IMF’s bailout plan for Sri Lanka

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 

• 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.

Limitations

• 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.