Why is it in the news?
- Addressing global challenges like climate change mitigation, pandemic response, and managing rising debt burdens demands significant financial resources, which the current IMF resources may not be adequate to address.
- Current IMF practices, including lending conditions and resource distribution, have the potential to worsen global inequalities. Thus, there is a pressing need for reforms that prioritize a fairer and more equitable international financial system to address these challenges effectively.
Need for Reforms
- Quotas in the IMF determine member countries’ financial contributions and voting power. However, these quotas do not accurately reflect the current economic significance of member nations.
- For instance, China’s quota stands at 6.40%, which is disproportionately small compared to its substantial economic stature. Conversely, the U.S. holds an outsized quota of 17.43%, granting it significant influence within the IMF. India’s quota is also relatively low at 2.75%.
- Crucial decisions within the IMF require an 85% majority, effectively granting the United States a de facto veto power. This issue has been raised and criticized by initiatives such as the Palais Royal Initiative.
Special Drawing Rights (SDR) Allocation
- The IMF issued a $650 billion SDR allocation in 2021 to member countries to alleviate financial stress caused by the COVID-19 pandemic.
- However, the distribution of SDRs was based on member quotas, leading to wealthier nations benefiting more from this allocation than those in greater need.
- The IMF’s surveillance and oversight activities primarily focus on countries that are seeking its financial assistance or support, potentially leading to less scrutiny of influential nations’ economic policies and practices.
Proposed Reforms for IMF
- Quotas: Reform the IMF’s quota system to ensure that member countries’ contributions and voting power accurately reflect their current economic importance on the global stage. This entails adjusting quotas to rectify existing imbalances.
- Composition of Board of Directors: Modify the composition of the IMF’s Board of Directors to ensure a more balanced representation of member countries. This would help mitigate the disproportionate influence of certain nations.
- Distribution of Special Drawing Rights (SDR): Change the distribution system for SDRs to promote fairness. For instance, allocate a certain percentage (e.g., 20%) of future SDR allocations to the poorest countries, rather than relying solely on quotas.
- In IMF Surveillance: Broaden the scope of IMF surveillance to include countries with significant external reserves or systemic influence. This ensures a more even-handed approach to monitoring economic policies globally.
- Surveillance of Capital Flows: Enhance the IMF’s role in monitoring capital movements, which can impact economic stability and financial crises.
- Role of a Global Central Bank: Expand the IMF’s role in managing global liquidity through the use of Special Drawing Rights (SDRs), effectively functioning as a global central bank.
- Role of Lender-of-Last-Resort: Explicitly recognize and strengthen the IMF’s role as a lender-of-last-resort. This would provide security and support to countries facing fluctuations in capital flows and financial crises.
- Strengthen the Decision-Making Role: Empower the International Monetary and Financial Committee (IMFC), a key decision-making body within the IMF, for more effective and inclusive decision-making.
- Review the G20’s Composition: Ensure that the composition of international bodies like the G20 reflects universal and equitable representation. For example, follow the steps taken under India’s G20 presidency to promote broader representation and diversity.
Special Drawing Rights (SDR)
· An international reserve asset created by the IMF to supplement the official reserves of its member countries.
· SDR is neither a currency nor a direct claim on the International Monetary Fund (IMF). It represents a potential claim on the freely usable currencies held by IMF member countries.
· SDR serves as the unit of account for the IMF and certain other international organizations.
· It is used as a reference point for financial transactions and calculations within these organizations.
· The value of the SDR in terms of actual currencies is determined by summing the values, in US dollars, of a specific basket of currencies. This calculation is based on market exchange rates for these currencies.
· The SDR basket of currencies includes several major world currencies: US dollar, Euro, Japanese yen, Pound sterling and Chinese renminbi (added to the basket in 2016)
· The currency value of the SDR is calculated on a daily basis. This calculation occurs every business day, except on IMF holidays or when the IMF is closed for business.
· The composition of the SDR valuation basket is reviewed and adjusted periodically, typically every five years. This review ensures that the basket reflects the importance of different currencies in the global economy accurately.
Palais Royal Initiative
· An initiative born out of the global financial crisis, involving a group of experts who aimed to understand the causes of the crisis and propose improvements to the international monetary system.
· The initiative promotes international cooperation and provided recommendations to the G-20 president in 2011.
· These proposed reforms aim to make the IMF a fairer, more responsive, and equitable institution, better equipped to address global challenges and promote the stability of the international financial system.