Chapter

The IMF’s Conditionality Re-Examined

Editor(s):
Joaquín Muns
Published Date:
September 1984
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Author(s)
E. WALTER ROBICHEK

The subject of the IMF’s conditionality is somewhat shopworn, so much so that I should perhaps have given my paper the title “The IMF’s Conditionality Re-Re-Examined.” But it would seem that there is room for shedding some new light on certain aspects of the IMF’s conditionality that are still not fully understood. This paper is organized in four sections: The first section establishes the legal basis for the IMF’s conditionality: the second explores the constraints of the margin of flexibility that the IMF has for accepting those adjustment programs that it can support with its resources; the third examines the rationale of the policy instrumentation of such adjustment programs; and the fourth addresses certain dilemmas that the present world economic conditions pose for the IMF’s conditionality.

I. LEGAL BASIS FOR THE IMF’S CONDITIONALITY

The principle that access to the IMF’s resources in the upper credit tranches under its general purpose facilities, that is, under stand-by and extended arrangements, should be subject to conditions has found increasing acceptance over time, but certain doubts linger on. It is a matter of record that the controversy over the principle of conditionality was not settled at Bretton Woods; that the signals in the early years of the IMF’s existence, in fact, pointed to the acceptance of a considerable measure of automaticity of access to its resources; and that these signals proved to be false in the end. There is a wealth of documentation on this subject, including such in-house sources as the IMF’s official history1 and several articles by its former General Counsel, Sir Joseph Gold. A fairly recent exhaustive treatment of this subject by an outside source is an excellent article by Sidney Dell.2 The author concedes, albeit somewhat grudgingly, that the IMF’s Executive Board in the end settled the argument definitively in favor of conditionality when it created the stand-by arrangement on February 13, 1952.

It is no secret that the argument was settled under pressure from the U.S. Government, against the solid opposition of the rest of the IMF’s membership, for fear that the universal shortage of dollars would cause a run on the IMF’s resources unless access to them was made subject to conditions. A strong case can nevertheless be made in favor of the logic of the decision. The original Articles of Agreement foresaw two types of balance of payments deficits: a structural deficit that called for an exchange rate adjustment and a temporary self-correcting deficit that qualified member countries for access to the IMF’s resources. What the founding fathers apparently had not foreseen is that the typical balance of payments deficit is neither structural nor self-correcting inasmuch as it is caused by faulty domestic and external policies. The stand-by arrangement provided a solution for this typical intermediate case in that it assured a member country access to the IMF’s resources provided the member undertook to follow domestic and external policies designed to correct its balance of payments problem within a reasonable period of time.

Notwithstanding the historical record, and the inherent logic, challenges to the IMF’s right to impose conditions for access to its resources are still heard from time to time. What is invariably ignored by these challenges is that the IMF has the statutory authority and obligation to intercede with all its member governments in those aspects of their external and domestic policies that are customarily covered in programs supported by stand-by and extended arrangements, irrespective of their financial relationship with the IMF at the moment.

The IMF’s jurisdiction over the exchange rates and exchange practices of member governments was firmly established in the original Articles of Agreement; and its jurisdiction over the gamut of external and domestic policies and policy instruments that have an impact on a country’s balance of payments was given explicit recognition in the Second Amendment to the Articles of Agreement. Thus, Article IV, Section I, states under the heading “General obligations of members”:

Recognizing that the essential purpose of the international monetary system is to provide a framework that facilitates the exchange of goods, services, and capital among countries, and that sustains sound economic growth, and that a principal objective is the continuing development of the orderly underlying conditions that are necessary for financial and economic stability, each member undertakes to collaborate with the Fund and other members to assure orderly exchange arrangements and to promote a stable system of exchange rates. In particular, each member shall:

  • endeavor to direct its economic and financial policies toward the objective of fostering orderly economic growth with reasonable price stability, with due regard to its circumstances;

  • seek to promote stability by fostering orderly underlying economic and financial conditions and a monetary system that does not tend to produce erratic disruptions;

  • avoid manipulating exchange rates or the international monetary system in order to prevent effective balance of payments adjustment or to gain an unfair competitive advantage over other members; and

  • follow exchange policies compatible with the undertakings under this Section.”

Further, Section 3 of the same Article states under the heading “Surveillance over exchange arrangements”:

  • “(a) The Fund shall oversee the international monetary system in order to ensure its effective operation, and shall oversee the compliance of each member with its obligations under Section 1 of this Article.

  • (b) In order to fulfill its functions under (a) above, the Fund shall exercise firm surveillance over the exchange rate policies of members, and shall adopt specific principles for the guidance of all members with respect to those policies. Each member shall provide the Fund with the information necessary for such surveillance, and, when requested by the Fund, shall consult with it on the member’s exchange rate policies. The principles adopted by the Fund shall be consistent with cooperative arrangements by which members maintain the value of their currencies in relation to the value of the currency or currencies of other members, as well as with other exchange arrangements of a member’s choice consistent with the purposes of the Fund and Section 1 of this Article, These principles shall respect the domestic social and political policies of members, and in applying these principles the Fund shall pay due regard to the circumstances of members.”

The IMF carries out this surveillance mandate by means of periodic consultations with all its member countries. Those who are inclined to challenge the legitimacy of the IMF’s insistence on changes in a member government’s external and domestic policies as a condition for granting access to its resources, therefore, should face up to the fact that the institution is mandated to follow essentially the same approach in its relations with all member countries, regardless of whether or not they seek access to its resources; they should also realize that they are on the weakest possible ground when they single out the IMF’s advocacy of exchange rate changes and the liberalization of exchange regimes for challenge as undue interference with a country’s sovereignty.

2. CONSTRAINTS OF THE IMF’S FLEXIBILITY IN SUPPORTING ADJUSTMENT PROGRAMS

Frequent criticisms of the IMF’s approach to adjustment for being insufficiently flexible and too restrictive ignore the limited degree of freedom that the institution has in supporting adjustment programs with its resources. A cardinal rule for any IMF-supported adjustment program is that the contemplated balance of payments deficit can be expected to be fully financed from drawdowns of a country’s own international reserves, the IMF resources committed to it, and its access to other sources of balance of payments finance. Countries typically seek to enter into stand-by or extended arrangements with the IMF when their own international reserves are close to exhaustion and when their access to other external sources of finance is severely curtailed. When this is the case, the limits of the flexibility that the IMF has in supporting an adjustment program are essentially set by the amount of its resources which it is prepared to commit to the country concerned.

It is true that a number of IMF-supported programs call for the retention in a country’s international reserves of part or even all of the IMF resources committed under stand-by or extended arrangements, or the application of some or all of these resources to the repayment of reserve liabilities of the country’s monetary authorities and of its external payments arrears. The division of the resources, which the IMF commits under a stand-by or extended arrangement, between those that the member country can spend and those that it is expected to put into its international reserves or use to repay reserve liabilities (including external payments arrears) is determined either by an explicit balance of payments performance test or by a balance of payments target implicit in the difference between the projected growth of the pertinent monetary variable and the explicit credit ceiling. Thus, this allocation of a country’s use of IMF resources is mandatory under a test and notional under a target.

The balance of payments performance test or target is negotiated with the authorities, but in most cases within the constraints dictated by the country’s disposable international reserve holdings and its reserve liabilities (including, as appropriate, external payments arrears) repayable within the program period. It is logical that part or even all of the IMF resources committed under stand-by or extended arrangements be earmarked for these purposes, in appropriate cases, considering that a central bank can manage its exchange market efficiently only if it disposes of a minimum of international reserves and that external payments arrears almost always deprive a country of normal trade credits from abroad.

In negotiating adjustment programs the IMF takes full account, wherever this is appropriate, of its role as a catalyst beyond the commitment of its own resources, owing to the influence which it exerts over the flow of funds to deficit countries from other official sources and from private banks. The IMF has been able to bring this influence effectively to bear essentially only on behalf of countries with stand-by or extended arrangements. Thus, relief from government-to-government debt service within the framework of the so-called Paris Club is now invariably conditioned on the prior negotiation of a stand-by or extended arrangement with the debtor country, as is relief from debt service to foreign banks. When it comes to mobilizing new funds for debtor countries, the IMF has exerted its influence over government-to-government aid flows within the framework of country-specific donor groups, customarily chaired by the World Bank, by pointing to the financing gap in a program supported or expected to be supported by a stand-by or extended arrangement, and rarely, when there was neither prospect of such an arrangement nor a clear need for it, by a broad endorsement of the aid recipient government’s economic policies. The IMF’s experience with inducing private financial institutions to maintain their capital flows to debtor countries is new and is still subject to much experimentation. But it is already abundantly clear that the IMF could not consider going that far in its advocacy of a borrowing country’s case until the country has negotiated a stand-by or extended arrangement.

The IMF has been under perennial pressure to allow countries more time for adjustment. But the speed of adjustment, like the magnitude of the adjustment effort, is determined by the amount of emergency balance of payments finance available to a country from its own international reserves, the IMF resources committed to it, and its access to finance from other external sources; as already noted, this often comes down solely to the amount of IMF resources committed under a stand-by or extended arrangement. It is clear that the more drawn out the adjustment process, the greater will be the amount of emergency balance of payments finance needed to carry a country from an unsustainable to a sustainable external payments position; for example, an adjustment will require double the emergency balance of payments finance if spread smoothly over two years rather than one, triple the emergency finance if spread over three years, and so on.

3. POLICY INSTRUMENTATION OF ADJUSTMENT PROGRAMS

The point has been made repeatedly that the IMF tends to place undue reliance on demand management and insufficient reliance on supply-oriented structural adjustment; and, even among the ones who concede that demand management is of relevance there are those who allege that the monetarist approach to the balance of payments is not valid in certain country-specific conditions or at a given stage in the economic cycle. Dogmatic though it may sound, the monetarist model is a universally valid analytical framework, derived as it is from the balance sheet identity. The changes in the net international reserve position cannot but help to fully reflect the difference between changes in money and credit. The dismissal of the validity of this model on theoretical grounds, therefore, can only be explained by an altogether understandable human tendency to resist any form of determinism.

The argument that adjustment programs built on this approach are excessively vulnerable to errors in forecasting cannot be dismissed quite that easily. Programming errors do occur with some frequency because of lack of foresight about external market conditions or domestic production trends, for example, crop prospects. Such errors also occur because programmed policy measures, for example, discretionary government revenue measures, changes in exchange rate management or in the interest rate structure, the removal of exchange restrictions, or the liberalization of foreign trade, do not yield the expected results. But the potential implications of such programming errors for the balance of payments, the bottom line of any Fund-supported adjustment program, should not be exaggerated.

When it comes to the balance of payments outcome, there can be no specification error under a test, and under a target such an error is necessarily confined to the projected behavior of the critical monetary variable. Monetary projections obviously are subject to considerable margins of error, given that they are derived from forecasts of changes in real output, in domestic prices, and in the income velocity of the monetary variable selected, as well as from assumed levels of interest and exchange rates. But, if the programmed credit ceiling is observed, the departures from the implicit balance of payments target will of necessity equal the difference between the projected and the actual change in the pertinent monetary variable; and if the projection is reasonable, it is as likely that the balance of payments outcome will exceed the target as that it might fall short of the target.

The IMF has been experimenting with formulas for automatic adjustment of balance of payments performance tests to protect member countries from unforeseen contingencies and errors in forecasting, particularly shortfalls from projected levels of capital inflows. Such automatic adjustment formulas, of course, cannot be confined to the balance of payments performance test alone; for the sake of maintaining the coherence of a program, they must be carried through to all the interlocking quantitative targets and ceilings. It is worth emphasizing, however, that automatic adjustment formulas are possible only if either a country upon entry into a stand-by or extended arrangement disposes of international reserves or the program calls for the retention of at least part of the committed IMF resources in its international reserves, and only to the extent of any such international reserve availability and retention of IMF resources.

The emphasis placed in IMF-supported adjustment programs on demand management does not in any way detract from the frequently critical importance of building into such programs effective supply-oriented structural adjustment measures. A taxonomy of the latter is virtually endless. There can be no doubt that improvements in education, public health, and the distribution of land holdings will in time have a significant impact on national output. But leaving aside the fact that the IMF was designed to be a specialized doctor and not a general medical practitioner, and that as a consequence it lacks the technical competence to deal with problems in many important fields of socioeconomic policy, the structural improvements such as the ones just referred to have a gestation period that exceeds by many years the permissible time frame of a stand-by or extended arrangement. Another supply-oriented factor with far reaching implications for future output but beyond the IMF’s purview is the quality of domestic investment; not only are the requisite technical judgments within the competence of the IMF’s sister institution, the World Bank, but investments, too, typically have a gestation period exceeding the time frame of a financial arrangement with the IMF.

What remains of supply-oriented measures for the IMF to address in negotiating adjustment programs is essentially pricing policies, and foremost among them are those for the prices with the most pervasive effects throughout the economy, that is, the exchange rate, interest rate, and wage policies. My colleague, Mr. Loser, has extensively dealt in his paper with this particular subject. I will confine myself to only a few observations of a general character. Adjustment programs supported by stand-by or extended arrangements with the IMF have always focused on these economy-wide prices because of their relevance as supply-oriented instruments, as well as their critical relevance to demand management.

Therefore, it is largely in the eyes of the beholder whether to classify these or any other pricing policies as demand management tools or as instruments of a supply-oriented policy thrust. But it is worth stressing that, given the close linkages between exchange rate, interest rate, and wage policy, it would not be sensible to address one without taking the others into account. It is somewhat astonishing, therefore, that one hears so many argue that wage policy is none of the IMF’s business.

The IMF has also been taken to task for recommending the elimination of consumer subsidies, allegedly because of an ideological bias against policies benefiting the underprivileged. These critics go to the extreme of denying that subsidies have balance of payments implications either in the short or the long run. The truth of the matter is that subsidies paid by governments are a charge to the budget and as such have adverse balance of payments effects in the short run, and subsidies paid by producers discourage production and as such have an adverse balance of payments effect that is somewhat more delayed. Given the frequency of criticisms of the IMF along these lines, and their apparent lack of rationality, one is left to wonder whether there really is any general desire to see the IMF be supply oriented in its approach to adjustment.

4. IMPLICATIONS OF THE WORLD ECONOMIC RECESSION FOR THE IMF’S CONDITIONALILY

The IMF was founded to avert worldwide economic depressions. For this purpose, it was mandated to develop rules for orderly exchange rate changes and other exchange practices by its member countries and it was endowed with financial resources to place at their disposal in order to give them an alternative to their adopting policies that would be detrimental to international trade in goods and services. Until recently the IMF’s capability for averting a worldwide depression had not come to a test. It is conceivable that it now faces such a test, and this raises the question whether its approach to adjustment is still appropriate.

Let it be admitted that the IMF now faces a certain dilemma. Although it has increasingly adopted a global analytical framework, foremost within the context of its rather elaborate annual world economic outlook exercise, it is not at present well equipped to deal operationally with balance of payments problems except on a country-by-country basis. The unfortunate consequence of the IMF’s country-specific operations is that there is a risk that it may become an accomplice to the very beggar-my-neighbor policies that it was created to avert. Its advocacy of a flexible exchange rate management in the countries of South America has the potential for competitive devaluations when market-determined exchange rates overshoot equilibrium levels, as they have a tendency to do.

Perhaps of more relevance to the subject of this paper is the question that is increasingly being raised of whether in the present state of the world economy the IMF should not relax its standards for adjustment programs that it is prepared to support by stand-by or extended arrangements.

It was noted earlier that adjustment programs which the IMF supports by stand-by or extended arrangements frequently call for part, if not all, of the IMF’s resources committed under such arrangements to be retained in a country’s international reserves or to be used for repaying the reserve liabilities of its monetary authorities. When this is the case, it could be argued that the IMF’s pertinent practices should be liberalized in present world economic conditions. There is a certain logic in pleading for less ambitious balance of payments improvements when export earnings are falling and interest payments are rising and for greater agnosticism about fiscal deficits when government revenues are shrinking. But the margin of flexibility for qualifying a country for a stand-by or an extended arrangement that could be gained by allowing a larger proportion of the IMF’s resources committed under such an arrangement to be spent rather than saved would be small for the typical country embarking on an adjustment process. The predominant operational problem is that the resources available to countries are so meager, and, with few exceptions, this situation leaves in practice very little room for maneuver.

The margin of flexibility for framing adjustment programs would be more substantially increased by a liberalization of the IMF’s quantitative limits on access to its resources. This access is now limited to 150 percent of quota a year, 450 percent of quota for a three-year period—the maximum term of a stand-by or extended arrangement permissible under present policies—and 600 percent of quota for a country’s total outstanding indebtedness to the IMF at any given time; all these limits exclude use of the IMF’s compensatory financing and buffer stock facilities.3 However, the IMF’s resources are stretched at present and the general quota increase in train is not likely to improve this situation appreciably for any length of time. What the IMF would need to enable it to finance substantially larger balance of payments deficits is either a much greater capitalization or the authority to borrow on financial markets, or both; either of these options is within the discretion of member governments and not in the hands of the IMF’s management and staff.

BIBLIOGRAPHY

    DellSydney“On Being Grandmotherly: The Evolution of IMF Conditionality” Essays in International Finance No. 144International Finance Section, Department of Economics (Princeton, New Jersey: Princeton University PressOctober1981).

    GoldSir JosephConditionalityIMF Pamphlet Series, No. 31 (Washington1979).

    GuitiánManuelFund Conditionality: Evolution of Principles and PracticesIMF Pamphlet Series, No. 38 (Washington1981).

    HookeAugustus W.The International Monetary Fund: Its Evolution Organization and ActivitiesIMF Pamphlet Series, No. 37 (Washington3rd ed.1983).

    HorsefieldJ. Keith and othersThe International Monetary Fund 1945–1965: Twenty Years of International Monetary Cooperation (Washington: International Monetary Fund1969).

Commentary*

GUIDO DI TELLA

The paper by E. Walter Robichek could only have been written by someone with his knowledge and experience, which are evident in every part of his presentation. He touches upon very important topics and, especially, introduces a vital one in the last part: the relation between Fund conditionality and the present crisis, though he does not go into detail on the impact present conditions may have on conditionality. I intend to consider the paper section by section and draw some general conclusions at the end.

The first part explains the legal basis for the Fund’s conditionality. In my view this is not open to question, as conditionality, legal or not, does in fact exist, and Robichek explains that it is legal. He also quotes the appropriate Fund Article, the latter part of which reads; “These principles shall respect the domestic social and political policies of members, and in applying these principles the Fund shall pay due regard to the circumstances of members.” What more could we ask for? Robichek then shows his annoyance at the criticisms leveled at the Fund for “undue interference with a country’s sovereignty.” I do not consider this reaction justified. The Fund obviously does interfere, and very considerably so, in member countries; it might be acceptable to speak of appropriate or inevitable interference rather than undue interference, and there is no need to speak of sovereignty, but merely of autonomy. There is no doubt whatsoever that Fund interference is inevitable. This does not lead me to feel any particular annoyance, and I would quite simply adopt an attitude of resignation in this respect: such is the world, and what are we going to do about it. And I would say this with a smile and without bitterness. Developing countries are dependent countries, and all the more so if the financial behavior they adopt is reckless, as has been the case in our countries at times. We can win independence from you if, on our own account, we take the appropriate action. I believe there is no reason to take this question of interference so much to heart. We know it exists and we know how to break free from it.

Robichek then considers the constraints on the Fund’s flexibility in the implementation of policies. He presents this subject most logically, observing that limits have to be set, that no policy with unlimited flexibility is possible, that there must be cuts, that generalized pressure on the Fund to allow long adjustment periods implies greater costs, and that the Fund must inevitably resist such pressure. Such push and pull between the Fund and its members is not, I would say, a love-hate relationship but rather a debtor-creditor one which is somewhat equivalent. Inevitably there is a certain tension, sometimes ending in reconciliation, other times in anger. It cannot be otherwise. However, the limits to flexibility are not determined only by the limits to Fund resources, but also by the internal situation in a country, which imposes a de facto limitation, one which I fear is becoming more significant. There is thus a twofold limit. Sometimes we speak, as if in a dialogue of the deaf, about the limit on the Fund and about the limits on individual countries, when in reality both exist. Latin America may perhaps still be a relatively “safe” area; consequently, it may appear that the limits of adjustment may still not have been met. In Latin America there are not more than one or two communist countries, not more than two or three countries suffering from civil war, and not more than five or six countries that have had to resort to systematic repression of their population to maintain order; only two of the major four countries, namely, Mexico and Brazil, risk major social upheavals while the remaining two, Argentina and Venezuela, do not appear to be on the brink of such problems. I do not mention this either as a reassurance or a threat, but merely to state the way things are. I believe the limit must be handled with the greatest caution. We are speaking of a “safe” area which is verging on becoming unsafe. To bring together what the creditor countries can do or may have to do, and what the debtor countries can do or may have to do, will require a delicate economic and political balancing act. This is the problem that will need to be addressed in the next few years.

In the third part of the paper I have a problem either with the Spanish translation or with the original. The translation is slightly more aggressive. The original speaks of “the monetary approach to the balance of payments” while the translation reads “the monetarist approach to the balance of payments.” Further on, where Robichek adds that “the monetarist model is a universally valid analytical framework,” I was extremely surprised and went back to the English version, which allayed my fears somewhat. The monetaristic approach implies a whole series of policies which go far beyond the monetary approach to the balance of payments. For my peace of mind, Robichek clarifies that the monetarist approach is a “balance sheet identity.” Nothing can be said against mathematical identities, they always have to be accepted. The monetaristic approach, however, is more than a mere identity. The matter was clarified by Robichek when he made it quite clear that for him it was an operational tool rather than a philosophical concept. I trust this is indeed the case.

Where differences may arise is in the area of economic concepts; as can be seen from other views expressed, these are far from being trivial nuances. We do not propose to give a Fund version and say it is white while the opposite version is black, for this is not the case. These nuances, however, are important and in certain economic situations are at the origin of very considerable differences. These generally relate to the automaticity, stability, and speed with which the market adjusts.

Obviously, the Fund’s philosophy holds to the belief that markets adjust speedily and well. This implies believing that markets are competitive, that no oligopoly exists to hamper competitive adjustment, that the markets are transparent, that only a single price exists in each of them, that there are no natural disequilibria and those that do exist are temporary aberrations, that the markets are stable, and that no destabilizing trends exist or that these are temporary and of short duration. Furthermore, there is a particular evaluation of the magnitude of the variables required and the manner in which adjustments may be promoted. If a 1 percent increase in unemployment would permit adjustment of the economic situation, no one, not even the most extreme proponents of full employment, would challenge it. If the figure required were 2 percent or 3 percent, in view of what has occurred in the last decade, this would cause only a mild reaction. But if the unemployment rate required to adjust the system would have to increase from 7 to 20 percent, there would be a very different reaction, and some may believe no such policy can be contemplated. I have not the slightest doubt that by using a sufficient dose of monetary medicine the result can be achieved. I do not consider this model inconsistent, but it assumes a perfect world; in reality there is no automaticity, competitiveness, transparency, or stability in the markets, and the impact of the adjustment variables that need to be used is so great and spread over such a long period of time that they become impossible, if not to say Utopian. Contrarily, at best, the Fund gets nervous when faced with 20 percent annual inflation, while we get nervous with a monthly inflation rate of 5 percent, even though we recognize the terrible consequences of this. However, we are often faced with highly disagreeable choices. We do not have antithetical models; however, we suffer from different “allergies,” and this is the heart of the matter. This can be seen, for example, in the Fund’s attitude toward wages, a matter with which it considers rightly that it should concern itself. However, the Fund fails to speak clearly on the question of income distribution, which it never includes as a “target.”

Many of the Fund’s pronouncements are valid but only over long periods of time. The time frame of the adjustment appears to me essential in some cases. In reality, it is the transition that is the cornerstone of a policy rather than the target, which for one reason or another is never reached.

In the last part of the paper concerning the effects of economic recession or conditionality, Robichek mentions the fall in world exports and the increase in the interest rate as being problems. I feel, however, that one should elaborate on the consequences, which are extremely serious.

These two problems, in conjunction with that of the price of oil, have led to noteworthy indebtedness. If no mention is made of indebtedness, the central aspect of the present situation is being ignored. More than of indebtedness, this is a question of insolvency, and in proportions never before experienced in the financial history of the world. This is going to affect conditionality, will make it harsher, and especially will require that supervision be extended not only to debtors but also to creditors.

It is obvious that Fund surveillance during the past decade was insufficient. Beginning in 1973, the world which began to free itself to some extent from Fund supervision because of the large amount of international liquidity ended up having greater problems than it would have had had it been supervised by the Fund. I would say that in the past few years the Fund was not sufficiently alert in respect to countries that were plunging themselves into debt. At least as regards my country, we are not aware of any attempt by the Fund to tell Dr. Martínez de Hoz that something strange was happening in connection with indebtedness and overvaluation. In earlier times, governments of a different stripe received “reprimands”—of a much stricter kind for far lesser overvaluations.

I believe that the Fund’s surveillance function would have been a good thing. It is not that I am being slightly masochistic, since after all I have said about the Fund it might appear that I want it to intervene more. What I do want is for it to intervene more equitably with debtors and creditors alike. The Fund is going through a very, very delicate phase. It is doing an enormous favor to the international financial community and to our countries, but by staving off the problem of insolvency both for the debtor countries and especially for the creditor countries, it may well lead us into even greater difficulties. I am referring to the refinancing that is so very useful at this time and that allows us to “keep going” with short-term rescheduling, for five to seven years and at very high rates in real terms of 5 to 7 percent, which we all know to be rates the majority of countries cannot afford. The adjustment process required by the Fund needs to be extended over a longer period; the indebted countries are doing this through a reduction of the level of their revenue and lenders will have to do this if they wish to recover their loans, at least in the originally agreed period of time and at the originally agreed rate. Few believe this can be done within the system as it is now. We are approaching the “day of reckoning.” I do not know whether this is a year away, or two or three, but I believe it is not far off; what is being done now will merely postpone it. I believe the Fund’s efforts at postponement may help debtors and creditors to adapt to the change which will need to be faced, but I also believe that it would be infinitely preferable for the “day of reckoning” to be promoted by the creditor countries, by the creditor banks, and by the Fund, who have a sufficient sense of responsibility to understand the problem in its entirety rather than postpone discussion of the problem until after one of the large debtor countries plunges into scandalous default; this would be catastrophic for the international financial system and especially for the country in question, and would generate enormous pressure in other countries to follow the example of the “default” of the pioneer along that distressful path. I do not think there is time to stave off this situation indefinitely. We are beginning to hear proposals for considerable “stretching out” of the debt, not just by several years but by two or three decades. This, however, is not sufficient in itself, and a drastic decrease in real interest rates is also necessary. If these do not return to the levels they were at before 1973, the situation may well become catastrophic. It would be infinitely better for all these matters to be discussed among the creditors, the large international banks, and the Fund, rather than among the debtor countries. It is this task which poses the greatest challenge to the Fund and where it can make its greatest contribution in the future.

Commentary*

MIGUEL A. FABBRI

Calling on his years of experience as Director of the Western Hemisphere Department of the International Monetary Fund and on the methodological and conceptual skills that characterize his work, the noteworthy economist Mr. Robichek has provided us with a meaningful examination of the controversial topic of conditionality.

The author approached this subject from a traditional point of view, as well as from a new perspective reflecting the changes in circumstances from those prevailing in the years following World War II and in the 1950s and 1960s; as a result, he proposes to re-examine the scope and limitations of conditionality, that is to say, the combination of rules under which adjustment programs are planned and carried out.

Under the Bretton Woods agreement, the role of the Fund was to promote world economic equilibrium; this role was undermined following the reform of the international monetary system carried out between late 1972 and early 1976, when in the second amendment to the Articles of Agreement members were given the right to adopt the exchange arrangements of their choice. This option open to members is making it possible for some of them to maintain the level of their revenues by means of periodic competitive exchange devaluations followed up by restrictive exchange, trade, and tax measures.

As A. W. Hooke has observed, in the 1930s such measures achieved the desired results, namely, of maintaining revenues, but did so 3t the expense of aggravating the difficulties of neighboring countries. These in turn found themselves obligated to neutralize these restrictive practices by taking similar measures, thus producing a worldwide reduction in trade and employment, one of the principal causes of the Great Depression.

I wonder whether the decision to adopt freely selected exchange arrangements might not be one of the factors that unleashed the present crisis.

Mr. de Larosière would surely agree that successful implementation of adjustment programs by the developing countries is particularly dependent on two critical factors: first, continued recovery of the industrial countries, and second, support from commercial financing sources. Given the dominant characteristics of the present situation, it would appear that the prospects for the immediate future are not very bright; on the one hand, there are lingering rigidities and structural disequilibria which will make it very difficult to come up with a satisfactory recovery alternative, and, on the other hand, the international banking system is showing an unwillingness to maintain the level of current financing to the developing countries. If the two factors noted above do not positively reinforce one another, it will be extremely difficult, if not impossible, for traditional Fund adjustment programs to restore the domestic and external equilibrium hoped for in each case, despite the financial authorities’ strongest inclination and resolve to implement them.

As regards Fund conditionality and the degree of flexibility for the use of its resources, there are two clearly defined views. The first, supported by the industrial countries, argues that the adjustment programs are too mild. The second, espoused by a sizable majority of the developing countries, is that the conditionality established for access to Fund resources is extremely strict, and that the term “austerity program” would be more fitting than “adjustment program.” In my opinion, there is great merit in both these views since the greater or lesser intensity of a program depends on the extent of economic deterioration in a country and on the amount of monetary assets available to it.

A high-ranking Fund official has quite rightly observed that it is not really the Fund that imposes adjustment programs; instead, in the final analysis, they are required by the “scarcity” of external resources.

If conditionality is considered to be an instrument for lessening the balance of payments problems of member countries and facilitating the international adjustment process, the corrective measures must necessarily be paralleled by the necessary financing, failing which the process will be rendered more difficult and serious disorders will ensue. There are three sources for adjustment financing:

  • the country itself;

  • the International Monetary Fund; and

  • third parties (commercial banks and suppliers).

If the three sources make adequate flows of resources available, it may be assumed that adjustments will be implemented normally, giving rise to the hope that the pace of growth will recover in the short term; however, this will not be so if the reserves position is critical and if third-party sources of funds dry up. This latter hypothesis is generally the one that is borne out; from the outset, as regards both the amounts and term involved, the program will be highly rigorous and inflexible, raising the possibility of the adjustments skirting dangerously close to the edge of sociopolitical tolerance. Unfortunately, these factors cannot be overlooked even when the Fund plays an institutional role equivalent to that of a medical specialist. Consequently, the amount and term are the variables that determine the intensity of the adjustment. This problem routinely calls into question the Fund’s role in the restoration of international economic and financial equilibrium. I therefore believe that alternative solutions are required to avoid what commonly results: the design of highly inflexible programs. One such alternative would be for the Governors of the Fund to arrange for the rapid and complete publication of the Fund’s annual assessments of economic policies following routine and special consultations. Full knowledge of these reports can alert the economic, social, and political leaders, the international community, and financial organizations to a potential crisis that a given country might be approaching owing to its authorities’ vacillation in implementing corrective measures in a timely manner.

One other consideration pertaining to the flexibility of conditionally is the increase in quotas. The increase approved as part of the Eighth General Review of Quotas last February will make it possible for qualified member countries to increase their requests by almost 50 percent. However, the maladjustment brought about by the reduction of inflation in the developed countries has significantly weakened domestic demand and further slowed down international trade in the developing countries. These phenomena, compounded by the strengthening of the dollar and high interest rates, have caused serious liquidity problems, which can only be solved by sizable infusions of financial resources. Yet another quota increase is therefore necessary, as is an amendment to the Articles of Agreement raising the amount of Fund resources usable by countries with liquidity problems to at least twice the current percentages, and thereby making conditionality more flexible.

It is a fact that commercial banks are pulling out of the Latin American market. Even though the Fund has announced that in the last three cases it has taken steps to permit the joint participation of international banks in adjustment programs, we believe this to be circumstantial and that it will not become the rule, as there are indications that banks are declining to participate jointly in the adjustment program of the Republic of Uruguay—which is not a large country.

It is vitally important to maintain an adequate flow of the financial resources provided by banks, failing which adjustment programs will be less successful because of their tendency to be more severe. It is therefore necessary to consider the following alternatives:

  • That international banks guarantee in a formal agreement with the Fund that they will participate jointly in adjustment programs, providing financing in an amount not less than that currently extended;

  • That the Fund Agreement be amended to authorize it to have recourse to the financial market, as Robichek suggests, to cover shortfalls occurring because of the decreased participation of banks and suppliers;

  • That the General Arrangements to Borrow (GAB) be extended to other users. This measure will make it possible to deal with an economic situation characterized by a general liquidity shortage in Latin America resulting from the world economic crisis. Of course, the GAB expansion must endeavor to ensure that the benefit of using the financial resources generated in this kind of “private club” of the Group of Ten, the wealthiest countries, is actually extended to others.

Consequently, in view of the need for more financing of the longer terms mentioned and of the structural nature of the adjustments generally entailed in such programs, it is essential that the Fund coordinate its activities more closely with other organizations active in development finance, particularly the World Bank.

I believe that these remarks and various views expressed do, to some extent, confirm the truths expressed by Robichek. In brief, the notion of conditionally itself is not debatable. What does merit discussion is its intensity. Its success requires that it undergo another general review so as to adapt it to current circumstances, characterized as they are by crisis, overburdensome external debt, shortage of liquidity, and inflation. It is clearly of the utmost importance that the international monetary system be urgently restructured.

J. Keith Horsefield, and others, The International Monetary Fund 1945–1965: Twenty Years of International Monetary Cooperation (Washington, 1969).

Sidney Dell, “On Being Grandmotherly: The Evolution of IMF Conditionality,” Essays in International Finance, No, 144, International Finance Section, Department of Economics (Princeton, New Jersey: Princeton University Press. October 1981).

With the coming into effect of the Eighth General Review of Quotas on November 30. 1983, under a decision adopted by the Fund’s Executive Board, access to Fund resources became subject to annual limits of 102 or 125 percent of quota, three year limits of 306 or 375 percent of quota, and cumulative limits of 408 or 500 percent of quota (net of scheduled repurchases).

The original version of this paper was written in Spanish.

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