Economic and financial crises can take many forms. The IMF assists countries hit by crises by providing them financial support to create breathing room as they implement corrective policies to restore economic stability and growth. As crisis prevention is more effective than crisis resolution, the Fund also provides precautionary financing to help prevent and insure against crises. The IMF's lending instruments have evolved in recent years to meet countries' changing needs.
Why do crises occur?
The causes of crises are varied and complex, and can be domestic as well as external.
Domestic factors include inappropriate fiscal and monetary policies, which can lead to large economic imbalances (such as current account and fiscal deficits and high levels of external and public debt); exchange rate fixed at an inappropriate level, which can erode competitiveness and lead to persistent current account deficits and loss of official reserves; and a weak financial system, which can create economic booms and busts.
External factors include shocks ranging from natural disasters to large swings in commodity prices. These are common causes of crises especially for low-income countries, which have limited capacity to prepare for such shocks and are dependent on a narrow range of export products. Also, in an increasingly globalized economy, even countries with sound fundamentals could be severely affected by spillovers of economic crises and policies in other countries.
Crises can take many different forms: Severe balance of payment problems, which occur when a nation is unable to pay for essential imports or service its debt repayments, often lead to pressures on the currency and/or financial markets. Financial crises can be caused by difficulties in the financial sector, and fiscal crises caused by excessive fiscal deficits and debt. Crises often result in a large decline in consumer demand and investment by firms, higher unemployment, and lower incomes. They can impair the financial system, causing damage to the entire economy. A severe crisis is often followed by a deep recession, stress on public finances and financial systems, and a sudden stop or reversal of international capital flows. In acute crisis cases, defaults or restructuring of sovereign debt may become unavoidable.
How IMF lending helps
IMF lending aims to give countries breathing room to implement adjustment policies in an orderly manner, which will restore conditions for a stable economy and sustainable growth. These policies will vary depending upon the country’s circumstances. For instance, a country facing a sudden drop in the prices of key exports may need financial assistance until prices recover while implementing measures to strengthen the economy and widen its export base. A country suffering from severe capital outflows may need to address the problems that led to the loss of investor confidence—perhaps interest rates are too low; the budget deficit and debt stock are growing too fast; or the banking system is inefficient or poorly regulated.
In the absence of IMF financing, the adjustment process for the country would be more abrupt and difficult. For example, if investors are unwilling to provide new financing, the country would have no choice but to adjust—often through a painful compression of government spending, imports and economic activity. IMF financing facilitates a more gradual and carefully considered adjustment.
In response to increased spillover effects, the instruments the IMF recently introduced are aimed mainly at crisis prevention. The Flexible Credit Line (FCL) and the Precautionary and Liquidity Line (PLL) provide a form of insurance to members with sound policies. Other new instruments, such as the Rapid Financing Instrument (RFI), and the Rapid Credit Facility (RCF) for low-income countries, were created to provide rapid assistance countries with urgent balance of payments need, including from commodity price shocks, natural disasters, and domestic fragilities.
IMF lending in action
The IMF provides financial support upon request by its member countries. Following such a request, an IMF staff team travels to the country in most cases and holds discussions with the government to assess the economic and financial situation (including the public, financial, corporate, household, and external sectors) and agree on the appropriate policy response. IMF staff and the government also assess the size of the country’s overall financing needs and the amount of IMF resources that are expected to be drawn to fill the emerging financing shortfalls or needed as a form of insurance to prevent the occurrence of a crisis.
Typically, a country’s government and the IMF must agree on a program of economic policies before the IMF provides lending to the country. A country’s commitments to undertake certain policy actions, known as policy conditionality, are in most cases an integral part of IMF lending. Progress is typically reviewed by monitoring the implementation of these policy actions. Countries with sound policies, however, can use IMF resources with no or limited such conditionality under FCL or PLL arrangements by meeting the qualification criteria that assess the ability of the country to adjust on its own. In general, a country’s return to economic and financial health ensures that IMF funds are repaid so that they can be made available to other member countries.
Once an understanding has been reached on policies and a financing package, a recommendation is made to the IMF’s Executive Board to endorse the country’s policy intentions and extend access to IMF resources. This process can be expedited under the IMF’s emergency financing procedures (see box).
Rapid IMF Lending During Past Crises
The Fund has emergency procedures in place to help provide financing at short notice. The Emergency Financing Mechanism was used in 1997 during the Asian crisis; in 2001 for Turkey; in 2008-09 for Armenia, Georgia, Hungary, Iceland, Latvia, Pakistan, and Ukraine; and in 2010 for Greece and Ireland.
When can it be used? When a member country faces an exceptional situation that threatens its financial stability and a rapid response is needed to contain the damage to the country or the international monetary system.
How does it work? (i) The Executive Board is informed about a member’s request for assistance; (ii) a staff team is quickly deployed to the country; and (iii) as soon as staff reaches an understanding with the government, the Board considers the request to support a program within 48-72 hours.