MF – International Monetary Fund – As the name itself suggests it is an international organization created in July 1944 with only 45 members to monitor and regulate the world’s financial system and aid to bring stability where required. IMF describes itself as “an organization of 186 countries (as of June 29, 2009), working to foster global monetary cooperation, secure financial stability, facilitate international trade, promote high employment and sustainable economic growth, and reduce poverty”. (Quotation reference???) As for World Bank, based on the name is an international financial institution that acts as a bank not limited to a particular region but to support the nations of the world mainly the developing nations. Its openly stated purpose is to reduce poverty (Weiss, M. 2004). Just like the IMF, the World Bank was also created in the year 1944.
Both IMF and the World Bank are a production of the Bretton Woods conference which is basically the United Nation’s Financial Conference held in Bretton Woods. With around 45 members meeting in 1944 the conference gave birth to two of the major International financial institutions the IMF and the World Bank. The purpose of the former as per the Bretton Woods agreement was to regulate the economic system world wide, stabilize financial situations and exchange rates and to encourage globalization & international trade. While the latter was formed with two subdivisions: International Bank for Reconstruction and Development and International Development Association. IBRD was created for reconstruction purposes and to fight poverty in the middle-income nations with its advisory services and capital investments. IDA was formed to support the IBRD by helping fight poverty in the world’s poorest countries by offering them interest-free long-term loans. (Weiss, M. 2004);(World Bank, 2009)(No authors name mentioned)
The mere fact that both are international organizations and the scale in which they operate emphasize on the involvement of the institutions in the financial crises of the world. Any financial crisis after World War II has some role played by the two organizations. The paper further looks into the involvement of IMF and WB in two of the major Financial Crises of the world. It also sheds light on the criticisms received by many on the method of their work and the consequences of their activities & policies. (This paragraph says what is written in this paper)
Before moving further on their roles, it is worthwhile outlining their mode of work. As mentioned earlier, IMF basically regulates the financial and economic standards by using macroeconomic policies aiming at crisis-prevention. It also offers some short-term loans to countries with positive balance of payments and low-income countries in order to reduce poverty but with strict conditions. It provides technical support and training in its areas of expertise (Weiss, M. 2004). World Bank on the other hand, provides long-term loans at low interest rates but strict conditions. The task is divided in two divisions at the World Bank. As mentioned earlier, IBRD targets at the middle-income countries while the IDA targets at the world’s poorest countries. (World Bank, 2009)
Asian Financial Crisis
July 1997 was the beginning of a financial crisis with a caliber that gripped almost all of Asia. The fears were heightened of a global meltdown due to the financial contagion; meaning a Domino fall in companies. (introduction)
The impact began with the downfall of Thailand’s currency (Thai Baht) when the Thai government decided to follow floating exchange rates than fixed, separating it from the USD. Thailand was under huge debts and went bankrupt after attempting to support itself against the severe financial overextension, partly caused by the real estate businesses of the country. As the collapse spread, it took over many Southeast Asian countries presenting devaluation of stock market, priced assets, visible rise in private debts and a downfall in their currencies. (Khor, M.)
Although all of Southeast Asia was affected with the downfall Indonesia, Thailand and South Korea topped the list. (Ryan, L. 2000)
All this began when Asia as whole began intake of more than half of the total capital inflow from the developing countries. These countries had maintained higher interest rates that formed a great scope for the foreign investors seeking higher returned rates this resulted in huge cash injections to the company, which in turn increased asset prices and living standards economically all over. This was seen as a great achievement that became acclaimed by financial institutions such as IMF and World Bank and became known as the ‘Asian economic miracle'(Ryan,L. 2000)
In the late 1990’s known economist Paul Krugman argued the idea of the Asian economic miracle pointing out that only the capital investment hiked whereas the total productivity factor hardly increased (Krugman, P. 1998). Although an argument he himself had least thought of a fore coming crisis.
As more and more money was injected into Thailand’s economy what used to be a strict capitalist relationship, turned into crony capitalism which in turn meant that power role players and their influenced ones began taking over the economy. The capital flow became expensive and started to be used for quick profits which soon went out of control causing the money to profit certain individuals in particular depriving rest of the public from its money rights.
This caused large private current accounts deficit and the fixed exchange rates influenced external debts leading to foreign exchange risk exposure to both financial and corporate sectors. In the mid 90’s as the US began recovering from a recession from the early 90’s the US Federal Reserve Bank raised it interest rates to cause inflation. This caused the tables to turn and the foreign investor’s interest being taken over by the US. (Khor, M.)
During then the currency rates of the Southeast Asian countries were tied to the US dollars hence when the USD hiked the southeast nations became less competitive in the market and more expensive worldwide. This caused a deceleration in the exports from there and current account positions deteriorated. (Rana, B.P, 1998)
Many economists believed that the Asian crisis was created not by market psychology or technology, but by policies that deviated motivation within the lender-borrower relationship. The resulting large quantities of credit that became available generated a highly elevated economic state, and increased asset prices to an unsustainable level. These asset prices eventually began to collapse, causing individuals and companies to fall on debt obligations. This resulted panic amongst lenders that led to a large withdrawal of credit from the crisis countries, causing a credit crunch and further bankruptcies. In addition, as foreign investors attempted to withdraw their money, the exchange market was flooded with the currencies of the crisis countries, causing depreciation on the exchange rates. The Very high interest rates, started causing extreme damage to the economy that is healthy, this wreaked further havoc on economies in an already fragile state, while the central banks were hemorrhaging foreign reserves, of which they had finite amounts. When it became clear that the tide of capital fleeing these countries was not to be stopped, the authorities ceased defending their fixed exchange rates and allowed their currencies to float. The resulting depreciated value of those currencies meant that foreign currency-denominated liabilities grew substantially in domestic currency terms, causing more bankruptcies and further deepening the crisis. (Rana, B.P. 1998)
In order of damage control the IMF came up with a series of rescue schemes. This enables nations with the most effected economies to avoid defaults. The schemes are meant to help with the reformation of the currencies of the effected countries. It is an attempt to restore as much of the Asian currencies, banking and financial systems to the European and American statuses as possible. the IMF”s support was based on the condition that their neoliberal economic principles better known as Structural Adjustment Packages (SAP) be used to minimize crisis effects. The SAP worked in a way where the government of the hit countries had to cut back on the government spending to decrease deficits so as to allow insolvent banks and financial institutions to fail so that interest rates jump high. They justified this by stating that in doing so they would be able to restore belief in the nation’s fiscal solvency capabilities, allowing them to penalize insolvent companies and protect the currency value from depreciating. Furthermore another of the very important conditions out up were that the IMF-funded capital had to be monitored rationally there on with no biased funds being injected due to preference. (Truman, 2009)
As the crisis hit the nations the local business owners and governments of those countries became unable to payback their creditors. This happened due to the USD rates increasing making it expensive and hence making those loans taken in dollars unable to be paid back. The SAP received mixed responses and critics found an argument regarding these policies mentioning the traditional response to a crisis would be to increase govt. spending, lower interests and prop up major companies. They stated that by stimulating the economy the govt. could recover the confidence while preventing economic loss. Yet they incurred collapse of whole sectors at once, huge amounts of bankruptcies, currency devaluations, huge unemployment rates real estate loss, and a total social chaos brought on the panic stricken public members. This caused great criticism from all around nations regarding the IMF interventions (Rana, B. P., 1998).
Global Economic Meltdown
The beginning of this global economic melt down was witnessed in the late 2007 and has not yet been recovered from. The credit crunch in the US banks led to this Global Financial Crisis. The burst of the US housing bubble resulted in the Credit Crunch to begin with. This was followed by increasing rate of sub-prime mortgage defaults. What led to the US housing bubble in the first place was mortgage at extremely low interest rates and easy credit conditions. Consumers were then able to get various types of loans easily and hence number of consumers applying for loans kept increasing. Appreciating housing prices led to strategies of loaning such as collateralized debt obligations and mortgage-backed securities. As prices began to decline, consumers started to default on loans. What happened then was that Banks were left with collaterals and homes worth less than the amount loaned. This led to a liquidity crisis in the banks of the US and hence filing bankruptcies. This led to a spill-over effect in other economies and hence spreading world wide. (Introduction)
The IMF and the World Bank built a mission which had three tasks. The first task was Surveillance, this was meant primarily to prevent crisis. It deals with the developments of the real and financial sector monitoring it and advising policies. The second task dealt with lending money temporarily to the countries in crisis because if not done so chances are likely that the countries will have more poverty threats. The third task regards help in technical assistance and any training under their expertise they could provide to overcome the situational crisis (IMF and World Bank official sites). (there are no authors mentioned on the sites!)
During the first 2 tasks the IMF faced heavy criticism on its capability to tackle the issue, especially the first tasks failure to prevent and least to predict and warn against the current crisis. This failed the first task of surveillance based on the IV article consultation which introduced the crisis in 2007. In its 2006 Article IV consultation, the IMF concluded: “Mortgage securitization had helped channel foreign savings into the US housing market while allowing mortgage originators greater flexibility to diversify credit exposures and reduce systemic risk.” (IMF Country Report No. 06/279, July 2006, p.7(no author mentioned!) Within a years time this article was proven wrong when the subprime mortgage meltdown in the US began the global crisis.
Its effect even on the major developed countries such as the US is a target yet to be achieved.
Criticisms of IMF and World Bank
IMF and the World Bank have been criticized for various reasons. Their incapability was highlighted due to their failure of support in the Asian Financial Crisis. Two of the main criticisms of the IMF have always been its Conditions and the Structural Adjustment Programs (SAPs). SAPs basically advised the crisis hit nations to sell off their assets to at very low prices. Besides, the IMF has always been in support of increasing taxes so as to generate government revenue and reduce budget deficits (Eckaus, R.S. 1986). However, the increase in tax was an increased pressure on the nation which is already monetarily unstable and weak.
For instance, Argentina had gone through a severe economic crisis in the year 2001 due to its economic model which was always praised by the IMF. In fact the IMF always used it as a role model of successful financial system for other nations. In other terms, the reason for the crisis were the budget restrictions imposed by IMF leading to deprivation of support in the internal structure of the country such as health, education, security and national infrastructure (Blustein,P. 2004). Similar is the situation in Kenya where the IMF had forced to ease the movement of currencies which led to an imbalance in the exchange rate systems and hence further deterioration of the nation.
IMF is also criticized to have introduced privatization and in fact have always encouraged and suggested privatization of companies in the weaker economies. This led to increased rate of unemployment and further deterioration of the economy leading to more poverty. (Thacker, S.C. 1999)
It is also known to loan out money at low interest rates in the beginning but increase drastically over time, even within a span of six months. This leads to the developing nations always remain in debt and never recover from the situation they are in (Thacker, S.C. 1999). The question then arises, is IMF reducing poverty or increasing it?
Like the IMF, the World Bank has also been criticized by many for its loaning terms and conditions. In fact it has always been under the critical eyes of the NGOs and the academics. (it is the intro of this section!)
The main criticism of the Bank has been its administration structure. Although it claims to have 186 member countries, only a handful of nations actually rule the organization. In the most simplistic view, the major portion of the Bank is held by the US and hence US owns the majority votes. This means that a decision made by the US has a very high probability of over taking the other nations. Since the ruling body basically consists of some powerful nations, their interests will dominate any policy or movement in the bank. This then conflicts with the original motto of the existence of this organization (Wade, R.H. 2002).
Critics also speak of the free-market standards that are generally imposed by the bank do no good but worsen the situation of a weak economy in case of misuse (Wade, R.H. 2002).
It is worth to note that when the World Bank’s policies were influenced by the Washington Consensus it certainly involved regulation, free markets, privatization and reducing the influence of the government in the markets. However, what it did not involve were equity, employment and the modes of privatization. These were the basic structural necessities of a weak economy. Impact of the World Bank was required on the foundation of the economic structure of these nations. Instead what were targeted seemed to be the exteriors of the structure so weakening the situation even more (Weiss, M.A. 2008).
It is often critiqued of enforcing agendas and policies which basically deteriorate the situation of the weaker economy even more. This was because the World Bank provided support for issues that were not developed in the nation instead of focusing on how to develop those principles first. It has also been claimed to be biased towards the West since it was heavily influenced by the Western nations. (Wade, R.H. 2002)
Based on the above, it can be observed that the IMF and World Bank although formed to aid the nations in need but are now in question of whether they have fulfilled their purpose of existence.
With the failure of the organizations in the Asian Financial Crisis and the recent Global Crisis, it is now doubtful of its capabilities to regulate and support the monetary system of the world. While the IMF was created to stabilize the global economy it has been observed that in most cases it had only worsened the situation and reduced the GDP. Like wise, the World Bank with its strict regimes on the loans and support systems on the policies of the weaker economies has led to worsening of the economic situations in the particular nation.
In fact, it is also noted that the IMF has always delayed in responding to a situation of crisis instead of sending warning signals before. Since its role was to monitor and govern the World’s financial system why was it not able to predict the downfall in the US sub-prime mortgage market? Why has neither the IMF nor the World Bank been able to prevent the worsening situation of the developing nations? Why are their policies leading to rich nations becoming richer while the poor becoming poorer? These are a few questions that run through one’s mind when thinking of the organization and the purpose of their existence. Its methods of bridging a gap between the developed world and the developing world now seem to have increased the gap between the two sides of the world.
Finally, although IMF and the WB have been under such heavy criticism they are still looked upon in times of financial and economic needs by many nations. Just as a food for thought, if the economic problems were solved by these organizations then the requirement of their existence would be in question. The mere fact that the two institutions are still operating prove that the purpose of the organizations have not been met. In fact, the existence of the organization and its purposes conflict with each other. The question that arises then is that are the two institutions valuing its own requirement of existence than resolving the financial problems of the world?