Over the last three years, in the face of unprecedentedly large global payments disequilibria, the Fund has been more active than ever before in making its resources available to members in support of programs of balance of payments (BOP) adjustment. From January 1979 until December 1981, 88 arrangements were approved for a total of SDR 24.4 billion, compared with 54 arrangements totaling SDR 8.1 billion in the previous three years. Of the 1979–81 total, 73 arrangements in the sum of SDR 23.7 billion were either upper credit tranche stand-bys or extended arrangements; this compared with 29 arrangements for SDR 7.5 billion in the earlier three years.
The use of Fund resources under these facilities is usually preceded by intensive discussions between the authorities of member countries and the Fund’s management and staff concerning the economic policies to be adopted to correct the payments disequilibrium that gave rise to the financing need. This article describes a number of representative issues that arise in such discussions.
In analysing these issues, it must be borne in mind that the Fund’s essential purpose is the promotion of effective BOP adjustment. Both under the terms of its charter and because of the limited and revolving nature of the resources at its disposal, it must be assured that Fund lending supports policies that offer a firm prospect of achieving a sustainable payments position. In itself, this approach is not a source of controversy, since all member countries accept that the eventual restoration of external equilibrium is a constraint on policy that would apply regardless of the nature of the international economic system. It is therefore over the means by which such an equilibrium is achieved and maintained that differences of opinion chiefly arise.
Such differences reflect not only disagreements about the impact of particular economic measures on the BOP but also divergent perceptions of the way in which these measures impinge on the domestic policy objectives of the country concerned. As far as the latter are concerned, the Fund endeavors to ensure that programs supported by its resources achieve the desired degree of adjustment without causing undue harm to domestic goals, such as the growth of output and investment, and the equitable distribution of income.
A first step in the formulation of a program to be supported by the Fund’s resources is to assess the extent of the BOP improvement required and the member’s need for additional foreign exchange resources while that improvement is taking place. As just mentioned, the Fund can lend only for programs that give promise that the economy will be restored to a viable payments position. Such a position can be defined as one in which any remaining deficit on current account can be covered by sustainable capital flows—sustainable in the sense that they represent a willing long-term transfer of resources from overseas creditors and are consistent with the debt-servicing capacity of the economy.
For countries with limited access to international capital markets, an estimate of sustainable capital inflows is usually arrived at by assessing the economic assistance that is likely to be available from bilateral and multilateral sources during and after the period of adjustment. Where countries are in a position to tap additional, private, sources of foreign financing, an estimate is needed of the country’s capacity to attract and service additional debt. This assessment depends on a number of factors that cannot be forecast with any precision, such as the level of real activity in the world economy, international interest rates, the availability of finance for international lending, and the success of individual borrowing countries in achieving their objectives for growth in output, investment, and exports.
Not surprisingly, differences of view arise between the Fund staff and member authorities concerning what constitutes a viable payments position on current account and how rapidly it is feasible to attain it. Sometimes, the authorities in developing countries will argue that it is unfair to expect them to compress their current BOP deficit (which represents the net flow of real resources from the rest of the world), when their payment difficulties have arisen from factors largely beyond their control. They would prefer to plan an adjustment strategy on the assumption that the world economic climate will improve, perhaps with an implicit hope that additional resources would be available through the Fund to finance them in the event that it did not.
As noted above, however, the resources the Fund can make available to members in deficit are strictly limited. Under existing credit tranche policies the maximum that a member can borrow is one and a half times its quota subscription in any year, or four and a half times its quota over three years. (On average, Fund quotas are currently about 3 per cent of annual imports, though variations around this average are quite substantial.) If such lending is to be repaid, and if borrowing members are not to run into insurmountable difficulties when access to the Fund’s resources has been exhausted, lending must be accompanied by a planned program of economic rehabilitation. This need applies regardless of whether the factors that have given rise to an underlying payments disequilibrium are of internal or external origin.
At some risk of oversimplification, the kinds of measures and policies that usually form part of programs supported by use of the Fund’s resources can be grouped into three broad (and not always distinct) categories:
the management of the level and structure of aggregate demand;
the enhancement of the economy’s supply capacity, particularly of tradable goods; and
measures to shift the structure of output toward net exports.
Ensuring that aggregate demand is consistent with the economy’s supply capacity and the authorities’ objectives for price stability and the BOP is always a central aspect of macroeconomic policy. Beyond this, supply-side measures have received increasing emphasis in recent years, with the assistance of the World Bank, because of a growing realization that exploiting the scope that often exists for improvements in resource allocation can reduce the burden of external adjustment and increase economic welfare. Last, shifting the pattern of output toward exports and import substitution, often involving action on the exchange rate, is frequently necessary to provide a more immediate and direct incentive to shift resources toward an improvement in the BOP.
Demand management. In formulating a program with the Fund, member countries usually establish objectives for the rate of growth of output and investment and the moderation of inflation, as well as for the BOP. These objectives affect the flows of real and financial resources among sectors of the economy and between domestic and foreign sectors. They also usually require policy measures to ensure that the level and distribution of demand are consistent with the authorities’ broad macroeconomic objectives.
Much empirical evidence confirms that the rates of growth of monetary and credit aggregates affect the rate of nominal income growth and the BOP. Inevitably, therefore, understandings on monetary policy are an important part of the demand management strategy incorporated in programs supported by Fund resources. The objective is to set a target (or ceiling) for the rate of growth of bank credit that is consistent with the program’s objectives for real economic growth, inflation, and the country’s external payments position. Of course, there are numerous uncertainties in arriving at monetary targets. The determinants of the demand for money are often not well defined; BOP forecasts can turn out to be wrong for a number of reasons—real growth can be influenced by non-monetary developments (such as weather conditions) and so on. Nevertheless, it is clear that some judgment must be reached.
Adjustment programs also normally include a target for containing the government’s budget deficit. This target is employed because the fiscal deficit is an important determinant, in its own right, of the level and structure of demand and also because official borrowing to finance the deficit can put pressure on the availability of funds for the private sector. Broadly speaking, fiscal targets are arrived at by taking the overall rate of credit expansion compatible with the objectives of the program and determining the needs of the nongovernment sector for the desired level of output and investment. What remains is the volume of bank credit that can be used by the government without preempting productive nongovernment borrowing.
Setting fiscal and monetary targets is only the first stage in establishing a set of demand management policies. To give such targets credibility, it is usually necessary for specific measures to be implemented (or at least decided on) before a program is presented for approval by the Fund’s Executive Board. In the fiscal area, such measures might include the introduction of new taxes, the raising of tax rates, or constraints on spending authority under the government budget. When such measures are adopted, the Fund staff reviews the fiscal prospects with the authorities so that it can be in a position to report to the Board that the budgetary estimates are realistic and achievable. In the monetary area, it is more difficult to specify in advance the particular measures that will be used to limit credit growth, but the authorities usually indicate a willingness to use policy instruments such as interest rates, open market operations, and credit guidelines to restrain financial aggregates within the targets that have been set.
Adherence to fiscal and credit targets (usually on a quarter-to-quarter basis) is the principal monitoring instrument used by the Fund and member countries to assess whether adjustment programs are remaining on track. Programs always contain “ceilings” on overall credit expansion and bank lending to government; if these ceilings are not observed, drawing rights are interrupted unless new policy understandings are reached. Naturally, therefore, member authorities would prefer these ceilings to be relatively high, in order to give them freedom to respond to unforeseen developments. The Fund, on the other hand, has an interest in ensuring that the programs’ policies can be reviewed in circumstances where its financial projections do not materialize.
There can also be divergent views on the degree of precision with which policy measures (particularly in the fiscal area) should be articulated in advance. The Fund’s experience is that a program will carry greater credibility and have greater chances of success if the concrete demand management measures to be taken are clearly identified and, as far as possible, implemented at an early stage. While recognizing this, member countries may also see an advantage in postponing politically sensitive decisions. For this reason, they sometimes would prefer their commitment to be in terms of a general undertaking to raise revenue or reduce expenditures by a certain amount.
While the Fund seeks programs that are specific in describing the policy measures to be implemented, the actual choice of measures remains that of the member. So long as the aggregate impact of the fiscal stance is consistent with the required moderation in demand, the staff is not authorized to insist on the manner in which it is achieved. In some cases, of course, member countries may seek Fund advice on particular measures, and the staff may offer suggestions on ways in which a fiscal gap could be bridged in a manner most conducive to efficient resource allocation. But it is always clear that, when questions of specific taxes and expenditures are under consideration, the staff’s role is advisory and that the ultimate discretion belongs to the member.
Supply measures. In recent years programs supported by the Fund have given increased emphasis to measures aimed at developing the productive potential of borrowing members. There are several reasons for this. The large size of payments imbalances and their structural character have meant that many member countries have a large and growing external debt that can only be satisfactorily serviced if output and export growth are adequately maintained. Further, with large shifts in the terms of trade, particularly the rapid increase in the real price of energy, structural changes in production patterns in deficit countries have become even more necessary than formerly. Lastly, the fact that many Fund programs now extend over two or three years offers greater scope for supply-side measures that have an impact on economic efficiency and external performance in the medium term.
Broadly speaking, supply-side measures are aimed at improving the allocation of resources in the economy and enhancing both the quality and quantity of productive investment. By so doing, it is hoped that the underlying rate of real economic growth can be accelerated and the availability of tradable goods for export or import substitution increased. Higher growth of output and exports benefits the adjustment process in two ways. First, it will enable a given target for the current account deficit to be achieved with less sacrifice in the resources available for domestic use; and, second, it will improve the economy’s debt service capacity, making possible a higher inflow of external resources.
The nature of the program measures that directly affect a country’s output varies widely from case to case. Where an investment program exists, it is of critical importance, and the Fund staff collaborates closely with the staff of the World Bank in assessing whether development spending plans are consistent with aggregate resource availability and the need to build up competitive and adequately diversified export and import substituting sectors. Where changes in development policy are suggested, they are often aimed at reducing reliance on large-scale, long-gestation industrial projects (which are usually heavily dependent on imported capital equipment and intermediate inputs) and increasing the emphasis given to agriculture, infrastructure, energy, and relatively quick-yielding investments in the manufacturing sector.
Pricing policy is another area that is often carefully examined. In many countries, key prices are regulated both for social reasons and to prevent an undesired pattern of resource use resulting from an unrestricted play of market forces. While the reasons for such price regulation are important and in many cases valid, political pressures sometimes make regulated prices inflexible in the face of inflation and changing conditions. The Fund typically stresses the advantages, if resources are to be allocated according to their scarcity, of making adequate adjustments in controlled prices; for instance, the Fund invariably urges that user prices for energy products should be raised to at least world levels. Member countries, while usually agreeing with this analysis in principle, are naturally constrained by what they perceive to be the social and political repercussions of price rises.
Programs of medium-term adjustment also frequently cover the performance of public sector enterprises and the nature of the foreign trade regime. Concerning the latter, economic performance can often be improved by increasing the availability of needed imports, exposing domestic industry to increased competition (by reducing import controls), and concentrating domestic resources in the production of those goods in which the country enjoys a comparative advantage. These considerations point toward a more “open” foreign trade regime, with less reliance on administrative means to ration foreign exchange and regulate imports. In urging such a course, however, it is not uncommon for the Fund to encounter resistance from members who are concerned that such actions will undermine the economic viability of established domestic industries that are not competitive at world prices—which will, in turn, adversely affect the BOP.
Demand-switching policies. Often demand restraint alone is not sufficient to correct a serious BOP problem, and supply-side measures are, by their nature, likely to work only slowly in improving output and exports. Thus programs of payments adjustment supported by arrangements with the Fund usually involve measures with a more direct effect on the balance between external receipts and payments. Theoretical considerations, as well as a considerable amount of empirical evidence, suggest that the policy instrument that has the most general and direct impact on external competitiveness is the exchange rate. An appropriate exchange rate is central to the adjustment process and to the Fund’s other responsibilities, and discussions on this issue are frequently a major aspect of negotiations on a program to be supported by use of the Fund’s resources.
Exchange rate policy is almost always a sensitive issue, and an exchange rate change implies consequential changes in relative prices in the domestic economy, not all of which will be welcome on social and other grounds. As a result, exchange rate policy is often one of the most difficult areas in which to reach agreement. To avoid some of the less welcome consequences of exchange rate changes, member countries sometimes prefer to use administrative means (licenses and quotas) to limit import payments or to resort to special tariffs and subsidies to help balance the external accounts. The Fund’s experience, however, is that such mechanisms are less efficient, in an economic sense, than a straightforward exchange rate adjustment. They tend to interfere with efficient resource allocation, hamper economic growth, and can usually only postpone a direct change in the exchange rate.
Where a rate adjustment appears warranted, a judgment must be reached on the size of the required realignment and the manner in which it is to be brought about. The staff attempts to calculate how the demand for and supply of exports and imports will shift as the exchange rate changes, and it supports this analysis with a calculation of the extent to which domestic and international costs of production have diverged since some equilibrium base period (although information and techniques available seldom permit a very precise calculation of the size of the adjustment required). Where feasible, the profitability of export and import-competing sectors is assessed.
Sometimes, a comprehensive study is undertaken by the Fund staff in conjunction with member authorities in an effort to establish a common analytical framework and begin a dialogue aimed at reaching agreement on a suitable rate. In some cases, an exchange rate change is postponed pending completion of this process, with the provision that suitable understandings be reached during the life of the program. In cases where a member has a complex exchange system, with different rates for different transactions, a gradual adjustment can be brought about by a phased shifting of transactions from one rate to another. The ultimate objective, however, is usually a unified exchange rate at a realistic level. In still other cases, phased adjustment may be achieved through a series of rate adjustments, a crawling peg, or temporary or permanent floating of the exchange rate.
Preconditions, performance criteria, and review clauses
An essential aim of programs in the upper credit tranches is to provide the Fund with the assurance that its resources are being used to support needed adjustment. To some extent, this assurance is given through the adoption of measures by a member prior to the approval of an arrangement by the Executive Board: this is regarded as particularly necessary when a member country’s performance under earlier programs has been disappointing and international confidence in the member’s commitment to the adjustment process is weak. Such measures may include, depending on the circumstances, exchange rate action, interest rate adjustment, or fiscal measures designed to help bring about the needed budgetary improvement.
“… with or without the Fund’s involvement, the process of restoring a viable external position is likely to involve painful adjustments to existing economic structures.”
In addition, Fund programs in the upper credit tranches always include “performance criteria” that if not met, result in an interruption in the member’s right to make subsequent drawings under the arrangement. To avoid unduly detailed constraints on a member’s internal policymaking process, and to obviate the need for fine judgment by Fund staff, performance criteria are rather general in character and few in number. They typically include quarterly ceilings on the rate of overall bank credit expansion in the economy and subceilings on the amount of such credit absorbed by the government (or by the public sector). In addition, there is usually a limitation on the contracting of external debt guaranteed by the government. Beyond these ceilings, there are a number of qualitative performance criteria dealing with the member’s intention not to introduce or intensify restrictions on payments, or bilateral payments arrangements, with other members.
If one or the other of the performance criteria is not observed, the Fund staff hold consultations (often involving a staff visit) with the member on the reasons. If the excess over a ceiling is small and technical in character and does not invalidate the objectives of the program or cast doubt on the attainability of subsequent ceilings, a “waiver” may be recommended to the Board. If approved, this restores the member’s drawing rights. If the excess is more substantial and suggests that the member may experience difficulties in meeting the objectives of the program, the staff will begin discussions on the kind of measures needed to reestablish the momentum of adjustment. Following agreement on such measures, the staff will present modified performance criteria to the Board, which, if approved, similarly restore the member’s drawing rights under the arrangement. Where no such agreement can be reached, the program remains inoperative and the member’s drawing rights are in abeyance. Usually, if agreement is not reached on modifications that enable the basic goals of a program to be preserved, and if it remains inactive for a protracted period, the staff would suggest to a member that the original program be canceled or allowed to lapse and efforts be directed instead toward the formulation of a new program to take account of new circumstances.
“Review clauses” cover policy adjustments that may need to be made during the life of a program but that cannot be seen with clarity when the program is formulated. In this connection, mention has already been made of the exchange rate. It may also be that the budget year does not coincide with the period covered by the arrangement, in which case it may be necessary to make suitable fiscal measures subject to a review clause at the time the budget is introduced.
The review clauses just mentioned are performance criteria in the sense that drawings cannot continue unless policy understandings between the Fund and the member are reached at the time of the review. In addition, all programs contain provision for periodic (normally semiannual) consultation and review. Such consultation and review need not involve a requirement to reach policy understandings but are simply to provide the Fund with an opportunity to consult with the member on the implementation of the program.
One-year, multiyear programs
A financial program normally covers a period of 12 months, since such a period corresponds best with the financial planning horizon of monetary authorities. However, as already noted, a number of arrangements have been established in support of adjustment programs extending over two or three years. This raises the question of the relationship between the longer-term adjustment program and the annual financial program.
In a typical three-year stand-by or extended arrangement, the authorities indicate not only the structural measures they intend to introduce over the program period but also their demand management strategy. This may involve, for example, a gradual but sustained reduction in the fiscal deficit and a deceleration in the rate of growth of the money and credit aggregates. For the first year of the program, concrete measures to set this process in train would be described and reflected in precise targets or ceilings for the financial aggregates involved. For subsequent years, the policy description is usually at a more general level, covering, say, the intended size of the fiscal deficit and rates of growth of aggregate revenues and expenditures but not involving commitments to specific actions in the revenue and expenditure fields. At the beginning of the second and third program years, a detailed financial program for the ensuing 12-month period would be drawn up, with quantified fiscal and monetary targets.
It is clear from what has been said in this article that the economic policy measures involved in programs supported by the Fund’s resources are difficult and politically sensitive. Yet, it must be recognized that, with or without the Fund’s involvement, the process of restoring a viable external position is likely to involve painful adjustments to existing economic structures. The need for the kind of BOP financing the Fund provides to be accompanied by effective action to remove the basic sources of disequilibrium is rarely questioned. Of course there can be, and frequently is, disagreement regarding the nature of the precise policies to be adopted in individual circumstances. The Fund attempts to be flexible in this regard: matching the content of adjustment programs to the circumstances of individual members, while attempting to ensure that the momentum of adjustment is adequately sustained. The evolving nature of Fund programs is a reflection of this attempt to incorporate the lessons of experience into the current practice of the institution.
Procedures in establishing adjustment programs
Initiation. There is no fixed procedure for initiating discussions on a program to be supported by the Fund’s resources. The Fund has regular contact with member authorities through annual Article IV consultations (on exchange rate arrangements), through the Executive Directors, and through other visits either by Fund staff to member countries or by member government officials to Washington, D.C. Whenever BOP trends suggest that a financing gap is or may be emerging, the nature and scope of possible adjustment measures is a central feature of discussions during these contacts. At such times, the member country may request Fund assistance in designing a suitable program, or the Fund staff may itself suggest the advantages of comprehensive adjustment measures supported by use of the Fund’s resources. If, as occurs in quite a significant number of cases, a country is already using resources in the first credit tranche, a dialogue would already have begun, albeit on a less comprehensive basis than would be needed for a program supported by resource use in the upper credit tranches.
Request for assistance. The actual request to initiate discussions on the use of Fund resources, whether in the upper credit tranches or under the Fund’s other facilities, need not be formal. Typically, the authorities of a member country will indicate to the Fund staff or to their Executive Director their wish to discuss a possible arrangement, and this will be immediately communicated to the Managing Director. The request and the subsequent discussions are confidential and, as far as possible, unpublicized. This is because the policies that will be under discussion are sensitive and the success of the discussions cannot be assured; in the event that agreement cannot be reached, it is often desirable to avoid unnecessary speculation on the reasons for the disagreement.
Preparations by Fund staff. The Fund is prepared to try to respond to a request for discussions on the use of its resources as rapidly as the situation requires. Prior to its departure the staff team, or “mission” as it is called in the Fund’s terminology, prepares a comprehensive briefing paper that sets out the member’s current economic situation, reviews recent discussions between the staff and the authorities on adjustment policies, and considers in as much detail as possible the nature and scope of the options the staff believes are open to the authorities to bring about the needed adjustment. This briefing paper is reviewed within the Fund staff to ensure both a consensus on the adjustment measures proposed and consistency with the Fund’s uniform (which does not, of course, mean identical) treatment of all members. The briefing is then forwarded for review to the Managing Director, who will frequently call a meeting to discuss its contents with the mission head and other senior staff. When he is satisfied that the briefing is consistent with the guidelines established by the Executive Board, he gives it his approval, at which time it becomes the instructions under which the staff will operate.
Negotiating procedures. While the staff always negotiates ad referendum to the Fund’s management and Board, the degree of latitude given to a mission in its brief can vary. If, as often happens, the economic information on a member country available at headquarters is incomplete or not fully up-to-date, some flexibility is needed to enable the staff to respond to the actual situation when discussions take place. Further, the policy instruments that the authorities are prepared to consider may not be precisely those that the staff is able to foresee when it prepares its briefing. Since staff missions do not normally refer to headquarters for additional instructions during the course of their work, it is important for them to have adequate discretion to respond authoritatively to proposals by member authorities, even when these have not been foreseen.
Mission composition. A typical mission consists of four to six economists. The mission chief is usually a senior staff member of the area department concerned, and he is accompanied by one or two staff members from that department who specialize in the country involved. In addition, there will be a staff member from the Exchange and Trade Relations Department, whose specific assignment includes work on the external trade and payments aspects of the program, and often also a staff member from another department (such as the Fiscal Affairs Department), if a particular area of economic management warrants special attention. An increasing number of recent missions have been accompanied by a staff member from the World Bank. This has been found particularly useful, and even necessary, in adjustment programs stretching over more than one year to ensure that the BOP adjustment process is consistent with such longer-term goals as improving the efficiency of domestic resource use, promoting economic diversification, and rationalizing the development program.
A mission usually remains in the field for about two to three weeks, though this timetable can vary depending on the difficulty of obtaining necessary information, the complexity of the program, and the constraints faced by member authorities in marshaling a consensus for needed adjustment measures. This latter factor not infrequently prevents full agreement being reached during a single mission. In such circumstances, discussions are adjourned, which offers the authorities of the member country the chance to reflect on the scope of an adjustment program and permits the Fund staff the opportunity to present the Managing Director with a more comprehensive picture of the latest economic developments and the authorities’ thinking.
Forms of agreement. Once understandings have been reached between the staff and the authorities on needed adjustment measures, the staff assists the member country in drawing up a formal request for its use of Fund resources. The manner in which this request is presented varies slightly from case to case but, in a typical one, the Minister of Finance, on behalf of his government, will address a “letter of intent” to the Managing Director. This document, besides requesting use of resources, describes in some detail the measures that are being undertaken to improve economic and financial performance, the policies that will be followed during the life of the program, and the circumstances under which the member will request (or refrain from requesting) drawings under the arrangement.
When the staff returns to headquarters, the mission chief prepares a brief note summarizing the discussions for the Managing Director and attaches the draft letter of intent. This is also circulated to interested departments within the Fund. At this stage, it is not uncommon for minor changes in the letter of intent to be proposed to the authorities for legal or technical reasons. Once the Managing Director is satisfied that the policies described in the member’s request are appropriate to the situation, the staff prepares a report for the Executive Board that describes the background to the request, the economic developments and prospects, and the manner in which the proposed program will restore a viable economic position. Preparation of this document usually takes several weeks, though this timetable is shortened when the need for financial support is urgent.
Board discussion. The staff report, together with the member country’s request, is circulated to the Executive Directors and put on the Board’s agenda for discussion and decision four weeks later. Since the program will have been framed against the background of the Executive Board’s guidance (both from specific decisions and from comments made in the course of Board discussions on other subjects), a management recommendation to make resources available to a member country is likely to be approved. Nevertheless, Board discussion, which frequently extends over several hours, has an important influence on the way in which programs are put into effect. First, since usually a detailed record of the Board’s discussion, together with the Managing Director’s summing up, is transmitted to the authorities, it can affect the manner and pace at which measures contemplated for the program period are actually implemented. Second, it can guide the staff in conducting periodic reviews of performance under the program. This is particularly important when certain measures have been left for subsequent decision under “review clauses.” Lastly, the tenor of the Board’s views on a given program gives guidance to the staff in the negotiation of other programs. For example, if the weight of opinion is that, say, fiscal performance could have been more ambitious or that inadequate attention was being paid to the energy sector, additional emphasis would be given to these points, where appropriate, in subsequent programs.
EduardBrau “The consultation process of the Fund” Finance & Development (December1981).
JosephGoldConditionality Pamphlet No. 31 (Washington, DCInternational Monetary Fund1979).
ManuelGuitiánFund Conditionality: Evolution of Principles and Practices Pamphlet No. 38 (Washington, DCInternational Monetary Fund1981).