The International Monetary Fund

Voting is weighted and that is the standing criticism. Each member has basic votes plus votes proportional to its quota, so influence follows economic size. Major decisions require an eighty five per cent majority, which gives the United States, with over sixteen per cent of the vote, a veto over them. Quota reform has repeatedly lagged behind the shift of output towards Asia.

Conditionality is the second criticism, and it is the one an Indian candidate should be able to argue both ways. Because the Fund lends to a country in crisis, it can and does attach policy conditions: fiscal correction, exchange rate adjustment, trade liberalisation, structural reform. The defence is that a loan without conditions finances the imbalance instead of correcting it. The objection is that the conditions are decided by an institution weighted towards creditors and imposed at the moment of least bargaining power, and that they have often been contractionary in a downturn.

India and the Fund, briefly and concretely

India is a founding member and has borrowed repeatedly, most consequentially in 1981 and in 1991. The 1991 crisis is the one to know: reserves fell to about two weeks of imports, India pledged gold to raise foreign exchange, and the stand-by arrangement with the Fund was accompanied by the liberalisation of July 1991. India has not borrowed from the Fund since, and repaid its outstanding obligations in full by 2000.

The 1991 episode is also the beginning of the trade story this book tells. The dismantling of import licensing that followed was still incomplete when the United States brought the dispute that became India: Quantitative Restrictions on Imports of Agricultural, Textile and Industrial Products, WT/DS90/AB/R, adopted 22 September 1999. Facts. India defended import licensing on 2,714 tariff lines under Article XVIII:B of GATT, the balance of payments cover for developing countries. Held. the defence was justiciable by a panel notwithstanding the committee procedure, and on the Fund's assessment India's reserves were adequate, so the restrictions were not justified and breached Article XI:1. India lost and phased the licensing out by 1 April 2001. Why it matters here: it is Article XV of GATT in operation, the Fund's finding of fact deciding a trade dispute.

Distinctions the examiner rewards

A worked example

A member imposes import licensing on a long list of goods and says it is doing so because its reserves are falling. Follow the interaction between the two institutions, because that interaction is the only reason a trade paper studies the Fund at all.

The trade rule. Article XII of GATT, and for a developing member Article XVIII:B, permit quantitative restrictions to safeguard the balance of payments, subject to conditions: the restrictions must not exceed what is necessary, must be progressively relaxed as conditions improve, and must be notified and reviewed by the Committee on Balance-of-Payments Restrictions.

The evidentiary rule, and this is the point. Article XV:2 requires the WTO, in reaching a determination on monetary reserves, balances of payments or foreign exchange arrangements, to consult fully with the International Monetary Fund, to accept the Fund's determination as to whether the member's action is in accordance with the Fund's Articles, and to accept the Fund's findings of fact on reserves and the balance of payments.

So the trade dispute turns on a finding made by another institution.

That is exactly what happened in India: Quantitative Restrictions, WT/DS90/AB/R, adopted 22 September 1999. Facts. India maintained import licensing on a very large number of tariff lines, justified under Article XVIII:B, and the United States complained. Held. The panel was entitled to consult the Fund, whose view was that India's reserves were adequate and that the restrictions were not required; a panel has jurisdiction to review the justification, and the restrictions were not justified. India lost. Why it matters: the licensing was removed from 2,714 tariff lines by 1 April 2001, and it is the clearest illustration of Article XV:2 operating.

And the general obligation behind it: Article XV:4 provides that members shall not, by exchange action, frustrate the intent of the GATT provisions, nor, by trade action, frustrate the intent of the Fund's Articles.

What this does NOT mean

The Fund is not a bank in the ordinary sense. A drawing is technically a purchase of foreign currency with the member's own currency, repurchased later. The language of lending is a convenience.

The Fund does not enforce trade rules and the WTO does not police exchange rates. Article XV of GATT allocates the question: monetary and reserve facts to the Fund, trade measures to the trading system. A member may not, however, frustrate the intent of GATT by exchange action, and Article XV:4 says so expressly.

Quick revision

• Established by Articles of Agreement of 22 July 1944, in force 27 December 1945; India is a founding member.
• Purposes: exchange stability, no competitive depreciation, a multilateral payments system, and resources to correct imbalances without measures destructive of prosperity, which is the trade link in the Fund's own words.
• Design: par values, one per cent bands, change only for fundamental disequilibrium; ended 15 August 1971, floating legalised by the Second Amendment, 1 April 1978.
• Quotas determine subscription, voting and access. Special Drawing Rights created 1969. Major decisions need eighty five per cent.
• The trade connection is Article XV of GATT: the WTO consults the Fund and accepts its findings on reserves and payments.
• Worked example: India: Quantitative Restrictions, adopted 22 September 1999, decided against India on the Fund's assessment of its reserves.
• India borrowed in 1981 and 1991; the 1991 stand-by accompanied the liberalisation that began the modern story.

Test yourself

1. What is the International Monetary Fund and why does a trade syllabus include it? The Fund is the institution created by the Bretton Woods Articles of Agreement of 22 July 1944, in force 27 December 1945, to administer the par value system, to promote exchange stability and prevent competitive devaluation, and to lend foreign exchange to members in balance of payments difficulty. A trade syllabus includes it because the alternative to borrowing is restricting imports: a government that cannot finance its external deficit closes its border by licensing, quotas or exchange control, and each of those is a breach of GATT unless an exception applies. The connection is textual as well as economic. Article XV of GATT requires the trading system to consult the Fund on monetary reserves, balances of payments and foreign exchange arrangements and to accept its determinations on those facts, and Article XV:4 forbids a member to frustrate the intent of GATT by exchange action. India: Quantitative Restrictions, adopted 22 September 1999, is that machinery operating: the Fund's view that India's reserves were adequate defeated the balance of payments defence for import licensing on 2,714 tariff lines.

2. Describe the exchange rate system agreed in 1944 and explain how it ended. Each member declared a par value for its currency expressed in gold or in United States dollars of the weight and fineness in force on 1 July 1944, and undertook to keep market transactions within one per cent of that parity, intervening as necessary. The dollar was itself convertible into gold for foreign monetary authorities at thirty five dollars an ounce, so the system was a gold exchange standard with the dollar as the operative anchor. A par value could be altered only to correct a fundamental disequilibrium, and beyond a small initial margin only with the Fund's concurrence, which was the discipline against competitive devaluation. It ended because the dollar's gold backing became unsustainable as American liabilities abroad grew; the United States suspended convertibility on 15 August 1971, attempts to restore fixed parities failed, and the Second Amendment to the Articles, in force 1 April 1978, permitted members to choose their own exchange arrangements subject to surveillance and to an obligation not to manipulate rates to gain unfair competitive advantage.

3. State the principal criticisms of the Fund and the answers to them. Three, and each has a defence worth stating. First, weighted voting: influence follows quota, so creditor countries decide, major decisions require an eighty five per cent majority which gives the largest shareholder a veto, and quota reform has lagged behind the shift of world output. The answer is that lenders will not put resources into an institution they do not control, and that basic votes and periodic quota reviews give some correction. Second, conditionality: policy conditions are attached at the moment of a borrower's least bargaining power and have often required fiscal contraction during a downturn. The answer is that an unconditional loan finances an imbalance rather than correcting it, and the Fund has since moved towards fewer and more focused conditions. Third, asymmetry of adjustment: the burden falls on the deficit country and never on the persistent surplus country, which is precisely the defect the Keynes plan was designed to cure and the White plan preserved.