INTERNATIONAL FINANCIAL SYSTEMS

The Bretton wood institutions

The Bretton Woods Institutions are the World Bank, and the International Monetary Fund (IMF). They were set up at a meeting of 43 countries in Bretton Woods, New Hampshire, USA in July 1944. Their aims were to help rebuild the shattered postwar economy and to promote international economic cooperation. The original Bretton Woods agreement also included plans for an International Trade Organization (ITO) but these lay dormant until the World Trade Organization (WTO) was created in the early 1990s. The creation of the World Bank and the IMF came at the end of the Second World War. They were based on the ideas of a trio of key experts – US Treasury Secretary Henry Morganthau, his chief economic advisor Harry Dexter White, and British economist John Maynard Keynes. They wanted to establish a post war economic order based on notions of consensual decisionmaking and cooperation in the realm of trade and economic relations.

It was felt by leaders of the Allied countries, particularly the US and Britain, that a multilateral framework was needed to overcome the destabilizing effects of the previous global economic depression and trade battles. In his opening speech at the Bretton Woods conference, Henry Morganthau said the “bewilderment and bitterness” resulting from the Depression became “the breeders of fascism, and finally, of war”. Proponents of the new institutions felt that global economic interaction was necessary to maintain international peace and security. The institutions would facilitate, in Morganthau’s words, “[the] creation of a dynamic world community in which the peoples of every nation will be able to realize their potentialities in peace”. The IMF would create a stable climate for international trade by harmonizing its members’ monetary policies, and maintaining exchange stability. It would be able to
provide temporary financial assistance to countries encountering difficulties with their balance of payments. The World Bank, on the other hand, would serve to improve the capacity of countries to trade by lending money to warravaged and impoverished countries for reconstruction and development projects. The chief features of the Bretton Woods system were:

  • An obligation for each country to adopt a monetary policy that maintained the exchange rate by tying its currency to the U.S. dollar
  • The ability of the IMF to bridge temporary imbalances of payments. However, the Bretton Woods system collapsed in the early 1970s and by 1973 the Bretton Woods system of fixed exchange rates had been abandoned. This led to the emergence of a new international monetary framework. The main features of the current international monetary system are that:
  • The exchange rates are freely floating, determined by market supply and demand for currencies.
  • Secondly, the dollar retains its position as the world’s reserve currency.
  • Third, there is little international oversight or control over the international monetary system. The IMF is the institution that was created to play this role.
  • Another main feature of the international monetary system is that its rules, institutions and norms are guided by a particular ideology and economic model

6.1 International Monetary Fund (IMF)

The International Monetary Fund (IMF) is an international organization that oversees the global financial system by following the macroeconomic policies of its member countries; in particular those with an impact on exchange rates and the balance of payments. It is an organization formed to stabilize international exchange. The IMF was formally organized on December 27, 1945, when the first 29 countries signed its Articles of Agreement. Now, the IMF has huge influence in the world economy. It is a specialized agency of the
United Nations but has its own charter, governing structure, and finances. Its members are represented through a quota system broadly based on their relative size in the global economy. The IMF has 185 member countries and its headquarter is in Washington D.C. IMF’s unit of account is SDR. The current Managing Director of IMF is a French Jew named Dominique Strauss-Kahn .
The IMF works with other international organizations to promote growth and poverty reduction. It also interacts with think tanks, civil society, and the media on a daily basis.

6.1.2.Objectives of IMF

  • Promote international monetary cooperation
  • Expansion and balanced growth of international trade
  • Promote exchange rate stability
  • Help establish multilateral system of payments and eliminate foreign exchange restrictions
  • Make resources of the Fund available to members
  • Shorten the duration and lessen the degree of disequilibrium in international balances of payments

6.2 The World Bank

The World Bank Group
The World Bank Group is now made up of five institutions, four of which were created after 1944, but all sharing a similar mandate, of reducing poverty and facilitating economic growth in developing countries. The original institution is the International Bank for Reconstruction and Development (IBRD), often simply known as the World Bank. Since then other institutions have been added: the International Development Association (IDA); the International Finance Corporation (IFC); the Multilateral Investment Guarantee Agency (MIGA); and the International Centre for the Settlement of Investment Disputes (ICSID). While each of these institutions possess their own governing Articles of Agreement, all of them come under the general administration of the World Bank, sharing a common Board of Governors and Board of Directors and working under the leadership of World Bank president appointed by the US government. World Bank came into existence on 27th December, 1945. It is the part of the United Nations with different governance
structure. The World Bank is one of two major financial institutions created as a result of the Bretton Woods Conference in 1944. The International Monetary Fund, a related but separate institution, is the second.

Delegates from a wide variety of countries attended the Bretton Woods Conference, but the most powerful countries in attendance, the United States and Britain, mainly shaped negotiations. World Bank conceived during World War II at Bretton Woods, New Hampshire, the World Bank initially helped rebuild Europe after the war. Its first loan of $250 million was to France in 1947 for post-war reconstruction. Reconstruction has remained an important focus of the Bank’s work, given the natural disasters, humanitarian emergencies, and post conflict rehabilitation needs that affect developing and transition economies.

6.2.1 Objectives of World Bank
The World Bank provides over $20 billion in assistance to developing and transition countries every year. The Bank’s projects and policies affect the lives and livelihoods of billions of people worldwide – sometimes for the better, but very often in controversial and problematic ways. The World Bank isn’t like the usual conventional banks. A single person cannot open an account or ask for a loan.

Rather, the Bank provides loans, grants and technical assistance to countries and the private sector to reduce poverty in developing and transition countries. World Bank background and objectives have expanded and evolved over the years. The original purpose and
objectives as the International Bank for Reconstruction and Development was a facilitator role in post-war reconstruction. Since 1944, this role has expanded and World Bank’s objectives have grown to develop its current mandate to alleviate worldwide poverty. They work closely with their affiliate, the International Development Association.

With all this expansion and growth, World Bank’s original focus has not changed. Today, reconstruction remains a top priority in such situations as natural disasters, needs affecting developing economies, post conflict rehabilitation and needs affecting a transitioning economy.

6.3 Impacts of Bretton Woods Institutions

1. Surveillance
The IMF oversees the international monetary system and monitors the financial and economic policies of its members. It keeps track of economic developments on a national, regional, and global basis, consulting regularly with member countries and providing them with macroeconomic and financial policy advice. Surveillance covers a range of economic policies, with the emphasis varying in accordance with a country’s individual circumstances:

  • Exchange rate, monetary, and fiscal policies. The IMF provides advice on issues such as the choice of exchange rate policies and ensuring consistency between the regime and fiscal and monetary policies.
  • Financial sector issues are receiving elevated coverage in surveillance reports, building on the achievements under the Financial Sector
    Assessment Program (FSAP), which enables the IMF and the World Bank to gauge the strengths and weaknesses of countries’ financial sectors.
  • Assessment of risks and vulnerabilities stemming from large and sometimes volatile capital flows has become more central to IMF surveillance in recent years.
  • Institutional and structural issues have also gained importance in the wake of financial crises and in the context of some countries’ transition from planned to market economies. The IMF and the World Bank play a central role in developing, implementing, and assessing internationally recognized standards and codes in areas crucial to the efficient functioning of a modern economy such as central bank independence, financial sector regulation, and policy transparency and accountability.

2. Technical Assistance
To assist mainly low- and middle-income countries in effectively managing their economies, the IMF provides practical guidance and training on how to upgrade institutions, and design appropriate macroeconomic, financial, and structural policies. The IMF provides technical assistance and training mainly in four areas: Monetary and financial policies (monetary policy instruments, banking system supervision and restructuring, foreign management and operations, clearing settlement systems for payments, and structure
development of central banks);

  • fiscal policy and management (tax and customs policies and administration, budget formulation, expenditure management, design of social safety nets, and management of domestic and foreign debt);
  • compilation, management, dissemination, and improvement of statistical data; and
  • economic and financial legislation. The World bank provides technical assistance by:
  • Through economic research and data collection on broad issues such as the environment, poverty, trade and globalization,
  • Another is through country-specific, non-lending activities such as economic
  •  and sector work, where it evaluates a country’s economic prospects by examining its banking systems and financial markets, as well as trade, infrastructure, poverty and social safety net issues,

The World Bank also draws upon the resources of its knowledge bank to educate clients so they can equip themselves to solve their development problems and promote economic growth.

3. Lending
The IMF provides loans to countries that have trouble meeting their international payments and cannot otherwise find sufficient financing on affordable terms. This financial assistance is designed to help countries restore macroeconomic stability by rebuilding their international reserves, stabilizing their currencies, and paying for imports—all necessary conditions
for launching growth. The IMF also provides concessional loans to lowincome countries to help them develop their economies and reduce poverty.

Main lending facilities
1. Stand-By Arrangement (SBA)
In an economic crisis, countries often need financing to help them overcome their balance of payments problems. Since its creation in June 1952, the IMF’s Stand-By Arrangement (SBA) has been used time and again by member countries, it is the IMF’s workhorse lending instrument for emerging market countries. Rates are nonconcessional, although they are almost always lower than what countries would pay to raise financing from private markets. The SBA was upgraded in 2009 to be more flexible and responsive to member countries’ needs. Borrowing limits were doubled with more funds available up front, and conditions were streamlined and simplified. The new framework also enables broader high-access borrowing on a precautionary basis.

2. Flexible Credit Line (FCL)
The Flexible Credit Line (FCL) is for countries with very strong fundamentals, policies, and track records of policy implementation. It represents a significant shift in how the Fund delivers Fund financial assistance, particularly with recent enhancements, as it has no ongoing (ex post) conditions and no caps on the size of the credit line. The FCL is a renewable credit line, which at the country’s discretion could be for either one- or two years, with a review of eligibility after the first year. There is the flexibility to either treat the credit line as precautionary or draw on it at any time after the FCL is approved. Once a country qualifies (according to pre-set criteria), it can tap all resources available under the credit line at any time, as disbursements would not be phased and conditioned on particular policies as with traditional Fund-supported programs. This is justified by the very strong track records of countries that qualify to the FCL, which give confidence that their economic policies will remain strong or that corrective measures will be taken in the face of shocks.

3. Precautionary Credit Line (PCL)
The new Precautionary Credit Line (PCL) is also for countries with sound fundamentals and policies, and a track record of implementing such policies. While they may face moderate vulnerabilities that may not meet the FCL qualification standards, they do not require the same large-scale policy adjustments normally associated with traditional Fund-supported program.
The PCL combines pre-qualification (similar to the FCL), with more focused ex-post conditions that aim at addressing the identified vulnerabilities. Progress is assessed in the context of semi-annual monitoring over a one to two year period. The size of the credit line allows access to a larger amount of resources than under a typical SBA. While there may be no actual balance of payments need should at the time of approval, the PCL can be drawn upon should such a need arise unexpectedly.

4. Extended Fund Facility
The Extended Fund Facility is used to help countries address balance of payments difficulties related partly to structural problems that may take longer to correct than macroeconomic imbalances. A program supported by an extended arrangement usually includes measures to improve the way markets and institutions function, such as tax and financial sector reforms, privatization of public enterprises.

5. Trade Integration Mechanism
The Trade Integration Mechanism allows the IMF to provide loans under one of its facilities to a developing country whose balance of payments is suffering because of multilateral trade liberalization, either because its export earnings decline when it loses preferential access to certain markets or because prices for food imports go up when agricultural subsidies are eliminated.

6.4. Fund Generation

International Bank for Reconstruction and Development (IBRD) lending to developing countries is primarily financed by selling AAA-rated bonds in the world’s financial markets. While IBRD earns a small margin on this lending, the greater proportion of its income comes from lending out its own capital. This capital consists of reserves built up over the years and money paid in from the Bank’s 185 member country shareholders. IBRD’s income also pays for World Bank operating expenses and has contributed to International
Development Association (IDA) and debt relief. IDA is the world’s largest source of interest-free loans and grant assistance to the poorest countries.

IDA’s funds are replenished every three years by 40 donor countries. Additional funds are regenerated through repayments of loan principal on 35- to-40- year, no-interest loans, which are then available for re-lending.

6.4.1. Trust Funds and Grants
Donor governments and a broad array of private and public institutions make deposits in Trust funds that are housed at the World Bank. These donor resources are leveraged for a broad range of development initiatives. The initiatives vary significantly in size and complexity, ranging from multibillion dollar arrangements—such as Carbon Finance; the Global Environment Facility; the
Heavily Indebted Poor Countries Initiative; and the Global Fund to Fight AIDS, Tuberculosis, and Malaria—to much smaller and simpler freestanding ones. The Bank also mobilizes external resources for IDA concessionary financing and grants, as well as funds for non-lending technical assistance and advisory activities to meet the special needs of developing countries, and for co-financing of projects and programs. Direct World Bank grants to civil society organizations emphasize broad-based stakeholder participation in
development, and aim to strengthen the voice and influence of poor and marginalized groups in the development process.

6.4.2. Capacity Building
Another core function is to increase the capabilities of the partners, the people in developing countries, so as to help them acquire the knowledge and skills they need to provide technical assistance, improve government performance and delivery of services, promote economic growth and sustain poverty reduction programs. Linkages to knowledge-sharing networks such as these have been set up by the Bank to address the vast needs for information and dialogue about development. The Bretton Woods institutions (The IMF and
World bank) was an agreement to stabilize currencies and avoid restrictive exchange practices. It provided short-term liquidity to members with current account deficits, conditioned on their taking measures to restore balance of payments equilibrium. The World Bank was intended to make loans and guarantees for post–World War II reconstruction and for economic development. However, they have been subjected to a variety of criticisms in recent years and have been faced with severe problems in carrying out their
objectives. The International Monetary Fund (IME) and the World Bank have not performed in accordance with the original intentions of their founders.

For example, in recent years, a major problem has been the financial crises of member countries that have liberalized their economies in line with trends toward globalization. These crises have resulted in demands on the IMF and World Bank for financial assistance for purposes other than those for which their assistance was originally designed. Other problems of the two institutions include providing assistance to the world’s poorest countries that have made virtually no development progress in recent years, and assisting
the former communist countries in transition to market economies.

According to the Bretton Woods Agreements, the IMF was designed to assist a member country in financing its current account deficit while implementing policies to restore balance of payments equilibrium. Monetary and fiscal restrictions and exchange rate adjustments usually require several years to correct a current account deficit. Also, there is a close relationship between policies that affect the balance of payments and those that promote economic development. Therefore, both functions should be carried on by a single institution represented by a merger of the IMF and the World bank.

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