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 Module 1

 Module 2

 Module 3

 Module 4

 Module 5
Module 3
Module III

 IMF

 IMF
 Functions
 Special Schemes of Lending
 Conditionalities of IMF loans
 IMF’s role in providing international liquidity SDR’s
 International financial markets and instruments.
INTERNATIONAL MONETORY FUND

IMF_Slide_1

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Overview

The International Monetary Fund came into existence on December 27,1945

when 29 countries signed its Article of Agreement agreed at a conference held
in USA in 1944.The IMF commenced financial operations on March 1, 1947.The
IMF is the central institution of International Monetary System. It is primarily a
supervisory institution for coordinating the efforts of member countries to
achieve greater co-operation in the formulation of economic policies. Thus IMF
is an international organization that oversees the global financial system by
observing exchange rates and balance of payments and also offers financial and
technical assistance has 189 members.

PURPOSE OR OBJECTIVES OF IMF

1- To promote international monetary co-operation.

2- To ensure stability in foreign exchange rates.

3- To eliminate exchange control.

4- To help member-nations to achieve balanced economic growth.

5- To eliminate or reduce BOP disequilibrium.

6- To promote investment in backward and underdeveloped countries.

FUNCTIONS OF IMF

1- To gives advice to the member countries on economic and monetary matters.

2- It had created a monetary reserve fund.

3- Lending foreign currencies to member countries against their national

currencies.

4- It stabilizes the foreign exchange rate.

5- Reduces tariff and other trade restrictions among the member countries.

6- Conducts research studies and publishes the reports

7- Provides machinery for international consultancy.

8- It conducts short term training courses on monitory policies and BOPs for
employees of member countries

OPERATIONS OR SCHEMES OF IMF

1- Financial resources

It includes quota subscription of member countries, amount received from sale

of gold, loan of member countries etc. When a country joins the IMF, it is given
a quota. The quota is expressed in special drawing rights (SDR).

2- Lending

The IMF lends money only to member countries having BOP problems. A
member country With BOP problem can immediately withdraw from the IMF
the 25% of its quota.

3- Other credit facilities

Since the 1960’s, the IMF has created several new credit facilities for its
members. These are:

 Buffer Stock Financing Facility (BSFT) 1

  Extended Fund Facility (EFF)
 Supplementary Reserve Facility (SRF)
 Enhanced Structural Adjustment Facility (ESAF)
 Compensatory and Contingency Financing Facility (CCFF)
 Systematic Transformation Facility (STF) etc...

4- Determination of par values

The exchange rate system set up by the article of agreement was called par
value system. Under this system, each member is required to express the par
value of its currency in terms as a common denominator or in US dollar at a
value of $35 per fine ounce of gold.

5- Other services it sends specialists and experts to solve BOP problems. It

provides technical assistance. Set up three departments to solve banking and
fiscal problems. They are Central Banking Service

Department, Fiscal Affairs Department and IMF Institute

Resources and Lending Facilities

The IMF’s resources come mainly from two sources—quotas and loans. Quotas
are the subscriptions to be paid by the member countries to the IMF. Each
member country is assigned a quota based on a number of factors reflecting its
economic status. The member countries were required to contribute 25% of its
quota in gold and the rest in their own currencies. Thus, the IMF began with a
pool of different currencies contributed by member countries. The quotas are
enhanced periodically to raise additional resources for the IMF. Loans from
members and non-members constitute the other major source of funds for the
IMF. Since 1980, the IMF has been authorized to borrow from commercial
capital markets too. The resources of the IMF are used to provide financial
assistance to member countries in times of need. A variety of funding facilities
are made available by the IMF to suit the different needs of member countries.

Reserve tranche facilities and credit tranche facilities are two basic
facilities available for meeting balance of payments deficits. Every member
country is entitled to borrow, without any conditions, a part of its quota (i.e.,
the subscription paid to the IMF by the member). The borrowing may be in the
form of SDRs or any foreign currencies. This facility is known as the reserve
tranche facility. In addition to this facility, a member can borrow up to 100% of
its quota, in four instalments, called credit tranches. Each credit tranche would
be equivalent to 25% of the member’s quota. This facility is known as credit
tranche facility. Unlike the reserve tranche facility, this is not an unconditional
facility. Stringent conditions regarding policies to be pursued and performance
to be achieved by the borrowing member are attached to the credit tranches.
These conditions are intended for correcting the BOP deficit problem faced by
the borrowing country. The implementation of these conditions is regularly
monitored by the IMF.

Borrowing by a member from the IMF involves purchasing SDRs or other

foreign currencies with its own currency. Members who thus purchase foreign
currencies from the IMF must subsequently repurchase their own currencies
by repaying the foreign currencies to the IMF. It is essentially purchase of
foreign currencies (or SDRs) against own currency and subsequent repurchase
of own currency against foreign currencies (or SDRs).
 Over the years, the IMF has expanded its lending facilities which now
include the following types of facilities:

Poverty Reduction and Growth Facility (PRGF) and Exogenous Shocks

Facility (ESF): These are concessional lending arrangements to low-income
countries and are underpinned by comprehensive country-owned strategies,
delineated in their Poverty Reduction Strategy Papers (PRSPs). In recent years,
PRGF has accounted for the largest number of IMF loans. The interest rate
levied on PRGF and ESF loans is 0.5% only, and loans are to be repaid over a
period of 5½–10 years.

Stand-By Arrangements (SBA): The SBA is designed to help countries address

short-term balance of payments problems. Stand-bys have provided the
greatest amount of IMF resources. The length of an SBA is typically 12–24
months, and repayment is normally expected within 2¼–4 years.

Extended Fund Facility (EFF): This facility was established in 1974 to help
countries address long-term balance of payments problems requiring
fundamental economic reforms. Arrangements under the EFF are thus longer—
usually three years. Repayment is normally expected within 4½–7 years.

Supplemental Reserve Facility (SRF): This facility was introduced in 1997 to

meet a need for very short-term financing on a large scale. The motivation for
the SRF was the sudden loss of market confidence experienced by emerging
market economies in the 1990s, which led to massive outflows of capital and
required financing on a much larger scale than the IMF had previously
provided. Countries are expected to repay loans within 2–2½ years, but may
request an extension of up to six months. All SRF loans carry a substantial
surcharge of 3–5 percentage points.
Compensatory Financing Facility (CFF): The CFF was established in 1963 to
assist countries experiencing either a sudden shortfall in export earnings or an
increase in the cost of cereal imports, often caused by fluctuating world
commodity prices. Financial terms are similar to those applying to the SBA,
except that CFF loans carry no surcharge.

Emergency assistance: The IMF provides emergency assistance to countries

that have experienced a natural disaster or are emerging from conflict.
Emergency loans are subject to the basic rate of charge, although interest
subsidies are available for PRGF-eligible countries, subject to availability. Loans
must be repaid within 3¼–5 years.

Conditionality of lending

When the IMF provides financial assistance to member countries, it must

ensure that the members are pursuing policies that will improve or eliminate
their external payments problems. The explicit commitment that members
make to implement corrective measures in return for the assistance from the
IMF is called Conditionality. A country has to fulfill the conditionality's for
getting a loan from the IMF the broad guidelines or conditions of IMF are: The
recipient country is required to undertake such tax reforms as provide
incentives to the producers to enhance domestic production. The prices of
products of public enterprises should not be administered as these would entail
loss in efficiency for these undertakings. The borrowing country should take
appropriate steps to ensure export promotion and conserve energy in the
interest of development.
The investment program of the country should be oriented to the objectives of
steady growth.

The IMF laid down some more conditionality's after the 1995 Mexican and the
Asian financial crisis. These include:

 To liberalize trade by removing exchange and import controls.

 To eliminate all subsidies so that exports are not in an advantageous
position in relation to the other trading countries
 To treat foreign lenders on a equal footing with domestic lenders

Role of IMF in providing international liquidity

The IMF is an international monitory institution. It is the principle source of

supply of international liquidity to its 189 members. Over these years it has
adopted the following measures to increase international liquidity.

1- Quotas

2- Selling gold

3- Borrowings

4- Reserves tranche

5- Credit tranche

6- New credit facilities

7- IDA replenishments

8- Special drawing rights (SDR)

In 1969, the IMF introduced a scheme for the creation and issue of SDRs as
conditional reserve asset to influence the level of world reserves and to solve
the problem of international liquidity. It is a special scheme which has a unit
value fixed in gold. SDR is the international money existing only in the IMF’s
books and changing hands only in the ledger. But the members accept it as
payment. Therefore, this international money is known as paper gold. It
represents a new form of international paper money which can be used by
member countries to solve their BOP difficulties unconditionally and
automatically. Under the SDR system the member countries can use SDRs to
settle its international debt with other countries, in addition to gold, dollars,
pounds and normal rights with the IMF.

Features of SDR

1- SDRs are new additional international reserve asset

2- SDRs are like coupons

3- SDRs are transferable asset

4- SDR is the liability of the IMF but asset of the holder

5- It is not backed by asset like key currency

6- It is created on the basis of fundamental principles of credit creation

7- It is allocated among member countries on the basis of quota allotted to them

Uses of SDRs

1- To make use of US dollars, UK pounds and French francs to improve BOP

position in exchange of SDRs.
2- To make payment to IMF general account

3- To obtain balances of its own currency held by another country, in exchange

of the SDR by agreement with that country

4- To use swap arrangements

5- To make donation and settle financial agreements

Merits of SDRs

1- It is a new form of international monitor reserve

2- It cannot be demonetized like gold

3- It is costless to produce

4- It improves international liquidity

5- It is unconditional and automatic

Demerits of SDRs

1- It is an inequitable scheme

2- It is not linked with development finance

3- The interest rate on the use of SDR is high

4- It fails to distribute social saving.

INTERNATIONAL FINANCIAL MARKETS AND INSTRUMENTS.

International financial markets undertake intermediation by transferring

purchasing power from lenders and investors to parties who desire to acquire
assets that they expect to yield future benefits. International financial
transactions involve exchange of assets between residents of different financial
centre across national boundaries. International financial Centre’s are
reservoirs of savings and transfer them to their most efficient use irrespective
of where the savings are generated.

Functions

1- The interactions of buyers and sellers in the markets determine the prices of
the assets traded which is called the price discovery process.

2- The financial markets ensure liquidity by providing a mechanism for an

investor to sell a financial asset.

3- The financial markets reduce the cost of transactions and information.

International financial market may be classified in to two. One is International
money market and other is international capital market.
MOTIVES FOR INTERNATIONALIZATION OF FINANCIAL TRANSACTIONS

 Difference in interest rate

The interest rates in different countries are different. The interest rate
differentials across countries provide strong motivation for borrowing from
other countries or lending to other countries. Business corporations would like
to borrow funds from countries where the interest rates are lower compared
to the domestic interest rates. Similarly, investors with surplus funds would
like to transfer funds across countries seeking higher interest rates in other
countries.

 International diversification

Diversification of investment is a method of reducing the risk in investment.

The reduction in risk is generally proportional to the diversity of sectors over
which the investment is spread out. That is, the wider the diversity of sectors,
the larger the risk reduction expected. Different countries have different
economic conditions and resources, and experience different economic
performances. The diversity of economic conditions and performances across
countries offers unique opportunities to investors for larger risk reduction
through international diversification of their investment portfolios. An
internationally diversified asset portfolio is expected to have lower risk than a
domestically diversified portfolio. Creditors would also seek risk reduction
through diversification of their lending activities across countries

 Economic growth prospect

The developing countries have high potential for economic growth. Their rates
of growth are expected to be fairly high, compared to the growth rates in the
developed countries. Countries in the Asian region (such as China, India,
Malaysia, and Singapore), Eastern Europe and the Latin American region are
experiencing consistently high economic growth. These economies are
collectively referred to as emerging markets. Such Favourable economic
conditions attract investors and creditors to these regions from other
countries. Foreign entrepreneurs and business enterprises would be willing to
set up business units in these emerging/developing countries, seeking higher
profits.

 Exchange rate fluctuations

The exchange rates between different currencies fluctuate both in the short
term and the long run. The expectation regarding the future trends in exchange
rate movements also operate as a motivating factor for international financial
transactions. When a foreign currency is expected to appreciate against the
domestic currency, it would be advantageous for investors to purchase
financial securities denominated in the foreign currency which is expected to
appreciate. The income from such securities and the sale proceeds of the
securities to be received in the future would fetch more local currency on
conversion if the foreign currency appreciates as expected. Similarly, creditors
or banks would like to provide loans in currencies which are expected to
appreciate in the near future. In such cases, interest and loan repayments
would fetch more local currency on conversion. On the contrary, borrowers
would profit by borrowing in a foreign currency that is expected to depreciate
against the local currency in the near future. The foreign currency loan would
provide larger amount of local currency on conversion than the amount
required to purchase the foreign currency in future for repaying the loan. The
currency effect is a strong motivator for engaging in international financial
transactions.

SOURCES OF INTERNATIONAL FUNDS

 Multilateral Development banks or agencies

 Government/governmental agencies
 International banks
 Securities markets

INSTRUMENTS OF INTERNATIONAL FINACIAL MARKETS

 International Bonds
 Foreign Bond
 Euro Bond
 Global Bond
 Straight Bond
 Floating rate bond
 Convertible bond
 Zero Coupon Bond
 Callable bond
  Puttable
 Sinking Fund Bond
 International Equities
 GDR,ADR & IDR
 International Money Market Instruments
 Commercial Paper (CP)
 Certificate of Deposit (CD)
 Banker’s Acceptance (BA)

ADR_INVESTOPEDIA

ADR_&_GDR_(HINDI)

International money market

It is the market that trade debt securities or instrument with maturities of one
year and less. It is represented by the flow short term funds. In this market,
money and other liquid asset such as treasury bills, bills of exchange etc can be
borrowed or lent for a period of one year or less than one year. International
banks or short-term securities comes under this segment.

International Money Market Instruments

1- Eurodollar certificates of deposits

2- Euro notes

3- Euro commercial papers

4- Medium-term Euro notes

1- Eurodollar Certificates of Deposits: - Eurodollar certificates of deposits are
US dollar-denominated CDs in foreign banks. The maturities on Eurodollar CDs
are less than one year. Eurodollar CDs are issued in two forms- Tap CDs and
Tranche CDs

2- Euro Notes: - Euro notes are short-term notes similar to commercial paper.
These are like promissory notes issued by companies for obtaining short-term
funds. These have maturities of 3-6 months.

3- Euro Commercial Papers: - These are another short-term debt instrument.

These are issued by the dealers of commercial papers without involving a bank.
ECPs have longer maturity going up to one year.

4- Medium-term Euro notes: -

It is an extension of short-term euro notes. Issued for medium term (1 to 5

years). Medium term euro notes are issued to get medium term funds in foreign
currency without any need for redemption and fresh issue.

International capital markets

Capital markets deal with instruments whose maturity exceeds one year or
which lack definite maturity. It is a market where shares, bonds and other kind
of securities are traded and where fresh capital can be raised.

International capital market instruments

1- International bonds

2- Global depository receipts (GDR)

3- International equities

1- International bonds
It is a debt instrument issued by international agencies, Governments and
companies for borrowing foreign currency for a specified period of time. It is
divided in to two, one is foreign bonds and other is euro bonds.

2- Global depository receipts (GDR)

Depository receipt is a negotiable certificate issued by a financial institution

(depository banks) to represents the ownership of shares. These shares are
deposited with a local custodian appointed by a depository. This depository
issue receipts against the deposit of shares. Such receipts are called depository
receipts. These receipts are divided in to three. They are GDR, ADR and
international depository deposits. Overseas depository bank is a bank
authorized by the issuing company to issue

GDR against the ordinary shares of the issuing company.