial stability
―Facilitate international trade
―Promote high employment and sustainable economic
growth
―And reduce poverty around the world

3.
History
The IMF, also known as the Fund, was conceived at a
UN conference in Bretton Woods, New
Hampshire, United States, in July 1944.
The 44 countries at that conference sought to build a
framework for economic cooperation to avoid a
repetition of the competitive devaluations that had
contributed to the Great Depression of the 1930s.
Countries were not eligible for membership in the
International Bank for Reconstruction and
Development (IBRD) unless they were members of
the IMF.

4.
IMF, as per Bretton Woods agreement to
encourage international financial cooperation,
introduced a system of convertible currencies at
fixed exchange rates, and replaced gold with the
U.S. dollar (gold at $35 per ounce) for official
reserve.
After the Bretton Woods system (system of fixed
exchange rates) collapsed in the 1971, the IMF
has promoted the system of floating exchange
rates. Countries are free to choose their
exchange arrangement, meaning that market
forces determine the value of currencies relative
to one another. This system continues to be in
place today.

5.
During 1973 oil crisis, IMF estimated that
the foreign debts of 100 oil-importing
developing countries increased by 150%
between 1973 and 1977, complicated
further by a worldwide shift to floating
exchange rates. IMF administered a new
lending program during 1974–1976 called
the Oil Facility. Funded by oil-exporting
nations and other lenders, it was available
to nations suffering from acute problems
with their balance of trade due to the rise in
oil prices.

6.
IMF was one of the key organisations of the
international economic system; its design
allowed the system to balance the rebuilding of
international capitalism with the maximisation of
national economic sovereignty and human
welfare, also known as embedded liberalism.
The IMF played a central role in helping the
countries of the former Soviet bloc transition from
central planning to market-driven economies.

7.
In 1997, a wave of financial crises swept over
East Asia, from Thailand to Indonesia to Korea
and beyond. The International Monetary Fund
created a series of bailouts (rescue packages)
for the most-affected economies to enable them
to avoid default, tying the packages to currency,
banking and financial system reforms.

8.
Global Economic Crisis (2008): IMF
undertook major initiatives to strengthen
surveillance to respond to a more
globalized and interconnected world.
These initiatives included revamping the
legal framework for surveillance to cover
spill-overs (when economic policies in one
country can affect others), deepening
analysis of risks and financial systems,
stepping up assessments of members’
external positions, and responding more
promptly to concerns of the members.

9.
Functions
Provides Financial Assistance: To provide
financial assistance to member
countries with balance of payments
problems, the IMF lends money to
replenish international reserves,
stabilize currencies and strengthen
conditions for economic growth. Countries
must embark on structural adjustment
policies monitored by the IMF.

10.
Functions
IMF Surveillance: It oversees the
international monetary system and
monitors the economic and financial
policies of its 189 member countries. As
part of this process, which takes place both
at the global level and in individual
countries, the IMF highlights possible risks
to stability and advises on needed policy
adjustments.

11.
Functions
Capacity Development: It provides technical
assistance and training to central banks,
finance ministries, tax authorities, and other
economic institutions. This helps countries
raise public revenues, modernize banking
systems, develop strong legal frameworks,
improve governance, and enhance the
reporting of macroeconomic and financial
data. It also helps countries to make progress
towards the Sustainable Development
Goals (SDGs).

12.
IMF Reforms
IMF Quota: a member can borrow up to 200
percent of its quota annually and 600 percent
cumulatively. However, access may be higher in
exceptional circumstances.
IMF quota simply means more voting rights and
borrowing permissions under IMF. But it is
unfortunate that IMF Quota’s formula is designed
in such a way that USA itself has 17.7% quota
which is higher than cumulative of several
countries. The G7 group contains more than 40%
quota where as countries like India & Russia
have only 2.5% quota in IMF.

13.
Due to discontent with IMF, BRICS countries
established a new organization called BRICS bank
to reduce the dominance of IMF or World Bank and
to consolidate their position in the world as BRICS
countries accounts for 1/5th of WORLD GDP and
2/5th of world population.
It is almost impossible to make any reform in the
current quota system as more than 85% of total
votes are required to make it happen. The 85% votes
does not cover 85% countries but countries which
have 85% of voting power and only USA has voting
share of around 17% which makes it impossible to
reform quota without consent of developed countries.

14.
2010 Quota Reforms approved by Board of
Governors were implemented in 2016 with
delay because of reluctance from US
Congress as it was affecting its share.
Combined quotas (or the capital that the
countries contribute) of the IMF increased to a
combined SDR 477 billion (about $659 billion)
from about SDR 238.5 billion (about $329
billion). It increased 6% quota share for
developing countries and reduced same
share of developed or over represented
countries.

15.
More representative Executive Board:
2010 reforms also included an
amendment to the Articles of Agreement
established an all-elected Executive
Board, which facilitates a move to a more
representative Executive Board.
The 15th General Quota Review provides
an opportunity to assess the appropriate
size and composition of the Fund’s
resources and to continue the process of
governance reforms.

16.
• One proposed reform is a movement towards
close partnership with other specialist agencies
such as UNICEF, the Food and Agriculture
Organization (FAO), and the United Nations
Development Program (UNDP).
• IMF loan conditions should be paired with other
reforms—e.g., trade reform in developed
nations, debt cancellation, and increased
financial assistance for investments in basic
infrastructure.

17.
• COVID-19 Financial Assistance and Debt
Service Relief
• The IMF is providing financial assistance and
debt service relief to member countries facing
the economic impact of the COVID-19 pandemic.
overview of assistance approved by the IMF’s
Executive Board since late March 2020 under its
various lending facilities and debt service relief
financed by the Catastrophe Containment and
Relief Trust (CCRT). Overall, the IMF is currently
making about $250 billion, a quarter of its $1
trillion lending capacity, available to member
countries.

18.
As part of the COVID19-related rapid arrangements,
borrowing countries have committed to undertake
governance measures to promote accountable and
transparent use of these resources.
Total Debt Relief for 29 Countries:
1st Tranche: SDR 183.13 million / US$ 251.24 million
2nd Tranche: SDR 168.40 million / US$ 237.46 million
3rd Tranche: SDR 168.07 million / US$ 238.05 million
Debt service relief total: SDR 519.60 million / US$ 726.75
million
https://www.imf.org/en/Topics/imf-and-
covid19/COVID-Lending-Tracker#APD
Total Financial Assistance for 85 Countries:
SDR 81,715.40 million / US$ 113,067.08 million

19.
The Executive Board of the International Monetary
Fund (IMF) today approved a disbursement to
the Central Bank of Solomon Islands for an
amount of SDR 20.8 million (about US$28.5
million, 100 percent of quota), comprising SDR
6.93 million (about US$ 9.5 million, 33.3 percent
of quota) under the Rapid Credit Facility (RCF)
and SDR 13.87 million (about US$ 19 million,
66.7 percent of quota) under the Rapid
Financing Instrument (RFI) to help cover urgent
balance of payments needs stemming from the
COVID-19 pandemic.

20.
The Rapid Financing Instrument (RFI) provides
rapid financial assistance, which is available to
all member countries facing an urgent balance of
payments need.
The RFI was created as part of a broader reform to
make the IMF’s financial support more flexible to
address the diverse needs of member countries.
The RFI replaced the IMF’s previous emergency
assistance policy and can be used in a wide
range of circumstances.

21.
The Rapid Credit Facility (RCF) provides rapid
concessional financial assistance with limited
conditionality to low-income countries (LICs) facing
an urgent balance of payments need.
The RCF was created under the Poverty Reduction
and Growth Trust (PRGT) as part of a broader
reform to make the Fund’s financial support more
flexible and better tailored to the diverse needs of
LICs, including in times of crisis.
The RCF places emphasis on the country’s poverty
reduction and growth objectives.
Financing under the RCF carries a zero interest rate,
has a grace period of 5½ years, and a final maturity
of 10 years.

22.
IMF and India
International regulation by IMF in the field of
money has certainly contributed towards
expansion of international trade. India has,
to that extent, benefitted from these fruitful
results.
Post-partition period, India had serious
balance of payments deficits, particularly
with the dollar and other hard currency
countries. It was the IMF that came to her
rescue.

23.
The Fund granted India loans to meet the financial
difficulties arising out of the Indo–Pak conflict of
1965 and 1971.
From the inception of IMF up to March 31, 1971,
India purchased foreign currencies of the value
of Rs. 817.5 crores from the IMF, and the same
have been fully repaid.
Since 1970, the assistance that India, as other
member countries of the IMF, can obtain from it
has been increased through the setting up of the
Special Drawing Rights (SDRs created in
1969).

24.
India had to borrow from the Fund in the wake of the steep
rise in the prices of its imports, food, fuel and fertilizers.
In 1981, India was given a massive loan of about Rs. 5,000
crores to overcome foreign exchange crisis resulting from
persistent deficit in balance of payments on current
account.
India has availed of the services of specialists of the IMF
for the purpose of assessing the state of the Indian
economy. In this way India has had the benefit of
independent scrutiny and advice.
The balance of payments position of India having gone
utterly out of gear on account of the oil price escalation
since October 1973, the IMF has started making
available oil facility by setting up a special fund for the
purpose.

25.
India wanted large foreign capital for her
various river projects, land reclamation
schemes and for the development of
communications. Since private foreign
capital was not forthcoming, the only
practicable method of obtaining the
necessary capital was to borrow from the
International Bank for Reconstruction
and Development (i.e. World Bank).

26.
Early 1990s when foreign exchange reserves – for two
weeks’ imports as against the generally accepted 'safe
minimum reserves' of three month equivalent —
position were terribly unsatisfactory. Government of
India's immediate response was to secure an emergency
loan of $2.2 billion from the International Monetary Fund
by pledging 67 tons of India's gold reserves as collateral
security. India promised IMF to launch several structural
reforms (like devaluation of Indian currency, reduction in
budgetary and fiscal deficit, cut in government expenditure and
subsidy, import liberalisation, industrial policy reforms, trade
policy reforms, banking reforms, financial sector reforms,
privatization of public sector enterprises, etc.) in the coming
years.

27.
• The foreign reserves started picking up
with the onset of the liberalisation policies.
• India has occupied a special place in the
Board of Directors of the Fund. Thus,
India had played a creditable role in
determining the policies of the Fund.
This has increased the India’s prestige in
the international circles.

28.
Evaluations of International Monetary System
Gold Standard:
Gold has historically been used as a medium of
exchange primarily due to its scarce availability and
desirable properties. Besides its durability, portability,
and ease of standardization, the high production
costs of the yellow metal make it costly for
governments to manipulate short-run changes in its
stock.
As gold is commodity money, it tends to promote price
stability in the long run. Thus, the purchase power of
an ounce of gold will tend toward equality with its
long-run cost of production.

29.
The various versions of gold standards used
were:
Gold specie standard:
The actual currency in circulation consists of gold
coins with fixed gold content.
Gold bullion standard:
The currency in circulation consists of paper notes
but a fixed weight of gold remains the basis of
money. Any amount of paper currency can be
converted into gold and vice versa by the
country’s monitory authority at a fixed conversion
ratio.

30.
Gold exchange standard:
Paper currency can be converted at a fixed rate into
the paper currency of the other country, if it is
operating a gold specie or gold bullion standard.
Such an exchange regime was followed in the post-
Bretton Woods era.
Exchange rates from 1876 to 1913 were generally
dictated by gold standards. Each country backed up
its currency with gold, and currencies were
convertible into gold at specified rates. Relative
convertibility rates of the currencies per ounce of
gold determined the exchange rates between the
two currencies.

31.
Gold standard was suspended following World War I in 1914 and
governments financed massive military expenditure by printing
money. This led to a sharp rise both in the supply of money
and market prices. Hyperinflation in Germany presents a
classic example where the price index rapidly shot from 262 in
1919 to 12,61,60,00,00,00,000 (a factor of 481.5 billion) in
December 1923.
The US and some other countries returned to gold standards so
as to achieve financial stability, but following the Great
Depression in 1930, gold standards were finally abandoned.
Some countries attempted to peg their currencies to the US
dollar or British pound in the 1930s but there were frequent
revisions.
This followed severe restrictions on international transactions and
instability in the foreign exchange market, leading to a decline
in the volume of international trade during this period.

32.
Fixed Exchange Rates:
In July 1944, representatives of 44 allied nations
agreed to a fixed rate monetary system and setting
up of the International Monetary Fund in a
conference held in Bretton Woods, New Hampshire.
Each member country pledged to maintain a fixed or
pegged exchange rate for its currency vis-a-vis gold
or the US dollar.
Since the price of each currency was fixed in terms of
gold, their values with respect to each other were
also fixed. For instance, price of one ounce of gold
was fixed equal to US$35. This exchange regime,
following the Bretton Woods Conference, was
characterized as the Gold Exchange Standard.

33.
In the Bretton Woods era, which lasted from 1944
to 1971, fixed exchange rates were maintained
by government intervention in the foreign
exchange markets so that the exchange rates
did not drift beyond 1 per cent of their initially
established levels.
Under the Bretton Woods system, the US dollar
effectively became the international currency.
Other countries accumulated and held US dollars
for making international payments whereas the
US could pay internationally in its own currency.

34.
By 1971, the foreign demand for the US
dollar was substantially less than the
supply and it appeared to be overvalued.
On 15 August 1971 the US government
abandoned its commitment to convert the
US dollar into gold at the fixed price of
US$35 per ounce and the major currencies
went on a float.

35.
In an attempt to revamp the monetary
system, consequent to a conference of
various countries’ representatives, the
Smithsonian Agreement was concluded in
December 1971, which called for a
devaluation of US dollar by 8 per cent
against other currencies and pegging the
official price of gold to US$38 per ounce.
Besides, 2.25 per cent fluctuations in either
direction were also allowed in the newly
set exchange rates.

36.
Pros and cons of fixed exchange rate
system:
Under the fixed exchange rate system,
international managers can operate their
international trade and business activities
without worrying about future rates.
However, companies do face
repercussions of currency devaluation both
by their home and the host countries.
Further, the currency of each country
becomes more vulnerable to economic
upheavals in other countries.

37.
Floating Exchange Rate System:
Even after the Smithsonian Agreement,
governments still faced difficulty in maintaining
their exchange rates within the newly
established exchange rates regime. By March
1973, the fixed exchange rate system was
abandoned and the world officially moved to a
system of floating exchange rates.
Under the freely floating exchange rate system,
currency prices are determined by market
demand and supply conditions without the
intervention of the governments.

38.
Pros and cons of floating exchange rates:
A country under the floating exchange rate system
is more insulated from inflation, unemployment,
and economic upheavals prevalent in other
countries. Thus, the problems faced in one
country need not be contagious to another.
The adjustment of exchange rates serves as a form
of protection against exporting economic
problems to other countries. Besides, the central
bank of a country is not required to constantly
maintain the exchange rates within the specified
limits and to make frequent interventions.

39.
Although other countries are reasonably
insulated from the problems faced by one
country under the freely floating exchange
rates, the exchange rates themselves can
further aggravate the economic woes of a
country plagued by economic problems
and unemployment.
This possibility makes it essential for
international managers to devote
substantial resources to measure and
manage the exposure to exchange rate
fluctuations.

40.
Special Drawing Rights (SDR)
Special drawing rights (SDRs) are supplementary foreign
exchange reserve assets defined and maintained by
the International Monetary Fund (IMF)
SDR is not a currency, instead represents a claim to
currency held by IMF member countries for which they
may be exchanged.
The value of an SDR is defined by a weighted currency
basket of four major currencies: the US dollar, the euro,
the British pound, the Chinese Yuan and the Japanese
yen
Central bank of member countries held SDR with IMF which
can be used by them to access funds from IMF in case of
financial crises in their domestic market

41.
Controversy over Regulation of International
Finance
As the global market expands, the need for
international regulation becomes urgent. Since
World War II, financial crises have been the
result of macroeconomic instability until the
fatidic week end of September 15 2008, when
Lehman Brothers filed for bankruptcy. The
financial system had become the source of its
own instability through a combination of greed,
lousy underwriting, fake ratings and
regulatory negligence.

42.
Controversy over Regulation of International
Finance
From that date, governments tried to put together a
new regulatory framework that would avoid using
taxpayer money for bailout of banks.
In an uncoordinated effort, they produced a series
of vertical regulations that are disconnected from
one another. That will not be sufficient to stop
finance from being instable and the need for
international and horizontal regulation is urgent.