Select Committee on Treasury Written Evidence

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 the future.

  3.  The Fund earlier this year came forward with options to address the projected income shortfall in the year to April 2007.[78] 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.[79] 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 include:

    —  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 Fund activities.

    —  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 times—ensuring 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 recipients—however, 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

  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.

July 2006

78   "The Fund's Medium-Term Income-Outlook and Options" (SM/06/69) of 17 February 2006. Back

79   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

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Prepared 13 July 2006