IV Instruments and Policy Design
- Saleh Nsouli, and Justin Zulu
- Published Date:
- April 1985
Although there is general agreement on the objectives, each program is designed differently. There is no such thing as a “typical” Fund-supported adjustment program, although many articles have been written attempting to describe such programs by pointing out the commonality of objectives and instruments. The objectives and instruments, however, are limited and are clearly common to most countries. A program involves setting specific quantitative objectives and selecting the proper mix of instruments as well as deciding the degree to which each instrument will be used. In this sense, because no two countries share the same economic conditions, no two Fund-supported programs are alike. Each program addresses the specific problems of the country concerned, takes into account the macroeconomic relationships imposed by the institutional framework, and sets the quantitative targets for the instruments selected.
With these caveats in mind, it is possible to discuss in general the policy areas that recent Fund-supported programs in Africa covered. Because the problems of these countries are deep-rooted and structural, the policies emphasized supply-oriented measures designed to bring about structural changes. At the same time, financial policies were designed to reinforce the supply-oriented measures.6
Domestic Structural Policies
Because economic growth depends largely on the level of domestic capital formation, provided that investment is allocated efficiently, the programs incorporated measures to strengthen the development planning process. In this regard, the Fund relied mostly on the expertise of the World Bank. In addition, with a view to improving resource allocation, mobilizing domestic savings, and encouraging private sector investment, the programs paid close attention to pricing policies. Many of the countries maintained extensive systems of price controls and subsidies. Such policies temporarily masked inflationary pressures, led to shortages, and contributed to a misallocation of resources. Furthermore, to the extent that low agricultural producer prices were maintained, agricultural production suffered. To mitigate the impact of price controls and subsidies on the economy, the programs attempted to deal with the roots of inflationary pressures, namely the imbalances between demand and supply.
As can be seen from Chart 5, in the programs under consideration, close attention was paid to maintaining or increasing the ratio of savings to gross domestic product (GDP). In some countries, this ratio was expected to decline, owing in many instances to an expected reduction in “enforced” savings that resulted from liberalized trade. In contrast, investment ratio targets, compared with the previous year, show a wider dispersion (Chart 6). In some countries, an immediate increase in investment would have contributed to expanded production and, hence, supply-oriented adjustment. In others, however, investment was pushing against the limits of the absorptive capacity of the country and/or was contributing to a rapid accrual of external debt. In such countries, the programs aimed at containing investment to more realistic levels.
In most of the countries, public sector enterprises played an important role in production. The rationale for these enterprises was that, at the early stages of economic development, the private sector was not in a position to undertake a number of economic functions. Over the years, public enterprises in several countries incurred substantial losses, which were borne directly or indirectly by the central government budget. In the context of a number of these programs, the authorities reviewed carefully the operations of public enterprises. Invariably there was a consensus that these enterprises have to operate efficiently. Their operations were, in a number of cases, streamlined. In other cases, where the public enterprises were not considered viable on efficiency grounds, their operations were phased out. Clearly, public enterprises could not be judged solely on the grounds of profitability, as a number of these enterprises provided vital social services. However, the costs for such services should be specifically provided for in the budget; profit-oriented public enterprises should not be called upon to perform such a role. In setting up adjustment programs, the Fund has assisted the authorities in focusing on the implications of the position of public enterprises for production and financial management.
The government sector, through both its current and capital operations, has played a dominant role in the economies of most African countries. In many of the countries, revenues did not fully cover expenditures. Consequently, the governments resorted to domestic and foreign borrowing to finance their budgetary deficits. Financial stability could not be restored without first tackling the excessive expansionary impact of fiscal policy. Fund-supported programs, therefore, devoted considerable attention to measures which could improve the fiscal positions.
On the revenue side, a number of programs included tax measures designed to expand the domestic revenue base and increase the elasticity of the tax system. Improvements in tax collection procedures in most countries also contributed considerably to higher revenues. On the expenditure side, the emphasis was on limiting the growth in current expenditures by strengthening administrative expenditure controls, reducing new government hiring, restraining salary adjustments, and reducing the expansion in real administrative expenditures. Capital expenditures generally were assessed against the availability of resources and carried out within the context of the macroeconomic framework of the development plan.
The thrust of fiscal policy in Fund-supported programs in Africa can be seen in Charts 7–9. Most countries set a goal of increasing the proportion of government revenue (excluding foreign grants) to GDP. However, where economic conditions did not allow for an immediate increase in the program year, the revenue ratio was expected to drop (Chart 7). In most of the countries, the domestic revenue ratio was under 25 percent, but the ratio of expenditure to GDP was generally in excess of 25 percent. Accordingly, while in a few programs the expenditure ratio was targeted to increase, there was invariably an attempt to bring about a reduction in the ratio of expenditures to GDP (Chart 8). Because of the attempt to increase revenues and contain expenditures, nearly all programs aimed at reducing the ratio of the government deficit (excluding grants) to GDP (Chart 9).
In many of the countries, monetary policies critically depended on fiscal developments; the expansion of domestic credit generally was contingent upon the level of credit used by the central government to finance the budgetary deficit. The flexibility in conducting monetary policy, therefore, was generally limited to controlling credit to the private sector to offset partially the impact of the expansion in credit to the government sector. Not surprisingly, the government sector, in certain instances, tended to crowd out the private sector. As a result, the private sector was unable to secure adequate credit to carry out its activities. A more restrained fiscal policy stance would generally allow the monetary authorities to follow a more flexible credit policy toward the private sector and help promote economic growth.
Charts 10–13 show the diversity of monetary policies under Fund-supported programs. Nearly as many programs allowed for a higher rate of net credit growth to the government as allowed for a lower rate (Chart 10). However, in countries where credit to the private sector had grown at about 10 percent or less in the previous year—and these constituted the majority of the program countries—the programs tried to increase the growth rate of private sector credit. This was broadly reflected in the overall net domestic credit growth target. Generally, countries that had a net credit expansion in excess of 20 percent in the preceding year planned to reduce that to about 20 percent or less. Those with a rate of less than 20 percent aimed for an expansion rate greater than in the previous year. The domestic liquidity growth targets, reflecting the interdependent targets of domestic credit growth and changes in net foreign assets, do not allow for any significant generalizations; the rate of growth was expected to increase and decrease in nearly the same number of countries (Chart 13).
Within the context of monetary policy, the interest rate structure plays an important role in domestic resource allocation, the process of financial intermediation, the promotion of domestic savings, and the level of investment. The tendency has been, in many of these countries, to follow a low interest rate policy. This adversely affected their economies, because it tended to result in misallocation of resources and in financial disintermediation. In the context of high international interest rates, low interest rate policies may have resulted in a tendency for outward capital flows and a failure to attract private sector capital from abroad, although, admittedly, private capital flows depend on factors besides the interest rate. In formulating programs, the interest rate policy was reviewed to determine the most appropriate interest rate structure. In numerous programs, domestic interest rates were revised.
External Sector Policies
With regard to external sector policies, the programs focused on three main issues: restrictions on current international transactions, the exchange rate policy, and external debt. Restrictions on international current transactions are usually implemented because of imbalances that have led to shortages of foreign exchange at the prevailing exchange rate. The detrimental effects of such restrictions have already been discussed. Their phased removal, as imbalances declined, was an important element of the programs under consideration.
The exchange rate is one of the important instruments that can aid in the adjustment process. An inappropriate exchange rate generates cost-price distortions that have a negative effect on the consumption-investment mix as well as on the export-import mix and tends to reduce the profitability of export and import-competing activities in the country. Such factors are detrimental to economic growth. The appropriateness of the exchange rate level, therefore, was carefully reviewed in the context of the programs under consideration.
Several countries took steps to adjust exchange rates. Those that took such action supported it with appropriate financial and economic policies to reinforce its contribution to the adjustment process. Somalia, for example, devalued its currency by 150 percent in domestic currency terms during 1981–82. Uganda also devalued its currency by about 100 percent over the period May 1981–June 1982. Both Somalia and Uganda introduced dual exchange rate systems on a temporary basis.
Given the importance of external borrowing for achieving a sustainable external debt position, Fund-supported programs aimed at containing the debt burden at levels compatible with the debt-servicing capacity of the country. In countries that had accumulated external payments arrears, the programs provided for the gradual elimination of these arrears. As can be seen from Chart 14, most programs attempted to avoid a significant increase in the ratio of external debt to GDP.