The International Monetary Fund (IMF) confirmed a $3 billion bailout plan for Sri Lanka’s struggling economy.
Why do nations seek an IMF bailout?
Currency risk: Countries seek help from the IMF usually when their economies face a major macroeconomic risk, mostly in the form of a currency crisis.
For instance in the case of Sri Lanka and Pakistan, both countries have witnessed domestic prices rise rapidly and the exchange value of their currencies drop steeply against the U.S. dollar.
Mismanagement by Central Bank: Currency crises are generally the result of gross mismanagement of the nation’s currency by its central bank. Central banks may be forced by governments to create fresh money out of thin air to fund populist spending.
Such spending eventually results in a rapid rise of the overall money supply, which in turn causes prices to rise across the economy and the exchange value of the currency to drop.
Weakening confidence in currency: A rapid, unpredictable fall in the value of a currency can destroy confidence in said currency and affect economic activity as people may turn hesitant to accept the currency in exchange for goods and services.
Foreigners may also be unwilling to invest in an economy Foreigners may also be unwilling to invest in an economy
About International Monetary Fund (IMF)
The IMF was set up along with the World Bank after the Second World War to assist in the reconstruction of war-ravaged countries.
The two organizations agreed to be set up at a conference in Bretton Woods in the US. Hence, they are known as the Bretton Woods twins.
The IMF is governed by and accountable to the 190 countries that make up its near-global membership.
India joined on 27th December 1945.
The IMF's primary purpose is to ensure the stability of the international monetary system — the system of exchange rates and international payments that enables countries (and their citizens) to transact with each other.
The Fund's mandate was updated in 2012 to include all macroeconomic and financial sector issues that bear on global stability.
Reports by IMF:
Global Financial Stability Report
World Economic Outlook
Domestic economic policy: economic policy that imperils productivity can affect a country’s ability to attract the necessary foreign exchange for its survival.
For example, In the case of Sri Lanka, a decrease in foreign tourists visiting the country led to a steep fall in the flow of U.S. dollars into the nation.
How does the IMF help a country?
The IMF basically lends money, often in the form of special drawing rights (SDRs), to troubled economies that seek the lender’s assistance.
SDRs simply represent a basket of five currencies, namely the U.S. dollar, the euro, the Chinese yuan, the Japanese yen, and the British pound.
The IMF carries out its lending to troubled economies through a number of lending programs such as the extended credit facility, the flexible credit line, the stand-by agreement, etc.
Prerequisite structural reforms: The IMF usually imposes conditions on countries before it lends any money to them. For example, a country may have to agree to implement certain structural reforms as a condition to receive IMF loans.
Tough on public: The IMF’s conditional lending has been controversial as many believe that these reforms are too tough on the public.
Influenced by international politics: Some have also accused the IMF’s lending decisions, which are taken by officials appointed by the governments of various countries, to be influenced by international politics.