The Future Financing of the IMF

Katrine Graabæk Mogensen, International Relations

INTRODUCTION AND SUMMARY

The administration of international organisations is mainly financed by either the interest-rate margin on lending (e.g. the International Monetary Fund, IMF) or by annual member contributions (e.g. the UN and the OECD). The strong decline in IMF lending during the last two years has eroded the IMF's income base. As a result, the IMF is investigating new financing models, not least to finance the surveillance that constitutes the IMF's largest expenditure item and contributes to macroeconomic and financial stability and crisis prevention. In the face of globalisation, the focus is currently on strengthening this area.

An external committee chaired by Andrew Crockett was established to prepare a proposal, and in January 2007 the Committee presented its proposal for a new IMF financing model whereby the IMF's three core activities, i.e. surveillance, lending and technical assistance, each have their own financing. The key new sources of income in the proposal are the return on the investment of more resources, including investment of a part of the member countries' quota resources, and investment of the proceeds from the sale of a part of the IMF's gold. The Committee's mandate did not include an assessment of opportunities for spending restraints in the IMF's administration budget, but measures to curb the administration costs are planned for the coming years.

This article explains the new situation for the IMF's finances, followed by a presentation of and comments on the proposal of the Crockett Committee. The proposal's implications for Danmarks Nationalbank, as well as the further process, are also described. The Nordic-Baltic constituency – of which Denmark is part – regards the proposed financing model as a sound basis for the further work to ensure a sustainable income model for the IMF. However, it may be difficult to muster the required broad majority in favour of the new sources of income, even though they are less political in nature than the collection of annual contributions from the member countries. Furthermore, in view of the IMF's substantial reserves, not all member countries are convinced of the need for new sources of income. The process is therefore expected to be protracted.

THE IMF'S NEW FINANCIAL SITUATION

The IMF's lending has decreased considerably over the last two years to the lowest level since the beginning of the 1970s. One reason is the favourable global economic development in recent years, which has helped large borrowers to repay their IMF loans, and contributed to avoiding new crises. The credit facilities are now concentrated on a few countries – not least Turkey, which at the end of 2006 accounted for more than 70 per cent of the IMF's total credit outstanding under the general borrowing programmes (including both current programmes and loans that are being repaid). The IMF's general borrowing programmes now cover only seven countries (excluding concessional lending to low-income countries).^[1]

IMF lending is driven by credit to member countries with balance-of-payments problems. In the credit intermediation process, selected member countries make currency available to the IMF for lending. If lending rises, the IMF draws on these creditors, including Denmark.^[2] As a result, their contributions, or reserve positions with the IMF, are increased. Similarly, their reserve positions are reduced if lending decreases. The correlation is shown in Chart 1, where it is seen that Denmark's reserve position has been reduced in step with the decline in IMF lending.^[3]

So far, lending has been the key basis for the IMF's income and accumulation of reserves. The lending rate (rate of charge) has thus ultimately been fixed residually in order to meet the targets for income and accumulation of reserves. However, the creditors have also contributed, since part of the reserve position has not been remunerated, and deductions from the SDR interest rate on the interest-bearing part of the reserve position have been made^[4], cf. Box 1 in Appendix 1. Countries that are neither borrowers nor creditors have not contributed to financing.^[5]

In the light of the strong decline in lending, the relation between income and lending is not sustainable.^[6] The rate of charge would thus have to be so high that IMF loans would not be attractive, despite their other advantages besides an interest rate below the market rate, including the economic-policy discipline that is a precondition for an IMF loan, and which is vitally important to any private credit providers.

In the spring of 2006, the IMF's Executive Board decided to temporarily freeze the element of the rate of charge that would otherwise be determined residually, instead drawing on the IMF's reserves if required. The IMF's reserves have been accumulated to safeguard the IMF's credit facilities and have increased considerably in recent years to the current level of approximately SDR 6 billion. The reserves are thus now sufficient to cover a certain deficit on the IMF's administrative budget for a considerable number of years to come. Furthermore, an Investment Account was established in order to achieve a higher rate of return on the reserves. On the expenditure side, the IMF's budget includes a real IMF expenditure reduction by 2 per cent per annum for the fiscal years 2008-10. An increasing deficit is expected in the coming years, cf. Table 1.

THE CROCKETT COMMITTEE'S PROPOSAL FOR A NEW FINANCING MODEL

In January 2007, a report was published by the external " Committee of Eminent Persons" established in May 2006 to present proposals to ensure a sustainable income model for the IMF. The Committee consisted of Chairman Andrew Crockett, President of JPMorgan Chase International, Mohamed A. El-Erian, President and CEO of Harvard Management Company, and a wide range of current and former central-bank governors^[7].

The Crockett Committee proposes new sources of income under a new IMF financing model, with separate financing of the IMF's three core activities. The provision of public goods should thus be financed by the member countries in general, while lending should still be financed by the credit intermediation margin on lending. Other bilateral services – e.g. technical assistance (IMF expert advice) – should be financed by the recipients and/or by bilateral donors, cf. Chart 2.

The Committee is not in favour of mechanical application of the framework, as the division of the activities and sources is more complicated in practice. For example, the ongoing macroeconomic surveillance (a public good) gives an input of information in the preparation of borrowing programmes, and the provision of technical assistance (a bilateral service) may be required for a country to be able to implement some of the measures set out in a borrowing programme. However, the Committee finds this delineation important to the clarification of the level of income needed, and to establish who should pay for the service.

In addition to the new sources of financing, a dividend policy is proposed, to be applied if the income proves to exceed the expenditures and need for accumulation of reserves. It is also emphasised that the income and expenditure sides should not be considered separately, but that an assessment of the level of expenditures and the potential for spending restraint in the IMF's administrative budget is beyond the Committee's mandate. The proposed financing sources are described in more detail below.

Financing of lending
The Committee proposes that the current source of financing the costs of general lending is kept unchanged. The lending rate (rate of charge) must be set to cover the costs of administration and creditor remuneration, as well as the necessary accumulation of reserves. However, it should no longer be used to finance other IMF activities. The rate of charge should be set at a level to prevent sustained use of the IMF's resources when it is possible to borrow on market terms, but must be held within a reasonable band, subject to market conditions. However, the Committee does not propose any specific mode of setting the rate of charge.

The Committee proposes that creditor remuneration should not be reduced from the current level, among other things because the resulting additional income would still fluctuate with the level of IMF credit, and would not be robust in a low-credit environment.

Financing of the provision of public goods
The provision of public goods accounts for around half of the costs of the IMF's activities. To fund these, the Committee proposes new sources of income financed by a wider subset of member countries, since this service is to the benefit of the member countries in general. Specifically, the following three additional sources of income are proposed:

• Broadening the IMF's investment mandate.
• Investment of the proceeds from sale of a part of the IMF's gold stock.
• Investment of quota resources.

The Committee proposes to broaden the IMF's investment mandate by allowing longer duration, and by expanding the range of instruments in which the IMF may invest, in line with the investment policies of multilateral development banks with a high credit rating, e.g. the World Bank. This investment mandate applies to resources in the Investment Account established in April 2006 in order to achieve income from the investment of the IMF's reserves.^[8]

It is proposed to supplement the current balance of the Investment Account with investment of the proceeds from sale of gold.^[9] This resource is interest-free and the Committee proposes to use the entire proceeds from investment of the profit from the sale of gold – adjusted for inflation – to cover the IMF's costs. The amount of gold in question is 13 million ounces, or approximately 400 metric tons, for an average book value of only 207 SDR per ounce. The gold is assumed to fetch a market price of at least 500 SDR per ounce.

The Committee emphasises that only a limited amount should be sold, and thus proposes to sell the gold acquired after the Second Amendment of the IMF's Articles of Agreement in 1978. This gold is not subject to the same conditions for sale as the rest of the gold stock. Furthermore, the sale must be coordinated with central-bank gold sale agreements, among other reasons to limit the potential impact on the market. The Committee notes that using this gold would entail a relatively equal distribution of the financing burden among the member countries, since the gold is generally regarded as the joint property of the IMF member countries.

Finally, the Committee proposes to increase the investment resources by investing a part of the total quota resources, i.e. the resources that are currently only made available for re-lending to other member countries (e.g. approximately 10 per cent of the quota resources, or almost SDR 22 billion). The additional income will be generated as the difference between the rate of return and the rate of remuneration to the member countries. It is proposed to keep the remuneration unchanged at the present level, i.e. the SDR interest rate less deductions, cf. Appendix 1. The importance of investing these resources in sufficiently liquid securities is emphasised as the quota funds may be required for lending purposes.

The Committee states that it should be considered whether all member countries should be required to make quota resources available for investment. The alternative option of drawing only on selected creditors, as in the current lending structure, might give the impression that other member countries were not contributing resources for financing.

Financing of bilateral services
The Committee finds that the administration costs of concessional lending to low-income countries should be covered from the funds originally provided to the IMF for this purpose. These costs are thus proposed to be financed via the PRGF-ESF Trust. The costs were previously covered in this way, but since the 1998 fiscal year the Executive Board has allowed the administration costs to be financed via the IMF's general resources.

Technical assistance within the IMF's areas of expertise is classified as a bilateral service and not as a public good. The IMF's management is therefore encouraged to establish a mechanism to charge these services in order to regulate demand. However, the Committee acknowledges that 80 per cent of the costs of technical assistance are related to countries with relatively low income, which are unable to pay for the assistance, but which need it to promote growth, combat poverty and prevent crises. The option of donor contributions from more affluent countries is therefore proposed as one possibility. All in all, the Committee finds that the income generated by charges would hardly be substantial, but that the proposal nevertheless merits closer scrutiny for reasons of principle.

The additional income from the proposal and the decision-making process
The Committee recommends that the financing proposals be considered an overall package, and this proposed financing model is expected to generate additional annual income of SDR 320-420 million, cf. Table 2. This should be compared with an expected deficit of SDR 108 million in the 2007 fiscal year, increasing to SDR 265 million in 2010, cf. Table 1.

The most important financing sources proposed by the Committee require widespread support among the member countries, and several of the proposals even require amendment of the IMF's Articles of Agreement, i.e. adoption by at least 3/5 of the member countries with at least 85 per cent of the total voting power.

IMPLICATIONS OF THE PROPOSAL

The Committee's proposal for a new financing model for the IMF, including the new sources of income, is to be considered by the IMF's Executive Board, which so far has only held preliminary discussions. Denmark is part of the constituency that also comprises the seven other Nordic and Baltic countries.^[10]

The Nordic-Baltic constituency regards the proposed financing model as a sound basis for the ongoing work to ensure a sustainable income model for the IMF. One of the attractive qualities of the proposal is that it broadens the income base, making it less dependent on lending. The division of the IMF's activities into lending, provision of public goods, and bilateral services constitutes a relevant reference framework, but it should be borne in mind that all of the activities have elements of public good. Furthermore, excessively rigorous application of the model may prove to be problematic in practice.

The Nordic-Baltic constituency has also underlined that spending restraint is key to sustainable finances and that new sources of income as such should not increase spending or lead to new activities. A dividend policy can be a useful instrument in this connection. However, as income from the various " branches" might also be required to finance other activities, overall assessment of a dividend policy requires further analysis.

Financing of lending
The proposal entails that the borrowing costs are no longer determined by the IMF's general need for income, including for financing the macroeconomic and financial surveillance of the member countries. The proposal not to reduce the creditor remuneration is a natural extension of the wish to reduce the dependence of income on lending, since a reduction of the rate of remuneration would not make any significant contribution to income in a low-credit environment. Since the description of the principles for determining the rate of charge is not very specific, it is difficult to make any ultimate assessment of this proposal.

Financing of the provision of public goods
The Nordic-Baltic constituency supports a certain broadening of the IMF's investment mandate, but the proposal requires further analysis. The return will be uncertain, and will depend on the shape of the yield curve, and the risk associated with broadening the investment mandate, including the risk of longer duration, is not specified. An expected additional return of 50 basis points thus seems to be rather high in the light of the current market conditions with flat or declining yield curves, as well as central banks' typically prudent investment policies.

The Nordic-Baltic constituency supports the proposed sale of gold, which is designed to entail a number of attractive qualities. The proposal is for an actual sale of gold rather than a de facto revaluation of the book value of the gold, as was the case in 1999-2000.^[11] In addition, it is ring-fenced, since it comprises only gold acquired after the Second Amendment of the IMF's Articles of Agreement in 1978. This attenuates the pressure for sale of more gold to generate more income in the future. Another important aspect is that the sale will have no significant impact on the gold market. This plays a key role since the IMF has the third largest official gold reserve in the world. The amount of gold to be sold is around 400 metric tons (or 12.5 per cent of the IMF's total gold stock). Since the proposal keeps the sale within the central-bank gold sale agreements – and is supported by the Committee member from one of the largest gold-producing countries, i.e. Tito Mboweni from South Africa – the impact on the market can be assumed to be minimised.^[12]

The Nordic-Baltic constituency finds that investment of quota resources warrants closer analysis. A solution whereby all member countries will contribute to financing to a greater degree seems attractive. The scope for special measures to exempt low-income countries – whose financial resources are scarce – can be investigated further. However, it is unclear whether the requirement for member countries to make resources available for investment is compatible with the function of the reserve position as a central-bank reserve. Borrowing for investment purposes in order to achieve a higher rate of return than the rate of remuneration would be a new approach for the IMF, and the aforementioned caveats regarding the uncertainty of the return on investment are just as relevant in this connection.

Financing of bilateral services
In principle, the Nordic-Baltic constituency agrees that the administration costs of concessional lending to low-income countries should be financed separately via the funds provided for financing of these loans. However, this is likely to reduce the capacity for concessional lending to low-income countries, unless additional contributions are provided, for example from bilateral donors. The Nordic-Baltic constituency finds it important that this lending capacity is not undermined.

Furthermore, the Nordic-Baltic constituency is not convinced of the viability of introducing charges for technical assistance since the low-income countries need this expert advice, but would probably exclude it if they had to pay for it themselves. However, it should be investigated further whether charges can be introduced for more affluent countries. In the light of the limited income potential, however, this issue should be considered separately from the discussion of sustainable long-term financing of the IMF.

The implications of the proposed financing model for Danmarks Nationalbank
There is no assessment of the overall consequences of the Committee's proposals for the member countries.

The following conclusions can be drawn as regards Denmark as a creditor country:

• A change in the IMF's investment mandate will not as such have any immediate effect on Danmarks Nationalbank's balance sheet and accounts.
• The remuneration to creditors, including Denmark, will be increased, while the rate of charge will be reduced as a consequence of the proposed sale of gold.
  As a result of a number of technical caveats, the aforementioned deductions from the SDR interest rate for creditors will be reduced in this particular case, and the additions to the rate of charge will be equivalently reduced, resulting in higher remuneration of creditors.^[13]
• Danmarks Nationalbank's reserve position with the IMF will be increased by 10-12.5 per cent of Denmark's quota at the described level of investment.
  Quota resources will be invested by drawing on the member countries, which will increase Danmarks Nationalbank's reserve position with the IMF. At the described level of investment of 10 per cent of the total quotas, Danmarks Nationalbank's reserve position will be equivalently increased by 10 per cent of Denmark's quota, i.e. SDR 164 million, if all member countries contribute their respective quota shares. Alternatively, if only the present subset of creditor countries for financing of lending are to contribute quota resources, Danmarks Nationalbank's reserve position will be increased by 12.5 per cent of the quota, i.e. SDR 205 million.
• The proposals for a financing model for bilateral services will have no direct consequences for Danmarks Nationalbank, but as a contributor to the PRGF-ESF Trust, Denmark will contribute indirectly, unless additional resources are contributed to this Trust.^[14]

It should be noted that for Danmarks Nationalbank, the current opportunity costs of making resources available to the IMF are negligible. The reason is that the IMF draws on Danmarks Nationalbank's short-term placements that are subject to remuneration close to the SDR interest rate.

THE FURTHER PROCESS

In general, the report has been welcomed, but since the Crockett Report does not contain detailed information, a number of unanswered questions remain.

The proposals have not yet been subject to actual discussion by the IMF's Executive Board, but it is clear that this will be a prolonged process, especially in view of the decision-making procedures that currently apply to most of the proposals.

A sufficiently broad majority may be difficult to achieve. Especially the USA will play a key role as the USA's voting power of almost 17 per cent implies a de facto right to veto decisions for which a majority of 85 per cent is required. In this connection, it is noted that the USA has traditionally been against the sale of gold, which constitutes a significant part of the additional income generated by the proposed financing model, and it can be assumed that the sale of gold would have to be approved by the US Congress. Another potentially decisive factor is that amendment of the Articles of Agreement requires implementation, typically ratification, in 3/5 of the member countries with a voting power of 85 per cent.^[15]

Other proposals might be considered, notwithstanding the Committee's recommendation to regard the financing proposal as one overall package. For example, one proposal could be to reduce the creditor remuneration, even though this proposal is sensitive to the level of credit unless the quotas are used for investment purposes.^[16]

Finally, some countries might adopt the position that the situation is temporary and that the IMF has sufficient reserves for the time being. This position implies that any decision on a new financing model for the IMF would be taken at a later stage. Reserves of SDR 6 billion are sufficient to cover an operational deficit of around SDR 100-250 million for many years to come.

LITERATURE

Committee of Eminent Persons to Study Sustainable Long-Term Financing of the IMF, Final Report, 31 January 2007.

Danmarks Nationalbank, Report and Accounts, 1999, 2003 and 2006.

International Monetary Fund, Annual Report, 2006.

International Monetary Fund, Articles of Agreement, 1993.

International Monetary Fund, Establishment and Operation of the Investment Account, 12 August 2005.

International Monetary Fund, Financial Organization and Operations of the IMF, Treasurer's Department, no. 45, 6th edition, 2001.

International Monetary Fund, Financial Transactions Plan.

International Monetary Fund, Financing the Fund's Operations – Review of Issues, 11 April 2001.

International Monetary Fund, Review of the Fund's Income Position for FY 2007 and FY 2008, 9 April 2007.

International Monetary Fund, SDR Interest Rate, Rate of Remuneration, Rate of Charge and Burden Sharing Adjustments, 25 December 2006.

Mogensen, Louise, The IMF and Danmarks Nationalbank's Balance Sheet, Danmarks Nationalbank, Monetary Review, 4th Quarter 2003.

Segendorf, Björn and Eva Srejber, Who is paying for the IMF? Sveriges Riksbank, Economic Review, no. 3, 2006.

World Gold Council – www.worldgoldcouncil.org

APPENDIX 1 – DANMARKS NATIONALBANK'S RESERVE POSITION AND CREDITOR REMUNERATION

Danmarks Nationalbank's financial accounts with the IMF are based on its quota, which is Denmark's member contribution to the IMF. The quota is determined on the basis of each member country's calculated relative weight in the world economy, and determines the voting power in the IMF, the extent of possible drawing on the IMF's resources, and the allocation of Special Drawing Rights, SDR. Furthermore, the quota is key to the distribution of the member countries' contributions to finance lending activities. Since 1999, Denmark's quota has been SDR 1,642.8 million (approximately kr. 14 billion at end-2006).

The member contribution is paid as a mix of national currency (75 per cent of the quota) and " hard currency" and/or gold (25 per cent of the quota), in Denmark's case from Danmarks Nationalbank's foreign-exchange reserve.^[17] This gives the IMF a claim on Danmarks Nationalbank – holdings of Danish kroner – and Danmarks Nationalbank a claim on the IMF – the reserve position. In other words, the reserve position is the difference between the quota and the IMF's holdings of Danish kroner. The reserve position amounted to SDR 148 million at end-2006.^[18]

The reserve position is included in Danmarks Nationalbank's foreign-exchange reserve. Denmark may use its reserve position without any conditions regarding adjustment of the macroeconomic policy, i.e. conditionality.^[19] The contribution of currency to the IMF thus has no impact on the overall foreign-exchange reserve, but only on how it is invested.^[20]

A country's reserve position can be regarded as its net creditor position, since the IMF lends the contributed currency to member countries with balance-of-payments difficulties. Countries with a sufficiently strong balance of payments and international liquidity are the principal contributors to this lending system. These countries participate in the Financial Transactions Plan, making foreign exchange available to the IMF. The IMF draws on these creditors to loan to a borrower country under an IMF borrowing programme. As a result, the creditors' reserve positions are increased, and the IMF's holdings of Danish kroner are reduced by the drawing on Danmarks Nationalbank. In essence, hard currency, the foreign-exchange reserves, is " exchanged" for national currency. In years when the level of IMF credit was relatively high, Danmarks Nationalbank's reserve position thus strongly exceeded 25 per cent of Denmark's quota, while at end-2006 it accounted for only 9 per cent of the quota.

Denmark contributes to the financing of the IMF via two channels: by the part of the reserve position that is not remunerated, and by deductions from the remunerated part for burden-sharing purposes, cf. Box 1.

REMUNERATION IN CONNECTION WITH IMF LENDING	Box 1
Creditor remuneration and the rates of charge are based on the 3-month SDR interest rate, subject to respectively deductions and additions as elements of the burden-sharing mechanism. The burden-sharing mechanism is aimed at accumulating reserves as protection against debtors' default on their loans, and both creditors and debtors contribute. At the end of 2006, the SDR interest rate was subject to respectively deductions and additions of approximately 30 basis points for burden-sharing purposes. However, this amount was lower (typically 10-15 basis points) in the preceding years when the level of credit was far higher. As regards the IMF's debtors, a basis margin and further charges are also added to the SDR interest rate, depending on the size of the individual country's loan. So far, the basis margin has been determined residually in order to meet the IMF's targets for income and accumulation of reserves. This means that, all other things being equal, a decline in lending will result in a higher basis margin for the remaining debtors if the target for income and accumulation of reserves remains unchanged. The Chart below shows the relationship between the SDR interest rate and the remuneration of the reserve position and the rate of charge.
REMUNERATION OF RESERVE POSITION AND RATE OF CHARGE
Note:    The Chart does not show that part of the reserve position is non-interest-bearing. Source:  Segendorf and Srejber (2006) and IMF's SDR Interest Rate, Rate of Remuneration, Rate of Charge and Burden Sharing Adjustments. 1    For 2007, the basis margin is temporarily fixed at 108 basis points. 2    The additional charges depend on the size of the loan and in some cases the time elapsed since the loan was provided.
However, a part of the member countries' reserve position is non-interest-bearing. For Denmark, the amount is SDR 65 million, which is the value of the gold contributed by Denmark to the IMF (25 per cent of the quota before 1 April 1978), compiled at the historical price of SDR 35 per ounce.1 This corresponds to 4.0 per cent of the quota today – so that almost half of the reserve position of 9.0 per cent of the quota was non-interest-bearing at the end of 2006. On average, the non-interest-bearing reserve position amounted to 3.8 per cent of the quota for the member countries overall at the end of the 2006 fiscal year, although considerable variation is observed. For example, the non-interest-bearing reserve position of the UK is 6 per cent of its quota, while the ratio for Saudi Arabia is 0.5 per cent of its quota.
Source: IMF Annual Report (2006), IMF International Financial Statistics and own calculations. 1   1 (troy) ounce = 31 grammes.