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You’ve heard of the IMF. The International Monetary Fund.
They’ve garnered quite the reputation.
You often hear their name mentioned whenever a developing country is facing an economic crisis.
Argentina. Greece. Sri Lanka. Pakistan.
The list goes on.
So what’s this massive institution? Are they independent? Why does it exist? Who’s behind it?
How would such an entity operate under Islamic finance and Islamic banking rules?
You’ll hear that they’re responsible for the stability of the global economy.
But what does that mean? Why do they have such a mandate? Are they a force for good?
Let’s start at the beginning.
World War 2 is nearing its end.
Countries face huge economic losses from the war. Substantial investment is needed to rebuild.
730 delegates from 44 allied nations meet up in Bretton Woods, New Hampshire, US, to plan the world’s economic future.
No one wants a repeat of the 1930s. Economic instability and protectionism led to countries suffering economically. Germany’s economic hardships of the 1930s provided the necessary fuel for Hitler to rile up the country’s citizens behind Nazism. The world couldn’t let that happen again.
So they created a system to make global trade easier. An integrated global financial system.
The Bretton Woods system.
A new global monetary framework is born. Every nation’s currency would be pegged to the US dollar and could be freely converted to the US dollar. Each nation would have a different exchange rate. The US dollar would be pegged to gold at $35 per ounce.
This system would spur global economic growth by facilitating trade between countries.
This was the perfect way for the US to assert its financial dominance on the world.
Bretton Woods gave birth to the IMF. It would play an important role in managing this global foreign exchange system.
But as the years went by, countries weren’t happy with America’s dollar advantage.
The French understood this. By having the US dollar become the international reserve currency, the French Minister of Finance, in the 1960s, described this as an “exorbitant privilege”.
The US was borrowing and spending excessively. It had social programs to finance. Government budgets to balance. It had wars to pay for. The Vietnam War cost the US $168 billion. Or $1 trillion valued as of today after adjusting for inflation.
And how did they do that?
By printing US dollars.
The world realised this. They knew that the artificial peg of $35 per ounce of gold wasn’t the fair value. There were a lot more dollars in the system.
So countries like France started asking for their gold back. Their gold which was stored in the US. Others were converting their US dollars into gold.
There was fear that the US couldn’t keep its promise to convert dollars into gold at the agreed rate.
They started a run on the dollar.
At the same time the US was hurting because of an overvalued dollar. It reduced economic activity. It made exports less competitive.
So in 1971, the US decided to break off the peg. The US dollar would be backed by nothing. Nothing other than the mighty power of the US economy. Nothing other than a promise.
But by this time, the US dollar system was deeply entrenched in the global financial system. US dollars were everywhere. Thanks to Bretton Woods, countries across the world, who had their currencies pegged to the dollar, had to keep dollar reserves.
The Bretton Woods system created the global demand for dollars.
You can read more about it in my previous article here. You’ll learn that the global demand for US dollars gives the US an incredible advantage. It allows it to tap into the global market to borrow incessantly.
Now was it America’s plan all along? That the Bretton Woods system would create a dependence on the dollar so that they could eventually print more dollars whenever they needed to?
Who knows.
But that would’ve been incredibly cheeky.
After this, the IMF focused on helping countries manage their balance of payments. In other words, managing all the money that goes in and out of a country.
They also help with managing international crises. They step in as a ‘lender of a last resort’ when things go bad.
Most of the funding available to the IMF comes from quotas from its members. Members of the IMF, the 190 different countries, fund a pool based on their capabilities. This pool is then used to lend to countries that need it.
The members are split between lenders and borrowers.
Given lenders contribute significantly to the pool, they get more voting power.
There’s going to be an imbalance between lending-members and borrowing-members. Lenders will push for terms that guarantee repayments of their loans and borrowers will want to access more funds to help their economy. It’s only natural.
The IMF is usually involved in some kind of controversy.
On one hand people praise the institution for lending to impoverished countries. Helping ease the citizens out of poverty. Without them, there would be no ‘lender of last resort’.
On the other hand, others blame the IMF for these countries’ financial problems in the first place. They load them up with debt knowing that they won’t be able to pay it back. Then they exert economic pressure at the detriment of the country’s citizens.
But if a country is facing financial difficulties and needs to borrow money, where else can it get it from? Doesn’t make it sense to have a ‘neutral’ institution that can lend to countries in dire need?
The issue is more nuanced than that.
Some of these developing countries are quick to borrow money. Remember it’s the politicians that decide. They don’t have skin in the game. They probably won’t be in office anymore when it's time to pay the money back. And it won’t come out of their pocket. No. It will come out of the country’s pocket. The country’s tax payers.
During economic booms, politicians can cement their power by spending more on the country. They’ll do this by borrowing more. But good times never last.
So what happens when the tide turns? When they struggle to pay the money back?
That’s when the situation gets tough.
These same countries find themselves in a debt downward spiral. They’ll have to seriously tighten their belts to get a new loan from the IMF. They have to accept tough conditions set by the IMF that will hurt their economy.
They’ll force austerity measures in place.
The government will need to spend less on the country and its citizens and increase taxes, to make sure that its debts are paid back.
The economy is restructured at the discretion of the IMF. They can take hold of the country’s economic direction.
It’s a modern form of colonisation.
No warplanes. No submarines. No soldiers. Just pen and paper.
I agree that debts need to be paid back. They probably shouldn’t have borrowed in the first place.
Now are these same countries enticed to borrow from the IMF? Is the IMF incentivised to lend to put these countries into these situations? Do they become dependent on the IMF? Remember how those who fund the IMF have more voting power.
I don’t want to get conspiratorial but it’s something to consider.
It’s funny how some of these countries are commodity-rich. Yet they still struggle financially and have their hands tied by the IMF.
It surely becomes easier to handle these countries geopolitically should they have a fragile economy.
Let’s take the example of Sri Lanka. It’s not a commodity-rich country but a relevant example nonetheless.
COVID-19 hit the country hard. It destroyed tourism; no one could come and visit. This annihilated the main source of getting foreign currency into the country.
The government wasn’t the shrewdest either.
They previously made some poor economic decisions. By focusing on the domestic industry, they failed to boost exports. Meanwhile imports kept increasing. So foreign currency demand kept increasing. But they relied solely on tourism for that.
To put it simply, more money was going out of Sri Lanka than going in.
Mix that with COVID-19, the country found itself in a situation where it no longer had any foreign currency reserves. It could no longer pay for imports. So inflation rose dramatically. The government failed to make interest payments on its debt to international investors for the first time. Fuel ran out. Protests broke out.
Remember that the US could never have the same problem.
It could never face a balance of payments crisis.
As long as the US dollar remains the world’s dominant currency, they’ll always be able to pay for their imports in US dollars.
And what’s stopping them from printing as much of it as possible?
This is the “exorbitant privilege” that the French finance minister made reference to back in the 60s.
But for Sri Lanka, the IMF had to step in. They agreed to lend Sri Lanka $3bn.
That was taken as good news. The IMF came to save the day.
But when you dig a little deeper you realise that this help comes with thick strings attached.
I invite you to read this newsletter which does a great job of explaining what the money is being used for.
Just know that the money isn’t going to where it’s needed. You would think that it would be used to pay for the imports that are so badly needed. It’s not. The loan doesn’t really trickle down to the citizens.
The money will be used to shore up the central bank’s international reserves. To make sure that the creditors can get paid.
The argument goes that by helping manage its debt, private investments will come in to fill the gap.
Either in the form of investment or by lending the country money by tapping into the international debt system.
That was also the assumption with Argentina and Greece. But that didn’t happen.
We can expect Sri Lanka to suffer more economic hardships ahead.
Brad Setser at the Council on Foreign Relations noted:
“The proposed debt targets appear to be so generous to creditors that they call into question the ability of a restructuring to return Sri Lanka to debt sustainability.”
There are other damages to think about.
An article a few months back from Bloomberg highlights the kind of requests the IMF will force upon countries struggling.
A lot of these countries like Argentina, Nigeria, Malawi, Ethiopia, Bangladesh borrowed money when interest rates were very low.
These countries typically have a managed or pegged exchange rate. Meaning their exchange rate isn’t determined by the market. It’s fixed or kept within a range controlled by their respective central banks.
Similar to how countries managed their currencies under the Bretton Woods system.
But these countries will have to lower their currency pegs if they want to receive money from the IMF.
A weaker currency will attract more capital and make a country’s trade more competitive. That’s the economic theory. Which I tend to agree with. The issue is that it brings with it higher inflation.
The value of the imports will go up. If your currency goes down relative to whatever you import in dollars, then the imports become more expensive. If those imports can’t be replaced with the country’s domestic industry, then the citizens will suffer greatly.
Not only that, but it makes debt in foreign currency even harder to repay. It can get pretty nasty in the form of a debt downward spiral.
Take for example the Nigerian Naira. Prior to June of this year, $1 was equal to around 460 naira. This was kept artificially at these levels by the central bank. The black market rate was closer to 760 naira. That’s a huge gap.
But let’s look at Nigerian debt. Nigeria owes around $2.5 billion to the IMF. Now that went from being equal to 1.15 trillion naira to 1.93 trillion naira after the central bank abandoned the peg. That’s quite the jump.
I’m not blaming solely the IMF for this. Nigeria is partly to blame for mismanaging its economy and its currency. This is why a black market rate proliferated. Everyone knew that the official naira rate was overvalued.
But is there only one side to blame?
It’s different for every country. These indebted countries are often mismanaged.
Are there malicious intentions so that foreign institutions can exert more dominance? Do they take advantage of poor leadership? I wouldn’t completely dismiss that.
It’s something to think about.
This thought-provoking essay by Alex Gladstein is worth a read. He also released a book, Hidden Repression, which I have yet to read, on the IMF’s and World Bank’s dangerous influence on the world.
But how can we view all of this from an Islamic perspective?
Let’s assume that Muslim nations, or a Muslim caliphate, was the global superpower. Would there be an IMF-equivalent institution that could help some nations in times of need?
It’s something I started to ponder when I started reading more about the IMF.
The IMF might be helping but the creditors will always be favoured. The developed nations will always have the upper hand. The developing nations will always suffer and it will only get harder and harder for them.
I came across an interesting paper on the historical debt arrangements during the early years of the Islamic caliphate.
We have numerous examples of the prophet Muhammad (peace be upon him) borrowing money. Especially during the early years of his prophethood. The Prophet borrowed for a number of reasons. Be it for personal matters, to be able to donate and at other times for defense purposes and to finance wars. But debts were always paid back.
Islam is very strict on paying back one’s debt.
The Qur’an states quite clearly:
“O you who have believed, fulfill [all] contracts.” Qu’ran (5:1)
Another translation states:
“O believers! Honour your obligations” Qu’ran (5:1)
In another narration from Abu Hurayra, one of the companions of the Prophet (peace be upon him), the Prophet defends a creditor who had harshly and rudely demanded the Prophet to give him a camel that was owed to him.
So the Prophet does just that.
He asks his companions to give the man a better camel. The Prophet then says:
“The best among you are those who repay their debts handsomely.” Sahih al-Bukhari 2390
Even martyrdom doesn’t expiate the rights owed to other people. Dying a martyr can remove all sins except for any debts that remain outstanding. The Prophet (peace be upon him) said:
“All the sins of a Shahid (martyr) are forgiven except debt.” Sahih Muslim 1886a
This makes it clear that one must do everything in their power to pay their creditors back.
On the other hand the Qur’an is also clear that creditors are encouraged to give debtors respite. To be lenient with them. To show compassion towards them. This only applies if the debtor is unable to repay or needs more time.
This doesn’t apply if the debtor simply chooses to delay repayment out of convenience or greed.
So Islam is pretty clear on what the relationship between the creditor and debtor should be.
That fulfilling your contract is of utmost importance.
But what can we learn about how the early Islamic rulers handled debt contracts?
To be fair, the early years of the Islamic caliphate saw tremendous economic growth. The reign of the first 4 caliphs saw revenues growing incredibly fast. There was no need to borrow. The rapid conquests across the Byzantine and Persian empires fuelled organic growth.
That continued for some time.
There isn’t a single instance of public borrowing during the reign of the first 4 caliphs. This was during the first 30 years following the death of the Prophet (peace be upon him).
After that we had the rule of the Umayyad. They ruled for nearly 100 years.
But there wasn’t any instance of state borrowing at the level of the central administration either.
Although we do have reports of army commanders borrowing to equip their forces or governors borrowing to pay salaries on time.
The first report of public borrowing refers to a period during the 18th Abbasid Caliph Al-Muqtadir.
He came to the throne at the age of 13. It goes without saying that his reign was challenged, for obvious reasons, and a coup was attempted. But it was decisively crushed.
His reign started nearly 300 years after the Prophet (peace be upon him) passed away. Using the Gregorian calendar, his reign lasted from 908 to 932 AD.
Al-Muqtadir was uninterested in running government affairs.
Would you be at the young age of 13? Just imagine growing up in luxury and how blasé you would feel.
So he let his officials run the show.
These officials, called wazirs, were senior ministers of the Abbasid Caliphate. They became quite powerful as more and more responsibilities were bestowed on them. Some wazirs were more powerful than the Caliphs.
Poor mismanagement of resources and lack of internal measures meant that the public coffers were rapidly emptied.
Just how poorly managed was this governance? Well there were 14 changes of heads of governments (i.e. wazirs) during Al-Muqtadir’s reign. 14 different heads of state in 24 years.
Certain members of society took advantage of the ridiculous state of affairs.
Wazirs took on interest-bearing loans from many sources to balance out public budgets.
Remember in Islam it is both sinful to lend or borrow money with interest. Now did they do it out of desperation? That doesn’t justify it either (unless it really was a life or death situation).
It’s interesting to note that the Caliphs themselves didn’t take on these loans. It was the wazirs who ran the administration that took them on.
In any case, public borrowing during these periods had acted as bridge-financing. It’s not something we can compare to IMF loans. The wazirs took on these loans to cover expenses knowing that they could pay them back using future tax revenues.
One would need to look at later Islamic empires to see how they took on public borrowing. But we know that corruption and extravagance only grew as the years went by. We thus don’t have a real model for an IMF-like institution that follows real Islamic principles.
Whilst the ruling empires were certainly Islamic, none of them were perfect. The Qur’an is pretty explicit on interest-bearing loans and yet these transactions still took place.
But what would an Islamic IMF look like?
The first thing that comes to mind is an investment partnership. The institution takes on the risks with the country receiving such investment.
If we had an equivalent institution, with members pooling their funds, votes could be cast on whether the funds should be invested in a certain country. Not loaned to said country. But yes, invested.
If it were a loan, then no interest could be charged. This would be more of a charitable act.
Whilst donations and acts of charity have their place, especially during crises, this is not a sustainable or practical model that developing countries can rely on to help their economies.
So let’s go back to the idea of an investment.
Assuming this Islamic institution pooled all the funds from different nations, investments would be made into countries needing it based on the quality of the presented projects. The funds would be used for a particular project (i.e. a bridge or a port). One would find ways to monetise said project (i.e. tolls or port tax/usage) which would be shared with the investors.
For it to be considered an investment, all parties would have to share the same risks and profits.
Some of you may scoff at the idea of turning a country’s needs into an investment project.
But what’s the alternative?
Lend them with interest knowing that in most cases it results in further impoverishment?
If it were considered an investment from the beginning, all parties (the investor and the recipient country) will be a lot more careful in their approach. This goes back to my previous articles on incentives.
When a creditor isn’t taking as much risk, because of the collateral or contractual protections, they are more likely to lend and fund a project that may not be as profitable in the long-run should said protections be comforting enough.
But that changes once we look at this from an investment perspective.
The investor will be much more incentivised to make sure that the funds are being used appropriately.
It’s no coincidence that these countries tied to the IMF also suffer greatly from corruption. Surely the IMF is aware of this? But yet what measures are they taking to destroy corruption?
I’ll leave you with these questions.
I’m sure you’re thinking of a myriad of reasons why an investment vehicle instead of a lending vehicle couldn’t work.
But if an institution can dictate the economy of a country because of a contractual arrangement, I’m sure there are alternatives to consider if said institution really cared about doing the right thing.
It might sound utopic but I’m sure the idea of the IMF was viewed with the same lens initially. In the end it's a mammoth of an institution in which its intentions are cloudy to say the least.
I manage a $100m private investment fund and I explore Islamic finance and economics through a personal lens. I help simplify financial markets from a Muslim perspective.
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Letting curiosity guide me to help you make sense of our economic system and how Islamic principles provide equitable solutions.
