The role of the IMF in general and its role in Kosova

Contents

1 INTRODUCTION
1.1 The IMF objectives
1.2 Historic background
1.3 Great Depression
1.4 Bretton Wood system
1.5 Establishment of International Money (SDR)

2 THE ROLE OF THE IMF IN HELPING ITS MEMBERS
2.1 Different roles
2.2 Exchange rate stability through fixed exchange rates
2.3 Breakdown of the fixed exchange rate system
2.4 Macroeconomic and financial policies
2.5 Resolution of crisis

3 THE IMF’s ROLE TODAY
2.1 IMF and assistance to developing countries
2.2 Technical assistance
2.3 Poverty Reduction and Growth Facility
2.4 Heavily Indebted Poor Countries Initiative
3.1 Multilateral Debt Relief Initiative
3.2 Financial assistance

4 THE ROLE OF THE IMF IN KOSOVA
4.1 Short description of Kosova’s development since 1999
4.2 The overwiev of IMF estimation of Kosova’s economy

5 FIRST IMF’s MISSIONS IN K OSOVA AND ITS FIRST RECOMMENDATIONS
5.1 Kosova’s Economic landscape
5.2 The IMF has been active under UN administration
5.3 The dearth of economic statistics
5.4 The economy is heavily dependent on official transfers

6 AID AND E CONOMIC A CTIVITY IN K OSOVA
6.1 The key to medium-term fiscal sustainability
6.2 Recommendations in private sector
6.3 Financial sector development
6.4 Privatization of socially owned enterprises

7 COMMITMENTS OF THE KOSOVA’S GOVERNMENT EXPRESSED IN THE LOI
7.1 Economic policy strategy in LOI
7.2 Fiscal policy
7.3 Macroeconomic objectives
7.4 Medium-term policy framework
7.5 Socially and publicly owned enterprises
7.6 Financial sector
7.7 Labour market
7.8 Technical assistance and statistics

8 IMF REPORT AND RECOMMENDATIONS FOR KOSOVA IN MAY 2006
8.1 Economic adjustment will be a challange for all
8.2 Status presents opportunities but also new demand on policy makers
8.3 Recent decisions raise concerns as to whether policies are up to the task
8.4 A deeper public debate on economic policy

9 CURRENT SITUATION
9.1 Fields in which Kosova has made progress
9.2 Fields in which Kosova needs improvements

10 CONCLUSION ABOUT THE IMF’s ROLE IN GENERAL AND ITS ROLE IN KOSOVA

Tables

Table 1: Macroeconomic indicators

Table 2: Share of the government in Kosova’s economy (in percent of GDP)

Figures

Figure 1: International Comparison of Current Expenditure & Central Government Wage Bill (in percent of GDP)

Figure 2: average Government Wage & General Government Spending on Wages and Salaries

Acknowledgements - Words of Thanking

This thesis is the end of my long tour in obtaining my Bachelor degree in Management, Business and Economics faculty, at University for Business and Technology. I have not traveled in a vacuum in this trip. There are some people who made this trip easier with words of encouragement and more intellectually satisfying by offering different places to look to expand my problem-solving skills and ideas.

First a very special thank you to Professor Thomas Schroeck

Professor Thomas gave me the confidence and support to begin my thesis. Even though I had to do the most important part of my studies within a quite short period of time, I got a support through fast encouraging feedback. Dr. Thomas challenged me to set my benchmark even higher and to look for possible solutions. I learned to believe in myself, my work, and my future;

Thank you Professor.

Many thanks goes to my lecturer Dr. Hazel Slin, who provided me with her advises and suggestions concerning the way of academic writing.

My thank goes to Agim Demukaj, IMF’s Resident Representative, here in Kosova, and to the Ministry of Finance in the Macroeconomic department especially to Hajdar Korbi, which work would not have been possible without the help, support and the valuable contributions of them.

My thanks are due to these and all other people not mentioned who have provided material for this thesis and who allowed me to use their statements and data.

ACRONYMS AND ABBREVIATIONS

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1. INTRODUCTION

The IMF’s Objectives

The objectives of the International Monetary Fund are:

To promote international monetary cooperation through consultation and collaboration on international monetary problems, as a permanent institution^[1]

To facilitate the expansion and balanced growth of international trade, and to contribute thereby to the promotion and maintenance of high levels of employment and real income and to the development of the productive resources of all members as primary objectives of economic policy.^[2]

To promote exchange stability, to maintain orderly exchange arrangements among members, and to avoid competitive exchange depreciation.

To assist in the establishment of a multilateral system of payments in respect of current transactions between members and in the elimination of foreign exchange restrictions which hamper the growth of world trade.^[3]

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.^[4]

In accordance with the above objectives, to shorten the duration and lessen the degree of disequilibrium in the international balances of payments of member states.^[5]

In addition, the objectives of the International Monetary Fund are also explained as follows:

The International Monetary Fund was established to promote international monetary cooperation, exchange rate stability and to provide temporary financial assistance to countries in order to help easing the balance of payments adjustment.

The IMF would also loan foreign currency to the states that had problems with their Balance of Payments. Each member state was required to contribute a designated amount of quota, for example, one quarter of gold and three quarters of national currency to the Fund. The amounts of loans were based on the amount that each respective state had contributed to the Fund. The more a state contributed, the more it could borrow. The USA was the dominant power with the highest amount of quotas.

Today the IMF maintains the same quota system and member countries enjoy the same privilege to borrow even though many are no longer maintaining a fixed exchange rate. Instead, many countries borrow from the IMF when they become unable to maintain payments on international debts. The IMF plays a major role in the global monetary system. The Fund surveys and monitors economic and financial developments, lends funds to countries with balance-of-payment difficulties, and provides technical assistance by training members states’ government officials in macroeconomic management, reforming tax systems, developing central banking and financing systems.

The IMF goals are to facilitate the expansion and balanced growth of international trade, to assist in the elimination of foreign exchange restrictions which hamper the growth of international trade, and to shorten the duration and lessen the disequilibrium in the international balances of payments of members. The mitigation of wide currency fluctuations is achieved through a complex lending system which permits a country to borrow money from other Fund members or from the Fund itself (by way of “SDR” Special Drawing Right) for the purpose of stabilizing the relationship of its currency to other world currencies.

Based on the IMF’s objectives and its operations we can notice that they fit mostly. As we go about our daily lives, it is easy to overlook the importance of international trade. For example, America ships enormous volumes of food, airplanes, machinery and computers to other countries, while in return it gets other goods and services.

That’s why the IMF's primary purpose is to ensure the stability of the international monetary system—the system of exchange rates and international payments that enables countries (and their citizens) to buy goods and services from each other. This is essential for sustainable economic growth and rising living standards and that’s why monetary stability was to be considered important. To maintain stability and prevent crises in the international monetary system, the IMF reviews national, regional, and global economic and financial developments. It provides advice to its 184 member countries, encouraging them to adopt policies that foster economic stability, reduce their vulnerability to economic and financial crises, and raise living standards, and serves as a forum where they can discuss the national, regional, and global consequences of their policies.^[6]

The IMF also makes financing temporarily available to member countries to help them address balance of payments problems—that is, when they find themselves short of foreign exchange because their payments to other countries exceed their foreign exchange earnings.^[7]

Historical Background

The Bretton Woods conference in 1944 represented a response to the international financial “anarchy” that had existed in the 1930’s as countries pursued beggar-my-neighbor policies in the form of competitive devaluations and protectionist commercial policy. Against a backdrop of global recession and shrinking world trade there was a belief that an international monetary order could be established that would facilitate global expansion and “full” employment without having to revert to the rigidities imposed by the gold standard.^[8]

Within the context of Bretton Woods’s system, the IMF fulfilled four key functions. First, it was an adjustment institution offering advice and some degree of compulsion in terms of appropriate domestic macroeconomic policy. Second, it was a financing institution providing short to medium term financial assistance in support of approved policy, designed to eliminate balance of payments deficits. Third, it helped to co-ordinate macroeconomic policy internationally by encouraging countries to design policies in ways that supported pegged exchange rates, in effect supervising a rule-based system of macroeconomic co-ordination. Finally, it acted as a forum for the debate of international monetary reform. Although never completely free from contemporary criticism, during the golden age of the 1950’s and 1960’s criticisms of the Fund were muted. As known, the Fund had been set up to run a system designed to encourage global economic growth, full employment and expanding world trade and on all counts the world economy seemed to be performing quite satisfactorily.^[9]

Great Depression

The Great Depression was an economic slump in North America, Europe, and other industrialized areas of the world that began in 1929 and lasted until about 1939. It was the longest and most severe depression ever experienced by the industrialized Western world. The Great Depression began in the United States but quickly turned into a worldwide economic slump owing to the special and intimate relationships that had been forged between the United States and European economies after World War I. The United States had emerged from the war as the major creditor and financier of postwar Europe, whose national economies had been greatly weakened by the war itself, by war debts, and, in the case of Germany and other defeated nations, by the need to pay war reparations. So once the American economy slumped and the flow of American investment credits to Europe dried up, prosperity tended to collapse there as well. The Depression hit hardest those nations that were most deeply indebted to the United States, i.e., Germany and Great Britain. In Germany, unemployment rose sharply beginning in late 1929 and by early 1932 it had reached 6 million workers, or 25 percent of the work force. Britain was less severely affected, but its industrial and export sectors remained seriously depressed until World War II. Many other countries had been affected by the slump by 1931.^[10]

Almost all nations sought to protect their domestic production by imposing tariffs, raising existing ones, and setting quotas on foreign imports. The effect of these restrictive measures was to greatly reduce the volume of international trade: by 1932 the total value of world trade had fallen by more than half as country after country took measures against the importation of foreign goods.^[11]

After the Great Depression, government action, whether in the form of taxation, industrial regulation, public works, social insurance, social-welfare services, or deficit spending, came to assume a principal role in ensuring economic stability in most industrial nations with market economies.

Bretton Woods System

One thing was evident, the huge need for a new stabilized monetary system, and there were plans made to monitor all actions by supervising institutions. In 1944 during the international conference, the International Monetary Fund and the International Bank for Reconstruction and Development were “created”. They agreed on implementing a system of fixed exchange rates with the US dollar as the main currency.

The plans for the Bretton Woods System were developed by two very important economists, the US financial secretary Harry Dexter White and the British economist John Keynes who stated: “We the delegates of this conference have been trying to accomplish something very difficult. It has been our task to find a common measure, a common standard, a common rule acceptable for all” ^[12]. This statement outlines the difficulty of creating a system that every nation could accept.

The end of the Bretton Woods System is a subject of debate. However, most economists agree that the System broke down due to the excessive expansion of the reserve currency upon which the System was based, the US dollar. The US went from being a surplus nation after the Second World War to running an enormous trade deficit primarily due to spending heavily on the Vietnam War and the President Johnson’s great society initiatives. Moreover, rather than increasing taxes to finance these expenses, the US resorted to an expansionary monetary policy, effectively printing more money to finance the growing budget deficit.^[13]

Establishment of International Money (SDR)

The SDR, or Special Drawing Right, is an international reserve asset that member countries (states) can add to their foreign currency and gold reserves and use for payments requiring foreign exchange. Its value is set daily using a basket of four major currencies: the Euro, Japanese yen, pound sterling, and US dollar. The IMF introduced the SDR in 1969 because of concern that the stock and prospective growth of international reserves might not be sufficient to support the expansion of world trade. The SDR was introduced as a supplementary reserve asset, which the IMF could “allocate” periodically to members when the need arose, and cancel, as necessary.^[14]

The Amended Articles of Agreement do not authorize allocation of SDRs except in accordance with a recipient’s quota, so that any attempt to revive the idea of linkage of SDRs to development aid would require an amendment to the Articles of Agreement.^[15]

The Role of the IMF in Helping its Members

Exchange rate stability through fixed exchange rates

Seeking to restore order to international monetary relations, the IMF’s founders charged the new institution with overseeing the international monetary system to ensure exchange rate stability and encouraging member countries to eliminate exchange restrictions that hindered trade. Under the Bretton Woods system, exchange rates were supposed to be “fixed but adjustable” with adjustment limited to cases of fundamental disequilibrium. Countries could, with the Fund’s agreement, adjust their par values to reflect their changing economic circumstances relative to other countries. The organizing idea was that the many changes in exchange rates in the inter-war period had produced instability, introduced extra risk to international trade, encouraged manipulation and generally contributed to the depression and war that were on the minds of all those who planned the post-war world^[16]. The aim was to prevent unilateral adjustments of the kind seen in the 1930’s and over the years, many exchange rate values were altered. Although increasing strains in the system became evident during the 1960’s, the Bretton Woods exchange rate regime, combined with trade liberalization, and had enabled the industrial countries in particular to grow rapidly in the postwar period. But the Bretton Woods system hinged on the continued willingness of the US authorities to maintain the so-called gold window- the right of anyone to convert their dollars into gold at the fixed rate of 35$ per ounce. For much of the postwar period, large US capital account deficits had been offset by current account surpluses. As the US economy came under pressure from the struggle to finance rapid rises in domestic spending programs and the cost of the war in Vietnam, the US government decided it could no longer underpin the international financial system. In august 1971, President Nixon announced that the gold window would be closed and by 1973 the system of fixed exchange rates had been abandoned.

Breakdown of the fixed exchange rate system

This breakdown of the fixed exchange rate system ended each country’s obligation to maintain a fixed price for its currency against gold and other currencies.^[17]

For the first three decades after World War II, under the Breton Woods arrangements, the US dollar was the main currency, where most of transactions in international trade and finance were carried out in dollars and even payments were made in US dollars. Based on this, the world was on a dollar standard. But on the other side, recovery contained the seeds of its own destruction. US trade deficits were fueled by an overvalued currency, budget deficits to finance the Vietnam War, and growing overseas investment by American firms.^[18]

By 1971, the stock of liquid dollar balances had become so large that governments had difficulty defending the official parities and the lower barriers to financial flows meant that billions of dollars could cross the Atlantic in minutes and threaten to overwhelm existing parities.^[19]

These are some of the main reasons why this system was demised, while as the United States abandoned the Bretton Woods system, the world moved into the modern financial system.

Macroeconomic and financial policies

Technically, countries do not receive loans from the IMF- they “purchase” foreign exchange from the IMF’s reserve assets, paying with their own currency. The loan is considered repaid when the borrower “repurchases” its currency from the IMF in exchange for reserve assets.

In its oversight of member states, the IMF focuses on the following:

- Macroeconomic policies relating to the government’s budget, the management of money and credit, and the exchange rate;
- Macroeconomic performance - government and consumer spending, business investment, exports and imports, output (GDP), employment and inflation
- Balance of payments - that is, the balance of a country’s transactions with the rest of the world
- Financial sector policies, including the regulation and supervision of banks and other financial institutions, and
- Structural policies that affect macroeconomic performance, such as those governing labor markets, the energy sector and trade.

The IMF advises members on how they might improve their policies in these areas so as to achieve higher rates of employment, lower inflation, and sustainable economic growth.^[20]

[...]

^[1] http://www.imf.org/pubs/ft/aa/aa01.htm

^[2] Ibid

^[3] Andreas F. Lowenfeld, International Economic Law, Great Clarendon Street - Oxford, First published 2002 (as paperback 2003), Page 503

^[4] Ibid

^[5] Ibid

^[6] http://www.imf.org/external/pubs/ft/exrp/what.htm#do

^[7] Ibid

^[8] http://books.google.com/books?id=dTw6oS_XXCUC&pg=RA1-PA2&ots=1ctDDwGBCR&dq=historical+background+of+IMF&sig=MjnkR7RK83mqYvDrwGgas_Nb-N4#PRA1-PA2,M1

^[9] Ibid

^[10] http://www.english.uiuc.edu/maps/depression/about.htm

^[11] Ibid

^[12] Book, International Trade and Economic Relations, Thomson West, West Nutshell Series

^[13] http://html.rincondelvago.com/bretton-woods_1.html
http://www.reference.com/browse/wiki/Bretton_Woods_system
http://www.answers.com/topic/bretton-woods-system

^[14] Book, International Economic Law, Andreas F. Lowenfeld

^[15] Book, International Economic Law, Andreas Lowenfeld, pg 521 and 522

^[16] Book, International Economic Law, Andreas F. Lowenfeld, pg.524

^[17] http://www.britannica.com/eb/article-247600/money

^[18] Paul A. Samuelson & William D. Nordhaus, ECONOMICS, Seventeenth Edition 2001, page 628

^[19] Ibid

^[20] http://www.imf.org/external/pubs/ft/exrp/what.htm#box5