This post continues from the series on International Relations for IAS Prep. Read the essential posts here –

• An IAS Aspirant’s guide to cracking International Relations
• Analysis | Previous year’s IAS Mains questions from IR

This was the first example of a fully negotiated monetary order intended to govern monetary relations among independent nation-states.

Where?

In Bretton Woods, New Hampshire in 1944 during the United Nations Monetary and Financial Conference at the Mount Washington Hotel <That’s why IMF and World Bank are known as Bretton Woods twins>

The aim was to help rebuild the shattered post-war economy ( WW2 had just finished in 1945) and to promote international economic cooperation.

Origins of Bretton Woods

Political origin lies in 2 key conditions –

• Shared experiences of 2 World Wars, with the sense that failure to deal with economic problems after the first war had led to the second <Treaty of Versailles demanding massive reparation amount from Germany  being the cause of collapse of German economy and Hitler’s rise to power>
• The concentration of power in a small number of states (US and Western Europe)

Members of Bretton Woods Family aka Bretton Woods Twins

#1. International Monetary Fund(IMF) – To maintain global financial stability through technical assistance, training, and loans to member states to tide over short term balance of payment crisis

#2. World Bank (WB) Group – Consisting of 5 agencies which provides vital financial and technical assistance to developing countries around the world to reduce global poverty

Remember that WTO has nothing to so with Bretton Woods. It officially commenced only in 1995 under the Marrakesh agreement and replace General Agreement on Tariff and trade (GATT)

Propounder of the idea of IMF and WB group:

Trio of  – US Treasury Secretary Henry Morgenthau, his chief economic advisor Harry Dexter White, and British economist John Maynard Keynes.

What are some of the concerns and criticism about Bretton Woods twins?

• Critics of the World Bank and the IMF are concerned about the conditionalities imposed on borrower countries
• The World Bank and the IMF often attach loan conditionalities based on what is termed the ‘Washington Consensus’, focusing on liberalisation of trade, investment and privatisation of nationalised industries <so if India asked for funds from IMF, it might ask India to allow FDI in multi brand retail, to end system of minimum support prices in agriculture, privatize coal India etc.>
• Many infrastructure projects financed by the WB Group have social and environmental implications for the populations in the affected areas
• For example, World Bank-funded construction of hydroelectric dams in various countries has resulted in the displacement of indigenous peoples of the area
• Criticisms against the governance structures which are dominated by industrialized countries <unwritten rule that president of World Bank will be from USA and Managing Director of IMF from Europe.> Otherwise who is more qualified than Rajan Bhai to become MD of IMF
• Decisions are made and policies implemented by leading industrialized countries, the G7, because they represent the largest donors without much consultation with poor and developing countries < Countries which would utilize that assistance not even consulted, you see the irony>

Let’s have a look at Bretton Woods organisations in brief

#1. International Monetary Fund (IMF)

Fundamental mission is to ensure the stability of the international monetary system.

It does so in 3 ways:

• Keeping track of the global economy and the economies of member countries (surveillance role)
• Lending to countries with balance of payments difficulties (Lending role)
• Giving practical help to members (technical assistance role)

When? 1944

Membership: 188 countries

Headquarters: Washington, D.C.

Publication- World Economic outlook, Global Financial Stability Report

Objectives:

• Promote international monetary cooperation
• Facilitate the expansion and balanced growth of international trade;
• Promote exchange stability
• Assist in the establishment of a multilateral system of payments
  Make resources available (with adequate safeguards) to members
• experiencing balance of payments difficulties

Functioning of IMF comes under 3 Mains types –

Surveillance –

This involves the monitoring of economic and financial developments and the provision of policy advice , aimed especially at crisis-prevention.

<Surveillance is the process of appraisal of the exchange rate policies of member countries. In the absence of surveillance, the financial volatility in the world today can become worse>

We all know, how good it’s surveillance is. It failed to predict worse it failed to even recognize the stress in the system which led to financial crisis of 2008. It again failed with the prediction of euro-zone crisis.

Lending –

The IMF also to countries with balance of payments difficulties, to provide temporary financing and to support policies aimed at correcting the underlying problems, loans to low-income countries are also aimed esp. at poverty reduction <most criticized part, riddled with commonalities we discussed above>

Technical Assistance –

The IMF provides countries with technical assistance and training in its areas of expertise, which it calls capacity development

Obviously IMF would need money to perform all these functions. Money is contributed by member states and each country’s contribution is fixed in terms of it’s quota.

Let’s learn about Member’s Quota in IMF –

• Quota represents the subscription by a member country to the capital fund of the IMF i.e it’s contribution to the IMF
• the quota also forms the basis for determining its drawing rights from the IMF <simple, more you contribute, more you can withdraw at the time of crisis, fair point>
• But the quota also determines voting power i.e. if 10% quota, your vote will carry 10% weight <this seems very undemocratic, gives all the power to rich countries or is it just fair, private companies mein bhi to same hi hota hai, jitni equity, utna vote>

But how is quota of each country calculated?

• Quota is calculated using a quota formula
• The current Quota formula is a weighted average of GDP (50%), openness (30 %), economic variability (15%), and international reserves (5%)
• In the GDP category, weight of GDP at market exchange rate is 60% and at purchasing power parity rate (PPP) is 40% <developing countries GDP is more in PPP terms and they want the IMF to change the formula to give greater weightage to GDP at PPP plus frequent revision of quotas as they grow faster>
• The largest share of 17.5 per cent belongs to the USA, while the smallest share belongs to Palau (0.001 per cent) <now think what can tiny Palau do at IMF>
• Any change in quotas must be approved by 85% voting power i.e USA with more than 15% quota holds virtual veto over all such decisions <now compare power of US with tiny Palau at IMF>
• 25% of a country’s quota is to be contributed in the form of SDRs or foreign exchange and 75 per cent in the country’s own currency.

What is this Special Drawing Rights or SDR?

Bretton Woods established an international monetary system of fixed exchange rates pegged to dollar which was roughly pegged to gold known as gold exchange standard i.e. for every unit of currency fixed amount of dollars could be bought and with those dollars fixed amount of gold.

But with high trade growth in world resources did not keep pace with the growth in international trade because there simply wasn’t enough gold. World needed some other asset to supplement shortfall in dollar and gold and IMF brougth in SDR. But in 1971 gold standard and dollar peg collapsed and world moved to flexible exchange rate system. Role of SDR as international reserve asset diminished.

The value of the SDR is based on a basket of key international currencies (weighted avg value). With the addition of Renminbi, 5 currencies, dollar, yen, euro and pound-sterling form the SDR basket. (Renminbi value will be taken into account from Oct 1, 2016 only)

Please remember that SDR is not a currency i.e it is not a claim on the IMF. On the other hand, SDR is a claim on the countries whose currency is included in the SDR basket.(claim as is written on your 500 rs note with Rajan’s signature: I promise to pay the bearer the sum of 500 rupees)

Now, it has primarily become a unit of account i.e. IMF record keeping is done in SDR, Quotas are allocated in SDR.

• SDRs are entitlements granted to member-countries enabling them to draw from the IMF apart from their quota. It is similar to a bank granting a credit limit to the customer
• When SDRs are allocated the country’s Special Drawing Account with the IMF is credited with the amount of the allotment
• Originally, SDRs were to be utilised only for meeting BOP difficulties. But as a consequence of endeavours to make it an international unit of account, the use of SDRs has been liberalised

Current Position of SDR:

• Now SDRs can be used directly among the members without the approval of the IMF
• A country may swap SDRs with another country to acquire a currency it desires. SDRs may be utilised to pay charges to IMF
• SDR has gained importance both as a reserve asset and as a unit of settlement of international transactions. Some countries have pegged their currencies to SDR.

Reforming the IMF

Role of IMF was criticized for following reasons –

• One size fits all policy under which it gives the same recipe for all ills
• Conditionalities that go with the loans that it disburses demand that spending on poor be curtailed <privatize your industries, stop subsidies, open up your markets etc.>
• The private international flows are huge and in comparison, the IMF resource base is small and so is rendered ineffective
• IMF MD is invariably from a European country, so India and other emerging markets are demanding that it should not be geographically confined and be merit – based
• India wants that its economic power as it is emerging should be recognised and so is given greater voting rights
• IMF failed to predict the global recession in 2008-09, let alone prevent it with its surveillance mode

IMF recently passed long standing reform of changing quota share of member countries after US Senate withdrew its virtual veto. A few points

1. With this structural shift, more than 6 % of the quota, including both the Fund’s capital and voting rights, have been transferred from developed to emerging economies
2. India’s voting rights increase to 2.6 per cent from the current 2.3 per cent, and China’s, to 6 per cent from 3.8, as per the new division.
3. All the directors on IMF board will now be elected and developed countries will not be able to nominate (earlier Europeans and US used to nominate up to 4 members to the board)
4. Total resource base of IMF has doubled

To follow the newscards related to IMF as they are pushed, follow this story, IMF and India

India and the IMF equation –

• India and IMF have had an amicable relationship, which has beneficial for both. IMF has provided India with loans over the years and this has helped the country in times of Balance Of Payments (BOP) crisis pressure
• India joined the IMF in 1945, as one of the original founding members
• IMF credit has been instrumental in helping India respond to emerging BOP problems on 2 occasions
• In 1981-82, India borrowed SDR 3.9 billion
• In 1991-93, India borrowed a total 2.2 billion under 2 stand by arrangements, and in 1991 it borrowed SDR 1.4 billion under Compensatory Financing Facility

As a member of the Fund, India has derived following benefits:

Foreign Exchange for Meeting BOP Deficits:

Such drawings of foreign exchange have enabled the country to tide over the acute foreign exchange crisis and to maintain the imports of essentials goods

Oil Facility from the IMF:

India resorted to drawals from the IMF under the Oil Facility created in June, 1974 to meet larger outlays for the import of petroleum crude.

Assistance under SDRs:

The SDRs provide unconditional liquidity since the participants have access to foreign exchange resources at will.

• The country has made use of the Fund’s facilities a number of time Aid from the World Bank: The country’s membership of the IMF has entitled it to become a member of the World Bank; as a member of the Bank, India has received large technical and financial assistance for the various development projects
• Assistance under the Extended Credit Facility: Loan under this facility is contracted at softer terms but there is a serious conditionality clause attached to it
• Preparation of Valuable Reports: The country has availed the services of the specialists in the Fund for the purpose of assessing the state of the Indian economy and for preparing valuable reports on various aspects of the economy.

<We will take World Bank group, a part of bretton woods institutions in next article of this series>

UPSC ke sawaal

#1. Which one of the following groups of items is included in India’s foreign-exchange reserves? (IAS pre 2013)

1. Foreign-currency assets, Special Drawing Rights (SDRs) and loans from foreign countries
2. Foreign-currency assets, gold holdings of the RBI and SDRs
3. Foreign-currency assets, loans from the World Bank and SDRs
4. Foreign-currency assets, gold holdings of the RBI and loans from the World Bank

#2, Regarding the international monetary fund, which one of the following statements is correct ?

• (a) It can grant to any country.
• (b) It can grant loans to only developed countries.
• (c) It grants loans to only member countries.
• (d) It can grant  loans to the central bank of a country.

#3.Which of the following organizations brings out the publication known as ‘World Economic Outlook’? (IAS pre 2014)

(a) The International Monetary Fund
(b) The United Nations Development Programme
(c) The World Economic Forum
(d) The World Bank

#4. The World Bank and the IMF, collectively known as the Bretton Woods Institutions, are the two inter-governmental pillars supporting the structure of the world’s economic and financial order. Superficially, the World Bank and the IMF exhibit many common characteristics, yet their role, functions and mandate are distinctly different. Elucidate. (Mains 2013)

Further Readings –

• The Great fall of China (Brief compilation of news cards)
• Chinese Move – Currency Devaluation
• Nursery rhymes on SDR