Understanding IMF bailouts

Source: This post is created based on the article “Understanding IMF bailouts”, published in Indian Express on 27^th Feb 2023.

Syllabus Topic: GS Paper 2 – International Institutions

News: IMF recently approved a bailout plan for Sri Lanka. It is also in a negotiation with Pakistan for bailout plan.

What are the situations in which nations seek IMF bailout?

When nations face major macroeconomic risk, mostly in the form of a currency crisis. In the case of both Pakistan and Sri Lanka, their currency value has dropped steeply against the U.S. dollar.

Currency depreciation often results into government forcing central banks to create fresh money without any basis. It results in a rapid rise of the overall money supply. It leads to price rise due to demand and further reducing currency value.

The rapid decline in the currency value makes people hesitant to accept the currency in exchange for goods and services.

It also discourages foreign investment into country.

Many times, domestic policies of government adversely impacts the currency’s exchange rate and foreign exchange reserves. 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.

It results into shortage of money to meet their external debt and other obligations, to purchase essential imports, and also to prop up the exchange value of their currencies.

In this case, countries seek IMF’s help.

How IMF helps countries in distress?

The IMF lends money, often in the form of special drawing rights (SDRs),

IMF provides assistance to countries through a number of lending programs such as the extended credit facility, the flexible credit line, the stand-by agreement, etc.

What are the conditions of IMF’s bailout and are these justified?

IMF imposes certain conditions, before it lends any money to countries. The country will have to agree to implement certain structural reforms as a condition to receive IMF loans.

As per some critics, these reforms are too tough on the public of country. Some accuses IMF’s conditions to be influenced by international politics.

However, IMF argues that countries that seek an IMF bailout are usually in a crisis due to certain policies adopted by their governments. Thus, it will not be fruitful for IMF to waste the resources on country, where same policies continue. For instance, the IMF may demand a country affected by high price inflation to ensure the independence of its central bank. Handling corruption is usually one of the demands, like in case of Sri Lanka.