The Political Economy of Foreign

Debt
Rizki Rahmadini Nurika, S.Hub.Int., M.A.
Week 13
Introduction: International Monetary Fund
(IMF)
• What is IMF?
▫ IMF is an international organization of
188 member countries. It was
established to promote international
monetary cooperation, exchange
stability, and orderly exchange
arrangements; to foster economic
growth and high levels of employment;
and to provide temporary financial
assistance to countries to help ease
balance of payments adjustments.
Member-States of IMF
• How does the IMF achieve its objectives?
▫ Surveillance: monitoring of economic and financial
developments, and the provision of policy advice, aimed
especially at crisis-prevention.
▫ Lending to countries with balance of payments difficulties
providing temporary financing .
▫ Support policies aimed at correcting the underlying
problems and reduce poverty.
▫ Providing technical assistance and training in its areas of
expertise.
• The IMF finances.
▫ Quota System.
 Each member’s quota is based on its relative size in the world
economy. Upon joining the IMF, a country normally pays up to 1/4 of
its quota in the form of widely accepted foreign currencies (such as the
U.S. dollar, the euro, the yen, or the pound sterling) or Special
Drawing Rights (SDRs). The remaining 3/4 is paid in the country's
own currency.

▫ SDRs are defined as major currencies used in international trade and finance. They are
used as international reserve assets.

 Lending capacity: The IMF can only use its quota-funded holdings of
currencies of financially strong economies to finance lending.
▫ Gold holdings.
 Valued at current market prices, are worth about
$68 billion as of March end 2007, making the IMF
as one of the largest official holders of gold in the
world.
▫ Borrowing.
 IMF can borrow money from World Bank or its
member countries and other associations when it
feels are not sufficient to meet the financial needs of
all its member countries.
▫ When can a country borrow
from the IMF?
 A member country may
request IMF financial
assistance when has no
sufficient financing to meet its
net international payments
(balance of payments).
 IMF loan eases the balance of
payments problem.
 IMF suggests the country to
correct its policies in order
restore conditions for strong
economic growth.
• How is the IMF lending process?
▫ Member-state requests for external financing assistance.

▫ The IMF staff enters into negotiations with the borrower

government’s finance ministry over the amount and
terms of the loan package  signing of a “letter of
intent”.

▫ Borrower will undertake as conditions of the loan

(“conditionality”)
▫ The program must be approved by the IMF’s
Executive Board (EB), a 24-member body
composed of member-states’ representatives that
is the IMF’s ultimate decision-making authority
which approves all Fund programs.
Powerful States’ Interest behind IMF
Lending
• Loans are made on the basis of a
“Doctrine of Economic Neutrality”.
▫ Disregarding international politics and
the nature of developing country regimes.
▫ May impose strict lending requirements
but it applies fairly to all countries.
• Fact: political factors play an important
role.
▫ Why do some countries get a better deal
from the IMF, while others receive less
Fund credit on more stringent terms?
• 3 reasons to suspect that politics matters in IMF.
▫ The decisions to lend were based on political
preferences of the leading industrialized countries
instead of compatibility with repayment terms.
▫ Each country’s representative on the IMF’s
Executive Board hold the political interests of
their government which influence their decisions.
▫ Weighted voting and decision-making procedures
 veto power.
• US tends to excess its hegemonic power on the IMF.
▫ Political friends of the US are more likely to receive loans than
are its enemies.
 US disregarded the IMF’s economic criteria and pressured the
Fund to approve loans to politically friendly South Africa, El
Salvador, and Haiti.
 US pressured the IMF to deny loans to economically worthy
political enemies of the US such as Vietnam.

▫ The more closely a country aligns with the US, the higher the
probability it will receive a loan from the IMF.
• Political interests of US and advanced
industrialized countries in controlling Fund
lending.
▫ Lending for countries that are important for
domestic financial or geopolitical reasons.
▫ Promote expansion of global capitalism.
 Capitalists in the core states dictate IMF policy at the
expense of the periphery states.
 Inflow of foreign exchange would benefit core states’
exporters and foreign investors.
HOW ABOUT WORLD BANK? COMPARE THEM!
World Bank
• World Bank is an
internationally supported
bank that provides financial
and technical assistance to
developing countries for
development programs.
• Special features of World Bank.
▫ As one of the world’s largest
sources of funding for the
developing world.
▫ Its primary focus is on helping the
poorest people and the poorest
countries.
▫ It uses its financial resources, its
staff, and extensive experience to
help developing countries, reduce
poverty, increase economic growth,
improve their quality of life.
• Where does the World Bank get its
money from?
▫ Through the sale of its bonds in
international capital markets.
▫ Members’ subscriptions to its
capital stock.
 Only 10% of the subscriptions is
used by the Bank.
▫ “Callable Capital”.
 Portion of the subscriptions that the
Bank borrows.
 The Bank charges a rate of interest
rate on its loans to pay this back.
• Objectives of World Bank.
▫ Reconstruction and development.
▫ Encouragement to capital investment.
▫ Encouragement to international trade,
▫ Establishment of peace time economy,
▫ Infrastructure development.
Impacts of Debt on Developing Countries
• POSITIVE IMPACTS.
1. Bridge up the gap between government
expenditures and revenues which may not be
covered by domestic savings.
2. Help the economy to import the capital goods,
machinery and technology for investment
purposes.
3. Export promotion or import substitution
industries, which can help in reducing the
dependency on foreign debt in future.
• NEGATIVE IMPACTS.
1. Raised taxes by the government
to generate additional revenues
for the debt servicing.
2. Reduce future savings because
of the fact that debt is to be
paid by future income.
3. “Debt Trap Peonage” in which
debt can affect the economy by
changing consumption,
investment, savings and
income levels.
Debt Trap
• Debt trap: Why do developing
countries and LDCs depend on
foreign debt?
1. Deficit in the national budgets
originates when the national
revenues < national
expenditures.
2. Capital flight. Countries kept
their exchange rates too high.
3. Shortage of foreign exchange. Due to high
deficits in balance of payments, countries have
to borrow from abroad to finance their projects.
4. Borrow to pay their old debts and for their
interest payments.
THANK YOU