However good the IMF’s surveillance process and the economic policies governments implement, it is unrealistic to expect that crises will never occur. Indeed, a dynamic market economy will tend to face occasional crises. The IMF’s role is to help mitigate their impact and shorten their duration through its policy advice and financial support. Containing crises has sometimes required the commitment of substantial resources by the IMF In most cases, this investment has paid off. For example, the IMF’s loan of $21 billion to Korea in December 1997 was very large by any standards, but it helped restore financial stability by early 1998 and strong growth the following year. And Korea repaid the IMF ahead of schedule. That was a case where large-scale support was appropriate and successful. The IMF played a similar role in Brazil in 1998 and Turkey in 2001.
Traders on the floor of the Futures and Commodities Market, Sao Paulo, Brazil.
Why do economic crises occur?
Bad luck, bad policies, or a combination of the two may create balance of payments difficulties in a country—that is, a situation when the country cannot obtain sufficient financing on affordable terms to meet net international payments. In the worst case, the difficulties can build into a crisis. The country’s currency may depreciate at a rate that destroys confidence in its value, with disruptive and destructive consequences for the domestic economy, and the problems may spread to other countries.
The causes of such difficulties are often varied and complex. But key factors have included weak domestic financial systems, large and persistent fiscal deficits, high levels of external debt, exchange rates fixed at inappropriate levels, natural disasters, and armed conflicts.
Some of these factors can directly affect a country’s trade account—reducing exports or increasing imports. Others may reduce the financing available for international transactions— for example, by causing investors to lose confidence in their investments in a country, leading to massive asset sales and a sudden departure of capital overseas, or “capital flight.”
How IMF lending helps
IMF lending seeks to give countries breathing room while they implement policies of adjustment and reform aimed at resolving their balance of payments problems and restoring conditions for strong economic growth. These policies will vary depending on the country’s circumstances, especially the root causes of the problems. For instance, a country facing a sudden drop in the price of a key export may simply need financial assistance to tide it over until prices recover and to help ease the pain of an otherwise sudden and sharp adjustment. A country suffering from capital flight needs to address whatever problems led to the loss of investor confidence: perhaps interest rates that are too low, an overvalued exchange rate, a large government budget deficit, a debt stock that appears to be growing too fast, or an inefficient and poorly regulated domestic banking system.
Before a member country—whether or not it is facing a crisis—can receive a loan, the country’s authorities and the IMF must agree on an appropriate program of economic policies (see Lending and Conditionality, page 22). In the absence of IMF financing, the adjustment process would be more difficult. For example, if investors do not want to buy any more of a country’s government bonds, its government has no choice but to reduce the amount of financing it uses—by cutting its spending or increasing its revenues—or to finance its deficit by printing money. The “belt tightening” involved in the first case would be greater without an IMF loan. And, in the second case, the result would be inflation, which hurts the poor most of all. IMF financing can facilitate a more gradual and carefully considered adjustment.
Resolving external debt crises
Some balance of payments difficulties arise because countries amass debts that are not sustainable—that is, they cannot be serviced under any feasible set of policies. In these circumstances, a way must be found for a country and its creditors to restructure the debt. This may involve some easing of the repayment terms, like an extension of maturities and/or an agreed reduction in the face value of the debt.
Together with the World Bank, the IMF has been working to reduce to sustainable levels the large debt burdens of low-income countries under the enhanced Heavily Indebted Poor Countries (HIPC) Initiative and the Multilateral Debt Relief Initiative (see page 29) and has continued to promote mechanisms aimed at the orderly resolution of debt crises between countries and their private creditors. It has taken an active role in encouraging sovereign issuers to include collective action clauses (CACs)—which prevent small minorities of creditors from blocking restructuring deals to which large majorities agree—in international bond issues in all markets. Partly as a result, the use of CACs has become the market standard in international sovereign bonds issued under New York law. Consequently, the share of issues with CACs from emerging market countries has grown considerably since early 2004.
In other developments outside the IMF, progress has been made on a monitoring process for the Principles for Stable Capital Flows and Fair Debt Restructuring in Emerging Markets, a private sector-led initiative that outlines standards of engagement and responsibilities for sovereign debtors and their private creditors in the prevention and resolution of financial crises.