The International Monetary Fund (IMF), is a supranational lending institution whose primary mission lies in furnishing short-term credit for countries suffering balance of payments deficits. Balance of payment deficits occur when a country’s outflow of money from transactions with foreign countries exceeds its inflow. Like its sister institution, the World Bank, the IMF was born of the Bretton Woods Conference. That 1944 meeting of international monetary officials put foreign exchange markets under a system of fixed exchange rates—a system that lasted until 1971. The IMF began operations in 1946 and in 1964 it founded its headquarters in Washington, D.C. Although the mission of the World Bank lay in financing development and reconstruction projects, the IMF bore responsibility for loaning foreign currency reserves to countries on a short-term basis.
An excess of imports and investment in foreign countries relative to exports and domestic investment financed by foreign investors causes an excess outflow of a country’s currency. This leads to currency depreciation in foreign exchange markets unless some type of market intervention occurs. A country can prevent currency depreciation by borrowing foreign currencies from the IMF and using these foreign currencies to purchase its own currency in foreign exchange markets, increasing the demand for its own currency and arresting its depreciation.
The funds of the IMF come from subscriptions of member countries, which contribute on the basis of such variables as national income and foreign trade. In 1946 member countries numbered 35, but by 1998 the number had grown to 182 countries. Soviet bloc countries did not join the IMF until after their transition to market countries. The United States has the largest quota of contributions and in 1998 contributed about 18 percent of all IMF funds. Each country contributes sums of its own currency, which serve as the IMF’s lending capital. Out of these funds the IMF might make foreign currency loans to countries that use the proceeds to buy up excess amounts of their own currency in foreign exchange markets. The borrowing country puts up its own currency as collateral for such a loan.
Perhaps the greatest economic innovation of the IMF during the period of fixed exchange rates was the development of Special Drawing Rights (SDRs), sometimes referred to as “paper gold.” By international agreement the SDRs are exchangeable for other currencies just as gold reserves.
Under the fixed exchange rate system the IMF loaned funds to countries that needed to intervene in foreign exchange markets to maintain the values of their currencies at the fixed rates. Under the floating exchange rate system the industrially developed countries had little need of the resources of the IMF. The IMF turned its attention to the less-developed countries, making longer-term loans to finance balance of payments of deficits, and granting soft loans to the poorest of the world’s countries. These balance of payments deficits allowed these countries to import capital.
The oil price revolution of the 1970s not only pushed the fixed exchange rate system to the breaking point, but also put a heavy burden on the less-developed countries of the world, which responded by incurring large amounts of debt to foreign lenders. During the 1980s high interest rates increased the cost of servicing this debt, and reduced exports to the recession-ridden United States, decreasing the inflow of dollars needed to service this debt. Many of the less-developed countries also turned to inflationary policies at home, further endangering the investments of foreigners. Under these conditions the IMF assumed the thankless task of requiring these countries to follow responsible monetary and fiscal policies as a condition for receiving additional IMF credit. The IMF usually requires policies of high interest rates, depreciated currencies, and smaller budget deficits, translating as less social spending. Private lenders often refuse credit to countries that fail to follow IMF adjustment programs.
The decade of the 1990s kept the IMF unusually busy. The decade opened with Soviet bloc countries making the transition to market economies and needing domestic currencies convertible into hard currencies at stable exchange rates. The IMF provided expertise on the organization of central banks and supplied loans of hard currencies such as U.S. dollars to help these countries stabilize their currencies at stable exchange rates. In 1995 Mexico fell victim to a severe financial crisis, prompting the IMF to extend a record loan of over $17 billion dollars to that country. Toward the end of the decade global financial crisis was placing heavy demands on the resources of the IMF. By the end of 1998 Russia had received over $20 billion in loans, and $35 billion was committed to Korea, Indonesia, and Thailand to assist with the Asian financial crisis.