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posted on 26 June 2016

Budgetary Effects Of The United States Participation In The International Monetary Fund

from the Congressional Budget Office

Since 1945, when the International Monetary Fund (IMF) was established to promote global economic cooperation and stability, the United States has been its largest contributor. Today, the United States' financial commitment to the IMF totals approximately $164 billion; that is the maximum amount that the IMF can draw from the United States to make loans to other IMF members.

The budgetary cost of participation in the IMF is, however, significantly smaller than the amount of that commitment. The United States and other countries earn interest on the portion of their commitment held by the IMF, and the IMF's assets, including loans to other members, gold, and financial securities, are sufficient to allow it to return those funds to members in most circumstances. Nevertheless, a small risk remains that the IMF could incur losses on its lending so large that it could not repay the United States the full value of its commitment. Because of that risk, participation in the IMF has a cost to the United States, which CBO currently estimates to be about 2 cents per dollar committed.

How Does CBO Account for the United States' Participation in the IMF in Budget Estimates?

The nature of the United States' transactions with the IMF makes accounting for them in the federal budget difficult. When the United States pledges funds to the IMF, it commits to loan up to that specified amount to the organization - that is, it extends a line of credit. Some of the pledged funds are immediately transferred to the IMF, which either invests them in a range of securities or lends them to other members. The IMF can draw on the remainder of the pledged funds as needed for lending; it returns those funds to the United States when the borrowing members repay their loans.

In exchange for the funds that it provides to the IMF, the United States receives special drawing rights (SDRs). The SDR, whose value is based on a basket of widely circulated currencies, serves as the unit of account for the IMF. The United States earns interest on its SDRs and retains the right to withdraw funds from the IMF - that is, to cash in its SDRs at the current SDR exchange rate with the dollar - at any time. Thus, each dollar that the United States commits to the IMF retains value over time, though the exact amount that will be returned depends on the extent of IMF lending, the income that the IMF earns on its investments and lending, how much of that income is passed through to members as interest, and the exchange rate between the SDR and the U.S. dollar.

Since 2009, laws providing for additional U.S. commitments to the IMF have specified that the budgetary effects of those commitments be estimated on a fair-value basis - that is, using a present-value amount that is a market-based measure of the net cost of the indefinite commitment of additional funds to the IMF. The use of the present-value method reflects the notion that each dollar committed to the IMF retains most of its value for the United States and is not simply a cash expenditure. But the present value of the cost is not zero - as it would be if the commitment had no cost to the federal government - because the interest that the United States receives on its contributions is not sufficient to fully compensate it for the very small risk of catastrophic losses that could occur following large or widespread defaults by IMF borrowers.

Why Is There a Cost Associated With the United States' Participation in the IMF?

When the United States makes a deposit with the IMF, the rate of interest that it receives on its SDRs is indexed to the rates available on a basket of low-risk debt. However, deposits with the IMF pose an additional risk beyond that posed by investing directly in a portfolio of low-risk debts of developed countries because some of the value of those deposits may be lost as a result of financial, economic, or political crises that triggered widespread defaults among borrowers of IMF loans. Although the conditions that the IMF imposes on its lending, its de facto seniority in repayment, and its holdings of gold and reserve assets protect members from losses, the possibility of members having to incur large losses on the IMF's loans remains, though the probability of that happening is very small.

Although the IMF has experienced only negligible losses on its lending to date, global economic circumstances could generate large losses in the future if many IMF borrowers were to cease repayment of their loans. In those circumstances, the IMF would not have enough income from its lending and investments to continue paying members interest on their SDR holdings, and the amounts flowing to the United States and other members would be reduced. Any present-value estimate of the United States' commitment should therefore reflect the possibility of such a reduction in the future.

How Does CBO Estimate the Fair-Value Cost to the United States of New Commitments to the IMF?

To estimate the cost to the United States of new commitments to the IMF, CBO first estimates the two components of that cost: the cost to the IMF of the loans it makes to its members and the effect of the IMF's reserves.

The cost of the loans that the IMF makes to its members is equal to the present value of the loan amounts disbursed minus the principal and interest received on that lending. The IMF charges its borrowers a higher interest rate than the rate it pays to members on their SDR holdings. However, CBO estimates that in a crisis in which a large number of borrowers defaulted, the IMF would not receive a significant amount of the scheduled principal and interest payments, which means that the IMF's lending has a small net cost.

Some of the losses on the IMF's loans would be absorbed by the organization's reserves, which would reduce the cost to the United States of its new commitments to the IMF. The IMF adds amounts approximately equal to the income it earns on its loans to its already large reserves, which it can use to mitigate losses before they are passed on to its members. CBO estimates that those reserves could absorb a substantial share of the losses that could occur in the future.

To make its projections of those two components of the cost of the United States' participation in the IMF, CBO uses a probabilistic model to simulate changes in the IMF's financial assets and liabilities - including inflows and outflows from investments, loans to members, quotas, lines of credit, and operating expenses - under a range of outcomes for loans made by the IMF to member countries. The simulated annual cash flows to and from the U.S. government are expressed as a present value using market-based discount rates.

Why Does CBO Use a Market-Based Estimate of Cost?

The use of the fair-value method to estimate the cost of the United States' commitment to the IMF was established following consultation with the House and Senate Budget Committees and was the method specified in law the last time legislation affecting the IMF was enacted. CBO has concluded that it would continue to use that approach in analyzing future legislation that provided U.S. funding for the IMF.

Because CBO uses market-based discount rates to compute the present value of commitments to the IMF, its estimates include the cost of market risk that is inherent in the IMF's lending activities. Market risk - the risk that remains even after a portfolio has been diversified as much as possible - arises because most investments tend to perform relatively poorly when the economy is weak and relatively well when the economy is strong. Thus, incorporating the cost of market risk accounts for the fact that losses incurred by the IMF will tend to be largest in those cases in which the global economy is weakest. When the U.S. government takes on market risk, that risk is effectively passed on to private citizens who, as taxpayers and beneficiaries of government programs, bear the consequences of the government's financial losses. Private citizens tend to value their income more highly when the economy is weak than when it is strong, so bearing market risk associated with government programs is costly to them.

CBO accounts for the market risk associated with IMF commitments by using slightly higher discount rates to make the present-value calculations than the market rates of interest on the basket of low-risk debt. The use of higher discount rates for IMF cash flows reflects the fact that those flows have more market risk than funds invested in a basket of low-risk sovereign debt. CBO determines that discount rate from the market yields of sovereign debt securities with risks comparable to those of loans that would be made by the IMF. Without that adjustment to the discount rate, each additional dollar that the United States committed to the IMF would, CBO estimates, have a budgetary cost of approximately 0.5 cents per dollar committed instead of 2 cents.

Some analysts have expressed concern about using the fair-value approach in federal budgeting. One criticism is that adjusting some programs for market risk but not others might make comparison between programs difficult. Another concern is that changes in the cost of market risk over time make estimates more volatile. Finally, some critics of fair-value estimates note that such estimates are more complex than others and that they are therefore more difficult to communicate to policymakers and the general public.

Proponents of the fair-value approach counter that decisions about spending the public's money should take into account how the public assesses financial risks as expressed through unbiased market prices. They also note that concerns about volatility and complexity can be mitigated by using well-developed accounting practices.

How Uncertain is CBO's Estimate?

Although the risk posed by the IMF's lending strongly suggests that the United States' participation in the IMF has some budgetary cost, there is a great deal of uncertainty about the magnitude of that cost. No market-based financial instrument shares exactly the same risks that are inherent in IMF lending, so there is no comparable data from which the cost of members' commitments to the IMF could be inferred. There is also no clear historical precedent for an event that would generate losses to the IMF that were significant enough that they would be passed on to the United States; thus, the parameters of such losses are estimated with a large degree of uncertainty.

Those parameters include the frequency, magnitude, and duration of crises extreme enough to bring about a large increase in the IMF's lending and to cause a significant number of the borrowers to default on those loans. In addition, the terms of those loans (the interest rate paid by borrowers, for example) and the IMF's reserves affect the value of the United States' commitment. Finally, the actions of members and other entities may affect the IMF's finances and thus the value of the United States' commitment to the organization: Some actions, such as establishing programs to assist borrowing members to repay their IMF loans, might help the IMF's financial position, but others, such as challenging the priority of the IMF's claims above those of other debt holders, might hurt it. CBO intends for its estimate of the cost of the United States' participation to reflect the central estimate of the range of uncertain outcomes for each of those factors.

What Other Effects Does Participation in the IMF Have on the Federal Budget?

The United States' participation in the IMF has potential budgetary effects beyond those incorporated in CBO's fair-value estimates. Those effects include gains and losses attributable to fluctuations in interest rates and exchange rates, the potential value to the United States of the IMF's gold and other reserve assets, and the indirect effects on the budget from the IMF's role in stabilizing the global economy.

Data and Supplemental Information - Data Underlying Figures

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