Unit 3 – International Monetary and Financial System

Introduction
The international monetary system refers to the guide of money, policies, institutions, and
deals that help global trade and finance. The international monetary system allows nations to
trade goods and services with each other as well as make financial investments across
borders. At its core, the system has other money and exchange rates that help trade among
nations. The international monetary system allows global trade and investments by giving a
guide of money, exchange rates, central banks, and global institutions mixing economic
policies across borders. The stability and efficacy of this system are crucial for helping
bearable growth in the global economy.
Evolution of International Monetary System
Bimetallism: before 1879 The international monetary system prior to the 1870s can be
characterised as based on bimetallism, in the sense that both gold and silver were used as
international means of payment. This does not, however, imply that each individual country
was on a bimetallic standard; many countries accepted either a gold standard or a silver
standard. For example, China, India, Germany and Holland were on the silver standard while
in the UK, bimetallism was maintained until 1816 when Parliament abolished the free
coinage of silver. In the United States, bimetallism was maintained until 1873, when
Congress adopted the gold standard only. Similarly, France introduced bimetallism from the
French Revolution to 1878, when the franc effectively became a gold currency. Note that the
exchange rates among currencies were determined by their gold or silver contents, and
sometimes by their exchange rates against another currency. For example, the exchange rate
between the British pound (gold standard) and German mark (silver standard) was
determined by their exchange rates against the French franc (bimetallic standard).
Classical Gold Standard: 1879–1914 By 1879, all major industrial countries and most smaller
countries had adopted the gold standard, which lasted until the First World War in 1914, when
European governments ceased convertibility of their currencies either into gold or other
currencies. The United States, however, remained on the gold standard until 1933. In
principle, the gold standard was seen as an automatic mechanism linking the financial
systems of all countries in a way that ensured stability; the link was based on the principle
that all international payments between countries had to be settled in gold and that the
domestic money supply was linked to the country’s stock of this metal, whose value was
internationally agreed. In a simple model, stability was ensured in each country’s balance of
payments by the automatic mechanism of buying and selling gold. This idea can easily be
illustrated by a simple example. Assume that the domestic money supply in each country is
linked only to gold, which is equal to the country’s stock of gold (an assumption which was
never exactly valid but does simplify the analysis). Suppose that Britain is in the fortunate
position of having full employment, a stable price level and equality between exports and
imports. Now imagine that for some reason British imports increase without a change in
British exports, and a balance of payment deficit occurs. Under the gold standard, the deficit
on the current account of the balance of payments is temporary and self-correcting. The
deficit leads to an outflow of gold to pay for the net imports, and hence the domestic money
supply is reduced by an equal amount.
The reduction in the supply of money would lead to a fall in the domestic price level
according to the Quantity Theory of Money. This theory states that MV = PT so that, with
constant V and T (the Velocity of money and Transactions), the reduction in M (the money
supply) is matched by the reduction in P (the price level). The fall in the domestic price level
makes home produced goods relatively cheap compared to foreign produced goods and,
therefore, imports will fall and exports rise. The process will continue until the current
account of the balance of payments is restored to balance and the outflow of gold is halted.
This adjustment mechanism is usually known as the ‘price-specie–flow mechanism’, which is
attributed to the 18th century Scottish philosopher, David Hume. In reality, the gold standard
did not operate with such simple consistency, and during the 19th century and early 20th
century, politicians and economists were confronted by major difficulties over how to operate
it and, in the 20th century, even over whether to adhere to the gold standard at all. The debate
of the early 19th century focused on the way the domestic money supply worked if the
currency was ‘inconvertible’, or separated from the stock of gold, and upon the operation of
the banking system. Those debates, which became known as the ‘debate between the banking
and currency schools’, were among the most important debates of all time in monetary
theory, and have many modern parallels in theories of banking and financial innovations,
which you will probably meet in your later studies. Here, however, I shall concentrate on the
practical problems of the gold standard in the 20th century, which are more relevant to your
study of the evolution of the modern system of international finance.
In the 19th century, the gold standard took a form best known as the ‘gold exchange
standard’. The stock of money in the country was not equal to the stock of gold, and gold was
not the only or main form of money used in international transactions. In particular, the
pound sterling developed into a ‘key currency’ as it was used to finance international trade,
and it was held as an international asset in the portfolios of foreign banks, central banks and
investors. Pounds were used for these purposes instead of gold, but the pound was able to
operate in this way because it was convertible into gold at a fixed price. The system whereby
sterling as a key currency was linked to gold and exchangeable for the metal was known as
the gold exchange standard. Its operation was more complex than the mechanism described
by Hume, but its underlying principle, the link between domestic price and holdings of gold-
backed money, was supposed to be the same.
The Interwar Period: 1914–1944 The First World War ended the classical gold exchange
standard in August 1914 when Britain, France, Germany and Russia suspended the
convertibility of their currencies into gold and imposed embargoes on gold exports. After the
war there was considerable debate over how to reactivate the gold exchange standard and, in
1925, the British government restored the convertibility of the pound. Switzerland, France
and the Scandinavian countries restored the gold standard in 1928. However, Britain restored
convertibility at a price that implied high exchange rates, and for that and other reasons
Britain could not sustain the arrangement. Sterling was forced to leave the gold standard in
September 1931, and the pound was allowed to float. Other countries abandoned it
subsequently: Canada, Sweden, Austria and Japan followed suit by the end of 1931, the
United States in April 1933 after experiencing bank failures and serious outflows of gold, and
France left the gold standard in 1936. The end of the gold exchange standard was associated
with great monetary instability. Under the gold exchange standard, each country had a fixed
exchange rate with each other since they all fixed the value of their currency in terms of gold.
But when the gold exchange standard ended, foreign exchange dealers had greater freedom to
influence exchange rates and governments had greater freedom to alter the exchange rates
they would support. During the 1930s, exchange rate variations became a prominent
instrument of policy. With the world in serious depression and countries facing weak markets
for their exports, the major industrial countries engaged in a process of competitive
devaluation. Each reduced the exchange rate of its currency in attempts to increase exports
and reduce imports; this was a measure to increase its own share of the world market at the
expense of the other countries, but it was self-defeating since each country’s action was offset
by the others’ devaluation. The instability of foreign exchange markets in the 1930s was
accompanied by further government measures, in addition to competitive devaluation, to
solve their balance of payments problems. For example, tariffs were raised to reduce imports.
Thus, the end of the gold standard was an element in a period of shrinking world trade, with
declining world markets for industrial and agricultural products and rising unemployment in
the major economies. In 1939, at the outbreak of the Second World War, the existing system
of international finance and international trade broke down and was replaced by one which
could not really be called an international system. During the following years, when each
industrialised country was concentrating mainly on fighting the war, the small amount of
trade and remuneration that existed was organised on the basis of bilateral deals organised by
governments. These deals, in turn, reflected the balance of political power between countries
instead of being on equal or purely economic terms. In other words, during the war the
system of international finance broke down, and arrangements constructed at the end of the
war provided the beginning of the modern system.

The Bretton Woods System: 1945–1972 In the sphere of international finance, the system
agreed at Bretton Woods was set up without major changes and its main features lasted
almost unchanged until 1971. It started operating in 1946, so the arrangements in force from
then until 1971 are known as the Bretton Woods System.
Two new institutions agreed at Bretton Woods were at the heart of the Bretton Woods System
– the International Monetary Fund (IMF) and the International Bank for Reconstruction and
Development (IBRD, or World Bank). We shall look at these institutions themselves in more
detail later in the module. In this section, I concentrate upon the international financial
arrangements supervised by the IMF, for they were the core of the Bretton Woods system.
These arrangements can be divided into three elements:
• exchange rates
• the financing of balance of payments deficits
• international liquidity.
Exchange rates: dollar-based gold exchange standard Under the Bretton Woods System,
exchange rates between the currencies of all countries belonging to the IMF were fixed. The
US dollar was the key currency and all currencies had a fixed exchange rate with respect to
the dollar. Moreover, the value of the dollar in terms of gold was fixed at US$35 per ounce of
gold; therefore, the value of each currency was fixed in terms of gold. In other words, each
country established a par value in relation to the US dollar, which was pegged to gold at
US$35 per ounce. The main rules of the game of international finance were now:
• to fix an official par value for domestic currency in terms of the dollar, and keep the
exchange rate within 1% of this par value
• to permit free convertibility of currencies for current account transactions.
Feature of International Monetary System
• Multiple Currencies - The system consists of over 180 national currencies that act as
units of account and mediums of exchange for global trade. Each country has its
sovereign currency.
• Floating Exchange Rates - Most major currencies have floating exchange rates limited
by supply and demand market forces. This feeds flexibility but can lead to volatility.
• Reserve Currencies - A few dominant currencies like the US dollar, euro, Japanese
yen, and British pound act as extra currencies for global trade, investments, and
central bank reserves.
• Free Capital Flows - There are fairly few rules on the flow of capital among nations.
This eases global investment and trade.
• Role of Central Banks - Central banks handle monetary policies and foreign exchange
rates within their economies. They aim for price stability, financial health, and
balanced payments.
• Functions of IMF - The International Monetary Fund promotes global monetary
cooperation, sets standards, and gives financing to member countries in need. It also
publishes economic data and research.
• Functions of World Bank - The World Bank gives financing, policy advice, and
technical assistance to growing countries for economic action projects.
• Financial Globalization - Growing integration of global financial markets has shaped
the modern international monetary system. But it also brings risks of financial
contagion.
• Need for Reforms - There are calls to reform the system to address global economic
imbalances, financial flux, and lack of replica for emerging economies.
Functions –
• Facilitating Global Trade: The system helps global trade by feeding a set of currencies
and exchange rates that act as a joint unit of account. It allows nations to price and
settle trade trades.
• Financing Global Trade: The system helps the flow of finance must keep global trade.
Importers and exporters can access foreign exchange markets to alter currencies.
• Absorbing Shocks: The system helps absorb economic and financial shocks in one
country that could spread to others. The IMF and other institutions feed financing and
policy advice to ease contagion risks.
 • Boosting Financial Stability: The IMF, along with other actors in the system, work to
keep financial stability by watching financial risks, issuing debt, and boosting
transparency and alliance.
• Allocating Global Savings: The system gives global savings to where they can be
most productively funded. It channels the extra savings of some nations to the deficit
nations that need funds.
• Facilitating Diversification of Risk: The system allows nations to diversify
macroeconomic risks by allowing global investments and trade in other markets and
economies.
• Transmitting Monetary Policies: Shifts in monetary policies and interest rates in one
nation can be shared with others through the exchange rate tool in the system.
• Setting Standards and Guidelines: The system - through institutions like the IMF and
Bank for International Settlements - sets standards and policies for member nations.
Importance
• Facilitates Global Trade and Investment: The most important function of the system is
that it enables trade and investment among nations by feeding currencies and
exchange rates that act as a joint unit of account. This drives global economic activity.
• Promotes Financial Stability: The system helps boost overall economic stability
through institutions like the IMF that scan risks, feed crisis financing, and issue
policies. This helps upheld growth.
• Allows Risk Diversification: The system allows nations to diversify
their macroeconomic risks by helping global trade and investments across other
markets. This makes economies more resilient.
• Transmits Monetary Policies: Shifts in monetary policies and interest rates in one
country can be sent to other economies through exchange rate adjustments. This helps
blend policies.
• Fosters Economic Growth: An efficient international monetary system easing trade,
investment, and risk diversification can support faster economic growth for member
nations.
• Reduces Poverty: Economic growth aided by the system can help ease poverty over
time by forging more jobs and income options.
• Spreads Technological Inventions: The system boosts the spread of new technologies,
management rules, and ideas across borders, also going productivity and growth.
• Sustains Global Economic Stability and Political Stability: A stable and well-
functioning international monetary system supports broad geopolitical stability by
melding national economies.
Types of International Monetary System
 • Fixed Exchange Rate System: Currencies are pegged to a contract currency (like the
US dollar) at a fixed rate. It feeds stability but lacks flexibility. Rarely used in practice
now.
• Floating Exchange Rate System: Exchange rates are defined by supply and demand in
the foreign exchange market. It feeds more flexibility but can be volatile. Most widely
used now.
• Hybrid Exchange Rate System: It blends elements of fixed and floating exchange
rates.
• It includes the following.
• Crawling pegs: Exchange rates adjust in small increments over time.
• Crawl-like formats: Trade rates shifts within agreed bands.
• Currency boards: Domestic currency is tied to a foreign currency at a fixed
rate.
• Currency Unions: Its member nations adopt a joint currency and share a single
monetary policy. Examples include the Eurozone and East Caribbean Currency
Union.
• Commodity-based Systems: A commodity (like gold) is used as the top means of
payment. Example: The gold standard that was chief earlier.
• Bancor System: It is proposed by Keynes as part of the Bretton Woods system. It
involved a global currency (Bancor) backed by a basket of key items. It was not
enforced.
Evaluation
• Easing trade and investment - The system has largely been successful in enabling
global trade and investment by feeding vital parts like currencies, exchange rates, and
financial institutions. Yet, imbalances and volatility pose challenges at times.
• Helping stability - While the system has aided grip economic shocks to an extent, it
has also been blamed for failing to prevent global financial crises and flux, as seen in
the 1997 Asian financial crisis and the 2007-08 global financial crisis. Reforms are
needed to make the system more resilient.
• Helpful flexibility - The move to a more elastic exchange rate system has let
economies adjust better to altering conditions. However, undue volatility in currency
markets can also be disruptive. A balance of stability and flexibility stays elusive.
• Adjusting imbalances - The system has toiled to enough correct large trade and
payments imbalances among nations, which have built up over time. This stresses
gaps in surveillance, policy coordination, and incentive tools.
• Representativeness and governance - The system has been criticized for being hogged
by a few grown economies and reserve currencies. Growing governance systems to
apply rising economies more can enrich legality and efficacy.
 • Innovation and reform - The system has evolved over time through next shifts in
institutions, rules, and currencies used. However, the pace of reform has often been
too slow to keep up with the rapid pace of global economic and financial integration.
More dynamic and forward-looking reforms are ought.
European Monetary Union
• The Economic and Monetary Union (EMU) represents a major step in the integration
of EU economies. Launched in 1992, EMU involves the coordination of economic
and fiscal policies, a common monetary policy, and a common currency, the euro.
• The decision to form an Economic and Monetary Union was taken by the European
Council in the Dutch city of Maastricht in December 1991, and was later enshrined in
the Treaty on European Union (the Maastricht Treaty). Economic and Monetary
Union takes the EU one step further in its process of economic integration, which
started in 1957 when it was founded. Economic integration brings the benefits of
greater size, internal efficiency and robustness to the EU economy as a whole and to
the economies of the individual Member States. This, in turn, offers opportunities for
economic stability, higher growth and more employment - outcomes of direct benefit
to EU citizens. In practical terms, EMU means:
• Coordination of economic policy-making between Member States
• Coordination of fiscal policies, notably through limits on government debt and deficit
• An independent monetary policy run by the European Central Bank (ECB)
• Single rules and supervision of financial Institutions within the euro area
• The single currency and the euro area
• Within the EMU there is no single institution responsible for economic policy.
Instead, the responsibility is divided between Member States and the EU institutions.
The main actors in EMU are:
• The European Council – sets the main policy orientations
• The Council of the EU (the 'Council') – coordinates EU economic policy-making and
decides whether a Member State may adopt the euro
• The 'Eurogroup' – coordinates policies of common interest for the euro-area Member
States
• The Member States – set their national budgets within agreed limits for deficit and
debt, and determine their own structural policies involving labour, pensions and
capital markets
• The European Commission – monitors performance and compliance
• The European Central Bank (ECB) – sets monetary policy, with price stability as the
primary objective and act as central supervisor of financial Institutions in the euro
area
 • The European Parliament - shares the job of formulating legislation with the Council,
and subject economic governance to democratic scrutiny in particular through the new
Economic Dialogue
• There are 27 countries in the European Union.
• Eurozone Members - Austria, Belgium, Croatia, Cyprus, Estonia, Finland, France,
Germany, Greece, Ireland, Italy, Latvia, Lithuania, Luxembourg, Malta, Netherlands,
Portugal, Slovakia, Slovenia, and Spain.
• Non-Eurozone Members - Bulgaria, Czech Republic, Denmark, Hungary, Poland,
Romania, and Sweden
• Germany has the largest economy in the European Union, with a gross domestic
product (GDP) of $4.46 trillion as of 2023. It is followed by France, with a GDP of
$3.03 trillion as of 2023; and Italy, with a 2023 GDP of $2.25 trillion.
• Adoption of the euro provides a variety of benefits to EU member countries due to the
ways that it unifies and connects their economies.
• Promoting Trade – the currency risks were eliminated from European Trade
• Encouraging Investment
• Mutual support
• The member nations in the eurozone have economies of different sizes and strengths,
as well as a wide variety of economic cultures. While this can sometimes be a benefit,
it can also create drawbacks.
• Rigid Monetary Policy
• Possible bias in favor of Germany - The first stage of the euro was the European
exchange rate mechanism (ERM), under which prospective future members of the
eurozone fixed their exchange rates to the German mark. Germany has the largest
economy in the eurozone and has a history of sound monetary policy since World War
II. However, pegging exchange rates to the German mark may have created a bias in
favor of Germany.

International Monetary System (IMF)

The International Monetary Fund (IMF) came into official existence on December
27, 1945, when 29 countries signed its Articles of Agreement (its Charter) agreed at a
conference held in Bretton Woods, New Hampshire, USA, from July 1-22, 1944. The
IMF commenced financial operations on March 1, 1947. Its current membership is 182
countries. Its Total Quotas are SDR 212 billion (almost US$300 billion), following a 45
per cent quota increase effective from January 22,1999.
• Staff: approximately 2,700 from 110 countries.
• Accounting Unit: Special Drawing Right (SDR). As of August 23, 1999, SDR I equalled
US $1.370280.
IMF is a cooperative institution that 182 countries have voluntarily joined because
they see the advantage of consulting with one another on this forum to maintain a stable
system of buying and selling their currencies so that payments in foreign currency can take
place between countries smoothly and without delay. Its policies and activities are guided
by its Charter known as the Articles of Agreement.
IMF lends money to members having trouble meeting financial obligations to other
members, but only on the condition that they undertake economic reforms to eliminate
these difficulties for their own good and that of the entire membership. Contrary to
widespread perception, the IMF has no effective authority over the domestic economic
policies of its members. What authority the IMF does possess is confined to requiring the
member to disclose information on its monetary and fiscal policies and to avoid, as far as
possible, putting restrictions on exchange of domestic for foreign currency and on making
payments to other members.
There are several major accomplishments to the credit of the International Monetary
System. For example, it
• sustained a rapidly increasing volume of trade and investment;
• displayed flexibility in adapting to changes in international commerce;
• proved to be efficient (even when there were decreasing percentages of reserves to
trade);
• proved to be hardy (it survived a number of pre-1971 crises, speculative and otherwise,
and the down-and-up swings of several business cycles);
• allowed for a growing degree or international cooperation;
• established a capacity to accommodate reforms and improvements.
To an extent, the fund served as an international central bank to help countries
during periods of temporary balance of payments difficulties by protecting their rates of
exchange. Because of that, countries did not need to resort to exchange controls and other
barriers to restrict world trade.
Organization of IMF
On joining the IMF, each member country contributes a certain sum of money called a ‘quota
subscription’, as a sort of credit union deposit. Quotas serve various purposes.
· They form a pool of money that the IMF can draw from to lend to members in times of
financial difficulty.
· They form the basis of determining the Special Drawing Rights (SDR).
· They determine the voting power of the member.
Statutory Purposes –
The main purposes of the International Monetary Fund are:
a. To promote international monetary cooperation through a permanent institution
that provides the machinery for consultation and collaboration on international monetary
problems.
b. 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
objectives of economic policy.
c. To promote exchange stability, to maintain orderly exchange arrangements among
members and to avoid competitive exchange depreciation.
d. To assist in the establishment of a multilateral system of payments in respect of
current transactions between members and in the elimination of foreign exchange restrictions
which hamper the growth of world trade.
e. 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 maladjustment in their balance of payments without resorting to
measures destructive to national or international prosperity.
f. In accordance with the above, to shorten the duration and lessen the degree of
disequilibrium in the international balances of payments of members.

Financial Assistance
The IMF lends money only to member countries with balance of payments
problems. A member country with a payments problem can immediately withdraw from
the IMF the 25 per cent of its quota. A member in greater difficulty may request for more
money from the IMFand can borrow up to three times its quota provided the member
country undertakes to initiate a series of reforms and uses the borrowed money effectively.
The frequently used mechanisms by the IMF to lend money are:
a. Standby Arrangements
b. Extended Arrangements
c. Structural Adjustment Mechanism (With low interest rates)
Regular IMF facilities
a. Standby Arrangements (SBA) are designed to provide short-term balance of
payments assistance for deficits of a temporary or cyclical nature, such arrangements are
typically for 12 to 18 months. Drawings are phased on a quarterly basis, with their release
made conditional on meeting performance criteria and the completion of periodic
programme reviews. Repurchases are made 31/4 to 5 years after each purchase.
27
3.4.3 STATUTORY PURPOSES
The main purposes of the International Monetary Fund are:
a. To promote international monetary cooperation through a permanent institution
that provides the machinery for consultation and collaboration on international monetary
problems.
b. 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
objectives of economic policy.
c. To promote exchange stability, to maintain orderly exchange arrangements among
members and to avoid competitive exchange depreciation.
d. To assist in the establishment of a multilateral system of payments in respect of
current transactions between members and in the elimination of foreign exchange restrictions
which hamper the growth of world trade.
e. 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 maladjustment in their balance of payments without resorting to
measures destructive to national or international prosperity.
f. In accordance with the above, to shorten the duration and lessen the degree of
disequilibrium in the international balances of payments of members.
3.4.4 FINANCIAL ASSISTANCE
The IMF lends money only to member countries with balance of payments
problems. A member country with a payments problem can immediately withdraw from
the IMF the 25 per cent of its quota. A member in greater difficulty may request for more
money from the IMFand can borrow up to three times its quota provided the member
country undertakes to initiate a series of reforms and uses the borrowed money effectively.
The frequently used mechanisms by the IMF to lend money are:
a. Standby Arrangements
b. Extended Arrangements
c. Structural Adjustment Mechanism (With low interest rates)
Regular IMF facilities
a. Standby Arrangements (SBA) are designed to provide short-term balance of
payments assistance for deficits of a temporary or cyclical nature, such arrangements are
typically for 12 to 18 months. Drawings are phased on a quarterly basis, with their release
made conditional on meeting performance criteria and the completion of periodic
programme reviews. Repurchases are made 31/4 to 5 years after each purchase.

b. Extended Fund Facility (EFF) is designed to support medium-term programmes

that generally run for three years. The EFF aims at overcoming balance of payments
difficulties stemming from macroeconomic and structural problems. Performance criteria
are applied, similar to those in standby arrangements and repurchases are made in 4½ to
10 years.

c. Concessional IMF facility

a. Enhanced Structural Adjustment Facility (ESAF) was established in 1987
and enlarged and extended in 1994. Designed for low-income member countries with
protracted balance of payments problems, ESAF drawings are loans and not purchases
of other members’ currencies. They are made in support of three year programmes and
carry an annual interest rate of 0.5 per cent, with a 51h year grace period and a 10 year
maturity. Quarterly benchmarks and semi-annual performance.
Responsibility –
i. Promoting international monetary cooperation
ii. Facilitating the expansion and balanced growth of international trade
iii. Promoting exchange stability
iv. Assisting in the establishment of a multilateral system of payments.
v. Making its resources available, under adequate safeguards to members experiencing
balance of payments difficulties
The Fund seeks to promote economic stability and prevent crises; to help resolve crises
when they do occur, and to promote growth and alleviate poverty. To meet these objectives,
it employs three main functions, as discussed here.
Role of IMF –
(IMF) played a significant role in stabilizing the exchange rates thereby facilitating
international payment adjustments. Economists across the world have commended its role in
enforcing monetary discipline among its members.
a. IMF brings stability in exchange rate: The IMF has laid down a clear guidance
of exchange rate policies. Its policies prevent the member countries from making competitive
devaluation to boost up exports. As a result of all these, the system of exchange under the
IMF is stable.
b. IMF’s role in development of international trade: The IMF has been
instrumental to the growth of international trade. It acts as the reservoir of the currencies of
all the member countries. A borrowing country can borrow the currency of another country
out of this reservoir. It extends loans in foreign exchange to the member countries for
financing the current transactions. It also provides technical advice on monetary and fiscal
matters. It conducts research studies and publishes them. This multilateral assistance helps
members in solving their problems in trade, thereby promoting international trade.
c. IMF is strict on multiple exchange rates: The IMF does not permit the member
countries to adopt multiple exchange rates leading to restrictive practices. The system of
exchange rate combines the element of stability with flexibility. It maintains stability in
exchange rates.
d. IMF’s elaborate lending operations: The main operation of the fund is lending
to member countries. It has introduced a variety of loan facilities to its members. Initially,
the lending operations were confined only for solving the problems of deficit payments.
But now they have been remarkably extended. Member countries can have regular facilities,
concessional facilities and special facilities. Credit Tranches and extended fund facility are
some of the regular facilities. Structural adjustment facility and enhanced structural
adjustment facility are some concessional schemes offered to the member countries. The
special facilities offered by the IMF fund include compensatory and contingency financing
facility, systematic transformation facility and contingency credit line.
e. IMF’s role in currency convertibility: With the charges introduced after 1973
in the international monetary system, a member can peg its currency to
· either a single major currency or
· a basket of currencies or
· allow it to float independently.
A currency is said to be floating when its is left free to find its own parity in the international
market. The IMF is the catalyst in the convertibility of currencies. It endeavors to achieve
full global convertibility of currencies in the next decade. All developing countries will
achieve full convertibility.
f. IMF’s role in Consultation and guidance: The IMF provides the necessary
machinery for consultation and collaboration on international monetary problems. Monetary,
fiscal and financial problems and also matters relating to exchange and trade affecting
international payments are clearly studied. It deputes experts to member countries to deal
with the balance of payments problems. It also conducts short term training courses on
fiscal, monetary and balance of payments for personnel from member nations.
g. Boon to developing countries: The IMF is a boon to developing countries.
Less developed countries get enormous assistance from IMF like
· Financial assistance to get rid of balance of payment deficits
· concessional financial assistance for promotion of exports
· suggestions for overcoming constraints in the development process
· Assistance in the formulation of development oriented monetary, fiscal, exchange
and trade policies
· extension of central banking advisory services to less developed countries towards
the improvement of functioning of their central banks
· institutional training for the personnel in member countries; and
· Special Drawing Rights (SDRs) to resolve the problem of international liquidity.
Functions of IMF –
Surveillance: A core responsibility of the IMF is to encourage a dialogue among
its member countries about the national and international consequences of their economic
and financial policies, to promote external stability. This process of monitoring and
consultation, normally referred to as ‘surveillance’, has evolved rapidly as the world
economy
has changed. IMF surveillance has also become increasingly open and transparent in recent
years. The initiatives used to inform bilateral surveillance and aimed at promoting global
economic stability are as follows:
· The IMF works to improve its ability to assess the member countries’ vulner-abilities
to crisis, identifying and promoting effective responses to risks to economic stability,
including
risks from payments imbalances, currency misalign-ment, and financial market disturbances.
· In collaboration with the World Bank, the IMF conducts in-depth assessments of
countries’ financial sectors under the Financial Sector Assessment Programme (FSAP).
The Fund is further deepening financial and capital market surveillance, particularly in its
analysis of emerging market members.
· The IMF has developed and actively promotes standards and codes of good
practice in economic policy making. It is also involved in international efforts to combat
money laundering and the financing of terrorism.
The importance of effective surveillance was underscored by the financial crises of the late
1990s. In response, the IMF has undertaken many initiatives to strengthen its capacity to
detect vulnerabilities and risks at an early stage, to help member countries strengthen their
policy frameworks and institutions, and to improve transparency and accountability.
b. Technical Assistance: The objective of IMF technical assistance is to contribute
to the development of the productive resources of member countries by enhancing the
effectiveness of economic policy and financial management. The IMF helps countries
strengthen their capacity to design and implement sound economic policies. The IMF
helps its member countries build their human and institutional capacity to design and
implement effective macroeconomic and structural policies, put in place reforms that
strengthen their financial sectors, and reduce vulnerability to crises. The IMF generally
provides technical assistance free of charge to any requesting member country within the
IMF resource constraints. About three-quarters of the Fund’s technical assistance go to
low- and lower-middle income countries, particularly in sub-Saharan Africa and Asia, and
post-conflict countries. The IMF provides technical assistance in its areas of expertise:
namely macroeco-nomic policy, tax policy and revenue administration, expenditure
management, monetary policy, the exchange rate system, financial sector sustainability,
and macro- economic and financial statistics.
Since the demand for technical assistance far exceeds supply, the IMF gives priority in
providing assistance where it complements and enhances the IMF’s other key forms of
assistance, i.e., surveillance and lending.
30
3.4.7 FUNCTIONS OF THE INTERNATIONAL MONETARY FUND
a. Surveillance: A core responsibility of the IMF is to encourage a dialogue among
its member countries about the national and international consequences of their economic
and financial policies, to promote external stability. This process of monitoring and
consultation, normally referred to as ‘surveillance’, has evolved rapidly as the world
economy
has changed. IMF surveillance has also become increasingly open and transparent in recent
years. The initiatives used to inform bilateral surveillance and aimed at promoting global
economic stability are as follows:
· The IMF works to improve its ability to assess the member countries’ vulner-abilities
to crisis, identifying and promoting effective responses to risks to economic stability,
including
risks from payments imbalances, currency misalign-ment, and financial market disturbances.
· In collaboration with the World Bank, the IMF conducts in-depth assessments of
countries’ financial sectors under the Financial Sector Assessment Programme (FSAP).
The Fund is further deepening financial and capital market surveillance, particularly in its
analysis of emerging market members.
· The IMF has developed and actively promotes standards and codes of good
practice in economic policy making. It is also involved in international efforts to combat
money laundering and the financing of terrorism.
The importance of effective surveillance was underscored by the financial crises of the late
1990s. In response, the IMF has undertaken many initiatives to strengthen its capacity to
detect vulnerabilities and risks at an early stage, to help member countries strengthen their
policy frameworks and institutions, and to improve transparency and accountability.
b. Technical Assistance: The objective of IMF technical assistance is to contribute
to the development of the productive resources of member countries by enhancing the
effectiveness of economic policy and financial management. The IMF helps countries
strengthen their capacity to design and implement sound economic policies. The IMF
helps its member countries build their human and institutional capacity to design and
implement effective macroeconomic and structural policies, put in place reforms that
strengthen their financial sectors, and reduce vulnerability to crises. The IMF generally
provides technical assistance free of charge to any requesting member country within the
IMF resource constraints. About three-quarters of the Fund’s technical assistance go to
low- and lower-middle income countries, particularly in sub-Saharan Africa and Asia, and
post-conflict countries. The IMF provides technical assistance in its areas of expertise:
namely macroeco-nomic policy, tax policy and revenue administration, expenditure
management, monetary policy, the exchange rate system, financial sector sustainability,
and macro- economic and financial statistics.
Since the demand for technical assistance far exceeds supply, the IMF gives priority in
providing assistance where it complements and enhances the IMF’s other key forms of
assistance, i.e., surveillance and lending.
c. Lending: Even the best economic policies cannot eradicate instability or avert
crises. In the event that a member country does experience financing difficulties, the IMF
can provide financial assistance to support policy programmes that will correct underlying
macroeconomic problems, limit disruptions to the domestic and global economies, and
help restore confidence, stability, and growth. IMF financing instruments can also support
crisis prevention. The IMF is accountable to the governments of its member countries. At
the apex of its organizational structure is its board of governors, which consists of one
governor from each of the IMF’s 190 member countries. All governors meet once a year
at the IMF-World Bank Annual Meetings.
The IMF’s resources are provided by its member countries, primarily through payment of
quotas, which broadly reflect each country’s economic size. The annual expenses of running
the Fund are met mainly by the difference between interest receipts on outstanding loans
and interest payments on quota ‘deposits’.

IBRD/ World Bank

The IBRD was set up in 1945 along with the IMF to aid in rebuilding the worldeconomy. It
was owned by the governments of 151 countries and its capital is subscribed
by those governments; it provides funds to borrowers by borrowing funds in the world
capital markets, from the proceeds of loan repayments as well as retained earnings. At its
funding, the bank’s major objective was to serve as an international financing facility to
function in reconstruction and development. With Marshall Plan providing the impetus for
European reconstruction, the Bank was able to turn its efforts towards the developing
countries.
Generally, the IBRD lends money to a government for the purpose of developing that
country’s economic infrastructure such as roads and power generating facilities. Funds are
directed towards developing countries at more advanced stages of economic and social
growth. Also, funds are lent only to members of the IMF, usually when private capital is
unavailable at reasonable terms. Loans generally have a grace period of five years and are
repayable over a period of fifteen or fewer years. The projects receiving IBRD assistance
usually require importing heavy industrial equipment and this provides an export market
ror many US goods. Generally bank loans are made to cover only import needs in foreign
convertible currencies and must be repaid in those currencies at long-term rates.
The government assisted in formulating and implementing an effective and comprehensive
strategy for the development of new industrial free zones and the expansion of existing
ones; reducing unemployment, increasing foreign-exchange earnings and strengthening
backward linkages with the domestic economy; alleviating scarcity in term financing; and
improving the capacity of institutions involved in financing, regulating and promoting free
zones.
31
c. Lending: Even the best economic policies cannot eradicate instability or avert
crises. In the event that a member country does experience financing difficulties, the IMF
can provide financial assistance to support policy programmes that will correct underlying
macroeconomic problems, limit disruptions to the domestic and global economies, and
help restore confidence, stability, and growth. IMF financing instruments can also support
crisis prevention. The IMF is accountable to the governments of its member countries. At
the apex of its organizational structure is its board of governors, which consists of one
governor from each of the IMF’s 190 member countries. All governors meet once a year
at the IMF-World Bank Annual Meetings.
The IMF’s resources are provided by its member countries, primarily through payment of
quotas, which broadly reflect each country’s economic size. The annual expenses of running
the Fund are met mainly by the difference between interest receipts on outstanding loans
and interest payments on quota ‘deposits’.
3.5 INTERNATIONAL BANK FOR RECONSTRUCTION AND
DEVELOPMENT(IBRD) / WORLD BANK
The IBRD was set up in 1945 along with the IMF to aid in rebuilding the world
economy. It was owned by the governments of 151 countries and its capital is subscribed
by those governments; it provides funds to borrowers by borrowing funds in the world
capital markets, from the proceeds of loan repayments as well as retained earnings. At its
funding, the bank’s major objective was to serve as an international financing facility to
function in reconstruction and development. With Marshall Plan providing the impetus for
European reconstruction, the Bank was able to turn its efforts towards the developing
countries.
Generally, the IBRD lends money to a government for the purpose of developing that
country’s economic infrastructure such as roads and power generating facilities. Funds are
directed towards developing countries at more advanced stages of economic and social
growth. Also, funds are lent only to members of the IMF, usually when private capital is
unavailable at reasonable terms. Loans generally have a grace period of five years and are
repayable over a period of fifteen or fewer years. The projects receiving IBRD assistance
usually require importing heavy industrial equipment and this provides an export market
ror many US goods. Generally bank loans are made to cover only import needs in foreign
convertible currencies and must be repaid in those currencies at long-term rates.
The government assisted in formulating and implementing an effective and comprehensive
strategy for the development of new industrial free zones and the expansion of existing
ones; reducing unemployment, increasing foreign-exchange earnings and strengthening
backward linkages with the domestic economy; alleviating scarcity in term financing; and
improving the capacity of institutions involved in financing, regulating and promoting free
zones.
The World Bank lays special operational emphasis on environmental and women’s
[Link] that the Bank’s primary mission is to support the quality of life of people in
developing
member countries, it is easy to see why environmental and women’s issues are receiving
increasing attention. On the environmental side, it is the Bank’s concern that its development
funds are used by the recipient countries in an environmentally responsible way. Internal
concerns, as well as pressure by external groups, are responsible for significant research
and projects relating to the environment.
The women’s issues category, specifically known as Women In Development (WID) is
part of a larger emphasis on human resources. The importance of improving human capital
and improving the welfare of families is perceived as a key aspect of development. The
WID initiative was established in 1988 and it is oriented to increasing women’s productivity
and income. Bank lending for women’s issues is most pronounced in education, population,
health and nutrition and agriculture.

Purpose of the World Bank

The World Bank group is a multinational financial institution established at the end
of World War II (1944) to help provide long-term capital for the reconstruction and
development of member countries. The group is important to multinational corporations
because it provides much of the planning and financing for economic development projects
involving billions of dollars for which private businesses can act as contractors and suppliers
of goods and engineering related services.
The purpose for the setting up of the Bank are
a. To assist in the reconstruction and development of territories of members by
facilitating the investment of capital for productive purposes, including the restoration of
economies destroyed or disrupted by war, the reconversion of productive facilities to
peacetime needs and encouragement of the development or productive facilities and
resources in less developed countries.
b. To promote private foreign investment by means of guarantees or participation in
loans and other investments made by private investors; and when private capital is not
available on reasonable terms, to supplement private investment by providing, on suitable
conditions, finance for productive purposes out of its own capital, funds raised by it and its
other resources.
c. To promote the long-range balanced growth of international trade and the
maintenance of equilibrium in balance of payments by encouraging international investment
for the development of the productive resources of members, thereby assisting in raising
productivity, the standard of living and condition of labour in their territories.
d. To arrange the loans made or guaranteed by it in relation to international loans
through other channels so that the more useful and urgent projects, large and small alike,
can be dealt with first.
e. To conduct its operations with due regard to the effect of international investment on
business conditions in the territories of members and, in the immediate post-war years,
to assist in bringing about a smooth transition from a wartime to a peacetime economy.
The World Bank is the International Bank for Reconstruction and Development (IBRD)
and the International Development Association (IDA). The IBRD has two affiliates, the
International Finance Corporation (IFC) and the Multilateral Investment Guarantee Agency
(MIGA). The Bank, the IFC and the MIGA are sometimes referred to as the “World
Bank Group”.
FUNCTIONS OF THE WORLD BANK
The principal functions of the IBRD are set forth in Article I of the agreement as
follows:
a. To assist in the reconstruction and development of the territories of its members
by facilitating the investment of capital for productive purposes.
b. To promote private foreign investment by means of guarantee of participation in
loans and other investments made by private investors and when private capital is not
available on reasonable terms, to make loans for productive purposes out of its own
resources or from funds borrowed by it.
c. To promote the long-term balanced growth of international trade and the
maintenance of equilibrium in balance of payments by encouraging international investment
for the development of the productive resources of members.
d. To arrange loans made or guaranteed by it in relation to international loans through
other channels so that more useful and urgent projects, large and small alike, will be dealt
with first. It appears that the World Bank was created to promote and not to replace
private foreign investment. The Bank considers its role to be a marginal one, to supplement
and assist foreign investment in the member countries.
e. A little consideration will show that the objectives of the IMF and IBRD are
complementary. Both aim at increasing the level of national income and standard of living
of the member nations. Both serve as lending institutions, the IMF for short-term and the
IBRD for long-term capital. Both aim at promoting the balanced growth of international
trade.
ROLE OF THE WORLD BANK
The World Bank is internationally recognised and supported that provides technical
& financial assistance to many developing countries in the world. It also aids their
advancement, in an economy with a primary goal of reducing poverty. World Bank has the
largest knowledge of developing countries. Also, they are the largest source of funding.
The role of world bank is
a) To help the war-devasted countries by granting them loan for reconstruction.
33
e. To conduct its operations with due regard to the effect of international investment
on business conditions in the territories of members and, in the immediate post-war years,
to assist in bringing about a smooth transition from a wartime to a peacetime economy.
The World Bank is the International Bank for Reconstruction and Development (IBRD)
and the International Development Association (IDA). The IBRD has two affiliates, the
International Finance Corporation (IFC) and the Multilateral Investment Guarantee Agency
(MIGA). The Bank, the IFC and the MIGA are sometimes referred to as the “World
Bank Group”.
3.5.2 FUNCTIONS OF THE WORLD BANK
The principal functions of the IBRD are set forth in Article I of the agreement as
follows:
a. To assist in the reconstruction and development of the territories of its members
by facilitating the investment of capital for productive purposes.
b. To promote private foreign investment by means of guarantee of participation in
loans and other investments made by private investors and when private capital is not
available on reasonable terms, to make loans for productive purposes out of its own
resources or from funds borrowed by it.
c. To promote the long-term balanced growth of international trade and the
maintenance of equilibrium in balance of payments by encouraging international investment
for the development of the productive resources of members.
d. To arrange loans made or guaranteed by it in relation to international loans through
other channels so that more useful and urgent projects, large and small alike, will be dealt
with first. It appears that the World Bank was created to promote and not to replace
private foreign investment. The Bank considers its role to be a marginal one, to supplement
and assist foreign investment in the member countries.
e. A little consideration will show that the objectives of the IMF and IBRD are
complementary. Both aim at increasing the level of national income and standard of living
of the member nations. Both serve as lending institutions, the IMF for short-term and the
IBRD for long-term capital. Both aim at promoting the balanced growth of international
trade.
3.5.3 ROLE OF THE WORLD BANK
The World Bank is internationally recognised and supported that provides technical
& financial assistance to many developing countries in the world. It also aids their
advancement, in an economy with a primary goal of reducing poverty. World Bank has the
largest knowledge of developing countries. Also, they are the largest source of funding.
The role of world bank is
a) To help the war-devasted countries by granting them loan for reconstruction.
b) To provide extensive experience & the financial resources of the bank to help the
poor countries increase their economic growth, reducing poverty & a better standard
of living.
c) To grant development loan to the under-developed countries
d) To provide loans to various governments for irrigation, agriculture, water supply,
heath, educations etc.
e) To promote foreign investments to other organisations by guaranteeing the loans.
f)` To provide economic, monetary & technical advice to the member countries for
any of their projects.
g) To encourage the development of industries in under-developed countries by
introducing the various economic reforms.

Theory of Purchasing Power Parity (PPP)

• This theory was enunciated by Gustav Cassel. Purchasing power of a currency is
determined by the amount of goods and services that can be purchased with one unit
of that currency. If there is more than one currency, it is fair and equitable that the
exchange rate between these currencies provides the same purchasing power for each
currency. This is referred to as purchasing power parity.
• It is ideal if the existing exchange rate is in tune with this cardinal principle of
purchasing power parity. On the contrary, if the existing exchange rate is such that
purchasing power parity does not exist in economic terms, it is a situation of
disequilibrium. It is expected that the exchange rate between the two currencies
conform eventually to purchasing power parity.
• Likewise, if the rate of inflation is different in two countries, the floating exchange
rate should accordingly vary to reflect that difference. Let us consider two countries,
A and B. The rate of inflation in the country A is higher than that in the country B. As
a result, imports of the country A increases since the price of foreign goods tend to be
lower. Similarly exports from the country A decreases since the prices of its goods
appear to be higher to foreigners (residents of country B included). This situation
 cannot persist for long. In consequence, the currency of country A will depreciate with
respect to that of the country B.
• If ih and if are the inflation rates in the home country and the foreign country; and
ERo is the value in terms of home currency for one unit of foreign currency at the
beginning of the given period and ERt is the value in terms of home currency at the
end of the period,

• Criticism of the PPP Theory

Conceptually, this theory is sound. However, there are a number of recognized factors that
prevent this theory from determining exchanges rates, in practice. Some of the major factors
in this regard are:
1. Government intervention, directly in the exchange markets or indirectly through trade
restrictions;
2. Speculation in the exchange market;
3. Structural changes in the economy of the countries;
4. Continuation of long-term flows in spite of the disequilibrium between purchasing power
parity and exchange rates.
• The theory takes into account only the movement of goods and services and not that
of capital. In operational terms, it is concerned only with the current account segment
of the balance of payment and not with the total BOP.
• The PPP theory can be considered as an ideal theory to determine exchange rates in
specific situations, such as high inflation or monetary disturbances. In such situations,
the response to individuals to changes in value of real and monetary assets can be
expected to be strong and the exchange rate prediction by PPP theory may turn out to
be realistic.
• Absolute Purchasing Power Parity : A theory which states that the exchange rate
between one currency and another is in equilibrium when their domestic purchasing
powers at that rate’ of exchange are equivalent. In short, what this means is that
bundle of goods should cost the same in India and the United States once you take the
exchange rate into account.
• Relative PPP - Relative PPP takes into account changes in price levels over time due
to inflation. It implies that the rate of change in the exchange rate between two
currencies during a period should be equal to the difference in inflation rates between
the two countries. Therefore, if a country has higher inflation than another, its
currency should depreciate relative to the other currency.
• Expenditure PPP - Expenditure PPP calculates PPP on the basis of some categories
of expenditure like government consumption, private consumption, and capital
formation. It offers more refined information on relative prices because it is calculated
by comparison of the price of a bigger consumption basket as opposed to that of
goods and services alone. This kind of measure enables better and more
encompassing comparisons of countries' standards of living and their productivity
levels.
• Why Purchasing Power Parity theory doesn’t always work in practice?
Anything which limits the free trade of goods will limit the opportunities people have in
taking advantage of these arbitrage opportunities. A few of the larger limits are :
• Import and Export Restrictions
• Travel Costs
• Perishable goods
• Location
• So while purchasing power parity theory helps us understand exchange rate
differentials, exchange rates do not always converge in the long run the way PPP
theory predicts. Absolute PPP works as a theoretical construct to understand an
imaginary world of perfect competition. It does not serve well as a practical model to
forecast exchange rates. As a practical matter, a relative version of PPP has evolved,
which states that the change in the exchange rate over time is determined by the
difference in the inflation rates of the two countries.
Significance
• PPP has deep economic implications:
• Comparative Analysis: PPP enables better comparisons of economic productivity
and living standards across nations by removing distortions caused by fluctuating
exchange rates.
• Economic Policy: Using PPP, policymakers make more rational decisions about
monetary policy, fiscal spending, and social welfare programs.
• Global Trade: Understanding competitiveness in the global market by accounting for
price level differences is possible through PPP.
• Investment Decisions: International investors utilize PPP to make relative valuation
of investments among countries, after having considered risk due to changes in
currency.
• Measurement of Living Standards: Agencies such as World Bank and UN have
been utilizing PPP to gauge the extent of poverty, inequality of income distribution,
and living standards in different nations.
Issues associated with PPP
• Basket of Goods: The choice of goods and services to include in the comparison
basket is not going to reflect perfectly the consumption pattern of various countries.
Hence, it leads to error.
• Non-Traded Goods: PPP does not account for non-traded goods and services, which
creates significant differences in the cost of living among countries.
• Quality Differences: PPP fails to capture differences in the quality of goods and
services. This might lead to an over or underestimation of the purchasing power.
• Market Imperfections: Transportation costs, tariffs, and differences in product
availability can affect the validity of PPP calculations.
• Exchange Rate Volatility: Short-term exchange rate movements do not always
reflect basic price level differences, which can mislead the interpretation of PPP.
• Import and Export Restrictions: Restrictions such as quotas, tariffs and laws will
make it difficult to buy goods in one market and sell them in another.
• Travel costs: If it is very expensive to transport goods from one market to another, we
would expect to see a difference in prices in the two markets.
• Perishable Goods
• Location : You can’t buy a piece of property in Indore and move it to New Delhi.
Because of that real estate prices in markets can vary wildly. Since the price of land is
not the same every where, we would expect this to have an impact on prices, as
retailers in New Delhi have higher expenses than retailers in Indore.
• Tax Differences

• International Development Association (IDA)

Formed in 1960 as a part of World Bank Group to provide financial support to LDCs
on a more liberal basis than could be offered by the IBRD
• 15 founder countries - Australia, Canada, China, Germany, India, Italy, Malaysia,
Norway, Pakistan, Sudan, Sweden, Thailand, United Kingdom, United States, and
Vietnam.
• Every three years, member nations that provide funds to the IDA gather together to
replenish the IDA's resources. These funds come primarily from well-developed
countries including the United States, Japan, France, Germany, and the United
Kingdom with 58% from the US, 22% from France, and 8% from the UK.
• India is a member of four of the five parts of the World Bank Group, including the
IDA.
• The IDA has lent money to India's health sector since 1972.
• India has been the largest borrower from the IDA, with total borrowings of $44.26
billion.
 • The IDA has helped India improve child nutrition, meet health goals, and address
disease.
• IDA’s funds come from subscriptions from its developed members and from the
earnings of the IBRD.
• Credit terms usually are extended to 40 to 50 years with no interest.
• Repayment begins after a ten-year grace period and can be paid in the local currency,
as long as it is convertible.
• Eligibility for IDA support depends first and foremost on a country’s relative poverty.
• The present emphasis seems to be on helping the masses of poor people in the
developing countries become more productive and take an active part in the
development process. Greater emphasis is being placed on improving urban living
conditions and increasing productivity of small industries.
• Some countries, such as Nigeria and Pakistan, are IDA-eligible based on per capita
income levels and are also creditworthy for some IBRD borrowing. They are referred
to as “blend” countries.
MIGA
• Established in 1988
• To encourage equity investment and other direct investment flows to developing
countries by offering investors a variety of different services.
• It offers guarantees against non commercial risks; advises developing member
governments on the design and implementation of policies, programs and procedures
related to foreign investments; and sponsors a dialogue between the international
business community and host governments on investment issues.
• Functions –
• Political risk insurance
• Credit enhancement
• Dispute resolution
• Environmental and Social Management
• It has 182 member Governments
• MIGA helps India
• Reduces risk for the Government
• Lower financing costs
• Promotes cross border investment
• Supports innovative projects – Ex:- Solar Rooftop System
International Finance Corporation (IFC)
 • Established in 1956.
• IFC has 186 member countries. The United States is the largest shareholder, followed
by Japan, Germany, France, and the United Kingdom.
• Responsibilities –
a. To provide risk capital in the form of equity and long-term loans for productive
private enterprises in association with private investors and management;
b. To encourage the development of local capital markets by carrying out standby and
underwriting arrangements; and
c. To stimulate the international flow of capital by providing financial and technical
assistance to privately controlled finance companies. Loans are made to private firms
in the developing member countries and are usually for a period of seven to twelve
years.
• The key feature of the IFC is that its loans are made to private enterprises and its
investments are made in conjunction with private business. In addition to funds
contributed by IFC, funds are also contributed to the same projects by local and
foreign investors. IFC investments are for the establishment of enterprises as well as
for the expansion and modernization of existing ones.
• They cover a wide range of projects such as steel, textile production, mining,
manufacturing, machinery production, food processing, tourism and local
development finance companies. Some projects are locally owned, whereas others are
joint ventures between investors in developing and developed countries. In a few
cases, joint ventures are formed between investors of two or more developing
countries.
• Instrumental in helping to develop emerging capital markets.
World Trade Organization (WTO)
Following the end of the Second World War, a General Agreement on Tariffs and
Trade (GATT) came into force in 1947 to deal with issues concerning trade and tariff at
the global level. In the 1980s, as technology became the dominant engine for economic
growth, the clamour of multinational corporations, which are the principal generators of
technology, for an effective mechanism for world-wide protection of intellectual property,
and strict enforcement of IP rights gained momentum. They had full and active support of
their governments. Developed countries and international agencies projected intellectual
property protection as the major factor in the growth of the world trade and made it an
important item of discussion under GATT in what is known as the Uruguay Round of
negotiations. The Uruguay Round began in 1986 and after intense debate spreading over
eight years, concluded on April 18, 1994 with the signing of a Final Act in Marrakesh,
Morocco. The World Trade Organisation (WTO) was thus born at Marrakesh. The basic
purpose of the WTO is to ensure a smooth and full flow of the world trade. The WTO is
the only international Organization dealing with the global rules of trade between nations.
The GATT which underwent a major revision as the result of negotiations is now the
principal rule book of the WTO for trade in goods. New rules came into force for dealing
with trade in services, trade related aspects of intellectual property, dispute settlement and
trade policy reviews. All WTO members are subjected to periodic review of their trade
policies to ensure transparency and adherence to the WTO agreement. As of October
2004, 148 countries were members of the WTO accounting for over 97% of world trade.
Decisions in WTO are made by the entire membership, typically by consensus.
The WTO is concerned with trade between nations and strives to develop
universally agreed rules of global trade. It stands for liberalization of trade, and serves as
the forum where global trade agreements are negotiated and trade disputes between member
nations are resolved and settled. The WTO Agreements are legal ground rules binding
member countries in the conduct of international commerce – national trade policies have
to honour and remain within the limits set in these agreements. The objectives of the
Agreements are two fold: to enable free flow of global trade without undesirable side
effects and to allow governments to meet social and environmental objectives. For free flow
of trade, obstacles have to be removed and fast: custom duties are to be lowered,
quotas have to be ended, subsidies are to be withdrawn and non-tariff barriers are not to
be erected. The WTO seeks to establish a transparent, rule-based system for global
trade, where everyone is to abide by the agreed rules. It has an effective disputes resolution
system which is meant to inspire confidence among members about a fair mechanism and
neutral procedures to ensure speedy resolution of disputes. It may be remembered how
the WTO is different from its predecessor, the General Agreement on Tariffs and Trade
(GATT). In the first place, as its name implied GATT was an agreement between contracting
parties and not an international organisation regulating global trade in a compelling manner.
Secondly, the GATT dealt with trade in goods, but the WTO agreements additionally
cover trade in services, as also trade in intellectual property. The subject matters of various
agreements under the WTO include: agriculture, textiles and clothing, banking,
telecommunications, government purchases, industrial standards and product safety, food
sanitation regulations, intellectual property.
4.3.1 TRADING PRINCIPLES UNDER THE WTO
A few fundamental principles serve as the bedrock for all WTO agreements. These
underlying principles are:
• Trade without discrimination “ Most-favoured-nation (MFN) treatment “ National
treatment
• Freer trade (bringing down trade barriers)
• Predictability, through binding commitment and transparency
• Promoting fair competition
• Encouraging development and economic reform
a. Most favoured nation (MFN) treatment: Despite its apparent, discriminating
overtones, in the WTO parlance, the MFN means non-discrimination, where every WTO
member is assured of getting the same treatment at the hands of a WTO member which it
grants to any other WTO member. If a member country of WTO grants a special favour in
trade to some favoured country, then all other WTO members will have to be given the
same favour. Thus all countries, in the WTO system, become the most favoured nation in
all other countries, making every country equal. The name, MFN, derives from the practice
in earlier bilateral MFN treaties, where a country could create a club of most favoured
trading partners. Under WTO it is no more possible. Every member is a most favoured
trading partner. The principle of MFN treatment figures prominently in the Agreements for
all three main areas of trade handled by the WTO, namely,
• the General Agreement on Tariffs and Trade (GATT)” deals with trade in goods
• the General Agreement on Trade in Services (GATS) “ deals with trade in services
• the Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPS
Agreement) “ deals with intellectual property
There could be exceptions to the MFN principle. For example, a group of countries can
enter into a free trade agreement in respect of goods that are traded within the group only;
a country can give special access to its markets to developing countries; a country can
raise barriers against goods from special countries on consideration of unfair trade practices.
But the exceptions are permitted only under strict conditions.
b. National Treatment: In essence it means treating foreigners and locals equally
by all members of the WTO. In the context of trade, this means that all WTO members are
bound to give equal treatment to imported goods and locally produced goods, foreign
services and domestic services, foreign and local trademarks, copyrights, patents, designs
etc. under their national laws. The national treatment principle is emphasised in all three
WIPO agreements i.e. GATT, GATS, and TRIPS, though it is handled slightly differently
in each of them. A point to note is that the principle of national treatment is applicable only
after a relevant item under any of the three WIPO agreements (a product, service or
intellectual property) has entered the market. Its implication is that a custom duty can be
levied on an item of import, even if its local counterpart attracts no tax, without violating
the national treatment principle.
c. Free Trade: Countries are known to raise barriers to impede free flow of trade.
Imposing customs duties (tariffs), selectively restricting quotas of import of various items,
banning of imports altogether are some of the obvious barriers. There may be other measures
which may not be so obvious but which would still have the same effect e.g. subsidies, red
tape, artificially propped up exchange rates, etc. for freer trade, barriers have to be removed
or lowered through negotiations. The WTO agreements encourage progressive liberalisation.
d. Predictability: Economic development of a country requires foreign capital,
technologies and expertise. However, foreign investments are drawn if there is a promise
of stability and the policy environment is predictable. Uncertainly does not exactly help
confidence of foreign investors and collaborators, whether individual or institutional. The
multilateral trading system under the WTO strives to create stability and predictability in
the business environment through negotiations, that create binding commitments on the
part of members. Examples of binding commitments are: open access to markets and
ceilings on customs tariffs. Transparency in trade rules and government policy goes a long
way to inspire confidence in trading partners. The WTO has a Trade Policy Review
Mechanism which keeps national trade policies under regular surveillance.
e. Fair competition: The WTO encourages fair competition in free trade, though
the degree of freedom is circumscribed by reality. In some circumstances where trading
practices of a country are proven to be unfair, as in the case of dumping and subsidies, the
WTO rules permit raising of customs duty, and even other forms of protection. The MFN and
the National Treatment principles ensure, in substantial measure, that the trading
environment is fair. It strongly disapproves of subsidies and dumping (exporting a product
at below production cost to capture large market share). Several WTO agreements provide
for conditions of fair competition to prevail e.g. in agriculture, services, intellectual property,
government procurement.
f. Development and Reforms: Alive to the realities of the situation in developing
countries, the WTO agreements provide for special assistance and trade concessions to
them. Some three fourths of the members of the WTO fall under two categories: developing
countries and countries in transition to market economies from the Centrally Planned
Economies. They have been given additional time to comply with the requirements of the
WTO agreements and join the mainstream. Developed countries have opened their markets
to exports from least developed countries allowing duty free, quota free imports.

Structure of WTO

The Ministerial Conference (MC) is at the top of the structural organisation of the [Link] is
the supreme governing body which takes ultimate decisions on all matters. It is
constituted by representatives of (usually, Ministers of Trade) all the member countries.
The General Council (GC) is composed of the representatives of all the members. It is the
real engine of the WTO which acts on behalf of the MC. It also acts as the Dispute
Settlement Body as well as the Trade Policy Review Body.
There are three councils, viz.: the Council for Trade in Services and the Council for Trade-
Related Aspects of Intellectual Property Rights (TRIPS) operating under the GC. These
councils with their subsidiary bodies carry out their specific responsibilities
Further, there are three committees, viz., the Committee on Trade and Development (CTD),
the Committee on Balance of Payments Restrictions (CBOPR), and the Committee on
Budget, Finance and Administration (CF A) which execute the functions assigned to them
by e WTO Agreement and the GC.
The administration of the WTO is conducted by the Secretariat which is headed by the
Director General (DG) appointed by the MC for the tenure of four years. He is assisted by
the four Deputy Directors from different member countries. The annual budget estimates
and financial statement of the WTO are presented by the DG to the CBFA for review and
recommendations for the final approval by the GC.
WTO Bodies:
Two key units are the Dispute Settlement Body (DSB) and the Trade Policy Review Body
(TPRB). The DSB, on which all member countries can sit, usually meets twice a month to
hear complaints of violations of WTO rules and agreements. It sets up expert panels to
study disputes and decide if the rules are being broken. The DSB’s final decisions, unlike
those of a similar but less powerful body in the old GATT, cannot be blocked.
The TPRB is a forum for the entire membership to review the trade policies of all WTO
states. Major trading powers are reviewed every two years, others every four years.
Other major bodies are the Council for Trade in Goods, the Council for Trade in Services
and the Council for Trade-Related Aspects of Intellectual Property Rights

Objectives –
• To ensure the reduction of tariffs and other barriers to trade.
• To eliminate discriminatory treatment in international trade relations.
 • To facilitate higher standards of living, full employment, a growing volume of real
income and effective demand, and an increase in production and trade in goods and
services of the member nations.
• To make positive effect, which ensures developing countries, especially the least
developed secure a level of share in the growth of international trade that reflects the
needs of their economic development.
• To facilitate the optimal use of the world’s resources for sustainable development.
• To promote an integrated, more viable and durable trading system incorporating all
the resolutions of the Uruguay Round’s multilateral trade negotiations.
• Above all, to ensure that linkages trade policies, environmental policies with
sustainable growth and development are taken care of by the member countries in
evolving a new economic order.
Functions –
• To lay-down a substantive code of conduct aiming at reducing trade barriers including
tariffs and eliminating discrimination in international trade relations.
• To provide the institutional framework for the administration of the substantive code
which encompasses a spectrum of norms governing the conduct of member countries
in the arena of global trade.
• To provide an integrated structure of the administration, thus, to facilitate the
implementation, administration and fulfillment of the objectives of the WTO
Agreement and other Multilateral Trade Agreements.
• To ensure the implementation of the substantive code.
• To act as a forum for the negotiation of further trade liberalisation.
• To cooperate with the IMF and WB and its associates for establishing a coherence in
trade policy-making.
• To settle the trade-related disputes.
Features –
• The distinctive features of the WTO are:
a. Unlike the GATT, it is a legal entity.
b. Unlike the International Monetary Fund (IMF) and the World Bank (WB) it is not an agent
of the United Nations.
c. Unlike the IMF and the World Bank, there is no weighted voting, but all the WTO
members have equal rights.
d. Unlike the GATT, the agreements under the WTO are permanent and binding to the
member countries.
e. Unlike the GATT, the WTO dispute settlement system is based not on dilatory but
automatic mechanism. It is also quicker and binding on the members. As such, the WTO is a
powerful body.
f. Unlike the GATT, the WTOs approach is rule- based and time-bound.
g. Unlike the GATT, the WTOs have a wider coverage. It covers trade in goods as well as
services.
h. Unlike the GATT, the WTOs have a focus on trade-related aspects of intellectual property
rights and several other issues of agreements.
i. Above all, the WTO is a huge organisational body with a large secretariat.

Asian Development Bank (ADB)

Functions –
1. Economic and Social Advancement
This bank has a membership program under which there are various benefits available for the
members’ countries.
These benefits include providing loan and investment at a concessional rate. One of the
functions of the ADB is to provide loans and equity investments for the economic and social
upgrade of developing member countries.
2. Technical Assistance
Most of the countries require a lot of services like advisory services. Moreover, they while
operating at the international level, most of the countries require technical support too.
One of the functions of the Asian Development Bank is to provide technical assistance for the
preparation and implementation of development projects and advisory services.
3. Investment Promotion
Firstly, the Asian Development Bank provides a lot of services to the member countries in the
form of investments. At the same time, they also provide some specific sort of investment
facilities for development purposes.
4. Support in Policies and Plans
Plans and policies play an important role in any country. There are various domestic agencies
providing help to the authorities while framing various policies.
But there is a need for some international agencies at the same time for the same function.
One of the main functions of the ADB is to provide help to the member countries in framing
policies and plans at the international level.
Objectives of the Asian Development Bank
1. Firstly, its objective is to help the member countries in countering poverty. Hence, it
helps them in poverty reduction and country development.
 2. If both the social as well as the economic aspects of a country is rising, then it leads to
economic growth. One of the objectives is to help the countries to go towards
economic growth.
3. Thirdly, their objective is to support human development.
4. Moreover, they believe in preserving and protecting the environment.
5. Lastly, they work and wish to continue working towards empowering women and
improving their status in society.

BRICS –
• The BRICS Development Bank is now known as the New Development Bank
(NDB). It is a multilateral development bank that was established in July 2015 by the
BRICS countries. The BRICS countries are Brazil, Russia, India, China, and South
Africa.
• The NDB's headquarters are in Shanghai, China.
• NDB’s main objectives are fostering the development of member countries,
supporting economic growth, promoting competitiveness and facilitating job creation,
and building a knowledge-sharing platform among developing countries. NDB’s key
areas of operation include clean energy; transport infrastructure; irrigation, water
resource management, and sanitation; sustainable urban development; and economic
cooperation and integration among member countries.
• In June 2022, ADB and the NDB signed a memorandum of understanding to develop
and facilitate collaboration in matters of common interest and to set out areas for
strategic cooperation toward achieving their common objectives.
• In November 2023, ADB’s Office of Safeguards met with the NDB, Asian
Infrastructure Investment Bank, and Multilateral Cooperation Center for Development
Finance in Beijing as part of ongoing consultations on ADB’s draft environmental and
social framework. During the mission, they discussed safeguard policy harmonization,
policy implementation and opportunities for enhanced cooperation, and capacity
building.
• During the 2023 United Nations Climate Change Conference (COP28), multilateral
development banks, including ADB and the NDB, made a joint statement affirming
their commitment to strengthening collaboration with clients, development partners,
civil society, the private sector, and others to reduce poverty and inequality, and
address the crises.
• ADB, India Sign $926 Million Loan for Two New Mumbai Metro Lines - ADB
and the Government of India signed a loan agreement to operationalize two lines for
the Mumbai Metro Rail System, which will help provide a cleaner and less congested
city. The project marks ADB’s first cofinancing with the New Development Bank.
EBRD –
• The European Bank for Reconstruction and Development (EBRD), headquartered in
London, was established in April 1991. The mandate of the Bank is to help the
erstwhile countries of Central and Eastern Europe to reconstruct their economies in
the post-Cold War era, evolve into open market oriented economies, and promote
private entrepreneurial initiatives by committing to the principles of multiparty
democracy and pluralism (EBRD, 1990). EBRD is the only institution in the group of
MDBs that has a predominantly private sector orientation, with a view to promoting
private sector development and support efficiency through increased market discipline
and policy reforms. The ability to operate in both the public and private sector
reinforces the uniqueness of the Bank.
• The operations span agribusiness, infrastructure, transport and many other sectors.
They are world leaders in climate finance. All the activities have been aligned with
the Paris Agreement from the end of 2022 and we plan to be a majority green bank by
2025.
• As of today, India is the shareholder in all the major MDBs except Inter-American
Development Bank (IADB). India joined the EBRD on July 11, 2018, as its 69th
member by subscribing 986 shares, comprising 179 paid-in shares and 807 callable
shares with the current shareholding of 0.033 per cent.
• The EBRD works with clients, regulators and government authorities to strengthen
regulatory and legislative frameworks and to enhance corporate governance and the
integrity of financial institutions. The Bank conducts regular discussions on the
business environment, privatisation policies and regulatory issues and encourages the
development of new financial products.
• The EBRD plays an active role in promoting anti-money-laundering procedures and
the prevention of terrorist financing. The Bank recently launched an ambitious
programme to raise awareness of this issue across its countries of operations.
• The EBRD provides tailor-made solutions for each project it finances, assigning a
dedicated team of specialists with project finance, sector, legal and environmental
skills. In the financial sector the EBRD works across six areas:
• Loans
• Micro and Small Business Finance
• Bank equity
• Equity funds
• Insurance and pension
• Other financial services