Chapter 4



International finance


International finance (also referred to as international monetary economics or international macroeconomics) is the branch of financial economics broadly concerned with monetary and macroeconomic interrelations between two or more countries.


The field of international finance concerns itself with studying global capital markets and might involve monitoring movements in foreign exchange rates, global investment flows and cross border trade practices.

International finance examines the dynamics of the global financial system, international monetary systems, balance of payments, exchange rates, foreign direct investment and other important issues associated with international financial management and how these topics relate to international trade.


Sometimes referred to as multinational finance, international finance is additionally concerned with matters of international financial management.

Investors and multinational corporations must assess and manage international risks such as

Political risks [risk faced by investors, corporations, and governments that political decisions, events, or conditions will significantly affect the profitability of a business actor or the expected value of a given economic action] and


foreign exchange risk [exchange rate risk or currency risk] )including

transaction exposure [measures cash (realized) gains and losses from a change in exchange rates.]

economic exposure [the risk that a company's cash flow, foreign investments, and earnings may suffer as a result of fluctuating foreign currency exchange rates] and

translation exposure [measures accounting (book) gains and losses from a change in exchange rates. ].


Like international trade and business, international finance exists due to the fact that economic activities of businesses, governments, and organizations get affected by the existence of nations.


It is a known fact that countries often borrow and lend from each other. In such trades, many countries use their own currencies.


Therefore, we must understand how the currencies compare with each other. Moreover, we should also have a good understanding of how these goods are paid for and what is the determining factor of the prices that the currencies trade at.


Some examples of key concepts within international finance are the Mundell Flemming modl, the optimum currency area theory, purchasing power parity and the international Fisher effect.


Whereas the study of international trade makes use of mostly microeconomic concepts, international finance research investigates predominantly macroeconomic concepts.


The three major components setting international finance apart from its purely domestic counterpart are as follows:

  1. Foreign exchange and political risks.
  1. Market imperfections [A market where information is not quickly disclosed to all participants in it and where the matching of buyers and sellers isn't immediate. Generally speaking, it is any market that does not adhere rigidly to perfect information flow and provide instantly available buyers and sellers]
  2. Expanded opportunity sets [the possible expected return and standard deviation pairs of all portfolios that can be constructed from a given set of assets].


These major dimensions of international finance largely stem from the fact that sovereign nations have the right and power to issue currencies, formulate their own economic policies, impose taxes, and regulate movement of people, goods, and capital across their borders.


Note − The World Bank, the International Finance Corporation (IFC), the International Monetary Fund (IMF), and the National Bureau of Economic Research (NBER) are some of the notable international finance organizations.


International trade is one of the most important factors of growth and prosperity of participating economies.

Its importance has got magnified many times due to globalization.

Moreover, the resurgence of the US from being the biggest international creditor to become the largest international debtor is an important issue.

These issues are a part of international macroeconomics, which is popularly known as international finance.



Importance of International Finance

International finance plays a critical role in international trade and inter-economy exchange of goods and services.

It is important for a number of reasons; the most notable ones are listed here.


  • International finance is an important tool to find the exchange rates, compare inflation rates, get an idea about investing in international debt securities, ascertain the economic status of other countries and judge the foreign markets.
  • Exchange rates are very important in international finance, as they let us determine the relative values of currencies. International finance helps in calculating these rates.
  • Various economic factors help in making international investment decisions. Economic factors of economies help in determining whether or not investors’ money is safe with foreign debt securities.
  • Utilizing IFRS [International Finance Reporting Standard ts an accounting standard] is an important factor for many stages of international finance. Financial statements made by the countries that have adopted IFRS are similar. It helps many countries to follow similar reporting systems.
  • IFRS system, which is a part of international finance, also helps in saving money by following the rules of reporting on a single accounting standard.
  • International finance has grown in stature due to globalization. It helps understand the basics of all international organizations and keeps the balance intact among them.
  • An international finance system maintains peace among the nations. Without a solid finance measure, all nations would work for their self-interest. International finance helps in keeping that issue at bay.
  • International finance organizations, such as IMF, the World Bank, etc., provide a mediators’ role in managing international finance disputes.


  • Companies are motivated to invest capital in abroad for the following reasons
  • Efficiently produce products in foreign markets than that domestically.
  • Obtain the essential raw materials needed for production.
  • Broaden  markets and diversify
  • Earn higher returns
  • foreign investment




The very existence of an international financial system means that there are possibilities of international financial crises. This is where the study of international finance becomes very important. To know about the international financial crises, we have to understand the nature of the international financial system.

Without international finance, chances of conflicts and thereby, a resultant mess, is apparent. International finance helps keep international issues in a disciplined state.





  • “International monetary systems are sets of internationally agreed rules, conventions and supporting institutions, that facilitate international trade, cross border investment and generally there allocation of capital between nation states”.
  • International monetary system refers to the system prevailing in world foreign exchange markets through which international trade and capital movement are financed and exchange rates are determined
  • The International Monetary System is part of the institutional framework that binds national economies,
  • such a system permits producers to specialize in those goods for which they have a comparative advantage, and
  • serves to seek profitable investment opportunities on a global basis



  • Providing countries with sufficient liquidity to finance temporary balance of payments deficits.
  • Should at least try avoid adding further uncertainty.
  • Allowing member countries to pursue independent monetary and fiscal policies.






  • Bimetalism [before 1875]
  • Classic Gold Standard (1816 – 1914)
  • Interwar Period (1918 – 1939)
  • Bretton Woods System (1944 – 1971)
  • Present International Monetary System  Nixon’s announcement (1971)
  • Smithsonian Agreement December 1971
    • Flexible exchange rate system 1973 onwards
    • Jamaica agreement 1976.






“Bimetallismis the economic term for a monetary standard in which the value of the monetary unit is defined as equivalent to certain quantities of two metals, typically gold and silver creating a fixed rate of exchange between them”.

ie a monetary system in which a government recognizes coins composed of gold or silver as legal tender. The bimetallic standard (or bimetallism) backs a unit of currency to a fixed ratio of gold and/or silver.

Breakdownof ‘Bimetallic Standard’

The bimetallic standard was first used in the United States in 1792 as a means of controlling the value of money.

For example, during the 18th century in the United States, one ounce of gold was equal to 15 ounces of silver.

Therefore, there would be 15 times more Silver (by weight) in $10 worth of silver coins than $10 worth of gold coins.

Adequate gold and silver was kept in reserves to back the paper currency.

This bimetallic standard was used until the civil war, when the Resumption Act of 1875 stated that paper money could be converted to gold.






  • 22nd June 1816, Great Britain declared the gold currency as official national currency (Lord Liverpool’s Act).
  • On 1st May 1821 the convertibility of Pound Sterling into gold was legally guaranteed.
  • •Other countries pegged their currencies to the British Pound, which made it a reserve currency.
  • This happened while the British more and more dominated international finance and trade relations. •
  • At the end of the 19th century, the Pound was used for two thirds of world trade and most foreign exchange reserves were held in this currency.
  • Between 1810 and 1833 the United States had de facto the silver standard.
  • In 1834 (Coinage Act of 1834), the government set the gold-silver exchange rate to 16:1 which implemented a de facto gold standard.
  • In 1879 the United States set the gold price to US$ 20,67 and returned to the gold standard.
  • With the “Gold Standard Act” of 1900, gold became an official instrument of payment
  • From the 1870s to the outbreak of World War I in 1914, the world benefited from a well integrated financial order, sometimes known as the First age of Globalization.
  • Money unions were operating which effectively allowed members to accept each others currency as legal tender including the Latin Monetary Union and Scandinavian monetary union•
  • In the absence of shared membership of a union, transactions were facilitated by widespread participation in the gold standard, by both independent nations and their colonies

Rules of classic gold standard

  • Each country defined the value of its currency in terms of gold.
  •  Exchange rate between any two currencies was calculated as X currency per ounce of gold/ Y currency per ounce of gold.
  • These exchange rates were set by arbitrage depending on the transportation costs of gold.

Central banks are restricted in not being able to issue more currency than gold reserves.

Arguments in favour of classic gold standard

  • Price Stability:-
  • By tying the money supply to the supply of gold, central banks are unable to expand the money supply.
  • Facilitates BOP adjustment automatically:-
  • The basic idea is that a country that runs a current account deficit needs to export money (gold) to the countries that run a surplus.
  • The surplus of gold reduces the deficit country’s money supply and increases the surplus country’s money supply.

Arguments against classic gold standard

  • The growth of output and the growth of gold supplies needs to be closely linked.
  • For example, if the supply of gold increased faster than the supply of goods did there would be inflationary pressure.
  • Conversely, if output increased faster than supplies of gold did there would be deflationary pressure.
  • Volatility in the supply of gold could cause adverse shocks to the economy, rapid changes in the supply of gold would cause rapid changes in the supply of money and cause wild fluctuations in prices that could prove quite disruptive


  • In practice monetary authorities may not be forced to strictly tie their hands in limiting the creation of money.
  • Countries with respectable monetary policy makers cannot use monetary policy to fight domestic issues like unemployment.





  • The years between the world wars have been described as a period of de-globalization, as both international trade and capital flows shrank compared to the period before World War I.
  • During World War I countries had abandoned the gold standard and, except for the United States.
  • The onset of the World Wars saw the end of the gold standard as countries, other than the U.S., stopped making their currencies convertible and started printing money to pay for war related expenses.


  • After the war, with high rates of inflation and a large stock of outstanding money, a return to the old gold standard was only possible through a deep recession inducing monetary contraction as practiced by the British after WW I.
  • The focus shifted from external cooperation to internal reconstruction and events like the Great Depression further illustrated the breakdown of the international monetary system, bringing such bad policy moves such as a deep monetary contraction in the face of a recession.


  • Conditions Prior to Bretton Woods:-
  • Prior to WW I major national currencies were on asystem of fixed exchange rates under the internationalgold standards.
  • This system had been abandoned duringWW I.
  • There were fluctuating exchange rates from the end ofthe War to 1925.
  • But it collapsed with the happening ofthe Great Depression.
  • Many countries resorted to protectionism and competitive devaluation.
  • But depression disappeared during WW II






  • Prior to WWI major currencies were on a system of fixed exchange rates under the international gold standard. This system had been abandoned during the wwi.
  • There were flictuating exchange rates fom the end of the war to 1925. but it collapsed with the happening of the great depression.
  • Many countries resorted to protectionism and competitive devaluation. But depression disappeared during the WWII.


  • British and American policy makers began to plan the post war international monetary system in the early 1940s.
  • The objective was to creaye an order that combined the benefits of an integrated and relatively liberal international system with the freedom of governments to persue domestic policies aimed at promoting full employment and social wellbeing.
  • The principal architects of the new system were Lord John Maynard Keynes and Prof  Harry Dexter White.


  • Bretton Woods is a little town in New Hampshire, famous mostly for good skiing.
  • In July 1944, the International Monetary and Financial Conference organized by the U.N attempted to put together an international financial system that eliminated the chaos of the inter-war years.
  • The terms of the agreement were negotiated by 44 nations, led by the U.S and Britain.
  • The main hope of creating a new financial system was to stabilize exchange rates, provide capital for reconstruction from the war and foment international cooperation.


Features of Bretton Woods SYSTEM

  • The features of the Bretton Woods system can be described as a “gold-exchange” standard rather than a “gold-standard”.
  • The key difference was that the dollar was the only currency that was backed by and convertible into gold. (The rate initially was $35 an ounce of gold)
  • Other countries would have an “adjustable peg” basically, they were exchangeable at a fixed rate against the dollar, although the rate could be readjusted at certain times under certain conditions.


  • Each country was allowed to have a 1% band around which their currency was allowed to fluctuate around the fixed rate.
  • Except on the rare occasions when the par value was allowed to be readjusted, countries would have to intervene to ensure that the currency stayed in the required band.
  • The IMF was created with the specific goal of being the multilateral body that monitored the implementation of the Bretton Woods agreement.
  • Its role was to hold gold reserves and currency reserves that were contributed by the member countries and then lend this money out to other nations that had difficulty meeting their obligations under the agreement.
  • The borrowing was classified into tranches, each with attached conditions that became progressively stricter.
  • This enabled the IMF to force countries to adjust excess fiscal deficits, tighten monetary policy etc, and force them to be more consistent with their obligations under the agreement.


  • Currencies had to be convertible: central banks had to exchange domestic currency for dollars upon request.•
  • Although the adjustable exchange rate system meant that countries that could no longer sustain the fixed exchange rate vis-a-vis the dollar would be allowed to devalue their currencies, they could only do so with the consent of the other countries and the auspices of the IMF.


  • In a world with N currencies there are only N-1 exchange rates against the reserve currency.
  • If all the countries in the world are fixing their currencies against the reserve currency and acting to keep the rate fixed, then the reserve country has no need to intervene.•
  • Reserve currency country can use monetary policy for its own domestic policy purposes while other countries are unable to use monetary policy for domestic policy purposes.
  • Therefore a decrease in the reserve country’s money supply would cause an appreciation of the reserve currency and force the other central banks to lose external reserves.
  • So the reserve country can affect both the output in its country as well as output in other countries through changes in its monetary policy.

The Demise of the Bretton Woods System

  • The Demise of the Bretton Woods System • In the early post-war period, the U.S. government had to provide dollar reserves to all countries who wanted to intervene in their currency markets.
  • Lead to problem of lack of international liquidity.
  • The increasing supply of dollars worldwide, made available through programs like the Marshall Plan, meant that the credibility of the gold backing of the dollar was in question.
  • U.S. dollars held abroad grew rapidly and this represented a claim on U.S. gold stocks and cast some doubt on the U.S.’s ability to convert dollars into gold upon request.


  • Domestic U.S. policies, such as the growing expenditure associated with Vietnam resulted in more printing of dollars to finance expenditure and forced foreign governments to run up holdings of dollar reserves.
  • Although they pursue this for a while a few countries began to become growingly less keen on holding dollars and more keen on holding gold.



In 1971, the U.S. government “closed the gold window” by decree of President Nixon.



  • The world moved from a gold standard to a dollar standard from Bretton Woods to the Smithsonian Agreement December 1971.
  • Growing increase in the amount of dollars printed further eroded faith in the system and the dollars role as a reserve currency.•




By 1973, the world had moved to search for a new financial system: one that no longer relied on a worldwide system of pegged exchange rates.


Bretton woods system outlived its utility and was replaced by the flexible exchange rate system in 1973. All the IMF members accepted it.



In 1976 when IMF members met in Jamaica they agreed to a new set of rules for International Monetary System. The key elements of this agreement were as follows.


1] All the IMF members accepted it. Central banks were now allowed to intervene in exchange markets to iron out volatilities.

2] gold was officially abandoned [ie demonitised] as an international reserve asste.

Half of IMF’s gold was returned to its members and the other half was sold and the proceeds were used to help poor nations.

3] non-oil exporting countries and the less developed countries were given greater access to IMF funds.


IMF continued to provide assistance ti countrie facing balance of payments and exchange rate difficulties.

It also extended assistance and loans to member countries on the condition that these countries follow the IMF’s macroeconomic priscriptions. This condition involned elimination of various subsidy programmers and countries were not happy.





The group of closed interconnected markets in which residents of different countries trade assets such as currencies, stocks and bonds

A global capital market is the interlinking of various investment exchanges around the world that enable individuals and entities to buy and sell financial securities on an international level.

The interlinking of these various exchanges results in the emergence of an informal, but never-the-less structured global capital market.

Spurred by the decoupling of exchange controls and foregoing of adjustable peg exchange rates from individual capital markets, in addition to technological advances that have facilitated the movement of capital around the world, investors have increasingly sought investments in multiple currencies.

While equities still lag behind, other investments, such as bonds, currencies and foreign exchanges are all interlinked and highly visible in international trading.

Yet to reach full maturity, the market is growing and integrating at a steady pace as investors continually shift investments to the most stable, well-regulated or high-growth economies around the globe.

As the complexity and interlinking of the global economy grows, so follows the capital markets. Currently, financial institutions around the world transfer billions of dollars worth of assets and investments on a daily basis in cross border exchanges.

Assessing the worth of the global capital market, many researchers and economists have concluded the total represents more than $200,000,000,000,000 US Dollars (USD) and will continue to grow well into the future.

Potential benefits of the global capital market can have a profound impact both on economies at large and individual businesses. Corporations and governments that solicit the public for capital can solicit investors all over the globe, not just in a defined geographical market. Investors can respond by investing assets that best meet their investment objectives, whether in developing economies with the aim of achieving high growth or in stable economies that are mature to better shield investments. Regulatory consequences, however, are inherent to the process and are usually pulled along by demands of investors.

Information has always been crucial in investment decisions, but in the global capital market access to this information in a transparent and rapid manner is essential for investors to make qualified decisions. With the technology available to deliver that transparency rapidly, regulatory requirements are left with little options other than to keep up with investor demands. Thus, many researchers have predicted that by the time the market matures, economies will tend to be more stable, reliable and predictable due to the unique investors requirements that demand solid and enforceable regulation that allows investment growth while mitigating associated risks.


Growth of the International Capital Market

The removal of barriers to private capital flows across countries’ borders has contributed to rapid growth in the international capital market.

A policy “trilemma” refers to three available options:

Fixed exchange rate

Monetary policy oriented toward domestic goals

Freedom of international capital movements


The international capital market has contributed to an increase in international portfolio diversification since 1970.


The Structure of the International Capital Market

The main actors in the international capital market are:

Commercial banks


Nonbank financial institutions

Central banks and other government agencies




International Monetary Fund (IMF):


Origin of IMF:

The origin of the IMF goes back to the days of international chaos of the 1930s. During the Second World War, plans for the construction of an international institution for the establishment of monetary order were taken up.

At the Bretton Woods Conference held in July 1944, delegates from 44 non-communist countries negotiated an agreement on the structure and operation of the international monetary system.

The Articles of Agreement of the IMF provided the basis of the international monetary system. The IMF com­menced financial operations on 1 March 1947, though it came into official existence on 27 December 1945, when 29 countries signed its Articles of Agreement (its charter). Today (May 2012), the IMF has near-global membership of 188 member countries. Virtually, the entire world belongs to the IMF. India is one of the founder- members of the Fund.



(i) International Monetary Co-Operation:

The most important objective of the Fund is to establish international monetary co-operation amongst the various member countries through a permanent institution that provides the machinery for consultation and collaborations in various international monetary problems and issues.

(ii) Ensure Exchange Stability:

Another important objective of the Fund is to ensure stability in the foreign exchange rates by maintaining orderly exchange arrangement among members and also to rule out unnecessary competitive exchange depreciations.

 (iii) Balanced Growth of Trade:

To facilitate the expansion and balanced growth of international trade, and to contribute thereby to the promotion and maintenance of high levels of employment and real income and to the development of the productive resources of all members as primary objective of economic policy.

 (iv) Eliminate Exchange Control:

Another important objective of the Fund is to eliminate or relax exchange controls imposed by almost each and every country before Second World War as a device to deliberately fix the exchange rate at a particular level. Such elimination of exchange controls was made so as to give encouragement to the flow of international trade.

(v) Multilateral Trade and Payments:

To establish a multilateral trade and payment system in respect to current transactions between members and in the elimination of foreign exchange restrictions which hamper the growth of world trade, in place of the old system of bilateral trade agreements was another important objective of IMF.

(vi) Balanced Growth:

Another objective of IMF is to help the member countries, especially the backward countries, to attain balanced economic growth by exchange the level of employment.

(vii) Correction of BOP Maladjustments:

V. To give confidence to members by making the general resources of the Fund temporarily available to them under adequate safeguards, thus providing them with the opportunity to correct maladjustments in their balance of payments, without resorting to measures destructive of national or international prosperity.

(viii) Promote Investment of Capital:

Finally, the IMF also promotes the flow of capital from richer to poorer or backward countries so as to help the backward countries to develop their own economic resources for attaining higher standard of living for its people, in general.



The principal function of the IMF is to supervise the international monetary system. Several functions are derived from this. These are: granting of credit to member countries in the midst of temporary balance of payments deficits, survei­llance over the monetary and exchange rate policy of member countries, issuing policy recommen­dations. It is to be noted that all these functions of the IMF may be combined into three.

These are: regulatory, financial, and consultative functions:

Regulatory Function:

The Fund functions as the guardian of a code of rules set by its (AOA— Articles of Agreement).

Financial Function:

It functions as an agency of providing resources to meet short term and medium term BOP disequilibrium faced by the member countries.

Consultative Function:

It functions as a centre for international cooperation and a source of counsel and technical assistance to its members.


The main function of the IMF is to provide temporary financial support to its members so that ‘fundamental’ BOP disequilibrium can be corrected. However, such granting of credit is subject to strict conditionality. The conditionality is a direct consequence of the IMF’s surveillance function over the exchange rate policies or adjustment process of members.


The main conditionality clause is the introduction of structural reforms. Low income countries drew attraction of the IMF in the early years of 1980s when many of them faced terrible BOP difficulties and severe debt repayment prob­lems.

Against this backdrop, the Fund took up ‘stabilisation programme’ as well as ‘structural adjustment programme’. Stabilisation programme is a demand management issue, while structural programme concentrates on supply management.

The IMF insists member countries to implement these programmes to tackle macroeconomic instability.

Its main elements are:

(i) Application of the principles of market economy;

(ii) Opening up of the economy by removing all barriers of trade; and

(iii) Prevention of deflation.


The Fund provides financial assistance. It includes credits and loans to member countries with balance of payments problems to support policies of adjustment and reform. It makes its financial resources available to member countries through a variety of financial facilities.

It also provides concessional assistance under its poverty reduction and growth facility and debt relief initiatives. It provides fund to combat money- laundering and terrorism in view of the attack on the World Trade Centre of the USA on 11 September 2001.


In addition, technical assistance is also given by the Fund. Technical assistance consists of expertise and support provided by the IMF to its members in several broad areas : the design and implementation of fiscal and monetary policy; institution-building, the handling and accounting of transactions with the IMF; the collection and retirement of statistical data and training of officials.

Maintenance of stable exchange rate is another important function of the IMF. It prohibits multiple exchange rates.

It is to be remembered that unlike the World Bank, the IMF is not a development agency. Instead of providing development aid, it provides financial support to tide over BOP difficulties to its members.


Organisation of IMF:

The permanent headquarters of the IMF are at 700 19th Street, N.W., Washington, DC 20431. As of 21st August 2002, the staff consisted of about 2,650 persons from 140 countries.

The IMF has a regional office for Asia and the Pacific, located in Tokyo.

The IMF, which started functioning in March 1947, is an autonomous organisation and is affiliated to U.N.O. As per Fund Agreement, the headquarters of the IMF should be located in that country which usually possess the highest quota of capital of the IMF. Accordingly, the head office of IMF is located at Washington. At the initial stage, the IMF had 30 countries as its members. Later, as on April 30, 1986, the total membership of the IMF rose to 149.

Like many international organisations, the IMF is run by a Board of Governors, an Executive Board and an international staff.

Since inception, the management of the IMF is rested on two bodies:

(a) Board of Governors and

Every member country delegates a representative (usually heads of central banks or ministers of finance) to the Board of Governors the top link of the chain of command, and also appoints one Alternate Governor to represent the Governor is respect of its absence.

The Board of Governors in authorized to formulate the general policies of the Fund.

It meets once a year and takes decision on fundamental matters such as electing new members or changing quotas.

(b) Board of Executive Directors.

The Executive Board is entrusted to the management of day-to-day activities and policy decisions.

The Board comprises 24 executive directors who are appointed or elected by member countries or by groups of countries

The Managing Director, serves as its Chairman and is responsible for the conduct of the ordinary business of the Fund. He is appointed for a five-year term

They supervise the implementation of policies set by the member governments through the Board of Governors.


Resources of IMF:

The resources of IMF is built up by the subscription of members.

Again the subscription quota of each member is determined by its national income and its condition of international trade.

After determination of quota, every member nation contributes 25 per cent of its quota in international reserve assets and the remaining 75 per cent is contributed in member’s own currency.

The contribution of first 25 per cent was made originally in terms of gold but now it is being made in Special Drawing Rights (SDRs), an international reserve asset created by the IMF in 1969.

There is also provision to enlarge the resources of the Fund by resorting to borrowing, by selling gold to the people and also by receiving fee from its borrowing members.

There is provision of revising the quotas of member countries in every five years.

The latest general increase in quotas as result of 9th review has enlarged the capital base of the Fund and accordingly the Fund could increase the loan assistance extended to its member countries.


Quota has a great significance to the member nations because of its following implications:

(i) Quota determines the subscription of members to the IMF and that determines the quantum of IMF resources;

(ii) It also determines the member country’s access to IMF resources either through drawings or borrowings from the IMF.

(iii) The quota can also determine the voting power of member in IMF management.

(iv) The quota can also determine the share of member country in respect of allocation of SDRs.


Critical Appraisal of IMF:


1] The IMF acts both as a financing and an adjustment-oriented international institution for the benefit of its members It has been providing financial assistance to the deficit countries to meet [eliminate] their temporary/short-term  disequilibrium in BOP.

2] The Fund aims at promoting exchange rate stability. In its early phase, the Fund made arrangements of avoidance of competitive exchange depreciation.

3] It has made an attempt to solve the problem of international liquidity.

To create international liquidity. Special Drawing Rights (SDRs)—an artificial currency—were created in 1969 as foreign exchange reserves to benefit the developing countries in particular. SDR allocations are made to member countries to finance the BOP deficits.

4] It is an institution through which consultation in monetary affairs takes place in an on-going way.

It acts as a forum for discussions and guidance of the economic, fiscal and financial policies formulation of member countries, keeping the BOP problems in mind.

5] Previously, the poorest developing countries did not receive adequate treatment from the Fund.

But from 1980s onwards—when the debt crisis broke out in poor/developing  countries—the Fund decided to divert adequate its financial resources to these countries.

6] In 1980s, centrally planned economies were not hitherto members of the Fund. With the collapse of the Soviet Union in 1989, ex-communist countries became members of the Fund and the Fund is providing assistance to these countries so as to instill, the principles of market economy.

7] It has decided to finance resources to combat terrorism and money-laundering.

8] Finally, the IMF has assisted its members in the formulation of appropriate monetary, fiscal, and trade policies.


In spite of achieving some degree of success by the IMF in certain areas, the Fund suffers as a result of failures in many fronts.

Following are some of these failures:

(i) The IMF has failed in respect of achieving the basic objectives of international exchange stability. Neither the Fund put any loan exchange fluctuations nor it prevents competitive devaluation of currencies by its members.

(ii) The Fund has followed discriminatory treatment in favour of certain members in its day to day functioning. It favours some Western countries and neglects the genuine interests of underdeveloped and backward countries.

(iii) The IMF has also failed to establish a stable and sound international monetary system and thereby experiences serious monetary crisis arising out of rapidly fluctuating exchange rates. Thus the Fund has failed to bring complete stability in foreign exchange rates.

(iv) The Fund has also failed to persuade the member countries to eliminate exchange controls and other restrictions on foreign trade.

(v) In respect of promoting international liquidity the Fund has found it difficult to meet the foreign exchange requirements of the members.

(vi) The IMF has also failed to eliminate the multiple exchange rates with regard to different transactions.

(vii) The IMF has also failed to bring the free convertibility of currency of different countries.

(viii) In respect of problems of long term disequilibrium in the balance of payments faced by different countries, the IMF can provide only short term credit facilities.

(ix) The IMF has also failed to tackle the problem of petro dollars. The Fund should have played an effective role in recycling the surpluses of OPEC countries towards the developmental purposes of developing countries.

(x) The IMF has also failed to remove the various restrictions of trade imposed by different countries. Accordingly, the most of the countries are making extensive use of the trade and exchange controls.

(xi)In IMF affairs, the developing countries are having inadequate representation. Although developing countries of Asia, Africa and Latin America constitute about 90 per cent of the members of IMF but in reality these countries are having 38 per cent of the total voting power in various affairs of Fund.

(xii) As a result of non-revision of quota of IMF, the share of quotas as a percentage of world trade has been declining fast from 16 per cent in 1965 to a mere 4 per cent in 1981.

(xiii) As a result of following faulty and biased method of extending credit on the basis of quotas but not on the basis of need, the underdeveloped and developing countries are not getting adequate financial support from the IMF because of their small quotas.

(xiv) The rich member countries are maintaining larger quotas and thereby can influence the policies and decisions of the IMF easily. Therefore, the IMF has been branded as Rich Men’s Club because of their growing dominance.

(xv) Finally, it has also been argued that IMF has been interfering or influencing the economic policies of poor and developing countries by putting various restrictions on them.





A short history of the World Bank,

The World Bank is an international organization affiliated with the United Nationa [UN] ,dedicated to providing financing, advice and research to developing nations to aid their economic advancement.

Initially founded as the International Bank for Reconstruction and Development (IBRD), at the Bretton Woods Summit in New Hampshire,

The purpose was to finance post-war reconstruction and development needed by the European and asian countries.

Initial projects ranged from industry to reconstruction of roads, bridges, and buildings.

It is the largest source of financial assistance to developing countries. It also provides technical assistance and policy advice and supervises—on behalf of international creditors—the implementation of free-market reforms.

Together with the International Monetary Fund (IMF) and the World Trade Organisation (WTO), it plays a central role in overseeing economic policyand reforming public institutions in developing countries and defining the global macroeconomic agenda.

Its present day mandate is much wider: worldwide poverty alleviation in conjunction with its affiliate, the International Development Association.

Since its inception, the World Bank has lent and given grants and credits worth $400 billion.

Its money is spent on specific projects such as freeways and dams. But it also employs economists and policy people to tackle the causes of poverty in the poorest nations.

Other issues on the World Bank’s agenda include the reduction of corruption, and the promotion of education and health care.

As of 2016, the Bank predominantly acts as an organization that attempts to fight poverty by offering developmental assistance to middle- and poor-income countries.

The 1944 establishment of the World Bank has its origins in the need for post-WWII reconstruction of Europe.


The Structure of the World Bank

The World Bank was established in 1944, is headquartered in Washington D.C., and has more than 10,000 employees in over 120 offices worldwide.

The World Bank has expanded from the single institution that was created in 1944 to a group of five unique and cooperative institutional organizations.

The first organization is the International Bank for Reconstruction and Development (IBRD) , an institution that provides debt financing [loans at market rates]to governments that are considered middle income income developing countries and creditworthy lower-income countries.

The IBRD raises most of its funds on the world’s capital markets,

The second organization within The World Bank is the International Development Association (IDA) founded in 1960, a group that provides interest-free loans long-term loans, technical assistance, and policy advice to low-income developing countries in areas such as health, education, and rural development.

The IDA’s lending operations are financed through contributions from developed countries.

The International Finance Corporation [IFC], the third organization, focuses on the private sector and provides developing countries with investment financing and financial advisory services.

The fourth part of The World Bank is the Multilateral Investment Guarantee Agency [MIGA], an organization that promotes Foreign Direct Investments [FDI] in developing countries.

The fifth and final organization is the International Centre for Settlement of Investment Disputes (ICSID), which operates independently of the IBRD, is responsible for the settlement by conciliation or arbitration of investment disputes between foreign investors and their host developing countries.



Board of Governors

The World Bank is related to the UN, though it is not accountable either to the General Assembly or to the Security Council. It is like a cooperative, made up of 189 member countries.

These member countries, or shareholders, are represented by a Board of Governors, who are the ultimate policymakers at the World Bank.

Generally, the governors are member countries’ finance ministers, ministers of development or central bank governors.

They meet once a year at the Annual Meetings of the Boards of Governors of the World Bank Group and the International Monetary Fund.

The governors delegate specific duties to 24 Executive Directors, who work on-site at the Bank.


Executive directors

Although the board of governors has some influence on IBRD policies, actual decision-making power is wielded largely by the bank’s 25 executive directors.

The five largest shareholders —the United States, Japan, Germany, the United Kingdom and France—appoint their own executive directors. appoint an executive director,

The other countries are grouped into regions, each of which elects one executive director. For instance, Australia’s executive director also represents Cambodia, South Korea, Kiribati and other Pacific nations.

Throughout the World Bank’s history, the bank president, who serves as chairman of the Executive Board, has been an American citizen.

They normally meet at least twice a week to oversee the Bank’s business, including approval of loans and guarantees, new policies, the administrative budget, country assistance strategies and borrowing and financial decisions.


The role of the president

By convention, the US has always nominated the president of the World Bank (the Europeans choose the head of the International Monetary Fund under this handshake agreement).

In recent years, developing nations have been highly critical of this process because they say it means the bank becomes the tool of developed countries, not those for whom it was set up to benefit.

The president is like the chief executive. He is responsible for the smooth running of the bank and he sets its tone and flavour. He also liaises with world leaders to look at ways of cutting poverty, and improving social and economic conditions in member states. But he is forbidden by the bank’s charter from taking a political stance.

The bank president has a key role as a representative of the world’s poorest people.


Voting rights

Voting power is based on a country’s capital subscription, which is based in turn on its economic resources. The wealthier and more developed countries constitute the bank’s major shareholders and thus exercise greater power and influence.

For example, at the beginning of the 21st century the United States exercised more than one-sixth of the votes, more than double that of Japan, the second largest contributor.

Because developing countries hold only a small number of votes—e.g., in the late 1990s approximately 2 percent of the votes were held by 25 African countries combined—the system does not provide a significant voice for these countries, which are the primary recipients of World Bank loans and policy advice.


World Bank Funds

The bank obtains its funds from the capital subscriptions of member countries, bond flotations on the world’s capital markets, and net earnings accrued from interest payments on IBRD and IFC loans. Approximately one-tenth of the subscribed capital is paid directly to the bank, with the remainder subject to call if required to meet obligations.


World Bank staff.

The World Bank is staffed by more than 10,000 people, roughly one-fourth of whom are posted in developing countries.

The bank has offices in about 70 countries, and in many countries staff members serve directly as policy advisers to the ministry of finance and other ministries.

The bank has consultative as well as informal ties with the world’s financial markets and institutions and maintains links with nongovernmental organizations in both developed and developing countries.



The following objectives are assigned by the World Bank:

1. To provide long-run capital to member countries for economic reconstruction and development.

2. To induce long-run capital investment for assuring Balance of Payments (BOP) equilibrium and balanced development of international trade.

3. To provide guarantee for loans granted to small and large units and other projects of member countries.

4. To ensure the implementation of development projects so as to bring about a smooth transference from a war-time to peace economy.

5. To promote capital investment in member countries by the following ways;

(a) To provide guarantee on private loans or capital investment.

(b) If private capital is not available even after providing guarantee, then IBRD provides loans for productive activities on considerate conditions.


For all its clients, the Bank emphasises the need for:

(i) Investing in people, particularly through basic health and education;

(ii) Focusing on social development, governance and institution-building as the major elements of poverty alleviation;

(iii) Strengthening the ability of the govern­ments to deliver quality services with greater efficiency and transparency;

(iv) Protecting the environment;

(v) Supporting and encouraging private business development and long-term planning.

Through its loans, policy advice, and technical assistance, the WB supports a broad range of programmes aimed at reducing poverty and improving living standards in the developing world including the achievement of the Millennium Development Goals (MDGs) by helping countries develop an environment for investment, jobs, and sustainable growth. The WB works with govern­ment agencies, non-governmental organisations (NGOs), and the private sector to formulate various assistance strategies



World Bank is playing main role of providing loans for development works to member countries, especially to underdeveloped countries. The World Bank provides long-term loans for various development projects of 5 to 20 years duration.

The main functions can be explained with the help of the following points:

1. World Bank provides various technical services to the member countries. For this purpose, the Bank has established “The Economic Development Institute” and a Staff College in Washington.

2. Bank can grant loans to a member country up to 20% of its share in the paid-up capital.

3. The quantities of loans, interest rate and terms and conditions are determined by the Bank itself.

4. Generally, Bank grants loans for a particular project duly submitted to the Bank by the member country.

5. The debtor nation has to repay either in reserve currencies or in the currency in which the loan was sanctioned.

6. Bank also provides loan to private investors belonging to member countries on its own guarantee, but for this loan private investors have to seek prior permission from those counties where this amount will be collected.


The Goals and Benefits of The World Bank

The World Bank has two stated goals that it aims to achieve by 2030.

The first is to end extreme poverty by decreasing the amount of people living on less than $1.90 a day to below 3% of the world population.

The second is to increase overall prosperity by increasing the income growth in the bottom 40% of the world’s population.

Beyond its specific goals, the World Bank provides qualifying individuals and governments with low-interest loans, zero-interest credits and grants.

These debt borrowings and cash infusions help with global education, health care, public administration, infrastructure and private sector development.

The World Bank also shares information with world governments through policy advice, research and analysis and technical assistance.


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