IMF bailouts

General Studies Paper 2

Context: The International Monetary Fund (IMF) recently confirmed a USD 3 billion bailout plan (under Extended Fund Facility (EFF)) for Sri Lanka’s struggling economy.

• It is also negotiating with Pakistan for a USD 1.1 billion bailout plan on account of its severe economic crisis marked by falling currency and price rise.

What are IMF Bailouts?

• Bailout:Bailout is a general term for extending financial support to a company/country facing a potential bankruptcy threat.
  • It can take the form of loans, cash, bonds, or stock purchases.
  • A bailout may (not) require reimbursement but is often accompanied by greater oversight and regulations.
• IMF Bailouts:Countries seek help from the IMF usually when their economies face a major macroeconomic risk, mostly currency crisis (such as the ones Sri Lanka is facing).
  • Countries seek such assistance from the IMF to meet their external debt and other obligations, to purchase essential imports, and to prop up the exchange value of their currencies.

How is an IMF Bailout Provided?

• Procedure:
  • The IMF lends money to the troubled economies often in the form of Special Drawing Rights (SDRs).
    • SDRs simply represent a basket of five currencies, namely the S. dollar,the euro, the Chinese yuan, the Japanese yen, and the British pound.
  • This lending is carried out by a number of lending programs such as extended credit facility, flexible credit line, stand-by agreements, etc.
  • Countries receiving the bailout can use the SDRs for various purposes depending on their individual circumstances.
• Conditions:
  • A country may have to agree to implement certain structural reforms as a condition to receive IMF loans.
  • Criticism of Lending Conditions:
    • Believed to be too tough on the public
    • Often accused of being influenced by international politics
    • Free-market supporters criticise the IMF for being too interventionist
  • Acclamation:
    • Conditions are essential for successful lending; it may not make sense for IMF to throw money at a country if its faulty policies that caused the crisis remain untouched.
    • Countries with poor institutional functioning and high corruption are most likely to misspend the bailout money.

What are the Impacts of Providing IMF Bailouts?

• Advantages:
  • They ensure continued survival of the country under difficult economic circumstances and help solve  BoP problems without resorting to measures that can be even more harmful to national/international prosperity.
  • A complete collapse of the financial system can be avoided when industries too big to fail start to crumble.
  • Insolvency of institutions that are needed for the smooth functioning of the overall markets can be avoided.
  • In addition to financial support, the IMF can provide technical assistance and expertise to help a country implement economic reforms and strengthen its institutions.
• Disadvantages:
  • IMF’s strict conditions for economic policy reforms may result in reduced govt spending, increased taxes which can be politically unpopular and may lead to social unrest.
  • Seeking an IMF bailout may harm a country’s reputation in the eyes of investors and lenders, making it more difficult for the country to access international capital markets.
  • Repeated IMF bailouts can create a sense of dependency on external funding and discourage countries from implementing necessary long-term reforms to address their economic problems.
  • IMF bailouts may be viewed as an admission of economic failure by a govt, which can lead to political instability and even the collapse of the govt.