Updated: Nov 9, 2019
By: Vani Manoraj
“Money plays the largest part in determining the course of history.”
- Karl Marx, Communist Manifesto (1848).
Unrecognized countries, because of their unrecognized status have a hard time attracting foreign direct investment. In addition, they are unable entirely from accessing and sourcing funds from international monetary organizations.
Money has been defining the destiny of people and countries over its vast history. It has been central to developing our international trade networks. It has come to form an essential part of our lives.
In 600 B.C. King Alyattes in Lydia (Turkey) introduced the first know currency in the form of coins (Burn-Callander, 2019).
In 1661 A.D. the first ever bank note was issued in Europe even though the first use of paper money (bank notes) was recorded in China during the Song dynasty. The use of money in daily transactions led to the establishment of banks. ("What Is Money?", 2019)
The word “bank” is derived from the Italian word banco used by Florentine bankers. The general role of banks is to provide financial services to public and business.
The banks also aid in ensuring economic and social stability thereby contributing to the growth of the economy.
The use of money in trade and transaction resulted in increased banking activities. The banks transformed from money lending organizations to wealth generating organizations.
The modern-day banks are therefore complex beings compared to their ancestors, that is the pawnbrokers of ancient Greece and Rome.
“It is well enough that people of the nation do not understand our banking and money system, for if they did, I believe there would be a revolution before tomorrow morning.”
- Henry Ford, founder of the Ford Motor Company.
International Financial Institutions
An international financial institution is a financial institution established by more than one country in order to assist development and international cooperation. The institutions are subject to international laws.
There are three types of IFI namely multilateral development banks created by a group of countries providing financing and advice for purposes of development (e.g. World Bank), regional development banks established by countries in a particular region with a specific focus on that region (eg. African Development Bank) and bilateral development banks created by an individual country to finance development projects in a developing country and its emerging market (e.g. Netherlands Development Finance Company (FMO).
International Monetary Fund (IMF)
World War II saw cities razed to the ground, countries economically affected and resources depleted. The biggest challenge in the aftermath of the war was rebuilding the cities, creating job opportunities and strengthening the economy. This was imperative to aid trade and peace.
The idea for an international financial institution was conceived by John Keynes (United Kingdom) and Harry White (United States) which was evidenced from the “Joint Statement by Experts on the Establishment of an International Monetary Fund” published on April 21, 1944.
The United Nations Monetary and Financial Conference also known as the Bretton Woods Conference was held from July 1 to 22, 1944.
The purpose of the Bretton Woods Conference was to discuss and formulate proposals for an International Monetary Fund and possibly a Bank for Reconstruction and Development ("Proceedings and Documents of the United Nations Monetary and Financial Conference", 1944).
The 44 Allied nations represented by 730 delegates attended the conference in Bretton Woods, United states. The conference was organised to decide on the manner to regulate monetary and financial order after the end of World War II. The negotiations were dominated by the United States and United Kingdom.
The International Monetary Fund was established as a framework for international economic cooperation and to avoid repeating the competitive currency devaluations resulting in the Great Depression.
The main purpose of the IMF is to ensure the stability of the international monetary system (i.e. system of exchange rates enabling international transactions) (IMF, 2019).
It plays a central role in management of balance of payments and financial crisis. The IMF has been tasked to improve the economises of the 189 member countries.
Therefore, IMF provides policy advice and financing to developing nations, assisting them to achieve macroeconomics stability and reduce poverty.
The Fund typically analyses the appropriateness of each member country's economic and financial policies for achieving orderly economic growth, and assesses the consequences of these policies for other countries and for the global economy.
This process is termed as surveillance (IMF, 2019). Furthermore, IMF provides alternate sources of financing for countries to correct large external payment imbalances.
In a globalised world where countries are interdependent, any financial crisis has the potential to usher the world economy into financial instability. The IMF aids in mitigating and containing economic crises.
The IMF Board of Governors are the highest-decision making body of the IMF, consisting of one governor and one alternate governor representing each member country. The governor is appointed by the member country and is usually the minister of finance or the governor of the central bank.
All powers of the IMF are vested in the Board of Governors. the Board of Governors is officially responsible for approving quota increases, special drawing right allocations, the admittance of new members, compulsory withdrawal of members, and amendments to the Articles of Agreement and By-Laws.
However, the Board of Governors have delegated their powers to the IMF Executive Board which consists of 24 Executive Directors representing 189 countries through a geographically based roster.
Countries with large economies have their own Executive Director, but most countries are grouped in constituencies representing four or more countries (IMF governance, 2019).
The votes of each member equal the sum of its basic votes (equally distributed among all members) and quota-based votes.
Therefore, a member’s quota determines its voting power. Each IMF member country is assigned a quota, or contribution, that reflects the country's relative size in the global economy.
Each member's quota also determines its relative voting power. Thus, financial contributions from member governments are linked to voting power in the organisation.
Membership of IMF is diverse and flexible. One can find non-sovereign states and countries not members of United Nations as members of IMF. Examples of such regions and countries are Aruba, Curacao, Hong Kong, Macau and Kosovo.
Therefore, any country can apply to be a member of IMF. Members needed to make periodic membership payments towards their quota, to refrain from currency restrictions unless granted IMF permission, to abide by the Code of Conduct in the IMF Articles of Agreement, and to provide national economic information.
However, stricter rules were imposed on governments that applied to the IMF for funding (IMF, 2019).
The IMF provides loans to countries under ‘IMF Conditionality’, which refers to set of policies or conditions that IMF requires in lieu of financial assistance.
This ensures that the borrowing country will not only be in a position to repay the loan but also that the country shall promote those policies which do not negatively impact the international economy.
The IMF provides financial support upon request by its member countries. A borrowing country can agree to a stand-by agreement which offers financing of a short-term balance of payments, usually between 12 to 18 months.
On the other hand, the extended fund facility (EFF) is a medium-term arrangement by which countries can borrow a certain amount of money, typically over a three- to four-year period.
IMF also provides loans under the poverty reduction and growth facility (PRGF) which aims at laying the foundation for economic development and administering low interest rates loans.
The World Bank
The World Bank is one of the multilateral development banks which is part of the international financial institutional system. The World Bank provides loans and grants to governments of developing countries to pursue capital projects (World Bank, 2019).
The World Bank comprises of two institutions: the International Bank for Reconstruction and Development (IBRD), and the International Development Association (IDA).
The Bretton Woods Conference resulted in the establishment of the IBRD. The main purpose of the creation of the World Bank, then called IBRD, was to finance the reconstruction efforts of the war-torn European Nations (Picincu, 2019).
The bank was empowered to demand policy reforms from the loan recipients. France was the first country to receive a loan from IBRD in 1947. The amount loaned was US$250 million and was issued under certain conditions.
France had to agree to generate a balanced budget and give priority of debt repayment to IBRD.
The loans of the IBRD were issued to aid the construction of infrastructure that generated income for the countries to ensure repayment of the loans. However, the loans were not attractive for the low-income developing countries as the lending terms of the IBRD were not favourable.
This resulted in the creation of the International Development Association (IDA) in 1960 which was purposed to provide an avenue for low income countries with low creditworthiness, to secure temporary loans from an international financial institution (Clemens, 2016).
The Bank provided concessional loans to developing countries with the lowest gross national income and unable to secure loans commercially. The United States was the main campaigner for the establishment of IDA.
The increasing influence of communist Soviet Union was a cause for concern for United States. The US wanted to dissuade the developing countries neighbouring USSR from joining the Eastern Bloc ("IBRD", 2019).
The IBRD and IDA are governed by the World Banks’s Board of Governors and consist of one governor per member country (most often the finance minister or treasury secretary of the country) serving a term of 5 years.
The Board of Governor’s meet annually. The ultimate decision-making power rests with the Board of Governors. The Governors are responsible for determining the admittance and suspension of members, review budgets and financial statements, capital stock, and distribution of income.
The Board of Governors however, have delegated the day to day activites of the bank to the Board of Executive Directors. The executive Directors are appointed by the Board of Governors. The Executive Directors also formally appoint (although the U.S. Government selects and nominates) the President of the World Bank, who serves as chair of the Board of Directors (Bicusa, 2019).
The current Boards of the World Bank Group consist of 25 Directors representing all member countries of the World Bank, although decisions regarding IDA matters concern only the IDA's 172 member states ("IBRD", 2019).
The IBRD and IDA are owned by the governments of the member nations. To become a member of the IBRD the country must first join the International Monetary Fund (IMF).
Membership to the IDA is conditional on the membership of the IBRD. When you are a member of the IMF, to apply a membership of IBRD you need to follow the International Bank for Reconstruction and Development Articles of Agreement. Article XI, Section 2 (f) specify that membership are open for anyone, even if you're member of the UN or not by stating “(f) After December 31, 1945, this Agreement shall be open for signature on behalf of the government of any country whose membership has been approved in accordance with Article II, Section 1 (b)”.
However, a country seeking membership of the Bank needs support for its application of at least 75 per cent of the existing members ("IBRD", 2019). Under IBRD each member receives votes on the weightage of the shares held by the member.
Each member receives votes consisting of share votes (one vote for each share of the Bank's capital stock held by the member) plus basic votes (calculated so that the sum of all basic votes is equal to 5.55 percent of the sum of basic votes and share votes for all members).
Under IDA, each member receives the votes as allocated under the IDA replenishments established in each IDA replenishment resolution.
The IDA has 173 member countries which pay contributions every three years as replenishments of its capital ("IBRD", 2019).
Eligibility to borrow money from IDA depends on the country’s relative poverty, which is defined as Gross National Income (GNI) per capita below an established threshold and updated annually.
The IMF and the World Bank
Though both the IFI were founded by the Bretton Woods Conference, IMF and World Bank vastly differ from each other.
Casually, both the institutions exhibit common characteristics namely, owned by governments of member nations, provide financial assistance and concern themselves with economic issues.
However, the difference lies in the nature of their activities. Where the Bank is primarily a development institution, the IMF is a cooperative institution primarily created to maintain economic stability.
The IMF compared to the World Bank is small in size and does not have any affiliates or subsidiaries.
The world bank acts more as an investment bank with its main function of borrowing and lending for development projects, IMF is not a bank and the sources its lending function from the membership fees paid by countries.
The money lent through IMF supplements the currency reserves of its members and is usually lent on strict conditions ("International Monetary Fund (IMF) vs. the World Bank: What's the Difference?", 2019).
Road to Recognition
“The country’s reputation is best described by the sum of money that it can borrow from other” - Winston Churchill
Membership of the IMF promotes confidence in the financial and economic stability of a country. The surety of a country following IMF code of conduct encourages investment and trade for the member country.
A member shall also have the advantage of securing technical assistance and financial support of the IMF.
The member countries shall benefit from “Access to information on economic policies of all member countries, opportunity to influence members’ economic policies, access to technical assistance in banking, fiscal affairs, and exchange matters, financial support in times of payment difficulties and increased opportunity for trade and investment” ("Money Matters, an IMF Exhibit -- The Importance of Global Cooperation, Obligations and Benefits of IMF Membership", 2019).
Furthermore, membership in the IMF allows for the membership of the World Bank. Membership of IBRD and IDA provide ease in money lending for development projects.
In recent times the bank has shifted its focus from supporting growth-related programs in middle-income countries towards global poverty alleviation (Council on Foreign Relations, 2019).
Therefore, the importance of an association with IFI cannot be stressed in simple terms. Unrecognized countries usually lack a strong economic infrastructure and are forced to rely on neighbouring countries to support their economy.
This places a huge burden on the countries by requiring them to focus on key issues and consequently are unable to develop social policies. Recognition by the international community of the sovereignty of the country is the first step towards economic growth.
Recognition provides legitimacy to a new country and allows it to participate in the international community. Recognition is an inherently sovereign act of a state and therefore, a state may bestow recognition at its own discretion.
Recognition is usually followed by a United Nations membership application. An application for U.N. membership is at the first instance considered by the Security Council, where the application to succeed needs the support of nine of the 15-member Council without a veto from the council’s five permanent members.
If approved, the Council’s recommendation is placed before the General Assembly where the application needs a two-third majority vote to gain admission.
It is therefore imperative that the country secure the support of the international community and recognition by majority of the states.
In light of the above, recognition is vital in order to secure funds from the World bank and IMF. The Board of Governors of both the organisations comprise of individual governments who decide the applications of borrowing countries. Lack of support from the international community shall result in the failure of any application or aid.
Unrecognized countries are generally under-developed regions which require large flows of funds to create employment, social welfare and develop infrastructure and security.
In the absence of aid from financial institutions, complete autonomy remains a distant dream. For some countries, their economic reliance on other countries is seen as a case against their recognition.
They are therefore caught in a vicious circle where they require recognition to secure funding and require funding to secure recognition.
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Money Matters, an IMF Exhibit -- The Importance of Global Cooperation, Obligations and
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Clemens, Michael A., and Michael Kremer. 2016. "The New Role for the World Bank." Journal of Economic Perspectives, 30 (1): 53-76.
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