Highlights of this section:

• The changing nature of lending
• Three main purposes of lending
• Conditions for lending
• Main lending facilities
• Helping low-income countries
• Debt relief

A country in severe financial trouble, unable to pay its international bills, poses potential problems for the international financial system, which the IMF was created to protect. Any member country, whether rich, middle-income, or poor, can turn to the IMF for financing if it has a balance of payments need—that is, if it cannot find sufficient financing on affordable terms in the capital markets to make its international payments and maintain a safe level of reserves.

IMF loans are meant to help member countries tackle balance of payments problems, stabilize their economies, and restore sustainable economic growth. The IMF is not a development bank and, unlike the World Bank and other development agencies, it does not finance projects.

The changing nature of lending

About four out of five member countries have used IMF credit at least once. But the amount of loans outstanding and the number of borrowers have fluctuated significantly over time.

In the first two decades of the IMF's existence, more than half of its lending went to industrial countries. But since the late 1970s, these countries have been able to meet their financing needs in the capital markets.

The oil shock of the 1970s and the debt crisis of the 1980s led many lower- and lower-middle-income countries to borrow from the IMF.

In the 1990s, the transition process in central and eastern Europe and the crises in emerging market economies led to a further increase in the demand for IMF resources.

In 2004, benign economic conditions worldwide meant that many countries began to repay their loans to the IMF. As a consequence, the demand for the Fund’s resources dropped off sharply (see chart below).

But in 2008, the IMF began making loans again to countries hit by the financial crisis and high food and fuel prices. In late 2008 and early 2009 the IMF lent $60 billion to emerging markets affected by the crisis.

While the financial crisis has sparked renewed demand for IMF financing, the decline in lending that preceded the financial crisis also reflected a need to adapt the IMF's lending instruments to the changing needs of member countries. In response, the IMF conducted a wide-ranging review of its lending facilities and terms on which it provides loans.

In March 2009, the Fund announced a major overhaul of its lending framework, including modernizing conditionality, introducing a new flexible credit line, enhancing the flexibility of the Fund’s regular stand-by lending arrangement, doubling access limits on loans, adapting its cost structures for high-access and precautionary lending, and streamlining instruments that were seldom used. It has also speeded up lending procedures and redesigned its Exogenous Shocks Facility to make it easier to access for low-income countries.

Three main purposes of lending

Article I of the IMF's Articles of Agreement states that the purpose of lending by the IMF is "...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 maladjustments in their balance of payments without resorting to measures destructive of national or international prosperity."

In practice, the purpose of the IMF's lending has changed dramatically since the organization was created. Over time, the IMF's financial assistance has evolved from helping countries deal with short-term trade fluctuations to supporting adjustment and addressing a wide range of balance of payments problems resulting from terms of trade shocks, natural disasters, post-conflict situations, broad economic transition, poverty reduction and economic development, sovereign debt restructuring, and confidence-driven banking and currency crises.

Today, IMF lending serves three main purposes.

First, it can smooth adjustment to various shocks, helping a member country avoid disruptive economic adjustment or sovereign default, something that would be extremely costly, both for the country itself and possibly for other countries through economic and financial ripple effects (known as contagion).

Second, IMF programs can help unlock other financing, acting as a catalyst for other lenders. This is because the program can serve as a signal that the country has adopted sound policies, reinforcing policy credibility and increasing investors' confidence.

Third, IMF lending can help prevent crisis. The experience is clear: capital account crises typically inflict substantial costs on countries themselves and on other countries through contagion. The best way to deal with capital account problems is to nip them in the bud before they develop into a full-blown crisis.

Conditions for lending

When a member country approaches the IMF for financing, it may be in or near a state of economic crisis, with its currency under attack in foreign exchange markets and its international reserves depleted, economic activity stagnant or falling, and a large number of firms and households going bankrupt.

The IMF aims to ensure that conditions linked to IMF loan disbursements are focused and adequately tailored to the varying strengths of members' policies and fundamentals. To this end, the IMF discusses with the country the economic policies that may be expected to address the problems most effectively. The IMF and the government agree on a program of policies aimed at achieving specific, quantified goals in support of the overall objectives of the authorities' economic program. For example, the country may commit to fiscal or foreign exchange reserve targets.

The IMF discusses with the country the economic policies that may be expected to address the problems most effectively. The IMF and the government agree on a program of policies aimed at achieving specific, quantified goals in support of the overall objectives of the authorities' economic program. For example, the country may commit to fiscal or foreign exchange reserve targets.

Loans are typically disbursed in a number of installments over the life of the program, with each installment conditional on targets being met. Programs typically last up to 3 years, depending on the nature of the country's problems, but can be followed by another program if needed. The government outlines the details of its economic program in a "letter of intent" to the Managing Director of the IMF. Such letters may be revised if circumstances change.

For countries in crisis, IMF loans usually provide only a small portion of the resources needed to finance their balance of payments. But IMF loans also signal that a country's economic policies are on the right track, which reassures investors and the official community, helping countries find additional financing from other sources.

Main lending facilities

The Stand-By Arrangement is a key lending facility established in 1952. Although its use has been declining in recent years, it has remained the most popular facility for middle-income countries that seek financial assistance. Under its structure, financing is provided in support of adjustment to a balance of payments need and disbursed in tranches based on conditions spelled out in the program. The IMF's largest loans have traditionally been provided under SBAs.

The IMF has introduced a new Flexible Credit Line (FCL) for countries with very strong fundamentals, policies, and track record of policy implementation. Once approved according to pre-set qualification criteria, countries can tap all resources available under the credit line at any time, as disbursements would not be phased and conditioned on compliance with a traditional Fund-supported program. This is justified by the very strong track records of countries that qualify to the FCL, which give confidence that their economic policies will remain strong or that corrective measures will be taken in the face of shocks.

The establishment of the FCL represents a significant shift in delivering Fund financial assistance. The FCL's flexibility includes:

• Assuring qualified countries of automatic and upfront access to Fund resources with no ongoing (ex post) conditions;
• Lack of restrictions in renewing the credit line, which at the country’s discretion could be for either a six-month period, or a 12-month period with a review of eligibility after six months;
• Longer repayment period (3¼ to 5 years).

The Extended Fund Facility is used to help countries address balance of payments difficulties related partly to structural problems that may take longer to correct than macroeconomic imbalances. A program supported by an extended arrangement usually includes measures to improve the way markets and institutions function, such as tax and financial sector reforms, privatization of public enterprises, and steps to make labor markets more flexible.

The IMF also provides Emergency Assistance to countries coping with balance of payments problems caused by natural disasters or military conflicts. The interest rates are subsidized for low-income countries.

The Trade Integration Mechanism allows the IMF to provide loans under one of its facilities to a developing country whose balance of payments is suffering because of multilateral trade liberalization, either because its export earnings decline when it loses preferential access to certain markets or because prices for food imports go up when agricultural subsidies are eliminated.

Lending to low-income countries

Low-income countries can borrow from the IMF at a very low, or concessional, interest rate. They can use the Poverty Reduction and Growth Facility, which is the main vehicle by which the IMF provides financial support to countries' poverty-reduction strategies. The facility's core objectives are to promote sustainable balance of payments positions and to foster sustainable growth, leading to higher living standards and a reduction in poverty. In recent years, the largest number of IMF loans has been made through the PRGF.

Member countries can also access the Exogenous Shocks Facility, which helps deal with economic shocks, such as food and fuel price hikes or a natural disaster, that are beyond the control of a government but have a significant negative impacts on the economies.

The interest rate levied on PRGF and ESF loans is only 0.5 percent, and loans are to be repaid over a period of 5½-10 years.

Several low-income countries have made significant progress in recent years toward economic stability and no longer require IMF financial assistance. But many of these countries still seek the IMF's advice, and the monitoring and endorsement of their economic policies that comes with it. To help these countries, the IMF has created a program for policy support and signaling, called the Policy Support Instrument.

Debt relief

In addition to concessional loans, some low-income countries are also eligible for debts to be written off under two key initiatives.

The Heavily Indebted Poor Countries (HIPC) Initiative, introduced in 1996 and enhanced in 1999, whereby creditors provide debt relief, in a coordinated manner, with a view to restoring debt sustainability; and

The Multilateral Debt Relief Initiative (MDRI), under which the IMF, the International Development Association (IDA) of the World Bank, and the African Development Fund (AfDF) canceled 100 percent of their debt claims on certain countries to help them advance toward the Millennium Development Goals.