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India’s Relations With The International Monetary Fund (IMF) 25 Years In Perspective 1991-2016  India’s Relations With The International Monetary Fund (IMF) 25 Years In Perspective 1991-2016 V. SRINIVAS Vij Books India Pvt Ltd Indian Council of World Affairs...

India’s Relations With The International Monetary Fund (IMF) 25 Years In Perspective 1991-2016  India’s Relations With The International Monetary Fund (IMF) 25 Years In Perspective 1991-2016 V. SRINIVAS Vij Books India Pvt Ltd Indian Council of World Affairs New Delhi (India) Sapru House, New Delhi  Published by Vij Books India Pvt Ltd (Publishers, Distributors & Importers) 2/19, Ansari Road Delhi – 110 002 Phones: 91-11-43596460, 91-11-47340674 Fax: 91-11-47340674 e-mail: [email protected] web : www.vijbooks.com Copyright © 2019, Indian Council of World Affairs (ICWA) ISBN: 978-93-88161-62-6 (Hardback) ISBN: 978-93-88161-63-3 (ebook) Price : ` /- All rights reserved. No part of this book may be reproduced, stored in a retrieval system, transmitted or utilized in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without the prior permission of the copyright owner. Application for such permission should be addressed to the publisher. The views expressed in this book are of the author in his personal capacity and do not represent the views of the ICWA. This book is dedicated to my wife Smt. Satyasree Pamulaparthy and our two beloved children Snigdha and Pranav  Contents Foreword ix Preface xiii Acknowledgements xvii Chapter - I The International Monetary Fund 1 Chapter - II Major Financial Crisis: From Great Depression to The Great Recession 25 Chapter - III India’s IMF Programmes—1966 and 1981: An Analytical Review 49 Chapter - IV India Circa 1991 – Origins of the Crisis 61 Chapter - V The Union Budgets 1991-96 81 Chapter - VI The IMF View - India’s Stand-By Arrangement 97 Chapter - VII Evolutionary Changes in India-IMF Relations 119 Chapter - VIII The IMF’s Article IV Consultations 1997 – 2016 135 Chapter - IX Finance Secretaries, Governors of RBI, Chief Economic Advisors and Executive Directors 151 Chapter - X My Years With The IMF 187 Chapter - XI G20 – A Decade in Multilateralism 205 Chapter - XII The Rise of China in the International Monetary System 223 Chapter - XIII Conclusion 245 Index 259 vii  Foreword The word International Monetary Fund (IMF) evokes strong reaction among many people in India. It is viewed as an institution that interferes with the conduct of public policy in India. It is sometimes viewed as an institution that propagates capitalist ideology and globalisation to the benefit of advanced economies and to the detriment of developing countries like India. No doubt, there are some elements of truth in these reactions, but the reality is that India is itself an important member of the IMF, sort of one of owners contributing to its capital. The origin of the IMF can be traced to the Breton-wood Conference convened in 1944 for purpose of formulating post-war currency system. India was invited to attend the meeting, though it was not yet independent. India, thus, became a founder member of IMF in December 1945 even before Independence. However, since Soviet Union did not join the IMF and the Peoples’ Republic of China was not represented in the IMF, the institution was identified with the capitalist system as distinct from the socialist block led by Soviet Union. The picture, however, changed in 1980s with the expanded membership to include them. India is not only a founder member, but for some time it was the 5th largest shareholder. In addition, it had been the leader of the voice of developing countries – a voice that has been disproportionately large relative to its voting power. In recent years, India has also emerged as an important player in the global economy and, therefore, in the functioning of the IMF. IMF is in the nature of a club where member countries come together to observe some rules of the game relating to international monetary system. The members of the club are entitled to draw resources when ix  India’s Relations with The International Monetary Fund needed. In some ways, IMF is a sort of lender of last resort. India has also been a beneficiary of resources from IMF in times of difficulties. While IMF is a cooperative institution, the voting power of the members is not equal. The voting power represents broadly the importance of the country concerned in terms of share in global economic activity in trade, etc. The United States of America has effective veto power. Its governance represents unequal economic and political strengths of member countries in the world. IMF is a creature of governments. Governments are political animals. A creature of such governments cannot but be political, to varying degrees. The major issues relating to IMF are: a) the governance of IMF and associated ideological biases; b) its asymmetric treatment of countries in its surveillance; c) differentiated conditionality prescribed as between borrowing countries; d) its failure in recognising the contribution of borrowers; e) its incapacity to resolve sovereign debt restructuring issues; and finally f) developing a system to replace U.S. Dollar as a de facto global currency since 1970s. There have been several controversies in regard to the IMF. Recent controversies relate to its failure in anticipating global financial crisis of 2008, its operations in Latin America, East Asia and Euro Zone. The impression has been that IMF has been somewhat soft in its conditionality in Latin America. IMF was severely criticised for the avoidable pain it imposed through conditionality in Asia. Its involvement in the Euro Zone crisis and making available resources to advanced economies with political overtones was, perhaps, the most controversial of its recent programmes. IMF is criticised for its ideological association with U.S.A. However, more recently it has demonstrated dilution of its adherence to pre-conceived ideas. This is evident from its approach to capital account management. At one stage on run-up-to-the global financial crisis in 2008, IMF did not have enough income to pay for its up-keep. As a result of great moderation, there was no demand for resources from IMF. There was a suggestion that the world no longer needs IMF and that it could be wound up since there were no takers for its money or services. However, the dominant view was that it should continue to be supported in case the need x  Foreword arises. So, to get over the difficulties, gold in IMF’s stock of reserves was monetised. India is one of the countries that bought the gold. In 1991, India pledged gold to manage the crisis, and IMF gave support. By 2008, India was ready to buy IMF’s gold. These should be convincing illustrations of productive partnership between IMF and India. As it happened, IMF became a focal point for global coordination in the global economy facing prospects of serious depression in 2008, and India has been a strong supporter of multilateralism. In all these deliberations, India’s leadership including professional inputs was conspicuous by its presence. The conclusion seems inevitable. Contrary to the popular beliefs, the partnership between India and IMF has been one of great mutual benefit. Mr. V. Srinivas has done an excellent service by bringing on record in detail with insights, many of the interactions between India and IMF. The Book fills a serious gap in the existing literature on the subject by providing an updated analytical and objective account of India and IMF relationship. It should be of great interest to academics, policy makers and indeed general public too. September 24, 2018 Y.V. Reddy xi  Preface The 2002 Annual Meetings witnessed unprecedented large-scale protests against the policies of the IMF and World Bank. The Anti-Globalization Protestors blocked Pennsylvania Avenue. The Washington Post dated September 27, 2002 said that anti-globalization protests were against the IMF programs in Brazil, Argentina, debt relief program for Africa and IMF’s maniacal support for privatization policies. The millions of protestors cried out that they were pushed into unemployment, poverty and debt by the IMF programs. 2002 was my first visit to the International Monetary Fund, as Private Secretary to Finance Minister, I was a member of the Indian delegation led by the Finance Minister to the Fund-Bank Annual Meetings. India had played several roles in the Fund, as a Founding Member and Owner; as a Borrower and then as a Creditor Nation. India’s continuous engagement with the IMF has been mutually beneficial. Some of India’s most distinguished civil servants, economists and central bankers have served as Executive Directors of India to the IMF. The Fund looks resplendent in Annual Meetings with delegations from 184 member countries, comprising of Finance Ministers, Central Bank Governors, Financial Sector Specialists, Development Economists and representatives of Non-Governmental Organizations. The Fund-Bank meetings represent the best elements of multilateralism and functional democracy. They are also the biggest gathering of top financial leadership of the world. There are several sub-components of the Fund-bank Annual Meetings–the IMFC (International Monetary and Finance Committee) meetings, the World Bank Governors meeting, the Plenary Meetings, the G7 meetings, G24 meetings, G20 Central Bank Governors meetings, bilateral meetings on the sidelines of the Annual Meetings, meetings with xiii  India’s Relations with The International Monetary Fund the Managing Director IMF and President World Bank and some of the top American think tanks. The world of Finance Ministers is driven by macroeconomic stability, control of inflation, promoting economic growth and boosting investments. In 2002, India’s economic growth was on an upswing and there was buoyancy in the economic outlook. The Finance Minister presented a rosy picture of India’s economic progress at the meetings of the IMFC, G20 and G24. At the IMFC, Indian Finance Ministers, largely stayed the course with the IMF’s themes of fiscal integrity, monetary restraint and structural reform with support for trade liberalization, and exchange rate management. India never held the chairmanship of the IMFC despite being an original member of the IMF. The IMFC is the apex committee to oversee the work of the IMF Executive Board. The IMFC is headed by a Finance Minister who is elected to office in his home Nation and continues to hold chairmanship of the IMFC till such time he demits office of the Finance Portfolio. Gordon Brown, as Chancellor of Exchequer of United Kingdom, had one of the longest stints in recent years as IMFC chairman. When he demitted office of Chancellor of Exchequer and along with it the position of Chairman IMFC, the IMF chose the Egyptian Finance Minister and then the Finance Minister of Singapore and subsequently the Governor of the Central Bank of Mexico as Chairman. It is rather surprising why India, currently the fastest growing major economy in the world never held chairmanship of IMFC even as other emerging market economies have held the highly influential position. For 5 years, I attended the Fund-Bank Spring and Annual Meetings in my capacities as Private Secretary to Finance Minister and subsequently as Advisor to the Executive Director (India) to the IMF. I attended an average of 17 Executive Board meetings every month for 38 months in my tenure in Washington DC. Globalization challenges were a constant theme of discussions. Many countries were concerned that globalization policies were not working. Globalization of finance was to result in capital flowing from advanced economies to the developing economies. Instead capital moved from poor countries to advanced countries. Reduction of tariffs and global free trade were assumed to be the growth model for developing economies. Instead xiv  Preface even Advanced Economies were not very enthused by free trade and looked at protectionist policies. Globalization was to enhance employment opportunities in countries with low wages. Instead in many cases massive job losses were witnessed and transnational Companies shifted capital with little accountability. There was a constant discussion in the Executive Director’s office if India had got anything more from the IMF than its due. We received technical assistance in the form of an RBI-IMF Institute at Pune, our quota was not entirely in accordance with the size of the economy, and India’s program financing was in accordance with the permissible quota norms. India never received exceptional financing like Korea or Argentina or Brazil. India never defaulted on IMF loans unlike many other borrowing countries. The IMF’s balance sheet in 2003 showed an outstanding loan of US $ 28 billion to Brazil, US $ 24 billion to Turkey, US $ 15 billion to Argentina and US $ 10 billion to Indonesia. Not all IMF loans are repaid and not all are repaid quickly. The Fund is a highly legalistic organization driven by rigid compliance of the Articles of Agreement and the Guidelines on Conditionality. The Articles of Agreement of the IMF are synergetic with the ideological viewpoints of economic liberalism and democracy. There are a number of Indians who served the IMF as Staff. They are brilliant economists well versed in the ideals of Keynesian Macroeconomics. The collective intellectual firepower of macroeconomists that the IMF carries is unmatched by any organization in the world. As the lender of the last resort and as the confidential advisor to the member countries on macroeconomic policies, the Fund’s views were taken seriously by Governments and Central Banks in addressing the external imbalances. India has had unique distinction of a number of staff exchanges. Several Chief Economic Advisors of India have been IMF Staffers. Ashok Lahiri, Raghuram Rajan, Arvind Subramanyam have all served at the IMF. One of the major reasons for the seamless implementation of the 1991 program was the synergy between the India’s top bureaucracy and the IMF Staff. There was an intellectual convergence of ideas on structural reforms and Fund conditionality. There were a lot of Indians who worked as staffers on the IMF. They were a part of an international bureaucracy and had reached high positions xv  India’s Relations with The International Monetary Fund as high meritocracy in an organization dominated by Americans and Europeans. Shailendra Anjaria, Anoop Singh, Sidharth Tiwary, Kalpana Kochhar, Ratna Sahay and several others served with high distinction on the IMF. In the Independent Evaluation Office Montek Singh Ahluwalia served as Director. A few of them returned to India to serve in the Ministry of Finance. xvi  Acknowledgements It is not an easy task for a serving civil servant to write a book. A subject of the complexity of India and IMF required a lot of research work and interactions with a number of senior officials who were involved with IMF. I was deeply driven to timely completion of my research work, and worked tirelessly to reach the end goal. My research work commenced on March 22, 2017 and concluded on July 8, 2018. Every day I wrote, every weekend, I worked for 12-14 hours on the book research. The IMF represented the greatest institution that I had served in, a global institution without parallel whose ideals of economic liberalism and democracy always inspired me. My wife and children put up with my obsession to write this book as I immersed myself into research and documentation for long hours. I am deeply grateful to them. I was encouraged to take up this task by Ambassador Nalin Surie, Ambassador Bhaswati Mukherji and Smt. Kalyani Shankar. I discussed the subject of my Book Research Proposal with Ambassador T.C.A. Raghavan, who had always encouraged me to pursue academic excellence since I first served with him in the Ministry of External Affairs. Following discussions with Ambassador T.C.A. Raghavan, I decided to submit a book research proposal titled “India and the International Monetary Fund” to the Indian Council of World Affairs (ICWA). Ambassador Nalin Surie was extremely kind to sanction the project from ICWA and advised me frequently on the modalities of the study. A book on India-IMF relations needed considerable inputs from India’s Central Bankers, Ministry of Finance officials and Chief Economic Advisors. Dr. Y.V. Reddy was extremely forthcoming in his guidance and outlined his vision for India-IMF relations, emphasizing that there was a convergence of views between the IMF staff and India’s Civil Servants during the 1991 economic reforms. Dr. Y.V. Reddy advised me to meet Dr. xvii  India’s Relations with The International Monetary Fund M. Narasimham to understand the 1981 IMF program. I visited Chennai to meet Dr. C. Rangarajan, he was kind to share with me his views on India’s 1991 IMF program, that the economic reforms were entirely home-grown. I met Dr. M. Narasimham at the Administrative Staff College Hyderabad, and spent an hour discussing India’s 1981 IMF program. My interactions with Dr. M. Narasimham were quite significant and I incorporated an additional chapter on India’s 1966 and 1981 IMF programs. Subsequently, I met Dr. Duvvuri Subbarao who advised me that the study of “India and IMF” has to take into consideration the “Rise of China in the International Monetary System” and “G20 – A Decade of Multilateralism”. I found the suggestions very forward looking and incorporated 2 separate chapters on both these topics. I also met Dr. Bimal Jalan and Dr. Rakesh Mohan, who were extremely forthcoming in their views on India’s economic reforms. I met a number of former Chief Economic Advisors of India – Dr. Nitin Desai, Dr. Deepak Nayyar, Dr. Shankar Acharya, Dr. Ashok Lahiri and Dr. Arvind Virmani and I am extremely grateful for their support. I met several colleagues in the Executive Director’s Office of IMF, Shri Bhaskar Venkatramany, Shri Kanagasabapathy Kuppuswamy, Shri Partha Ray and Shri Krishnan Saranyan for their inputs and guidance. I spoke to Executive Director (India) IMF Dr. Subir Gokarn a number of times to understand the changing role of the Fund post 2008. I had the opportunity to meet Dr. Montek Singh Ahluwalia and Dr. Rahul Khullar who served as Finance Secretary and Private Secretary to Finance Minister during the 1991 India-IMF program. The study of India-IMF relations is an area of considerable interest to several academic institutions. I was invited by a number of elite academic institutions for orations and talks. Some of the significant orations that I delivered included “Rise of China in the International Monetary System and Implications for India and Other Countries” at the Chennai Centre for China Studies, Chennai, “India and IMF” at the Kobe University, Osaka, Japan and at the Thammasat University, Bangkok, “Finance Commissions, NITI Aayog and GST Council” at the India International Centre, New Delhi, “Rise of China in the International Monetary System” at Indian Council of World Affairs, Sapru House, New Delhi, “G20: A Decade of Multilateralism” at the Nehru Memorial Museum & Library, Teen MurtiBhavan, New Delhi; “India at 70: Relations with IMF” at the India xviii  Acknowledgements International Centre, “Fiscal Federalism in India” at the Institute of Social Sciences, New Delhi, “World Economic History: Major Financial Crisis 1932-2017” at the National Archives of India, “Archiving the History of the Reserve Bank of India” - the International Archives Day Oration at the Reserve Bank of India Pune, and “India’s Economic History” at the 92nd Foundation Course, Lal BSNAA Mussoorie. The Executive Director(India) IMF invited me for an address at the IMF Headquarters, Washington DC in October 2018. I received immense support from the Library Staff of ICWA where I spent 120 days from 9 am to 6 pm, Shri A.O. Khan and Smt. Shashi Rawat in particular were extremely helpful in identifying the old newspaper collections dating back to 1966. I spent a number of days in the Library rooms at the National Institute of Public Finance and Policy and the Nehru Memorial Museum and Library going through several documents of historical value. I must mention the support given by Shri Mohammad Asif Khan in my work at the National Institute of Public Finance and Policy. I also visited the Parliament House Library for the Lok Sabha and Rajya Debates on 1991 economic reforms. Shri D.Ramesh the Library Assistant helped with identifying the various debates in Parliament in 1991-1996 period. I was posted as Chairman Board of Revenue for Rajasthan Ajmer and Chairman of the Rajasthan Tax Board from July 2017 and my office staff of Shri Satyamanyu Singh and Shri Naveen Anandkar supported me with the various inputs during this period to complete the work. (V. Srinivas) Chairman Board of Revenue for Rajasthan and Chairman Rajasthan Tax Board dated October 1, 2018 xix  Chapter - I The International Monetary Fund This chapter deals with the evolution of the International Monetary Fund for promotion and maintenance of monetary and financial stability in individual countries and at the international level. India is an original member of the International Monetary Fund. This chapter also provides an introduction to the mandate and functions of the International Monetary Fund as lender of the last resort in handling the economic crisis. The International Monetary Fund is amongst the most conservative financial Institutions in the world. Central Bankers and Macroeconomists are serious individuals. The 24 member IMF Executive Board meets three days a week, Mondays, Wednesdays and Fridays and considers 4 agenda items every day. The management of the Fund is the collective responsibility of the Managing Director and 4 Deputy Managing Directors. The Executive Board is the main decision-making body of the Fund, sitting in continuous session, with each of the 24 Executive Directors representing constituencies by their nationalities. Each member country is assigned a quota that determines the voting right and borrowing limits. The Executive Board exercises the onerous responsibilities of bilateral and multilateral surveillance, implementation of Stand-by Arrangements and Poverty Reduction and Growth Facilities and oversees Technical Assistance Programs. It is difficult to envisage a more driven organization with a global agenda than the International Monetary Fund. India is an original member of the IMF. Its bustling democracy and reform-oriented leadership always received support from the Fund 1  India’s Relations with The International Monetary Fund management. As a member of the G 20 and G 24 member countries, with a chair at the IMF since 1944, India’s contribution to the IMF has been phenomenal. India lends a powerful voice of support for African member countries on PRGF programs in the IMF Board. It acts as a bridge between the G 7 member countries and Emerging Market economies, a supporter for reforms in the CIS member States and above all a voice for economic progress and development in all of South Asia. India’s quota was the fifth largest in 1945. There were serious concerns in Parliament over the utility of membership of the IMF especially when the whole system of quotas worked as to give predominance to the United States of America while undermining the economic significance of India. That said, it was felt that India should lend its support to an Institution which was intended to put an end to the disastrous practices of competitive depreciation of currencies by establishing exchange rates. India’s membership to the Fund was duly ratified by the Legislative Assembly on 29th October 1947. Following the 7th Quota review, India lost its nominated seat on the IMF and had to settle for an elected seat. India’s position on the elected category was further eroded when the Government of the People’s Republic of China sought to re-enter the Fund in April 1980. Today, China has the 3rd largest quota on the IMF and India has the 8th position. IMF’s Managing Directors in India Christine Lagarde the Managing Director IMF was in New Delhi to address the students of Lady Shriram College on March 16, 2015 on the subject “Seizing India’s Moment”. This is what she said. “Here is your country. This is a special moment for India. Just as many countries around the world are grappling with low growth, India has been marching in the opposite direction. This year already, India’s growth rate is expected to exceed that of China, and by 2030, India will overtake China as the most populous country in the world. The conditions are ripe for India to reap the demographic dividend and become a key engine for global growth. We look forward to seeing India becoming even more active on the global stage—in fora such as the G-20 and the IMF. The IMF is a global multilateral institution where countries like India deserve a bigger say. We are working precisely on that—on implementing reforms that would lift India to the top 10 shareholders at the IMF…Today, the elements are all 2  The International Monetary Fund aligned to make India a global powerhouse. This is India’s moment. Seize it. Chak De India!” Dominique Strauss Kahn one of the most charismatic Managing Directors of IMF echoed similar sentiments too. In a 2010 speech at the FICCI in New Delhi Strauss Khan said the following: “Since my last visit to India—about three years ago—the world has suffered the worst financial crisis since the 1930s. India has weathered the crisis remarkably well, thanks in large part to sound macroeconomic and financial policies. Now, India’s growth is amongst the highest in the world—making it a driving force of the global recovery. India has traveled a remarkable distance over the last generation. Rapid growth has lifted hundreds of millions out of poverty. And innovation has put India in the vanguard of technologically advanced nations. India has truly become an economic superpower. The time has come for India—and Asia more generally—to play its rightful role in the global framework of economic governance.” For decades India had lent its voice to the IMF promoting the values of democracy and liberalism. It had joined the Fund despite grave reservations from its delegation members at the Bretton Woods conference in 1944. The IMF was an institution that India had sustained and helped it grow to the global Institution that it is today. In 2009 India’s committed to invest US$10 billion in IMF notes. The IMF welcomed the announcement by India’s intention to support the Fund’s lending capacity through the purchase of up to US$10 billion worth of IMF notes. The Fund said that the investment will help underpin the international financial system by ensuring the Fund has adequate resources to meet the financing needs of its membership, demonstrating the commitment of the Indian authorities to multilateral cooperation. The Evolution of IMF The IMF was established in 1944 following the Bretton Woods Conference. The world economy has witnessed dramatic changes since that time. For instance, the IMF’s membership has grown four-fold, from around 40 to 184. The IMF has continually evolved to meet the needs of its members and the international economic system. In the first half of the 20th century, nationalism and protectionism disrupted this integration, setting off the 3  India’s Relations with The International Monetary Fund Great Depression and contributing to World War II. The IMF—and the World Bank—were established to restore an open system of trade and finance, help countries rebuild from the war and, in the process, hopefully, build a new era of world peace and prosperity. In 2008 following the Great Recession, the IMF has led the international policy cooperation dialogue for stabilizing the global economy. The world’s financial landscape has dramatically altered over the past 70 years, with the rise of private international capital flows. The IMF’s mandate is promotion and maintenance of monetary and financial stability, in individual countries and at the international level. The IMF discharges this mandate in a variety of ways. It provides the framework and mechanisms for international economic cooperation through the annual IMFC and G-24 meetings. Second, the IMF helps countries design macroeconomic policies that achieve and maintain high levels of employment and income. The promotion of open economies and trade is a key element of these policies. Third, the IMF helps in the orderly correction of a country’s balance of payments problems by providing temporary financing. The International Monetary Fund represents an institution of immense asymmetric economic power. The IMF’s active lending role requires sustained involvement in countries facing an economic crisis, in the formulation of macroeconomic policies. The major events that shaped the IMF namely the Paris peace conference, the Great Depression, and the Second World War, made the creation of a multilateral financial institution possible and largely determined the form it would take. Subsequent events caused the IMF to alter its practices in various ways to stay relevant in a changing world. The absence of the Soviet Union Block of countries made the IMF, largely a capitalist club that helped stabilize market-oriented economies. The bulk of IMF analysis has always been mainstream and centrist, viewed from the perspective of the dominant strain of Anglo- Saxon economics. The leading universities of North America, the United Kingdom, and Australia have been the main training grounds for much of its professional staff. The IMF evolved over the years and underwent a number of changes. Its strengths are the depth of its surveillance in accordance with the needs of the member countries. The Fund represents the most conservative of 4  The International Monetary Fund global institutions, its ambience always projecting an environment of seriousness of purpose. For an organization with a global mandate as the lender of last resort, it has a small establishment, with about 1100 economists. The Fund’s economists work in various departments with India being handled by the Asia Pacific Department. The Fund’s development in the 1970s was marked by a series of challenges. The global oil crisis made restoration of pre-crisis economic growth to rates, reduce inflation and manage exchange rates for member countries a priority issue. The Fund was also called upon to finance current account deficits for oil importing countries. By 1980s the fiscal deficits in a majority of countries across the world had enlarged. There was a sharp increase in lending rates from 1 percent in the 1970s to 6 percent in 1980s. As a result, a number of countries were not able to service their external debts. There was a surge in IMF funding to developing countries, the quality of adjustment programs and Fund’s financial portfolio was under stress. The surveillance procedures were weak as the Executive Board was reluctant to establish procedures that would cast a shadow on the member’s economic policies. The global debt crisis of 1982-83 was the product of massive shocks to the world economy and serious misjudgments in the conduct of economic policy. The 1982 Debt Crisis changed the approach of the Fund significantly. The Washington Consensus was to reduce the state ownership and control. The Fund’s assessment of the correct level of real exchange rate was based on a model linking that level of macroeconomic policies to the behavior of the nominal exchange rate. The Fund recognized that macroeconomic adjustment alone would not be sufficient to cure the structural imbalances. It focused on reducing the roles of state ownership and control without exposing developing countries to instability and domination by more established economies and multilateral corporations. The Fund programs focused on Fiscal Integrity, Monetary Restraint and Structural Reforms. In the 1980s the demand for Fund resources rose rapidly with 73 of the 152 members having financial obligations and 22 countries implementing Stand-by Arrangements. Poland, Romania, Hungary, Mexico, Argentina and Brazil all witnessed severe debt crisis. The Fund’s approach was reduction in subsidies, raise taxes, reduce public sector borrowings, 5  India’s Relations with The International Monetary Fund increase domestic interest rates and successive mini-devaluations. Surveillance was intrusive and deep as donors did not have separate instruments for surveillance and relied extensively on Fund inputs. Delays in implementation of reforms made donors skeptical. Negotiations with creditors occurred on many fronts from creditor countries to banks. The Fund often found it difficult to distinguish strategies of one country from the other. African Independence resulted in significant enlargement of IMF membership. Only three of the IMF’s 40 original members were in Africa: Egypt, Ethiopia, and South Africa. 53 African countries joined the IMF as members by 1990. The fall of communism in 1991 resulted in further expansion of the IMF membership taking the total membership to 172. The IMF Executive Board expanded from 22 to 24 Members in 1991 where it stands till date. The IMF functions on a specific set of economic ideas. The primary amongst them is Keynesian macroeconomics emphasizing the use of countercyclical monetary and fiscal policies. The second is the Jacques Polak model of monetary approach to balance of payments. This approach designed in the 1950s says that if a country has balance of payments deficit, it can be resolved by reducing the domestic credit of banking system by fiscal and monetary means. The other major ideas that dominate the Fund’s policy are Flexible Exchange Rates, Supply side macro-economics and inflation targeting. The IMF’s purposes, and its operational activities were designed with a key objective of fostering healthy national economies, linked by finance and trade, as the foundation for a robust global economic system. Global per capita income has more than tripled since 1944, and amongst the biggest gainers have been the developing nations —whose ranks include Brazil, Chile, China, India, Korea, and Mexico— which were able to double their share in world trade, raise per capita incomes, and lift millions out of poverty. The IMF is an open and transparent institution. The Fund’s governing organs are the Executive Board and the International Monetary and Financial Committee (IMFC) assist the IMF management in carrying forward the reform process. 6  The International Monetary Fund The Fund’s oversight of the global financial stability is three-pronged (a) Surveillance (b) Monitoring of Financial sector and capital markets and (c) Financing and Lending. Surveillance involves monitoring of economic and financial conditions, both at the global level and in individual countries. For the IMF, surveillance is a central instrument for maintaining monetary and financial stability. By obliging each IMF member to engage in a regular consultation on its economic policies, the surveillance process also explicitly recognizes the role that all countries play in maintaining global stability. The IMF has often stated the central task of the Fund surveillance lies in a stronger and better-focused surveillance process. IMF surveillance provides the foundation for cooperation among member nations in the promotion of stability and growth in the global economy. Systemically important countries are given special attention. Further, the IMF has been carrying out comprehensive financial sector surveillance covering the financial sector and capital markets. The IMF conducts Financial Sector Assessment Program (FSAP) exercises for all participating member countries of systemic importance. The IMF’s lending role is focused on assisting members with balance of payments adjustments. Through the temporary provision of funds, the IMF lending gives members breathing room to implement policy measures to overcome underlying economic problems. For the poorest countries, financing may be provided on concessional terms, and with longer maturities. The availability of IMF funds to assist in economic adjustment gives confidence to members and the international system as a whole. The Fund has played a traditional role in financing and lending to help prevent capital account crises and their contagion effects. To succeed in this role, the IMF exercises selectivity in supporting only those adjustment programs that will put the relevant members firmly on the path to external viability. The existence of robust domestic institutional frameworks, and strong national ownership of programs, are the key. Building on these principles, the IMF seeks a consensus between the member country and lenders on the appropriate circumstances and scale for IMF lending, the possible need for additional financial instruments, and the adequacy of the present framework for the orderly resolution of sovereign debt problems. 7  India’s Relations with The International Monetary Fund The Fund also provides technical assistance. Technical advice and assistance is provided to member countries in areas of the IMF’s expertise, primarily in macroeconomic and financial policymaking. By helping to build institutional and human capacity for the making of sound economic policies, IMF technical assistance contributes to the building of strong economies and stable growth. Creation of IMF – India, an Original Member The United Nations Monetary and Financial Conference at Bretton Woods in July 1944 witnessed a consensus between 44 countries for the creation of the International Monetary Fund and the World Bank. India was represented at the Bretton Woods Conference by a six-member delegation including the Finance Minister Sir Jeremy Raisman, the Governor of the Reserve Bank of India Sir C.D. Deshmukh, and Mr. A.D. Shroff. The Indian delegation made a plea for adequate representation in the management of the Fund, and a workable agreement with the Government of the United Kingdom for liquidation of her sterling balances. Mr. A.D. Shroff in his statement at the Bretton Woods Conference said that: “What I ask for is a multilateral settlement of a portion of our balances. The purpose set out in our agreement are two: To secure a multilateral convertibility for a reasonable portion of our balances and secondly to devise a formula so as not to place undue strain on the resources of the Fund. We have not disguised from the Conference the very strong feeling in our country on this question. It may be that unfortunately situated as we are politically, perhaps the big guns in the Conference may not attach great importance to a country like India. But I am bound to point out this, if you are prepared to ignore a country the size of India, with four hundred million population and with natural resources though not fully developed, yet not incomparable to the natural resources of some of biggest powers on this earth, we cannot be expected to make our full contribution to the strengthening of the resources of the Fund. Suppose you don’t accept our position, you are placing us in a situation, which I may compare to the position of a man with a million-dollar balance in the bank but not sufficient cash to pay his taxi fare. That is the position you put us in.” 8  The International Monetary Fund The United States delegation expressed its sympathetic understanding of the importance of India’s problem but took the view that the problem of wartime indebtedness will be settled directly by the countries concerned directly in a spirit of mutual understanding. The United Kingdom delegation said that they were grateful to those Allies and particularly to our Indian friends who put their resources at our disposal without stint and themselves suffered as a result. Lord John Maynard Keynes said that “we appreciate the moderate, friendly and realistic statement of the problem, which Mr. Shroff put before you today. Nevertheless, the settlement of these debts must be a matter between those concerned.” Despite having lost the battle for orderly liquidation of sterling balances, India still participated in the Fund and the World Bank. The membership of the International Monetary Fund proved beneficial to India in the longer run. India benefitted from the Fund’s technical advice in Article IV discussions, participated in the international monetary discussions, gained valuable information and also established training institutions in India in collaboration between the Reserve Bank of India and the International Monetary Fund. Another important advantage India gained by becoming a member of the Fund is the membership of the World Bank. No Nation can become a member of the World Bank without being a member of the Fund. India received substantial loans for financing several developmental projects from the World Bank. The charter for the International Monetary Fund (IMF) was drawn up by John Maynard Keynes, the head of the British delegation at Bretton Woods, and by Harry Dexter White, the principal member of the U.S. delegation. Over the next 6 decades, the IMF became the leading international financial institution in the world acting as a lender of the last resort in all major economic crisis. IMF’s Articles of Agreement The purposes of the International Monetary Fund are laid down in Article I of the Articles of Agreement. So often was Article I referred to, in discussions on the Executive Board that the Managing Directors often carried the Article I of the Articles of Agreement in their pockets for ready reference. 9  India’s Relations with The International Monetary Fund The Fund is mandated to promote international monetary cooperation through a permanent institution, which provides the machinery for consultation and collaboration on international monetary problems; to facilitate the expansion and balanced growth of international trade; to contribute thereby to the promotion and maintenance of high levels of employment and real income and to the development of the productive resources of all member countries; to promote exchange stability, to maintain orderly exchange arrangements among members, and to avoid competitive exchange depreciation; to assist in the elimination of foreign exchange restrictions which hamper the growth of world trade. Further, the Fund has to give confidence to members by making the general resources of the Fund temporarily available to them under adequate safeguards, thus providing them with the opportunity to correct maladjustments in their balance of payments. In accordance with the above, the Fund has to shorten the duration and lessen the degree of disequilibrium in the international balances of payments of members. The Fund is also mandated to oversee the international monetary system to ensure its effective operation, and shall oversee the compliance of each member. In order to fulfill its functions, the Fund shall exercise firm surveillance over the exchange rate policies of members, and shall adopt specific principles for the guidance of all members with respect to those policies. Each member shall provide the Fund with the information necessary for such surveillance, and, when requested by the Fund, shall consult with it on the member’s exchange rate policies. The principles adopted by the Fund shall be consistent with cooperative arrangements by which members maintain the value of their currencies in relation to the value of the currency or currencies of other members. These principles shall respect the domestic social and political policies of members, and in applying these principles the Fund shall pay due regard to the circumstances of members. Quota Reform In December 2015, the US Congress adopted legislation to authorize the IMF 2010 quota and governance reforms and all the conditions for their implementation were met in January 2016. These wide-ranging historic reforms represented a crucial step for the Fund’s role in supporting global financial stability. Implementation of Quota reforms has enabled a more 10  The International Monetary Fund representative and modern IMF that is better equipped to meet the ends of its member countries in the 21st century. Under the quota reforms, more than 6 percent of the IMF quota shares were shifted to dynamic emerging market economies and developing countries and from over-represented to under-represented members. The four emerging market economies – Brazil, India, China and Russia are today amongst the IMF’s 10 largest member countries joining the United States, Japan, and the four largest European countries – France, Germany, Italy and the United Kingdom. The Advanced European economies committed to reducing their combined Executive Board representation by 2 chairs. Accordingly, the Belgium- Netherlands chairs have been merged and the Nordic Countries chair has been merged reducing the representation by 2 chairs. For the first time, all seats on the IMF Executive Board are held by Executive Directors elected by IMF member countries. Previously, five of the seats of the Executive Board were reserved for Directors appointed by members with five largest quotas. Further, multi-country constituencies with seven or more members have been permitted to appoint a second Alternate Executive Director so that their constituencies are better represented on the Executive Board. The quota shares of the 10 largest members of the IMF as of 2016 are the following: S NO COUNTRY QUOTA 1 USA 16.66% 2 JAPAN 6.21% 3 CHINA 6.14% 4 GERMANY 5.37% 5 FRANCE 4.07% 6 UNITED KINGDOM 4.07% 7 ITALY 3.05% 8 INDIA 2.66% 9 RUSSIA 2.61% 10 BRAZIL 2.24% 11  India’s Relations with The International Monetary Fund Exchange Arrangements and Surveillance The IMF’s oversight of the international monetary system and monitors the economic and financial policies is called surveillance. Fund surveillance covers 184 member countries. Article IV requires the Fund to conduct both bilateral and multilateral surveillance. Multilateral and bilateral surveillance are mutually supportive and reinforcing and accordingly have been operationally integrated despite being legally distinct. Under the Articles of Agreement, the IMF Member Countries shall notify the Fund of any changes in their exchange rate arrangements. In cases where a member pegs a currency, the member would notify the Fund of all changes in the peg. In the case of a flexible exchange arrangements, the members would communicate to the Fund any discrete exchange rate changes that are not consistent with the set of indicators. All members maintaining flexible exchange arrangements have to notify the Fund whenever the authorities have taken a significant decision affecting such arrangements and in all cases of decisions where public policy statements have been issued. The Managing Director is empowered to consult a member if no such notification is received and if considered appropriate can seek a notification from the member. The 2008 Great Recession and global financial crisis exposed the inconsistencies in the Fund surveillance necessitating significant changes. In July 2012, the IMF took an Integrated Surveillance Decision for Modernizing the Legal Framework for Surveillance. The decision said that there have been significant developments in the global economy that have highlighted the extent of trade and financial interconnections and integration and the potential benefits and risks spillovers across national borders. The Fund took the view of integrating bilateral and multilateral surveillance, including through the adoption of an integrated surveillance decision. The Fund clarified that there were no new obligations created for members other than the existing obligations. Article IV consultations would be used for both bilateral and multilateral surveillance with an enhanced scope of coverage and a careful prioritization of topics to be covered. Such an integration was expected to fill the important gaps in surveillance. The Fund reiterated the importance of dialogue and persuasion, clarity and candor, even handedness and due regard for member countries’ individual 12  The International Monetary Fund circumstances as part of Article IV consultations. The IMF replaced external stability with balance of payments stability to provide greater clarity to surveillance work. The Fund stated that it would focus on those policies of members that can significantly influence present or prospective balance of payments and domestic stability. The Fund will assess whether exchange rate policies are promoting balance of payments stability and whether domestic policies are promoting domestic stability and advise members on the policy adjustments necessary for the purposes. The 2014 Triennial Surveillance Review was conducted by the Executive Board in September 2014. The Fund identified five operational priorities for the 2014-2019 Surveillance. The priority areas were identified as risks and spillovers, macro-financial surveillance, macro- critical structural policy advise, cohesive expert policy advise and client focused approach to surveillance. Risks and spillovers represented a major issue for the Fund, even after the global crisis had subsided. The Fund sought a systemic analysis of outward spillovers and spillbacks in systemic countries, and greater quantification of the impact of risks and spillovers and spillbacks in systemic countries; and greater quantification of the impact of risks and spillovers in recipient countries, including through the presentation of alternate risk scenarios in Article IV Consultations. The Fund sought a deepening of analysis for sources and transmission of risks. Micro-Financial Surveillance was included as an integral part of Fund Surveillance along with Structural Policies. The Fund sought an analysis of macro-prudential policies and also micro-financial policies given the relationship between the financial sector and the real economy. Fund Surveillance was also to cover macro-critical structural issues and their macro-economic importance. As part of the cohesive expert policy advise, the Fund focused on strengthened efforts to improve the understanding of the inter-sectoral linkages and policy interactions, with focus on fiscal policy, growth and sustainability implications. A client-focused approach, effective communication and evenhandedness in surveillance were long-standing Fund approaches to Surveillance. 13  India’s Relations with The International Monetary Fund The Fund has adopted modalities for Surveillance over Euro Area Policies in the context of Article IV Consultations with member countries to cover monetary and exchange rate policies, regional perspectives and discussions with Euro Area institutions. Similarly, the Fund has adopted modalities for surveillance over Central African Economic and Monetary Union Policies, Eastern Caribbean Currency Union Policies, West African Economic and Monetary Union Policies. The Fund’s Surveillance had long recognized the importance of capital flows and policies to manage them. Massive surges and disruptive capital outflows posed serious policy challenges to the global economy post-2008. The Fund had an Institutional view of promoting capital flow liberalization for many decades. Amongst the major shifts in IMF positions in recent years was been the 2012 Institutional view on Trade Liberalization and Management of Capital Flows. The Fund took the Institutional view that it needs to remain flexible on issues of liberalization and management of capital flows taking into account specific country circumstances to be reviewed periodically. Capital flows have important benefits by enhancing financial sector competitiveness, facilitating productive investment and easing the adjustment of imbalances. There were considerable risks associated with the size and volatility of capital flows and premature liberalization had adversely affected many countries. The Fund took the view that capital flow liberalization needs to be well planned, timed and sequenced so as to minimize the possible adverse domestic and multilateral consequences. Further, the Fund took the view that in certain circumstances the capital flow management measures can be useful and appropriate. The circumstances include situations in which the room for macroeconomic policy adjustment is limited, or appropriate policies take undue time to be effective. Technical and Financial Services The Fund undertakes financial stability assessments (FSAP) where the financial sector of a member is systemically important under Article IV. The scope of the financial stability assessment contains an evaluation of the source, probability and potential impact of the main risks to macro- financial stability in the near term for the relevant financial sector. Such an evaluation involves an analysis of the structure and soundness of the financial system, trends in both financial and non-financial sectors, risk 14  The International Monetary Fund transmission channels and features of the overall policy framework that may amplify financial stability risks. It also undertakes an assessment of the effectiveness of the authorities’ financial sector supervision, the quality of financial stability analysis and reports, the role and coordination between various institutions involved in financial stability policy, and the effectiveness of monetary policy. In 2016, India’s financial sector was ranked 9th in size, 29th in Interconnectedness and has a 14th overall rank. United States was ranked 1st in size, 10th in interconnectedness and 3rd overall, while the United Kingdom was ranked 3rd in size, 1st in interconnectedness and 1st in overall rank. The IMF’s FSAP’s provide an in-depth assessment of stability risks and systemic resilience. After 2010, FSAP’s have been made mandatory for countries with systemically important financial sectors as a response to the global financial crisis. Country Ownership of Fund Programs The IMF extends credit to countries with an external imbalance, conditional on the country’s commitment to implement economic policies that will restore equilibrium. Fund conditionality serves two purposes – first it ensures the IMF’s financial resources are used for intended purposes to the benefit of the country and secondly it ensures that the IMF will operate as a revolving fund for the benefit of all member countries. The country authorities usually prefer conditional assistance as it comes relatively free of distorting influence of short-term political constraints that limit rational policy making. The willingness of creditor countries to influence the program may be enhanced by the perceived discipline conveyed by policy conditionality. The Fund has defined National Ownership as: “Ownership is a willing assumption of responsibility for an agreed program of policies by officials in a borrowing country who have responsibility to formulate and carry out the policies, based on an understanding that the program is achievable and is in the country’s interest.” Clearly establishing ownership is a two-way process, involving flexibility and responsiveness on the part of authorities of the borrowing 15  India’s Relations with The International Monetary Fund country and the Fund and external creditors. Given that several Fund programs have gone beyond the resolution of external financing problems, ownership and flexibility needs have increased. The Fund has a specific process of interaction between the international agency and the country based on partnership and flexibility. The initial discussions and negotiations commence with a letter of intent from the country authorities to the Managing Director of the IMF followed by a set of prior actions by the country authorities for fund approval. The letter of intent is followed by dialogue with the Fund for designing a program that is most suitable for speedy restoration external balances. Use of Fund Resources The IMF’s various loan instruments are tailored to different types of balance of payments need (actual, prospective, or potential; short-term or medium-term) as well as the specific circumstances of its diverse membership. Low-income countries may borrow on concessional terms through facilities available under the Poverty Reduction and Growth Trust. Concessional loans carry zero interest rates until the end of 2018. The IMF’s instruments for non-concessional loans are Stand-By Arrangements (SBA); the Flexible Credit Line (FCL); the Precautionary and Liquidity Line (PLL); for medium-term needs, the Extended Fund Facility (EFF); and for emergency assistance to members facing urgent balance of payments needs, the Rapid Financing Instrument (RFI). All non-concessional facilities are subject to the IMF’s market-related interest rate, known as the “rate of charge,” and large loans (above certain limits) carry a surcharge. The rate of charge is based on the SDR interest rate, which is revised weekly to take account of changes in short-term interest rates in major international money markets. The maximum amount that a country can borrow from the IMF, known as its access limit, varies depending on the type of loan, but is typically a multiple of the country’s IMF quota. This limit may be exceeded in exceptional circumstances. The Stand-By Arrangement, the Flexible Credit Line and the Extended Fund Facility have no pre-set cap on access. Stand-by Arrangements The Stand-by Arrangements are not expressly provided for by the Fund’s Articles of Agreement. They have been developed within the framework 16  The International Monetary Fund of the Articles and adapted with considerable flexibility to meet a variety of needs. The Stand-by Arrangements are a major feature of the Fund’s operations and a flexible instrument of financial assistance. The essential purpose of a Stand-by Arrangement is to assure a member of the Fund that the member can use the financial resources upto the quota held by the member in the Fund. The Stand-by Arrangement is entered into after consultations between the Fund and a member. The only document for a Stand-by Arrangement is a member’s letter or memorandum setting forth the policies and intentions utilization of Fund’s resources. Use of Fund’s resources, are not classified as loans. The words “Loan” and “Repayment” are carefully avoided in the Articles of Agreement. If a member needs to augment its foreign exchange resources in order to cope with its foreign payments problems, it purchases the currency or currencies of other members from the Fund and pays an equivalent amount of its own currency to the Fund. In order that the Fund’s resources may continue to revolve for the benefit of all members, the member is required to see that the transaction does not remain outstanding for a long period of time. Conditionality The goal of conditionality on IMF credit arrangements is to promote a combination of internal and external economic balance in borrowing countries. In its lending practices, the Fund seeks to help members to attain, over the medium term, a viable payments position in the context of reasonable price and exchange rate stability, a sustainable level and growth rate of economic activity, and a liberal system of multilateral payments. The Fund reviews the Guidelines on Conditionality on a periodical basis. Fund Conditionality is established on the basis of variables or measures that are reasonably within a member’s direct or indirect control and that are of crucial importance for achieving the goals of the member’s program. Conditionality also covered only those areas which are part of the Fund’s core areas of responsibility. These included macroeconomic stabilization, exchange rate policies, fiscal policies and measures related to functioning of institutions associated with these policies. The IMF handled a number of major crisis in 1980s and 1990s. The most important are the 1982 debt crisis in Mexico, Brazil and several countries of Latin America. This was followed by1992 Tequila Crisis in Mexico. The East Asian Crisis of 1998, the Korean Crisis 1998 and the 17  India’s Relations with The International Monetary Fund Brazil and Argentina Crisis in 2002. Turkey had a large IMF program in 2003-06 period. A detailed discussion on the world’s major financial crisis is taken up in the following chapter. Fund’s role in Low Income Countries The environment affecting low-income countries (LICs) and the Fund’s role in these countries have evolved considerably since the establishment of the Poverty Reduction and Growth Facility (PRGF), Poverty Reduction Strategy Paper (PRSP) process, and Enhanced Heavily Indebted Poor Countries (HIPC) Initiatives in the late 1990s. Notwithstanding pressures created by high food and fuel prices, macroeconomic policies and performance in LICs improved markedly. Many LIC’s benefitted from the highest growth and lowest inflation rates in decades. The Fund provided an important contribution to these gains as it refined its LIC involvement, placing a greater emphasis on the macroeconomic foundations of growth and poverty reduction. Greater flexibility was introduced in budget and inflation targets, the full use of aid was encouraged, and debt sustainability became a central tenet of good macroeconomic management, in the light of large-scale debt relief. The instruments to assist LICs were also modified and new ones created, including the Policy Support Instrument (PSI) and the Debt Sustainability Framework (DSF). The Fund has made substantial improvements in macroeconomic policies and performance in many LICs, and the gains made toward sustained growth and poverty reduction. There have been refinements and increased flexibility in the Fund’s approach in several key areas which played their part in facilitating these gains. Fund policy advice and program design have entailed greater flexibility in inflation and fiscal targets. The Fund has permitted prudent accommodation of larger fiscal and external deficits in the context of scaled-up aid and debt relief, have allowed increased spending in priority areas while placing a greater emphasis on debt sustainability. The Fund has also supported LICs in ensuring debt sustainability and avoiding a new unsustainable debt build-up. Shifting conditionality to measures critical for macroeconomic stability has helped focus the Fund’s work on its core competences and improve country ownership. The Fund’s engagement in LICs is outlined in its mission statement. The statement affirms that the Fund aims to help LICs achieve the 18  The International Monetary Fund macroeconomic and financial stability needed to raise sustainable growth and have a durable effect on poverty reduction. While recognizing that the Fund’s mandate is similar in all member countries, The Fund’s objective of achieving strong, sustained growth is an integral part of the policies to help LICs on stability path for achieving sustainable growth. The main channels for Fund’s engagement are macroeconomic policy advice, capacity-building assistance, and concessional balance of payments support. As in other member countries, the Fund focuses on its core areas of expertise, macroeconomic stabilization and fiscal, monetary, financial, and exchange rate policies, and the underlying institutions and closely related structural policies. The Fund’s work draws on country-owned development strategies, and its advice and engagement tailored to the specific characteristics of countries. Criticism of the IMF By 2002, the Fund was under severe criticism from economists Joseph Stiglitz, Alan Meltzer, Martin Feldstien, John Taylor and George Schultz and also by civil society that the IMF has outlived its mission and the time has come for it go into oblivion. The clarion call of the critics was “fifty years are long enough”. The issues pertain to the absence of adequate quota and voice for developing countries, resulting in the imposition of stringent conditionality for borrowings from the Fund exacerbating the problems in emerging market economies. The critics felt that the major issues and policies were not evolved in the Fund but in the G7 meetings with close to one half of the voting power of the Fund. They argued that the international monetary system would function better without the IMF as the leverage is with the G7. The counterfactual remains true that in the absence of the IMF, there will not be any other organization to finance countries in economic crisis. The Independent Evaluation Office (IEO) of the IMF has conducted an important study regarding the prolonged use of Fund resources in the case of Pakistan, Philippines and Senegal. The IEO defined prolonged use as any country that has been in Fund programs for atleast 7 years out of 10. The IEO said that the causes of prolonged use are partly the result of evolving Fund policies but are also due to lack of clarity in the Fund’s approach to the nature of the financial constraint and the design of Fund programs. Besides, in the 1990s the fund had set up a number 19  India’s Relations with The International Monetary Fund of concessional financing instruments which had limited availability of funding, necessitating long term involvement. The IEO also pointed out that in Stand-by arrangements, there was considerable over optimism with regard to projections of terms of trade, tax revenues, exports and there was a prolonged use of Fund resources in cases where the achievements were much lesser than projected. The IEO says thus: “The case studies show that during long period of IMF program involvement, significant progress towards solving these countries’ economic difficulties was eventually achieved in Philippines and Senegal and even more so in Morocco, although with a mixed record across areas of economic policy and at a much slower pace than originally envisaged. The record in Pakistan and Jamaica was more disappointing. In all cases substantial challenges remained at the end of the prolonged use period reviewed, especially as regards institutional reforms in tax administration and the broader public sector.” The IEO also addressed the question of Fund conditionality adversely affecting borrowing developing countries and impoverishing them. Fund conditionality comprises of prior actions and performance criteria which a country must meet to have access to Fund resources. On this the IEO said that the specific structure of conditionality is much less important than an underlying political commitment to core policy adjustment. Excessively detailed conditionality does not appear to have been effective in enhanced implementation. The IEO also found evidence that the conditionality focused on rules and procedures rather than onetime actions which was ultimately more effective. The IEO further said that ownership and implementation were the weak spots in Fund programs for prolonged users. The reason for this was the underestimation of the technical and political limits to implementation and the consequent over-optimism about the speed of success. The Fund also plays a gate keeper role providing signals to the private creditors that a clear assessment of that the member’s policies are strong enough to be supported. 20  The International Monetary Fund References 1. Lagarde, Christine, IMF Managing Director, Speech “Seizing India’s Moment” Lady Shri Ram College, New Delhi, March 16, 2015www. imf.org 2. Strauss-Kahn, Dominique, IMF Managing Director Speech, “India and the Global Recovery: Key Policy Challenges”, delivered at Federation of Indian Chambers of Commerce and Industry (FICCI) dated December 2, 2010www.imf.org 3. Press Release No 09/300 IMF Managing Director Dominique Strauss- Kahn Welcomes India’s Commitment to Buy up to US$10 Billion of IMF Notes, September 5, 2009www.imf.org 4. De-Rato, Rodrigo, IMF Managing Director Key Note address, “The IMF in a Changing World”, at the IMF/ Bundesbank symposium, Frankfurt, June 8, 2005www.imf.org 5. Press Release No. 16/91: IMF Executive Board Discusses Principles for Evenhanded Fund Surveillance and a New Mechanism for Reporting Concerns dated March 4, 2016www.imf.org 6. Report of the Coordinating Committee dated July 21, 1944 Bretton Woods Conference accessed from RBI Archives, Pune ACC No 44784 DEAP pages 27, 29-30, 31-32, 55-56 7. Kapuria R.S. “The Indian Rupee – A Study in retrospect and prospect”, 1967 Vora and Co Publishers Pvt Ltd. pp 115-130 8. Boughton, James M., American in the Shadows : Harry Dexter White and the Design of the International Monetary Fund IMF WP/ 06/6 January 2006www.imf.org 9. Boughton, James M., “The IMF and the force of History : Ten Events and Ten Ideas that Have Shaped the Institution” IMF WP/ 04/75; May 2004www.imf.org 10. Boughton, James M., “Who’s in Charge? Ownership and Conditionality in IMF Supported Programs” IMF WP 03/191; 2003www.imf.org 21  India’s Relations with The International Monetary Fund 11. Reinhart, Carmen M., and Christoph Trebesch. “The International Monetary Fund: 70 Years of Reinvention.” The Journal of Economic Perspectives, vol. 30, no. 1, 2016, pp. 3–27www.imf.org 12. Gold, Joseph., “The Law and Practice of the International Monetary Fund with Respect to Stand-By Arrangements” International and Comparative Law Weekly, January 1968www.imf.org 13. Public Information Notice No 08/125: IMF Executive Board Concludes Discussion on The Role of the Fund in Low-Income Countries, September 26, 2008www.imf.org 14. Selected Decisions and Selected Documents of the International Monetary Fund, Thirty Eighth Issue Washington DC, February 29, 2016 pp 25-26www.imf.org 15. Khatkhate, Deena. “Turning the Light Inward: Evaluation of IMF.” Economic and Political Weekly 37, no. 46 (2002): 4627-632. 16. Eichengreen, B., & Woods, N. (2016). The IMF’s Unmet Challenges. The Journal of Economic Perspectives,30(1), 29-51 17. Miller, Calum. “Pathways Through Financial Crisis: Turkey.” Global Governance, vol. 12, no. 4, 2006, pp. 449–464. 18. Petras, J., & Brill, H. (1986). The IMF, Austerity and the State in Latin America. Third World Quarterly,8(2), 425-448. 19. Auvinen, J. (1996). IMF Intervention and Political Protest in the Third World: A Conventional Wisdom Refined. Third World Quarterly,17(3), 377-400. 20. Dreher, Axel, Silvia Marchesi, and James Raymond Vreeland. “The Political Economy of IMF Forecasts.” Public Choice 137, no. 1/2 (2008): 145-71. 21. Lombardi, D., & Woods, N. (2008). The Politics of Influence: An Analysis of IMF Surveillance. Review of International Political Economy,15(5), 711-739 22  The International Monetary Fund 22. Dreher, Axel, and Roland Vaubel. “The Causes and Consequences of IMF Conditionality.” Emerging Markets Finance & Trade 40, no. 3 (2004): 26-54. 23. Copelovitch, M. (2010). Master or Servant? Common Agency and the Political Economy of IMF Lending. International Studies Quarterly,54(1), 49-77. 24. Conway, Patrick, and Stanley Fischer. “The International Monetary Fund in a Time of Crisis: A Review of Stanley Fischer’s ‘IMF Essays from a Time of Crisis: The International Financial System, Stabilization, and Development.” Journal of Economic Literature, vol. 44, no. 1, 2006, pp. 115–144. 25. Kapur, Devesh. “The IMF: A Cure or a Curse?” Foreign Policy, no. 111 (1998): 114-29. 26. Khan, Mohsin S., and Sunil Sharma. “IMF Conditionality and Country Ownership of Adjustment Programs.” The World Bank Research Observer 18, no. 2 (2003): 227-48. 27. Thacker, Strom C. “The High Politics of IMF Lending.” World Politics 52, no. 1 (1999): 38-75. 28. Yoon, Il-Hyun. “The Changing Role of the IMF: Evidence From Korea’s Crisis.” Asian Perspective 29, no. 2 (2005): 179-201. 29. Decision on Bilateral and Multilateral Surveillance Decision No. 15203 – (12.72) dated July 18, 2012 Selected Decisions and Selected Documents of the International Monetary Fund, Thirty Eighth Issue Washington DC, February 29, 2016 pp 25-26www.imf.org 30. The Acting Chair’s Summing up – The Liberalization and Management of Capital Flows – An Institutional View, Executive Board Meeting 12/105 November 16, 2012 Selected Decisions and Selected Documents of the International Monetary Fund, Thirty Eighth Issue Washington DC, February 29, 2016 pp 55-56www.imf.org 31. The Chairman’s Summing Up – 2014 Triennial Surveillance Review, Executive Board Meeting 14/90, September 26, 2014 Selected 23  India’s Relations with The International Monetary Fund Decisions and Selected Documents of the International Monetary Fund, Thirty Eighth Issue Washington DC, February 29, 2016 pp 41- 45www.imf.org 24  Chapter - II Major Financial Crisis: From Great Depression to the Great Recession To understand the role of the IMF, it is important to present the major financial crisis that were handled by the Fund since its inception. The 9 crises presented in this chapter are the Great Depression 1932; the Suez Crisis 1956; the International Debt Crisis 1982; the East Asian Economic Crisis 1997-2001; the Russian Economic Crisis 1992-97, the Latin American Debt Crisis in Mexico, Brazil and Argentina 1994-2002, the Global Economic Recession 2007-09 and the European Crisis 2010. The G7 Finance Ministers with the IMF and World Bank formulated lending policies to enable crisis-ridden countries to regain macroeconomic stability. Large macroeconomic imbalances represented by current account deficit and fiscal deficit contributed to vulnerability in Emerging Market Economies (EMEs). In most crisis countries, EME’s financed the twin deficits with short-term foreign currency debts. A financial crisis driven by excessive loan growth was normally preceded by currency crisis, high inflation and debt defaults resulting in high capital outflows. Financial crisis also resulted from poor banking regulation, macroeconomic distortions to promote excessive investment and external shocks like commodity price volatility deteriorated a country’s terms of trade. The Great Depression, the Suez Crisis, the International Debt Crisis, the East Asian Crisis, the Latin American Debt Crisis and the Great Recession were episodes in which a large number of countries simultaneously experienced crisis. In 25  India’s Relations with The International Monetary Fund each instance, the global crisis was preceded by elevated growth rates and collapses in the year of financial turmoil. THE GREAT DEPRESSION On October 25, 1929 the New York Stock Exchange saw 13 million shares being sold in panic selling. During the 1920s the American economy grew at 42 percent and stock market values had increased by 218 percent from 1922 to 1929 at a rate of 20 percent a year for 7 years. No country had ever experienced such a run-up of stock prices which attracted millions of Americans into financial speculation. Nobody had seen the stock market crash coming and Americans believed in permanent prosperity till it happened. There was no rational explanation for the collapse of the American markets in October 1929. Nearly US $ 30 billion were lost in a day, wiping out thousands of investors. In the aftermath of the US stock market crash, a series of bank panics emanated from Europe in 1931 spreading financial contagion to United States, United Kingdom, France and eventually the whole world spiraled downward into the Great Depression. The Great Depression lasted from 1929 to 1939 and was the worst economic downturn in history. By 1933, 15 million Americans were unemployed, 20,000 companies went bankrupt and a majority of American banks failed. Early in 1928, the US Federal Reserve began a monetary contraction to reduce stock market speculation. This coupled with declining value of bank assets resulted in a rush of bank withdrawals. As Americans held onto liquidity, the ability of the Banking system to generate money through deposits was curtailed. The US Banking system could have been saved by a massive recapitalization of Banks but the Federal Reserve did not intervene. In that period, the United States maintained significant current account surplus and Germany a substantial current account deficit. Borrowings by German public and private sector occurred in foreign currencies through dollar denominated bonds and credits from United States, routed through banks in the Netherlands, Switzerland and Austria. Monetary contraction in the United States culminated in a depression in Germany. The Reichsbank’s foreign reserves of gold and foreign exchange declined sharply. 26  Major Financial Crisis: From Great Depression to the Great Recession In May 1931, Austria’s largest Bank, the Kreditanstalt collapsed. As investors feared that their moneys would be frozen or lost, there was a huge capital exodus. Germany failed to obtain the foreign credits needed to halt the crisis. To halt the capital outflow, Germany had to close banks, devalue the mark, negotiate standstill agreements with foreign creditors and impose exchange controls. In the period 1930-32, money supply in the United States fell by 26 percent, Germany by 27 percent, in United Kingdom and France by 18 percent. The German currency and banking crisis impacted the British pound. Vulnerabilities emerged in the British economy, given the United Kingdom’s large short term indebtedness and slim gold reserves. European Banks whose assets were frozen by the German standstill agreements were making significant withdrawals from the United Kingdom resulting in a weakening of the pound. On September 16, 1931 United Kingdom suspended gold convertibility and allowed the pound to float. The Bank of England revalued its gold stock and expanded its domestic credit enabling a faster recovery than in United States and Germany. France felt the impact of the Great Depression once the pound became a floating currency and the dollar devalued. The French Franc was forced off the gold standard in 1936. By 1933, 35 Nations had abandoned gold and gold-exchange standards. The trade of countries with stable currencies – France, Germany and United States declined substantially higher than the trade of countries with depreciated currencies – the United Kingdom and Canada. The decreases in value of exports in 1932 from the previous year was 35 percent in France, 40 percent in Germany and 33 percent in the United States as compared to 7 percent in United Kingdom and 19 percent in Canada. It was broadly felt that currency depreciation would stimulate a country’s exports if other conditions are favorable. The United States promulgated the Tariff Act authorizing the President to raise or lower tariff rate by a maximum of 50 percent to ensure that the foreign currency depreciation did not result in millions of Americans losing their employment. The United States did not lead the recovery in 1933. Economic recovery as indicated by industrial activity was visible in Great Britain, France and Germany, with the United States witnessing a rapid industrial upturn during April and May 1933. The “New Deal” of President Franklin 27  India’s Relations with The International Monetary Fund Roosevelt brought in a sweeping reformation of the US economy, laying the foundations of the American welfare state – federal aid to the unemployed, stiffer regulation of industry, legal protections for workers, and the Social Security program. The “New Deal” was the first step in the United States muscular emergence from the Great Depression, and the beginning of the country’s rise to become the undisputed “leader of the free world.” THE SUEZ CRISIS On July 26, 1956, Egypt nationalized the Suez Canal Company and assumed control of the canal from the international consortium that had run it for nearly a century. France, Israel and United Kingdom initiated joint military action, with Israel invading the Sinai on October 29, 1956. The military action lasted two months and the Suez-canal was closed for 6 months resulting impacted the current account balances of all 4 countries. All four countries, had to seek IMF financial assistance in the face of an impending macroeconomic crisis. It also had a lot of political consequences - Egypt’s independence, Israel’s Nationhood, and a devastating blow to British empire. In September - October 1956, Egypt, Israel and France approached the IMF with financing requests. In 1956, Britain had a significant current account surplus. The pound sterling came under heavy speculative pressure and United Kingdom witnessed short-term capital outflows. The Bank of England was forced to deplete its US dollar reserves to defend the fixed value of the pound sterling against the dollar. By December 1956, the risk of currency devaluation was real. The United Kingdom did not qualify for financial assistance from the IMF. The IMF’s Articles of Agreement prohibit its lending finance to “large and unsustained” outflow of capital, which Britain faced. The Bank of England had enough resources to credit and fend off the outflow without IMF assistance. That said, the IMF financed all 4 countries on a stand-by basis. This involvement gave IMF the role of an International Crisis Manager. The Suez Crisis was the first major financial crisis of the post-war era. Egypt was borrowing from the IMF for the second time. It was a financing request for US $ 15 million and politics did not intrude in the IMF financing of Egypt. The United States spoke in favor, France consented by noting the absence of any legal basis for objecting, Britain and The 28  Major Financial Crisis: From Great Depression to the Great Recession Netherlands abstained. The IMF decision stated that the IMF expresses no objection to the financing request. Israel had joined the IMF in 1954 and the economy was not stable enough to sustain a fixed exchange rate for its currency. After resisting for several months, the IMF agreed to set a par rate of 1.8 Israeli pounds to the dollar. It was felt that Israel drawing from the IMF could help supplement its foreign exchange reserves and setting a par value for the Israeli currency was a step in this direction. Israel had a quota of US $ 7.5 million from the IMF in 1957 and the developments in the Mediterranean with consequent rise in military spending contributed to a worsening of the balance of payments situation. With the lone abstention from Egypt, the IMF financing for Israel was approved on May 15, 1957 at 50 percent of its quota. By September 1956, France witnessed a situation of low and depleting foreign exchange reserves. The French Franc was subjected to a flight of capital. France sought a financing arrangement for 50 percent of its quota of US $ 263.5 million. France was also fighting a war in Algeria and had a sharply reduced agricultural output that year due to frosts. These adverse influences disrupted France’s balance of payments position significantly. France’s current account position deteriorated by US$ 1.1 billion in 1956 from US $ 409 million surplus to US $ 700 million deficit. In October 1956, the IMF approved France’s financing request. Britain had a significant current account surplus and the second largest quota in the IMF after United States. The Bank of England had a parity of US $ 2.80 to the US Dollar and given the speculation, there was pressure to abandon the sterling parity. Britain viewed the US $ 2.80 as appropriate for trade purposes, regarded exchange rate stability as essential for preserving the sterling area as a preferential trade zone and as a reserve currency. Britain wanted to keep a minimum balance of US $ 2 billion reserves, and to fall through that floor would be interpreted as a signal that devaluation or even float was to be seriously considered. As market sentiments had shifted against the Pound Sterling, British authorities knew that they could not hold the pound at US $ 2.80 per dollar without support of the United States. The IMF financing was to address the psychological impact of a political crisis on financial markets. 29  India’s Relations with The International Monetary Fund The financial pressures drove Britain to accept a ceasefire and full withdrawal in the Mediterranean. The Suez Crisis was suddenly over. Following the ceasefire, American resistance to a British financing arrangement was out of the way and British request for a financing arrangement upto 75 percent of its quota was considered. Britain required US $ 1.3 billion to stem speculation against the pound. It was felt that given the United Kingdom’s role as a banker for a large trading area and the status of sterling as an international currency, the IMF agreed to lend in a situation of a large and sustained capital flows. The Suez Crisis was the first time the IMF played a significant role in helping countries cope with the international crisis. The IMF adopted a rapid response to the crisis which impressed the financial markets and convinced speculators. Britain had faced a speculative attack on a stable currency despite sound economic policies. Britain was unable to restore the level of foreign exchange reserves till 1958. THE INTERNATIONAL DEBT CRISIS 1982 - 1989 The international debt crisis began on August 20, 1982 when the Mexican Finance Minister informed the bankers in New York that Mexico could not repay the loan that was due. The Mexican authorities had informed the IMF that without an immediate rescue, Mexico had no option but to default. This was the commencement of a decade long international debt crisis. In March 1981, Poland informed its bank creditors that it could not repay its debt obligations. A number of Europe’s largest commercial banks were heavily exposed with loans to Poland, and European governments had little choice but to rescue these banks. Poland pushed several other countries into the precipice – Romania, Hungary and Yugoslavia also requested for rescheduling the terms of repayment. The monetary contraction in the United States in the 1970-80 period resulted in a sustained appreciation of the US dollar. It made repayments in dollar terms difficult for most countries of Eastern Europe and Latin America. The commercial debt crisis erupted in 1982 and lasted till 1989. In the 1970s, developing countries borrowed freely in the rapidly growing international credit markets at low interest rates. Banks had grown cash rich with large deposits from oil-exporting countries and there 30  Major Financial Crisis: From Great Depression to the Great Recession was increased lending to oil-importing countries. The loans were used on investment projects or to boost current consumption. Several developing countries had reached borrowings 12 percent of their national income, resulting in major debt-servicing difficulties. The monetary contraction in the United States in 1979-80 and the second oil shock resulted in sustained appreciation of the dollar. The May 1980 World Economic Outlook (WEO) said that the outlook for oil-importing developing countries was “frightening” and that current account deficits for those countries were not financeable under the existing development assistance. There was a concern in the WEO bordering on urgency, gravity and insistence about the potential problems in most heavily indebted countries. The overwhelming view was that debt accumulation was beneficial. No one saw the crisis coming, or who might be affected. Commercial banks believed that sovereign lending to developing countries was a highly profitable activity. Mexico and Poland were the first manifestations of the impending crisis. Soon after Mexico, several countries in Latin America – Argentina, Brazil, Chile, Ecuador, Peru and Uruguay encountered debt-servicing problems. This accelerated the eruption of crisis in other continents also. Clearly, too many Governments were pursuing unsustainable economic policies in the contracting economic policy environment of the 1980s. Sub-Saharan African countries with official debts too faced economic crisis. The tremors were felt in Asia too with India, Pakistan and China drawing on Fund’s support for ambitious development and reform plans. Korea was able to service its debt without restructuring by an effective adjustment and reform program. The International Debt Crisis lasted from 1981 to 1989. It covered nearly 20 countries around the world. The 3 major East European countries affected were Poland, Romania and Hungary and the 3 major Latin American countries affected were Argentina, Brazil and Chile. Each one faced serious debt problems but each one had unique problems in origin and implications. Long-term growth in most heavily indebted countries required a broader strategy. The Baker Plan was formulated to strengthen growth prospects of indebted countries and was followed by the Brady Plan. Inability to service debt was only a symptom of deeper economic mismanagement in most developing countries. Feasible economic reform 31  India’s Relations with The International Monetary Fund programs were put in place by a series of IMF programs under the Stand-By Agreements, Extended Fund Facility and Brady Plan. The strategy drawn up the IMF and the creditor countries envisaged financing a small portion of the debt through official programs. Traditional IMF relations with Commercial Banks were characterized by arms-length mutual dependency, with Banks financing strong economic policy programs recommended by the Fund. Post-Debt Crisis there was a major change in relations between the IMF and the Commercial Banks. Officials of the IMF participated in meetings between the Commercial Banks and Country authorities. Large Stand-By Arrangements and Extended Financing Facilities were put in place to persuade Commercial Banks against rapid withdrawal. The International Debt Crisis of 1982-89 was a threat to both creditors and debtors. The crisis could only be solved by cooperation between debtors and creditors. The coordination efforts were led by the International Monetary Fund. The systemic crisis gradually subsided by 1983, although debt-servicing difficulties remained. The period 1985-87 was a period of sustained growth and developing countries could reduce the burden of servicing debt. By 1989, there was a marked improvement in the external economic environment facing many of the indebted countries which brought an end to the international debt crisis. THE EAST ASIAN CRISIS A major economic crisis struck many East Asian economies in 1997. The East Asian economies, which were witnessing rapid growth and improvement in living standards, got embroiled in a severe financial crisis. Interrupting a decade of unparalleled economic growth, prosperity and promise, the crisis revealed the precariousness of the systems of economic governance in the region. No one had foreseen that these countries which were widely envisaged as economic models for many other countries could suddenly become embroiled in one of the worst financial crisis of the postwar period. The crisis was a result of large external deficits, inflated property and stock market values, poor prudential regulation, lack of supervision and exchange rate pegs to the US dollar resulting in wide swings to the exchange rates making international competitiveness unsustainable. 32  Major Financial Crisis: From Great Depression to the Great Recession The Southeast Asian currency collapse began in Thailand. Thailand’s current account deficit and the interest on foreign obligations had exceeded 4 percent of Thailand’s GDP. Creditors believed that Thailand’s large current account deficit reflected high business investment, as it was backed by high savings rates and government budget surplus. Thailand maintained a fixed exchange rate relative to the dollar. Foreign funds kept coming to Thailand given the high interest rates on Thai baht deposits and the fixed exchange rate at 25 baht per dollar. But the Baht’s fixed value to the dollar could not be sustained. In 1996 and 1997 the Japanese Yen declined by 35 percent to the dollar. Wide swings in the dollar/ yen exchange rate contributed to the build-up in the crisis through shifts in the international competitiveness which proved unsustainable. As foreign investors began selling bahts, Government intervened to support its value. However, the currency could not be sustained and eventually, the Thai currency collapsed. Contagion beset Indonesia and Korea as financial investors became worried about large current account deficits. On July 2, 1997, the Thai baht was floated and depreciated by 15-20 percent. On July 24, 2017 East Asia witnessed a “Currency Meltdown” with severe pressure on the Indonesian rupiah, the Thai baht and the Malaysian ringgit. The 1997 Indonesian economic crisis brought an end to 30 years of uninterrupted economic growth, and was amongst the worst faced by any country in the world in the 20th century. The economic crisis was exacerbated by a political transition which played out with widespread riots and resulted in the election of a new President. The Indonesian rupiah depreciated from about 2500 rupiah per US dollar in May 1997 to around 14000 rupiah per US dollar by January 1998 with imminent hyperinflation and financial meltdown. The closure of 16 banks created panic. The Indonesian authorities responded with steps to provide blanket guarantee for all depositors and creditors, creation of an Indonesian Bank Restructuring Agency and assurances to carry forward corporate restructuring. In 1997, Korea was the 11th largest economy in the world, with inflation rate less than 5 percent, unemployment rate less than 3 percent and GDP growth was 8 percent per annum. The Korean economic crisis emerged because its business and financial institutions had incurred short term foreign debts of nearly US$ 110 billion which were 3 times of its foreign exchange reserves. Massive financial bailouts were necessitated, 33  India’s Relations with The International Monetary Fund as countries suspended debt payments to private creditors. The Korean won came under severe pressure and Korea opted for an IMF bail-out. Korea required a US$ 57