Memorandum submitted by HM Treasury
1. At present most of the IMF's administrative
costs are met using income from charges on outstanding Fund credit.
This system has to date in every year provided income in excess
of the IMF's costs. However it leaves the Fund's income dependent
on the level of credit outstanding. Following early repayments
by Brazil and Argentina of their IMF loans, credit outstanding
has fallen to its lowest level for 25 years. If lending were to
remain at the current level, then to provide the same income level,
the rate of charge on the remaining Fund credit outstanding would
become prohibitively high. This could in turn precipitate further
early repayments of loans, meaning the IMF's income would fall
even more. The current income shortfall raises issues about the
sustainability of the IMF's current financing model.
2. While it would be a measure of the Fund's
broader success if policies improved to the point where no country
needed to borrow from the Fund, it would remove entirely this
source of income from the Fund. While this would be exceptional,
there could nevertheless be periods in future when the use of
Fund credit, and therefore its income, is very low. This is due
in part to the trend towards self-insurance through significant
reserve holdings by countries with historically volatile access
to private capital markets and the creation of alternative co-insurance
arrangements, such as the Chiang Mai Initiative. Given that the
Fund will continue to require funding to maintain its surveillance
and technical assistance activities, it would benefit from more
assured, less volatile, sources of income to meets its costs in
3. The Fund earlier this year came forward
with options to address the projected income shortfall in the
year to April 2007.
The IMF also recognises that there is a need to develop a more
durable medium-term solution; and has created a Committee of Eminent
Persons to Study Sustainable Long-Term Financing of IMF Running
Costs, chaired by Andrew Crockett.
The committee will identify and assess the range of options for
the sustainable long-term financing of the IMF's running costs,
and is expected to make specific recommendations to the Managing
Director in the first quarter of 2007. This paper offers some
principles which could guide thinking about this issue, and sets
out the main options for financing different areas of IMF activity
and their pros and cons.
4. There are a number of principles which
could be used in trying to find a longer-term solution. These
Reforms should aim to ensure a more
stable flow of income from more diverse sources. The higher the
volatility of income, the more difficult it becomes to plan future
The planning of the Fund's annual
budget will be aided by a system in which decisions on income
and expenditure are taken in an integrated framework.
Making the Fund's system of financing
simpler and more transparent is a key priority. Currently, Fund
finances are complex and opaque; making the Fund less accountable
to its shareholders.
A new financial structure should
also avoid the theoretically possible incentive problem which
exists under the present model, in which the Fund could encourage
countries to borrow in order to generate income.
In order to ensure support across
the membership, reforms should seek to address what is increasingly
viewed as an inequitable distribution of the Fund's financing
burden. In the Bretton Woods system, individual countries could
move from being debtors of the Fund to creditors at different
timesensuring a relatively equitable apportioning of the
Fund's running costs. In recent times, however, industrial countries
have largely ceased to borrow from the Fund while some emerging
and developing countries have become regular borrowers. A small
subset of the membership which still borrow from the Fund (which
does not include wealthy industrialised countries) now meets most
of the IMF's costs.
5. Two options for different ways to finance
the Fund's costs are possible. First, IMF member countries (or
a subset of the membership) could make annual contributions. Secondly,
an endowment could be created from which investment income is
earned and used to meet part of the Fund's costs.
Options for long-term reform
6. Annual contributions could help increase
transparency and ensure an equitable apportioning of costs. Being
required to make an annual contribution could also help focus
shareholders' minds on what functions they really value having
the Fund perform. Contributions could be based on quotas, or could
be weighted to draw primarily on the Fund's wealthier members.
However, members would have to provide annual subscriptions from
public expenditure. This could make the IMF dependent on annual
budgetary approval by members, and therefore introduce a different
sort of uncertainty into the Fund's income. Furthermore, annual
contributions based on quotas would require a change in the Articles.
9. An Endowment could be established, which
would be invested in interest-bearing assets. This could provide
a more regular source of income that could be used to meet all
or part of the Fund's running costs, though it would still be
subject to fluctuations in rates of return on investments. The
proportion of the costs met by this method would also depend on
the size of the endowment the shareholders were prepared to create.
10. The key challenge in establishing an
endowment would be how the substantial amount of capital that
would be needed could be raised. There are at least three possibilities:
(a) creditors could provide zero or low-interest rate loans on
a voluntary basis; (b) the IMF could draw down quotas and pay
no remuneration (or a very low rate) on the amounts drawn down;
and (c) the IMF could sell a proportion of its gold reserves.
(a) Voluntary contributions: low or zero
interest loans are a potential way of providing the Fund with
an endowment and are currently used by some countries to finance
the PRGF. But although loans would be an asset in the public accounts,
they still imply significant public expenditure. It is not clear
whether countries would be prepared to provide sufficient resources
on a voluntary basis.
(b) Draw down and invest an unremunerated
proportion of quotas: The IMF remunerates most of members' reserve
tranche positions (ie the part of quotas that have been lent to
other members), except on a small portion that is provided to
the IMF as interest-free resources. These interest free resources
could be increased by drawing down a larger share of the quotas
than currently from countries in the IMF's financial transactions
plan. However, since these funds would be drawn down for long
continuous periods, would not revolve, and would not pay any interest,
it is debatable whether countries could count these amounts as
part of their foreign exchange reserves. Also, the amount of quotas
drawn down in this way would reduce the Fund's immediately usable
resources since they would be invested in income-generating assets
and not be available to finance IMF loans.
(c) Gold sales: The IMF's gold holdings of
103.4 million ounces are currently valued on its balance sheet
at SDR35 per fine ounce, rather than at the current gold price.
If the IMF were to sell gold at market prices and invest the profits
then these could be used to establish an endowment. However, gold
cannot be sold without the agreement of 85% of the IMF's voting
power, and some IMF members have voiced strong opposition to sales.
11. At present the IMF's Technical Assistance
(TA) is financed from a combination of external donations and
the IMF's lending income. There are, however, at least three other
possible sources for financing TA:
(a) Payment by TA recipientshowever,
low-income countries may not be in a position to be able to pay
for high marginal value TA; and some TA, as well as benefiting
the recipient, can be viewed as a public good.
(b) Increased contributions from bilateral
and multilateral donors (in FY 2005, external financing accounted
for approximately a quarter of the IMF's total TA and training
activities); however, donors' willingness to contribute is uncertain
and may fluctuate from year to year; or
(c) Income earned on an endowment. This would
provide more certainty; but would mean that the size of the endowment
would need to be larger.
The Asian financial crisis and the subsequent
crises affecting Russia, Turkey, and Latin America highlighted
weaknesses in the IMF's tools for crisis resolution. The UK, along
with other countries, called for the radical reform of the arrangements
for handling sovereign debt in vulnerable countries. The IMF was
asked in 2001 to prepare proposals for the establishment of a
new Sovereign Debt Restructuring Mechanism (SDRM). The UK's statement
to the 2002 Spring Meetings set out the UK's proposals for action
in this area(see http://www.imf.org/external/spring/2002/imfc/stm/eng/gbr.htm).
The IMFC agreed at the 2002 Annual Meetings
on a "twin track approach" to sovereign debt restructuring.
The parallel strands of this were:
a statutory approach (embodied by
the IMF's Sovereign Debt Restructuring Mechanism, SDRM) to enable
a sovereign debtor and a supermajority of creditors to reach an
agreement that is binding on all creditors; and
a contractual approach to involve
incorporation of contractual clauses into sovereign debt instruments
which facilitate collective action and majority restructuring.
The 2002 Annual Report on the UK and the IMF
reports on progress made at the 2002 meetings (see HM Treasury,
The UK and the IMF 2002, paras 3.35-3.46).
Proposals on both strands were developed further
by the IMF and in other fora, notably the G10, in discussion with
members and Bond markets during 2002-3, along with work on a voluntary
code of conduct. At the 2003 Spring Meetings, the IMFC considered
progress on the voluntary and contractual approaches, and detailed
proposals from the IMF on a statutory framework for the restructuring
of unsustainable sovereign debts. The IMFC decided not to pursue
a statutory framework further. The 2003 Annual Report on the UK
and the IMF (see HM Treasury, The UK and the IMF 2003,
paras 3.29-3.37) reports these discussions. Work has continued
since 2003 on both the voluntary and contractual approaches:
On contractual approaches, market practice has
converged toward broad acceptance of the use of Collective Action
Clauses (CACs) in international sovereign bonds. With only two
exceptions, all sovereigns that have issued under New York law
since May 2003 have included CACs in their bonds. In 2005, more
than 95% of new issues, in value, included CACs, while the share
of bonds with CACs of the outstanding stock of sovereign bonds
of emerging market countries climbed to around 57% as of January
2006. The recent shift in market practice to accommodate majority
amendment clauses in sovereign bond contracts issued under New
York law constitutes a significant step forward.
In November 2004, a set of voluntary "Principles
for Stable Capital Flows and Fair Debt Restructuring in Emerging
Markets" were released, as the culmination of a co-operative
dialogue involving the Institute of International Finance (IIF),
other private sector representatives and major sovereign issuers
of international bonds. The UK and the diverse member governments
of the G20 also stated their support for the Principles. The IMF
continues to monitor the implementation of the Principles. through
a Principles Consultative Group, including emerging market countries
and the private sector.
78 "The Fund's Medium-Term Income-Outlook
and Options" (SM/06/69) of 17 February 2006. Back
IMF Managing Director de Rato Appoints Committee of Eminent
Persons to Study Sustainable Long-Term Financing of IMF Running
Costs- IMF Press Release No 06/100, 18 May, 2006 Back