IMF Loan Process

Why do crises occur?

The causes of crises are varied and complex and can be domestic, external, or both.

  • Domestic factors include inappropriate fiscal and monetary policies, which can lead to large economic imbalances (such as large current account and fiscal deficits and high levels of external and public debt); an 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. Political instability and/or weak institutions can also trigger crises by exacerbating economic vulnerabilities.
  • 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, sudden changes in market sentiment can result in capital flow volatility. Even countries with sound fundamentals could be severely affected by the impact of economic crises and policies in other countries.

Whether the cause is domestic or external in origin, crises can take many different forms: balance of payment problems occur when a nation is unable to pay for essential imports or service its external debt repayments; financial crises stem from illiquid or insolvent financial institutions; and fiscal crises are caused by excessive fiscal deficits and debt. Often, countries that come to the IMF face more than one type of crisis as challenges in one sector spread throughout the economy.

Crises generally result in sharp slowdown in growth, higher unemployment, lower incomes and greater uncertainty which cause a deep recession. In acute crisis cases, defaults or restructuring of sovereign debt may become unavoidable.

How IMF lending helps

IMF lending aims to give countries the 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 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.

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