1. ‘War to test resilience of global financial system’

IMF flags the risks of future shocks

Russia’s invasion of Ukraine has driven up financial stability risks “on several fronts” and will test the resilience of the global financial system at a time when interest rates are rising sharply, the International Monetary Fund (IMF) warned in its biannual Global Financial Stability Report on Tuesday.

While there has so far been no globally systemic financial event, there are several channels through which the Ukrainian turmoil could be amplified across the system, the IMF warned.

Those include banks’ and non-banks’ direct and indirect exposures to Russia; commodity market disruptions and increased counterparty risk; poor market liquidity and funding strains; and cyberattacks and the acceleration of crypto asset use, it said. “While the financial system has proven resilient to recent shocks, future shocks could be more harmful,” the IMF said.

“A sudden repricing of risk resulting from an intensification of the war and the associated escalation of sanctions may expose vulnerabilities built up during the pandemic, leading to a sharp [dip] in asset prices.”

International Monetary Fund (IMF)

Basics and Background:

• The International Monetary Fund (IMF) is an organization of 189 member countries, each of which has representation on the IMF’s executive board in proportion to its financial importance, so that the most powerful countries in the global economy have the most voting power.
• The IMF, also known as the Fund, was conceived at a UN conference in Bretton Woods, New Hampshire, United States, in July 1944.
• The 44 countries at that conference sought to build a framework for economic cooperation to avoid a repetition of the competitive devaluations that had contributed to the Great Depression of the 1930s.
• Countries were not eligible for membership in the International Bank for Reconstruction and Development (IBRD) unless they were members of the IMF.

Objectives:

• Foster global monetary cooperation
• Secure financial stability
• Facilitate international trade
• Promote high employment and sustainable economic growth
• And reduce poverty around the world

Functions

• Regulatory functions: IMF functions as a regulatory body and as per the rules of the Articles of Agreement, it also focuses on administering a code of conduct for exchange rate policies and restrictions on payments for current account transactions.
• Financial functions: IMF provides financial support and resources to the member countries to meet short term and medium term Balance of Payments (BOP) disequilibrium.
• Consultative fun­ctions: IMF is a center for international cooperation for the member countries. It also acts as a source of counsel and technical assistance.

IMF Quotas:

• IMF funds come from two major sources – Quota and Loans.
• Quotas which are pooled funds of member nations, generate most IMF funds.
• The size of a member’s quota depends on its economic and financial importance in the world.
• Nations with larger economic importance have larger quotas.
• The quotas are increased periodically as a means of boosting the IMF resources in the form of Special Drawing Rights.

Special Drawing Rights:

• Special Drawing Rights (SDRs) are supplementary foreign exchange reserve assets defined and maintained by the International Monetary Fund (IMF)
• SDR is not a currency, instead represents a claim to currency held by IMF member countries for which they may be exchanged.
• The value of an SDR is defined by a weighted currency basket of four major currencies – the US Dollar, the Euro, the British Pound, the Chinese Yuan and the Japanese Yen.
• Central bank of member countries held SDR with IMF which can be used by them to access funds from IMF in case of financial crises in their domestic market.

Concern with Quota System:

• The 15th General Review of Quotas (GRQ),the most recent attempt to revise the size and composition of the system, was to be completed by October 2017, but now extended to 2019.
• The delay was not unexpected, given the poor precedent set by the long delay in adoption in 2016 of the previous GRQ (originally approved in 2010).
• That had doubled the overall size of the quotas to $659 billion (from $329 billion) while allotting an additional 6% of quotas to the developing world.

India and IMF:

• International regulation by IMF in the field of money has certainly contributed towards expansion of international trade. India has, to that extent, benefitted from these fruitful results.
• Post-partition period,India had serious balance of payments deficits, particularly with the dollar and other hard currency countries. It was the IMF that came to her rescue.
• The Fund granted India loans to meet the financial difficulties arising out of the Indo–Pak conflict of 1965 and 1971.
• From the inception of IMF up to March 31, 1971, India purchased foreign currencies of the value of INR. 817.5 crores from the IMF, and the same have been fully repaid.
• Since 1970, the assistance that India, as other member countries of the IMF, can obtain from it has been increased through the setting up of the Special Drawing Rights(SDRs created in 1969).
• India had to borrow from the Fund in the wake of the steep rise in the prices of its imports, food, fuel and fertilizers.
• India wanted large foreign capital for her various river projects, land reclamation schemes and for the development of communications.
• India has availed of the services of specialists of the IMFfor the purpose of assessing the state of the Indian economy. In this way India has had the benefit of independent scrutiny and advice.
• The balance of payments position of India having gone utterly out of gear on account of the oil price escalation since October 1973, the IMF has started making available oil facility by setting up a special fund for the purpose.
• The foreign reserves started picking up with the onset of the liberalisation policies in 1991.
• India has occupied a special place in the Board of Directorsof the Fund. Thus, India had played a creditable role in determining the policies of the Fund. This has increased the India’s prestige in the international circles.