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Should RBI limit Its Intervention In Currency Market?

Context

  • According to the IMF’s recently published External Sector Report 2022, the RBI’s intervention in the currency market should be limited to addressing disorderly market conditions.
  • External Sector Report, published annually since 2012, analyses global external developments and provides multilaterally consistent assessments of the world’s largest economies’ external positions. 

Relevance

GS Paper – 3: Important International Institutions

Mains Question

What are the most common criticisms levelled at the World Bank and the IMF? Discuss. (150 Words)


International Monetary Fund (IMF):

  • The International Monetary Fund (IMF) is an international financial institution headquartered in Washington, D.C., that works to achieve long-term growth and prosperity for all of its 190 member countries. Its member countries govern it and hold it accountable.
  • Founded in 1944 at the Bretton Woods Conference, the IMF was formally established in 1945 with the goal of rebuilding the international monetary system.

The IMF is responsible for three critical missions.:

  • Strengthening international monetary cooperation; o Promoting trade and economic growth; and o Opposing policies that would harm prosperity.
  • To carry out these missions, IMF member countries collaborate with one another and with other international organisations.
  • The IMF advocates for fiscal stability and monetary cooperation, which are critical for increasing productivity, job creation, and economic well-being.
  • It now plays a key role in managing balance-of-payments difficulties (as experienced by a member country) and international financial crises.
  • Through a quota system, member countries contribute funds to a pool from which countries experiencing balance-of-payments problems can borrow money..

Functions of IMF

  • Financial Assistance: To help member countries with balance-of-payments problems, the IMF lends money to replenish international reserves, stabilise currencies, and improve economic growth conditions. Countries must implement structural adjustment policies that are overseen by the IMF.
  • Surveillance by the IMF: It monitors the economic and financial policies of its 190 member countries and oversees the international monetary system.
  • As part of this process, which occurs both at the global and national levels, the IMF identifies potential threats to stability and advises on necessary policy adjustments.
  • It offers technical assistance and training to central banks, finance ministries, tax authorities, and other economic institutions.
  • This assists countries in increasing public revenue, modernising banking systems, developing strong legal frameworks, improving governance, and improving macroeconomic and financial data reporting. It also aids countries in their efforts to achieve the Sustainable Development Goals (SDGs).

IMF and India

  • India is an IMF founding member.
  • International regulation of money by the IMF has undoubtedly contributed to the expansion of international trade. To some extent, India has benefited from these fruitful outcomes.
  • India had significant balance of payments deficits after partition, particularly with the US dollar and other hard currency countries. The International Monetary Fund (IMF) came to her aid.
  • The Fund provided loans to India to help it deal with the financial consequences of the Indo-Pak conflict of 1965 and 1971.
  • From the IMF’s inception until March 31, 1971, India purchased foreign currency worth Rs. 817.5 crores from the IMF, which was fully repaid.
  • Since 1970, the IMF’s assistance to India, as well as other IMF members, has been increased through the establishment of the Special Drawing Rights (SDRs created in 1969).
  • Following a sharp increase in the prices of its imports, including food, fuel, and fertilisers, India was forced to borrow from the Fund.
  • In 1981, India received a massive loan of approximately Rs. 5,000 crores to help it overcome a foreign exchange crisis caused by a persistent deficit in the balance of payments on current account.
  • India sought large amounts of foreign capital for its various river projects, land reclamation schemes, and communications development. Because private foreign capital was in short supply, the only viable option was to borrow from the International Bank for Reconstruction and Development (i.e. World Bank).
  • For the purpose of assessing the state of the Indian economy, India has engaged the services of IMF specialists. India has thus benefited from independent scrutiny and advice.
  • With India’s balance of payments out of whack due to the escalation of oil prices since October 1973, the IMF has begun making oil facilities available by establishing a special fund for the purpose.
  • Early 1990s, when foreign exchange reserves – for two weeks’ imports as opposed to the generally accepted’safe minimum reserves’ of three months equivalent – were woefully inadequate.
  • The Indian government’s immediate response was to secure a $2.2 billion emergency loan from the International Monetary Fund by pledging 67 tonnes of India’s gold reserves as collateral security.
  • In the coming years, India promised the IMF that it would implement several structural reforms (such as currency depreciation, reduction in budgetary and fiscal deficits, reduction in government expenditure and subsidies, import liberalisation, industrial policy reforms, trade policy reforms, banking reforms, financial sector reforms, privatisation of public sector enterprises, and so on).
  • With the implementation of liberalisation policies, foreign reserves began to rise.
  • India has a special place on the Fund’s Board of Directors. Thus, India had played an important role in determining the Fund’s policies. This has increased India’s standing in international circles.
  • Since 1993, India has not received any financial assistance from the IMF.
  • The repayment of all International Monetary Fund loans was completed on May 31, 2000.
  • The Finance Minister of India serves as an ex-officio Governor on the IMF’s Board of Governors.
  • The RBI Governor serves as the IMF’s Alternate Governor.
  • India’s current IMF quota is SDR (Special Drawing Rights) 5,821.5 million, making it the 13th largest quota holding country and giving it a 2.44 percent stake.
  • However, based on voting share, India (along with its constituency countries Bangladesh, Bhutan, and Sri Lanka) is ranked 17th out of 24 at the Executive Board.

Highlights from the External Sector Report 2022

  • Because of a shift in consumption from services to goods, the pandemic has continued to have an uneven impact on economies’ current account balances.
  • After recovering from the COVID-19 shock, commodity prices began to rise in 2021.
  • Global current account balances are gradually improving in the medium term as the pandemic’s impact fades, commodity prices normalise, and fiscal consolidation in current account deficit economies continues.

India specific observations:

  • The report comes at a difficult time for the Indian rupee and other emerging market currencies.
  • According to the report, o The RBI’s intervention in the currency market should be limited to addressing disorderly market conditions, with exchange rate flexibility acting as the primary shock absorber.
  • India’s official forex reserves are adequate for precautionary purposes, implying that additional reserves are unnecessary.
  • Rising commodity prices and the Ukraine conflict, according to the IMF, will push India’s current account deficit (CAD) to 3.1 percent of GDP in 2022, up from 1.2 percent last year.
  • According to the IMF, the CAD is also broadly consistent with India’s per capita income, positive growth prospects, demographic trends, and development requirements.
  • India’s low level of foreign liabilities in comparison to peers reflects an incremental approach to capital account liberalisation that has primarily focused on attracting Foreign Direct Investment (FDI).

Policy prescriptions:

  • The report recommended a phased withdrawal of fiscal and monetary policy stimulus, which has already begun and is boosting exports.
  • It proposed that the government negotiate free trade agreements with major trading partners in order to boost exports, liberalise the investment regime, and lower import duties.
  • Structural reforms could boost global value chain integration and attract FDI, reducing external vulnerabilities.

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