Information about Western Hemisphere Hemisferio Occidental

10 The Monetary Character of the IMF

Jacob Frenkel, and Morris Goldstein
Published Date:
September 1991
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W.F. Duisenberg and A. Szász

Since May 1981, a number of communiqués of the Group of Ten have called for the preservation of the “monetary role” or the “monetary character” of the Fund, without however providing a clear indication what this “monetary character” involved. The 1985 Report of the Deputies of the Group of Ten on The Functioning of the International Monetary Systemis emphatic on the subject (“The Deputies emphasize the importance of preserving the monetary character of the institution…” (para. 85)), but it again… fails to be specific as to what is meant by this injunction. Why, 35 years after the establishment of the IMF, did its industrial members* feel it necessary to admonish the institution to live up to its middle initial? A middle initial, incidentally, which the institution acquired at a late stage, and for no very obvious reason, having spent most of its embryonic years as the United Nations (later: International) StabilizationFund.**

Thus begins an unpublished paper by J.J. Polak.1 He points out (paragraph 4) that “No general definition of ‘monetary’ would explain what is meant by the expression here discussed.” Where an attempt to explain it is made, he finds it far from helpful. The absence of a published definition does not mean, however, that Polak did not deduct what the expression is intended to convey. “The call for preserving the monetary character of the Fund,” he writes (in paragraph 6), “is… a code expression for constraint on the Fund’s lending.” But it is a code of which he clearly doubts the usefulness. In attempts made to substantiate the concept, reference is made to the need to preserve the Fund’s liquidity position and to maintain the revolving character of its resources and Fund conditionality in order to contribute to the international adjustment process. In Polak’s view, concern about the Fund’s liquidity position seems exaggerated. As to the revolving character of the Fund’s resources, he considers this (in paragraph 8) “important whether it undermines the liquidity position of the Fund or not. Concern for the system and the working of the adjustment mechanism should make the Fund insist on revolving use by individual members, even when its aggregate liquidity ratios are not at risk. Whether new drawings should be allowed—e.g., in the context of the debt crisis—needs to be considered on the merits of each case, not by some general concern about the monetary character of the institution.” And he adds (paragraph 9): “If there is any lesson in all this with respect to the formulation of policy choices, it would be that it does not pay to present specific concerns by the use of allusive labels. That may initially provide some vague justification, but fails to focus attention on the precise issues that the institution must deal with.”

In the end, Polak decided not to publish his paper, leaving it to us to decide whether we had anything meaningful to say, either about the monetary character of the Fund or about its use as an allusive label. It is not our intention to try to define the concept. Polak’s notes are sufficiently discouraging in this respect. We do feel, however, that in spite of all its shortcomings the concept did serve a purpose. Hereafter, it will be examined whether this remains true in the present situation. First, however, some observations as to when and why the expression became fashionable.

I. The Monetary Character in the Early 1980s


As mentioned by Polak, the reference to the Fund’s monetary character emerges in the communiqué issued by the Group of Ten in May 1981. The summoning to preserve the Fund’s character—though the word “monetary” is not used—is already implied in their communiqué published in September 1980: “At the same time, they stressed that the basic [italics added] character of Fund lending should be preserved and that changes in the Fund lending policies that are called for in the present circumstances should be kept under review.” And even earlier, in mid-1978, a reference to the monetary role is made by the Dutch Executive Director Ruding, Polak’s predecessor: “We should not forget that the Fund, in accordance with its Articles of Agreement, acts and should act as a monetary institution for bridging temporary balance-of-payments deficits by providing short- or medium-term credit. It is not a development aid institution for the financing of long-term development projects or programmes.”2

That the monetary character of the Fund was not an issue at the international discussions on monetary matters for so long can be attributed to the fact that such a character was deemed self-evident for the Fund. Loans were provided to different countries at different times. Prolonged use was no acute problem. Nobody worried about the Fund’s liquidity. Only when it became clear that these characteristics ceased to be evident, did the code expression become fashionable. Two developments can be distinguished that were important in explaining the role which the expression “monetary character of the IMF” was meant to play. One is that by this time industrial countries had ceased to draw on the Fund. The other is that the liquidity position of the Fund deteriorated markedly.

As to the first point, the Fund’s debtors consisted exclusively of poor and middle-income developing countries. In itself this is not necessarily a worrisome situation. However, it led many to draw the conclusion that the IMF should no longer attach the same conditions to its lending as when industrial countries were still among its debtors. Developing countries, it was argued, had specific needs. The Fund should take them into account in fixing the amounts it lent, the duration, and the policy conditions attached. Political pressure on Fund conditionality increased markedly in the wake of the second oil shock. Criticism was by no means limited to developing countries but was widespread in industrial countries as well. The report of the Brandt Commission published in 1980 is but one example of that pressure.3 Monetary authorities in industrial countries faced the task of explaining, to an often uncomprehending public and parliament, the constraints to which Fund lending was subjected.

The constraints are a consequence of the aims of Fund credit, as laid down in Article I of its Articles of Agreement: “To give confidence to members by making the general resources of the Fund temporarily available to them under adequate safeguards, thus providing them with opportunity to correct maladjustments in their balance of payments without resorting to measures destructive of national or international prosperity.” The Fund thus can help “to shorten the duration and lessen the degree of disequilibrium in the international balances of payments of members.” Temporary balance of payments assistance implies that Fund conditionality has to focus on adjustment.

To many critics of the IMF this appeared to mean that the Fund gave priority to the restoration of balance of payments equilibrium over the maintenance of public expenditure to feed people and teach children. The explanation that the Fund’s conditionality was a consequence of the Fund’s purposes was not always accepted as convincing. Here was an institution with large reserves at its disposal: part of the resources of central banks of industrial countries. It did not need to compete for the scarce budgetary resources that industrial countries facing increasing financial pressures felt able to devote to developing countries. If its purposes, defined at a different time with different needs, stood in the way, then why not agree to change them? Ministers of finance and central bank governors of industrial countries had somehow to explain that one could not turn the IMF into an institution granting development aid while retaining its monetary resources. This was the message they wanted to convey when referring to the monetary character of the IMF.

The Fund’s Liquidity Position

The reason why a situation where the balance sheet of the Fund consists of monetary resources on the one hand, and claims in the form of development loans on the other, is neither possible nor desirable is illustrated by the Fund’s liquidity position. In the early 1980s Fund lending increased steeply, from SDR 2.4 billion in 1980 to SDR 11.3 billion in 1984. The result was that between 1980 and 1984 the IMF’s uncommitted own resources did not increase, notwithstanding a substantial quota increase, while its liquid liabilities tripled. As a consequence, the relation between these two, that is, the liquidity ratio, strongly deteriorated.

In the same period, the international debt problem became manifest. In 1982 Mexico led the way for a number of major developing countries in a massive rescheduling of debts to private banks. Most of these countries turned to the Fund at a stage when policy conditions had to be harsh and were therefore resented. The possibility could not be excluded that the international debt problem involving private banks would be followed by a debt problem involving the IMF.

If that would happen, the willingness of central banks in industrial countries to have part of their reserves at the disposal of the IMF would clearly lessen. That in turn would have consequences for the Fund, and, obviously, for the resources available to the debtor countries. For Polak the unease of some of the Fund’s creditors, combined with the U.S. reluctance to contribute to the periodic quota increases, was a reason to revive an older idea in 1983, viz., to merge the General and Special Accounts in the IMF and put the Fund on an SDR basis. It would then lend by creating SDRs, thus providing creditors with an asset they might prefer to claims on the IMF. The idea was ingenious, as could be expected from Polak. But it could not allay the concern of central banks in several industrial countries. Those worried about the deteriorating liquidity position of the IMF and the implications for the liquidity of their claims on the Fund were even more concerned about what might happen if the constraint on Fund lending would thus seem to have been removed.

Discussions in the Group of Ten and the Monetary Committee

These concerns were not equally shared by all Group of Ten countries, certainly not initially. When the Dutch Group of Ten Deputies argued at the meeting held in April 1982 that prospective Fund lending should not be solely determined by demand, but that the availability of resources and the cause of the imbalances should also be taken into account, they were listened to in shocked disbelief by several of their colleagues. Yet, in August of that year the Monetary Committee of the European Community held a discussion on the implications of “Preserving the IMF as a Monetary Institution” on the basis of a note which the Dutch members had presented at the Committee’s request. In February 1984, a modified version was presented to the Group of Ten Deputies.4

The Dutch Deputies found allies, among others, in the U.S. representatives who endorsed the criterion that the availability of Fund resources should be taken into account when deciding on prospective Fund lending. The U.S. authorities, in a paper also written as a preliminary study for the Group of Ten report on the “International Monetary System,” believed that the key to the Fund’s success and efficacy was its unique monetary character. They stressed the importance of a strong conditionality attached to Fund programs and advocated a forceful reduction in the Fund’s access limits. The Fund itself was not particularly worried about its liquidity. It challenged creditor countries to make more frequent use of their reserve tranches, in order to raise the perceived liquidity of the claims.5 Furthermore, it argued it was too simple to measure liquidity by a ratio between readily usable assets and liquid liabilities. However true this might be, the answer was not felt to be convincing because it failed to address the essential point: the lower the amount of usable currencies available to the Fund, the smaller the source from which payments can be made to countries that draw on their reserve positions.

Ultimately, a large part of the concerns brought forward by the Dutch Deputies was shared by the other Group of Ten members. It was reflected in the Group of Ten Deputies’ report cited by Polak: “The Deputies… stress the need to safeguard its [the Fund’s] monetary character and the revolving nature of its financing, as well as the importance of keeping it as a quota-based financial institution and its lending normally in line with quota resources. They also stress the need to continue to phase down the policy of enlarged access and to terminate it as soon as the situation of external payments permits, and to deal with the problem of prolonged use and arrears.”6

II. The Monetary Character in the Present Situation

The Fund’s Liquidity Position

So where do we stand now, ten years after the code expression had emerged in the Group of Ten communiqués? Is it still worthwhile to be concerned about the Fund’s middle initial? According to the Executive Board of the Fund it certainly is, as can be deducted from the 1990 Annual Report:“There was agreement by the Executive Board that… its basic monetary character… must be preserved by ensuring that the Fund would continue to provide balance of payments assistance on a temporary basis, that the Fund resources revolve, and that the Fund would continue to hold a level of usable assets sufficient to protect the liquidity and immediate usability of members’ claims on the Fund, thereby maintaining members’ confidence in and support of the institution.”7

On the face of it, one could argue that the concern should have waned because one of the key indicators of the Fund’s monetary character, its liquidity position, has improved markedly in the early 1980s. The ratio between the Fund’s highly liquid assets and its liquid liabilities is now over 100 percent, whereas in 1982 it was less than 40 percent, while the Executive Board of the Fund seems to have reached consensus that about 70 percent is adequate. Yet, it is not the actual ratio that is a cause for concern. A shortage of liquidity is, in the words of Polak, “a potential rather than an actual risk.”8 This does not mean that it can be neglected. On the contrary, future developments have to be scrutinized closely and reviewed regularly in order to prevent the painful situation where the Fund would not grant assistance to an eligible country, because of a shortage of resources. In order to assess these potential risks, two considerations are important: the potential supply and demand of Fund credit and the nature of the Fund exposure.

Potential Supply and Demand

First of all, some general observations on the credit facilities of the Fund. As is well known, the Fund in 1981 established its enlarged access policy on Fund resources. Under this policy, access limits were raised from 100 or 165 percent9 of a member’s quota to a cumulative total of 600 percent. It was clear from the outset that this could only be a temporary measure. Obviously in the long run the Fund would not be able to finance that much credit out of its own resources. The Fund staff has calculated a long-term sustainable ratio of around 250 percent. This is based on experience in the last decade where the ratio between the quotas of debtor countries and countries with weak external positions—whose currencies cannot be used for IMF drawings—and those of creditor countries is somewhere in the region of 30 percent versus 70 percent. It should be kept in mind, that this was the case in a situation where the IMF’s debtors consisted only of developing countries. At present this is still a realistic assumption, but it neglects the wish that some industrial countries could in the future become Fund debtors as well. If a broadening of the group of Fund debtors were to occur, a considerable impact might emerge on the percentages just mentioned. The conclusion is obvious: access limits have to be brought down markedly. At least to 250 percent, preferably to an even lower number. Did this happen?

It did not. As in politics, one should not overestimate the significance of the expression “temporary.” It can be regarded as an understatement for “wrong, but unavoidable under the circumstances.” In September 1983, the communiqué of the Interim Committee explicitly acknowledged that “the policy of enlarged access… is of a temporary character.”10 In line with this observation the limits were lowered11 to (cumulative) 408-500 percent from January 1, 1984. Two years later, the Interim Committee decided that for the moment only “modest adjustments” to the access limits were appropriate, while in the autumn of 1986 the Committee felt it could be even more generous. The temporary character was only given lip service, and the Committee refrained from reducing the limits any further. As from 1988, even this lip service has come to be considered superfluous. Moreover, the IMF recently decided to suspend the lower maximum limits under the policy of enlarged access in response to the crisis in the Middle East,12 which in point of fact implies an increase of potential access. Of course, it was decided that it should be a temporary measure only, that is, until the end of 1991.

Whether this potential access will indeed be brought down substantially by the time the proposed increase in quotas has become effective, which is planned for the end of 1991, is uncertain. It is certain, however, that in the recent past actualaccess within these limits has risen. This development coincided with the implementation of the Brady initiative. One of the objectives of this initiative was that “the IMF and the [World] Bank could provide funding, as part of their policy-based lending programs, for debt or debt service reduction purposes.” 13 This funding, known as “set aside accounts” and “augmentation for interest support” raised actual average access under stand-by and extended arrangements from around 40 percent of quotas to some 70 percent excluding and 110 percent including interest support. At the same time, the demand for Fund resources that can be expected in the near future is possibly considerable indeed. Balance of payments deficits on current account of the developing countries have again increased. Recent new commitments of Fund resources, SDR 11 billion in the financial year 1989/90, which is more than three times the amount recorded the year before, point in the same direction.

Furthermore, a new group of countries is knocking on the door. The former centrally planned economies of Central and Eastern Europe are increasingly demanding Fund resources. Their formidable task to reorganize the complete structure of their economies requires considerable financial assistance. The larger part of this probably needs to consist of funds with a structural character. Nevertheless, balance of payments assistance is necessary, too. What effects the Middle East crisis will have on the financial position of the Fund, we can only guess. For the moment, an oil element has been introduced in the compensatory and contingency financing facility, which enables countries that suffer from the oil price increase to draw 82 percent of quota at short notice with relatively weak conditionality attached to it.

Nature of the Fund Exposure

So, potential access is ample. Demand may be soaring. Moreover, prolonged use, which was already apparent in the early 1980s, has gained a new dimension: “super-prolonged use”—that is, overdue financial obligations to the Fund. In 1984 the Dutch Deputies stated that “more than half the outstanding Fund credit consists of claims on countries which have been more or less permanent IMF debtors for a period of ten years.”14 This implied that refinancing was in fact taking place. Nowadays, nearly allthe debtors of the Fund are in such a position. In numerous countries, the exposure remains stubbornly high. Obviously, this constellation is at variance with the revolving nature of short-term balance of payments assistance.

This is even more true for the arrears to the Fund which—at the time this paper was written—were again on the increase, amounting to more than SDR 3.3 billion. Nobody will deny that overdue financial obligations are contrary to the Fund’s monetary character, whatever the definition used. Moreover, as long as Fund resources are tied down in several member countries, they are not available to others. Whereas they should be, in a cooperative institution.

The Fund has sought to deal with this pressing problem in three different ways. First of all, to back up interest income forgone and to strengthen the Fund reserves, a burden sharing mechanism was introduced. It implies that creditors accept a lower rate of return on their remunerated reserve tranche position in the Fund, while the rate of charge on Fund drawings is raised. The consequence is that countries that actually service their debts, pay double. For instance, because of the arrears to the Fund of a certain African country, 82 countries, including 5 in Africa with per capita incomes equal to or below that of the country in question, have paid approximately SDR 13 million more in charges to the Fund than otherwise would have been necessary. A striking illustration of how arrears violate the cooperative nature of the Fund.

The burden sharing mechanism has its limitations. There is a limit as to how far the rate of charge can reasonably be raised without causing a “revolt” by the complying debtor countries that no longer wish to pay for their dissenting brothers. There is also a limit on the extent the rate of remuneration can be lowered: one cannot expect to allay the fears of creditor central banks about the effect the arrears have on the liquidity of their claims by eliminating the interest return on these claims.

As an alternative to the burden sharing mechanism, Polak set out a sophisticated plan on the back of an envelope. The idea was to temporarily reorganize part of the ninth quota increase in such a way that the Fund could save an annual SDR 300 million interest payments, roughly equal to the amount necessary at present to compensate for interest income forgone. An interesting suggestion that underlines the inexhaustible creativity Polak continues to demonstrate. However, it is also an illustration of how difficult it is to maintain orderly financial accounts in the Fund and to safeguard its reserves.

As a second measure, the Fund showed its collaborative grain. It introduced the possibility for the ineligible low-income countries with long-standing arrears to earn “rights” to drawings on the Fund as soon as a three-year shadow program had been successfully completed. Thus two birds are killed with one stone. That is, such was the aim. On the one hand, the country involved is provided with a—perhaps last—opportunity to improve its policies, supported by financial means from the international community. On the other hand, the Fund avoids having to depreciate its claims on these member states.

To prevent moral hazard, a third measure was initiated, and it was a rigorous one: an amendment of the Articles of Agreement, only the third in 45 years. It took the form of the possibility to suspend membership rights (i.e., mainly voting and representation rights) of a country that was judged to be insufficiently cooperative with the Fund in finding a solution to its long-standing arrears. The three decisions taken together constitute a solid, well-balanced approach, in principle. In practice, its efficacy is not beyond doubt because the underlying problem is not tackled. The failure to pursue adequate adjustment policies was—and is—at the heart of the problem. Whether the opportunity of receiving rights or the prospect of enhanced deterrent measures will at last turn out to be the appropriate incentive to improve on these policies remains to be seen.

III. Concluding Remarks

The monetary character of the Fund: defining it is difficult. It might be an allusive label. Yet it does serve a purpose. It conveys a simple message to the public at large: the Fund funds itself with the liquid reserves of its creditors, which they will only be prepared to continue to do, as long as proper constraints on the volume and character of Fund lending are adhered to. In this article, it has been argued that these constraints have been and possibly will be put to the test. As long as industrial countries are not prepared to draw on Fund credits, the consequences are twofold.

First, creditor countries will increasingly consider the Fund to be a development institution. This is emphasized by the potential worsening of the Fund’s liquidity position. In these circumstances, creditor countries will see their reserve position in the Fund not as liquid investments, but more and more as a means of development assistance. Indications already exist that industrial countries consider the liquidity of their claims on the Fund as less liquid than foreign exchange reserves, as can be derived from remarks of the President of the Swiss National Bank.15 Prospective members may be ready to accept this perceived inevitable cost of membership. However, the existing membership might become more hesitant to support any increase of its contribution to the Fund. This is illustrated by the fact that the preparedness to agree to the ninth quota increase was made dependent on a strengthening of the arrears strategy.

Second, it becomes more difficult to insist on strict conditionality on Fund drawings if it is obvious that the industrial countries themselves will never subject to it. The conditionality applied has indeed not succeeded in ensuring that countries are strict short-term users of Fund credit. On the contrary, adjustment programs have been insufficiently implemented, and Fund programs have tended to succeed one another quickly. The temporary policy of enlarged access, with its lengthened repayment periods and above-normal access, seems to be evolving into a more or less permanent feature. Extended arrangements have become more popular. An overwhelmingly large majority of debtor members has been indebted to the Fund for more than ten years continuously. Arrears keep rising; to cite again the Annual Report:“The reduction and elimination of overdue financial obligations to the Fund are essential for ensuring the cooperative nature of the institution and preserving its monetary character.”16

The implication is not, however, that the Fund should curb its role of financier to the international community. Although IMF credits cannot and should not replace development loans, they ought to remain an important catalyst for other forms of financial assistance. Most important, the Fund should lay emphasis on what is its speciality: to provide proper and well-balanced advice on adjustment policies. Adequate conditionality is necessary not only to preserve the revolving character of its credits but also for the success of the government policies in the debtor countries. Yet Fund advice is best if political influences are kept at an ample distance. In this respect the Fund is like a central bank. If a central bank is not independent of political authorities, monetary policy may opt for the soft option: a premature lowering of interest rates and monetary financing of budget deficits. If IMF credits are granted on mere political grounds, without a solid analysis of the repayment capacity of the debtor country involved and of the preparedness of national government to pursue adequate adjustment policies, the risk is obvious: too much financing, too little adjustment, and, consequently, repayment problems. To use the allusive label, the monetary character of the institution is endangered.

Of course, the Fund is in reality subject to political influence. After all, member states choose their representatives on the Executive Board, the day-to-day decision-making forum of the Fund. As a result, Executive Directors have two hats. On the one hand, they are supposed to—and should—voice the views of the members of their constituency, that is, governments. On the other hand, as Board members of an international monetary institution, they hold an independent position; for they need to look after the Fund—and cherish its monetary character—like a good paterfamilias should. A proper balance between these two functions requires an Executive Director to be a person of formidable quality and stature. From 1981 to 1986, with the eminent and creative Polak, the Netherlands couldn’t have fared better.

The authors thank D.H. Boot and C. Voormeulen for their help in preparing this paper.


And only they: the expression never appeared in a communique of the Interim Committee. That Committee did stress “the monetary character of the SDR” (and conveyed the intended meaning of its statement by continuing) “which should not be a means of transferring resources” (paragraph 7 of its communique of April 10, 1986).


The change from “stabilization” to “monetary” was made by the American drafters, in the tenth draft of the Joint Statement, in January 1944 in response to a British suggestion. J. Keith Horsefield, The International Monetary Fund, 1945-1965(Washington: International Monetary Fund, 1968), Vol. I, p. 54.


“Some Notes on ‘The Monetary Character of the IMF’,” August 18, 1989.


H.O. Ruding, “The IMF and International Credit,” The Banker(London), June 1978, pp. 27-31, at p. 31.


Independent Commission on International Development Issues, North-South: A Programme for Survival(Cambridge, Massachusetts: MIT Press, 1980).


Note by the Dutch Group of Ten Deputies, “The Future Role of the International Monetary Fund and Its Monetary Character,” February 20, 1984. The substance of this note has been published in a Dutch doctoral dissertation by A. Szász, Monelaire Diplomatie[Monetary Diplomacy] (Leiden: H.E. Stenfert Kroese BV, 1988).


In 1986 the Netherlands made a symbolic reserve tranche drawing for repayments of a European Monetary System intervention debt.


Deputies of the Group of Ten, The Functioning of the International MonetarySystem (June 1985), paragraph 112.


Intemational Monetary Fund, Annual Report, 1990(Washington), pp. 47-48.


“Some Notes on ‘The Monetary Character of the IMF’” (cited in footnote 1), paragraph 8.


Respectively, the limit for stand-by and extended arrangements.


International Monetary Fund, Annual Report, 1984(Washington), p. 143.


Though not nominal access, because quotas were increased simultaneously, on average by 50 percent.


International Monetary Fund, Press Release No. 90/57, November 15, 1990, reprinted in IMF Survey, International Monetary Fund (Washington), Vol, 19 (November 26, 1990), pp. 365-66.


Remarks by the U.S. Secretary of the Treasury, Nicholas F. Brady, to a conference sponsored by the Bretton Woods Committee and the Brookings Institution, Washington, March 1989, Third World Debt: The Next Phase, ed. by Edward R. Fried and Philip H. Trezise (Washington: Brookings Institution, 1989), p. 73.


Referred to in footnote 4.


“By exchanging assets held in dollars for a creditor position with the IMF the National Bank would be giving up liquid assets for assets that were virtually illiquid; furthermore, the foreign exchange reserves held with the IMF are of relatively lower quality than those held in the currency of an internationally solvent state. The Fund’s assets are effectively made up of loans to developing countries. Such debts clearly do not have the same degree of creditworthiness as those of the United States, for example. As the IMF has lent only to developing countries for nearly ten years now, holding debt at the Fund is equivalent to indirectly holding the debt of the most heavily indebted countries.” Excerpt from a speech given by the President of the Swiss National Bank, Dr. Markus Lusser, at a conference organized by the Programme for Strategic Studies and International Security in Geneva on November 14, 1990.


International Monetary Fund, Annual Report, 1990(Washington), p. 56.

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