International Monetary Fund (“IMF”) was founded in the aftermath of World War-II at the Bretton Woods Conference in 1944 to establish a post-war financial order that would facilitate economic cooperation.[1] The IMF has the mandate of providing financial support mechanisms such as bailouts to member countries that are experiencing actual or potential macroeconomic problems. A balance of payments crisis is a huge macroeconomic imbalance. It is also called currency crisis. It occurs when a nation is unable to pay for essential imports or service its external debt payments. Since 2010, world financial markets have expressed recurrent concerns about risks to debt sustainability. This was fuelled by the COVID-19 pandemic wherein most stressed economies got pushed into a pandemic induced financial crisis, making IMF bailouts the go to short-term ‘solution’ for failing balance of payments.
The IMF’s mandate originates from its Articles of Agreement (“Articles”), e., in an international treaty between the IMF and the members countries. The Articles set out the goals and powers of IMF and the different obligations of member states,[2] which are predominantly of two types: ‘soft/ best effort basis’ obligations regarding domestic policies, such as financial sector policies, primarily aimed at promoting domestic stability, and some ‘hard’ obligations in relation to matters with direct international impact.[3]
The ever-evolving Sri Lankan bankruptcy battle has yet again raised prominent questions about the efficacy of the IMF’s financial assistance programmes. Opponents of IMF bailouts argue that they make troubled countries further dependent on the IMF, while proponents claim that the liquidity provided by the IMF is crucial in preventing extreme financial consequences.[4] Irrespective, most stressed economies have resorted to bailouts to repay their sovereign debts. The question is whether it is time for the IMF to go for more country specific reforms and ‘result achievement’ oriented lending system for stressed economies?
Sri Lanka joined the IMF on August 29, 1950 and is currently experiencing the worst economic crisis since its independence from the British in 1948. Since joining, Sri Lanka has availed 16 IMF bailouts and it’s on its way to the 17th. All these bailouts are in addition to the credit lines/ debts secured from neighbouring countries and strategic partners and the controversial handing over of lease of strategically important sovereign assets to other countries to pay-off debt. It is often argued that Sri Lanka’s present situation has been exacerbated by government mismanagement, years of accumulated borrowing and ill-advised tax cuts[5].
The IMF bailout framework is not a simple infusion of cash and credit into a stressed economy. IMF bailouts come with conditionalities. IMF packages have three components: financing packages, structural reforms, and macroeconomic policies and debt conditionalities that are intricately associated with these components in the form of policy reforms. In exchange for financial assistance, the bailed-out country needs to implement the proposed conditionalities through a series of reform measures. Another way of looking at conditionalities is that they are the in-principal collateral offered by the debtor to the creditor i.e. the IMF.
Historically, IMF bailouts maybe a rescuer of troubled economies, but whether it is enabling countries to return to financial health and stability has been a matter of debate. For example: Pakistan became a member of IMF in 1950. Since then, it has availed 13 bailout packages, including a recent USD 6 billion loan.[6] Its 13th IMF bailout package resulted in heavy increase in government taxation and an IMF mandated devaluation of its currency. Greece is another such example, Greece’s public debt, which was 120% of its GDP when the ‘rescue’ was mounted, has since risen to 170%.[7] Greece may yet not be out of the woods. Such a spiral degradation may be attributed to the following aspects – that the bailed-out state was not able to effectively implement the conditionalities or that the conditionalities were not custom designed for the needs of that economy. Also, there are no strict repercussions for failing to meet with the conditionalities, within the IMF framework.
While some may argue that the bailed-out countries must be held accountable for ensuring that the conditionalities of an IMF bailout are implemented in a manner that ensure economic stability, per contra, others argue that the aspect of sovereignty is a well-established principle of international law, which mandates that a sovereign state must be accorded deference in forming and implementing its domestic policies and hence, an apolitical supra-national organisation such as the IMF cannot notionally step into the shoes of a sovereign state and interfere with the formulation and implementation of its policies and reforms.
IMF should not be viewed as a stricto-senso creditor. It is cast into a role wherein the international community collectively bails out economies through the infusion of cash and credit as the measure to avoid the crippling effect of a crashing domestic economy on the international monetary system. The IMF is also carefully navigating between the intersections of sovereignty of states over their domestic policies versus the responsibilities of a supra-national organisation in maintaining the heath and stability of the international monetary system. Given how intricately the world economies are linked and interdependent, even if one economy crashes, it would have a cascading impact on other economies as well. Therefore, the IMF is mindful of the fact that all economies must be carefully monitored to avoid another Great Depression like situation.
As of now, Sri Lanka is a tumultuous economy that is alternating from debt to currency crisis to hyperinflation and recession. It has a mounting pile of public debt, which is about 110 percent of its GDP. Pakistan and Sri Lanka are in similar situations, with USD pegged at around 183 Pakistani Rupee and 320 Sri Lankan Rupee.[8] Unfortunately, Sri Lanka is on the brink of bankruptcy and a possible 17th bailout doesn’t seem to be enough to infuse the needed magical revival. While cash/credit are infused into an economy during a bailout, debt payments are also deferred to a date when the economy is more stable. For countries such as Pakistan, Greece and Zimbabwe, the question to be asked is, when will that state of financial stability be achieved?
If a country defaults on its debt repayment to the IMF, there is no guarantee that a re-structuring of debt would bring the economy back on track. At the max, under Article XXIII of the Articles, any right to avail further lending may be suspended for such a defaulter. During the 1978-2010 period, there have been 41 serial defaulter countries, most of which defaulted after multiple restructurings.[9] It is debatable whether the IMF taking any stringent measures against a defaulting country would in any manner be economically fruitful in the longer run.
In the context of the aforesaid, the saga of the Indian economy is a pertinent one. The Indian economy faced grave balance of payments crisis in 1991 wherein, it is said that India had only USD 1.1 billion in its hard-currency reserves, enough for only about two weeks of imports. This had come at a time when India had not defaulted on a single loan in 44 years of its Independence and policies were formulated on strict principles of self-reliance. The circumstances were mostly of a trial by fire for the newly formed government. India opted for an IMF bailout and opened its economy in line with the IMF conditionalities. The government took a series of immediate measures, such as devaluing the Indian rupee in two phases, pledging gold holdings to shore up forex reserves and introducing a new trade policy that sought to bring a change in the cumbersome and often counter-productive licencing process. India embraced a game-changing new industrial policy, which proposed some massive changes in the way the country treated its industries and foreign investment by moving away from a ‘licence raj’ regime. India is one the examples where an economic crisis was turned into an opportunity to reform, and IMF conditionalities were implemented to place the crisis struck economy on the high growth trajectory.
Hence, IMF bailouts cannot be treated as a straitjacket formula for distressed economies. Post the COVID-19 pandemic, world economies are in a fragile state. Further, due to the ongoing Russia-Ukraine conflict, stressed economies have experienced greater discomfort. While most of these economies have already availed bailouts, their road to financial recovery will be an interesting one.
[1] https://www.cfr.org/backgrounder/imf-worlds-controversial-financial-firefighter last accessed on April 4, 2022.
[2] The Fund’s Mandate—An Overview; Prepared by the Strategy, Policy, and Review Department (In consultation with the Legal Department) Approved by Reza Moghadam January 22, 2010.
[3] The Fund’s Mandate- The Legal Framework; Prepared by the Legal Department (In consultation with the Strategy, Policy, and Review Department) Approved by Sean Hagan February 22, 2010.
[4] Insights into the IMF bailout debate: A review and research agenda by Larry Li∗, Malick Sy, Adela McMurray; Journal of Policy Modeling 37 (2015) 891–914.
[5] https://www.gulftoday.ae/news/2022/04/04/troubled-sri-lanka-set-for-new-cabinet-and-protests last accessed on April 4, 2022.
[6] https://mmnews.tv/pakistan-and-imf-an-overview-of-bailout-package last accessed on April 4, 2022.
[7] https://thewire.in/economy/imf-and-greece-crisis# last accessed on April 4, 2022.
[8] As on April 11, 2022.
[9] IMF Working Paper-Research Department; ‘Serial Sovereign Defaults and Debt Restructurings’; Prepared by Tamon Asonuma; Authorized for distribution by Atish Rex Ghosh; March 2016.
