The Fund in 1993/94
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International Monetary Fund
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English
Print Publication Date:
01 Jan 1994
Keywords:
AR; AREA; CFA franc; reform program; rate of inflation; adjustment program; deutsche mark; federal funds rate; structural adjustment; economic reform; Inflation; Baltics; Global; Eastern Europe; Central and Eastern Europe
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Abstract

The Fund is entrusted with a wide array of responsibilities over the functioning of the international monetary system. It fulfills this oversight role by providing a forum for member countries to consult and examine matters of global economic interest, as well as economic policies of individual countries. Central to the purposes and operations of the Fund is its mandate under the Articles of Agreement to “exercise firm surveillance over the exchange rate policies of countries” and to adopt “specific principles for the guidance of all members with respect to those policies.” The Fund carries out this mandate by examining international monetary issues and by analyzing all aspects of member countries’ macroeconomic and related structural policies since these policies taken together determine the way member countries conduct their exchange rate policies.

Surveillance

The Fund is entrusted with a wide array of responsibilities over the functioning of the international monetary system. It fulfills this oversight role by providing a forum for member countries to consult and examine matters of global economic interest, as well as economic policies of individual countries. Central to the purposes and operations of the Fund is its mandate under the Articles of Agreement to “exercise firm surveillance over the exchange rate policies of countries” and to adopt “specific principles for the guidance of all members with respect to those policies.” The Fund carries out this mandate by examining international monetary issues and by analyzing all aspects of member countries’ macroeconomic and related structural policies since these policies taken together determine the way member countries conduct their exchange rate policies.

This section describes the ways in which the Fund responded to the key issues facing the world economy, as well as individual member countries, during the financial year 1993/94. The first part of this section provides an overview of the Fund’s surveillance responsibilities, followed by summaries of Article IV consultations with selected member countries. The second part summarizes the Board’s discussion of approaches to assessing the consistency of exchange rates with economic fundamentals. The third part of the section focuses on Board discussions pertaining to another important function of the Fund, namely, the responsibility to monitor developments in the field of international liquidity and to manage the SDR system. As requested by the Interim Committee in April 1993, the Board discussions addressed the question of an SDR allocation, taking into account both the long-term global need for a supplement to existing reserve assets and the potential economic and monetary effects of an allocation. Directors also expressed their views on a related matter—the issue of an apparent inequity in the distribution of SDR allocations—and considered the situation of members that had never received an allocation of SDRs or had not participated in all allocations of SDRs.

Fund surveillance of the global monetary system aims at promoting the balanced growth of world trade and an orderly and stable system of exchange rates. At the individual country level it encourages countries to adopt appropriate economic policies consistent with the member’s obligations under the Articles of Agreement—taking proper account of the views of the international community—so as to provide the basis for sustained, noninflationary economic growth. The exercise of surveillance can help to identify issues and problems in a timely manner so that suitable corrective measures may be adopted and, in this way, periods of tension avoided.

The momentous changes that have taken place in the world economy over the past few years have made it particularly critical for the Fund to carry out its surveillance responsibilities in an effective manner. Noteworthy among these developments are, first, the rapid growth and internationalization of private capital markets that have made the international monetary system more vulnerable to macroeconomic imbalances among industrial countries and to any inconsistencies that may develop between exchange rates and macro-economic fundamentals; second, the major moves toward regional and monetary integration in many parts of the world, including in the context of economic and monetary union in Europe; and, third, the implementation of current account convertibility and market-oriented reform in a large number of countries. These unprecedented changes have been mirrored in increased responsibilities for the Fund: membership in the Fund has grown rapidly, making it a universal institution, and the Fund is assisting a record number of countries with policy advice, financial assistance, and technical assistance and training.

The principles and procedures of Fund surveillance are described in a document “Surveillance Over Exchange Rate Policies,” which was approved by the Executive Board in 1977 (see Annual Report, 1977, pages 107109). This document establishes principles both for the conduct of members’ exchange rate policies and for the Fund’s surveillance over those policies. The Board is required to review them at two-year intervals—or more frequently if the need arises—to see whether any modifications might be appropriate. The latest such review was carried out in January 1993, and the Board agreed that the principles of surveillance remained broadly appropriate. A summary of Directors’ discussions of the review appeared in the 1993 Annual Report. At that time, there was overall support for improving the Fund’s conduct of its surveillance responsibilities, including practical steps for adapting existing procedures to make surveillance more continuous, flexible, and relevant. The Interim Committee at its meeting in April 1993 endorsed the Board’s views and stressed the importance of the Fund’s effective surveillance over members’ exchange rate policies. Again, at its meeting in April 1994, the Interim Committee reiterated its support for the intensification of the Fund’s surveillance activities.

The Fund carries out its surveillance responsibilities mainly in two ways: through regular—usually annual—bilateral consultations with individual member countries, which are known as Article IV consultations since they are mandated by ArticleIV of the Fund’s Articles of Agreement, and multilateral discussions held in the context of the World Economic Outlook reviews, usually conducted twice a year.

Article IV consultations focus on a systematic review of economic developments and policies in the member country concerned and how these policies have affected the exchange rate and the balance of payments. Relevant structural policies are also examined if these are germane to macroeconomic developments and policies. In recent years, surveillance has taken more account of such topics as regional, social (poverty), industrial, labor market, and environmental issues if these have significant implications for macroeconomic policies and performance (Box 5 discusses the Fund’s concern for environmental issues).

Assessments in the context of Article IV consultations provide a comprehensive analysis of recent and prospective domestic and external developments and their effect on the international community. The World Economic Outlook discussions provide the Board with a framework for reviewing members’ policies from a multilateral perspective, for a systemic monitoring and analysis of the global economic situation, and for assessing prospects for the international economy under various policy assumptions.

To increase the continuity and flexibility of surveillance, Directors also discuss a wide range of country and systemic matters in the course of World Economic and Market Development sessions. These meetings, which are informal and confidential, are held about every six weeks and complement the World Economic-Outlook discussions and Article IV consultations. The sessions help to identify emerging trends and underlying tensions as early as possible and provide an opportunity for Fund staff and Directors to address a broad range of policy issues. In this way, important policy issues can be brought to the attention of the Board in a timely manner, filling an important gap between the World Economic Outlook discussions and Article IV consultations.

The Managing Director and other senior Fund staff periodically attend meetings of the Group of Seven industrial countries on matters affecting the functioning of the international monetary system. Such participation serves to strengthen the multilateral surveillance process.

As several Directors noted at the time of the January 1993 review of surveillance, ultimately it is the quality and relevance of the staff’s analysis that are most important for the effectiveness of the Fund’s surveillance role. The operational work of the Fund is supported by research carried out by Fund staff on a wide range of economic and monetary topics. Developments in the international economy and the changing circumstances of member countries are important factors governing the Fund’s research activities (see Box 6 for an overview). In the same vein, the availability of basic data is vital for the comprehensive analysis of economic policies and developments. Box 7 discusses some developments in statistical issues and methodologies over the past year.

The Fund and the Environment

The Fund’s staff has improved its understanding of the interaction between macroeconomic policies and the environment in recent years. In this work, the staff draws on the expertise of institutions with environmental competence and responsibilities, such as the World Bank and the Organization for Economic Cooperation and Development. In November 1993, the staff reported to the Board on the progress that had been made in this area. In addition, the Fund hosted a two-and-a-half-day conference in May 1993 on the relationship between macroeconomic policies and the environment that brought together Fund staff, academics, and 20 leading environmentalists representing nongovernmental organizations from a wide range of countries.

Although some aspects of the relationship between the macro-economy and the environment remain ambiguous, on balance, macroeconomic stabilization appears to be supportive of environmental protection. Current research has shown that disciplined macroeconomic policies are necessary for environmentally sustainable development: macro-economic instability is often associated with severe price distortions that lead to environmental damage and, in any case, countries in these circumstances are unlikely to have the necessary financial resources to protect the environment. Macroeconomic stabilization programs, by adjusting prices to market levels, or by reducing high or variable inflation, often encourage the preservation of natural and environmental resources. To the extent that the Fund promotes macroeconomic stability, it thereby helps the environment. However, macro-economic stability is not sufficient for environmentally sustainable development. A lack of environmental policies, poorly defined property rights, or failures in markets for environmental resources gives rise to the possibility that macroeconomic policy measures could have environmentally harmful effects. In these circumstances, it is important to use complementary environmental policies to eliminate the harmful distortion.

Currently, the Fund’s work in the environment area is following four courses of action. First, the staff—when the national authorities so wish—integrate the financial and fiscal implications of national environmental action plans into their policy discussions. Second, Fund staff continue to examine the links between the macroeconomy and the environment and to work with the World Bank on economic policies that are supportive of both macroeconomic and environmental objectives. Third, staff continue to participate in analytical work relating to the preparation of environmentally oriented national accounts being carried out at the United Nations (UN) and other agencies. Fourth, the Fund is cooperating with the UN Commission on Sustainable Development and is monitoring the commitments made by signatories to Agenda 21, particularly with regard to macroeconomic policies that are adopted in the name of sustainable development.

In recent years, in step with developments in the world economy, the Fund has increasingly taken regional considerations into account in its conduct of surveillance. Regional issues are considered in the course of Article IV consultation discussions if the influences of a country on the region or the influences of the region (or of a regional institution) on a country are germane to the analysis. Regional developments generally deal with cross-country comparisons of macroeconomic variables such as price developments, interest rate developments, and the size of government sectors. Regional developments are also considered, as appropriate, in cases where both goods and capital move relatively freely across open borders or where there is full convertibility between countries.

Research in the Fund

The key role of research in the Fund, as reiterated in the Board’s discussion of research activities in the Fund held in December 1993, is to provide the intellectual basis for, and establish the credibility of, the Fund’s economic policy analysis and advice. The main objectives of research in the Fund are to further the staff’s understanding of policy and operational issues of relevance to the institution, and to improve the analytical quality of the work prepared for management and the Board and of the advice provided to member countries.

Directors welcomed the activities of the Interdepartmental Working Group on Fund Policy Advice, which was established in 1989 to serve as a forum for identifying country-related, analytical, and policy issues and strengthening research collaboration on these issues so as to enhance the effectiveness of the Fund’s policy advice.

One of the major research activities of the Fund is the World Economic Outlook. This global survey of economic prospects and policies is an integral element of the Fund’s ongoing surveillance of economic developments and policies in its member countries and of the international economic system. The survey is the product of a comprehensive interdepartmental review, coordinated in the Research Department.

The Research Department is specifically charged with undertaking policy-oriented research relevant to the work of the Fund and coordinating the projections and analyses contained in the World Economic Outlook. Other departments contribute importantly to the Fund’s overall research in such areas as country-specific and regional issues and developments in the international monetary and financial systems.

Research programs are also directed toward improving technical assistance provided to countries; supporting the development and implementation of the Fund’s financial policies and operations; and providing up-to-date international statistical standards.

Directors generally supported the existing decentralized approach to research, under which it is the responsibility of the Board, management, and staff to identify topics meriting research. But, to a large extent, it is then up to the departments to take the initiative to design research projects and carry them out.

The scope of research in the Fund is defined by the purposes and functions of the institution. In recent years, research has been focused on

  • the international monetary and financial system;

  • international capital markets;

  • inflation and stabilization policy in developing countries;

  • structural issues, including policies for sustained growth, labor markets and unemployment, and trade policy and reform;

  • economies in transition from centrally planned to market-based systems, including price and trade liberalization, privatization, and reform of state enterprises;

  • fiscal issues, including social safety nets, the environment, and military spending;

  • financial sector reform; and

  • exchange rate behavior.

In addition, the Fund does substantial research on a wide range of macroeconomic issues in developing countries.

Research is typically undertaken in response to specific operational or policy issues identified by Fund management, or to those that have arisen in Board meetings, in mission-related work, and in interdepartmental meetings. Research projects may also be generated by an assigned operational task—for example, the establishment of improved data bases—or from departmental initiatives in response to emerging analytical and policy issues.

In order to encourage innovation and ensure quality control, the Fund makes much of its research output widely available to the public and encourages staff interaction with academia and other research organizations through conferences, seminars, and joint research efforts with other institutions, such as the World Bank and the Organization for Economic Cooperation and Development. Some Directors considered that even more effort was needed to broaden the Fund’s knowledge of research undertaken in universities and other institutions and to ensure better coordination with other institutions, including the World Bank. In this context, several Directors welcomed the Visiting Scholars Program, which brings to the Fund leading members of the economics profession from around the world to assist the staff in conducting research on Fund-related issues.

The Fund’s primary research documents and publications include the World Economic Outlook, which is published twice a year, International Capital Markets, and other studies in the World Economic and Financial Surveys; Occasional Papers; and Working Papers. Directors welcomed the recently launched Papers on Policy Analysis and Assessment, a series of brief, nontechnical studies of policy design and research, as a useful step toward making some of the Fund’s thinking on policy issues more readily understood and accessible to a broader audience of policymakers. Periodic publications include Staff Papers, Finance & Development (published jointly with the World Bank), the IMF Survey, and books and pamphlets, (See Appendix III for a list of publications issued during the financial year.)

In Article IV consultations with individual member countries of the European Union, economic policies of a member are frequently discussed in the framework of economic developments and policies of other members of the Union. In order to remain apprised of developments in the European Union, the Fund staff has also held informal discussions with the European Commission and the European Monetary Institute.

Reports on some African countries usually cover some aspects of regional issues such as those in the context of, say, the Central African Monetary Area, the Common Monetary Agreement, the West African Monetary Union, and the CFA franc zone or cross-border trade and payments initiatives in Eastern and Southern Africa. In the Middle East region, the relationship between a country and, for instance, the Gulf Cooperation Council, may be discussed. Other examples include discussions on regional integration, such as the North American Free Trade Agreement, or proposals for regional integration, such as an Association of South East Asian Nations Free Trade Area.

In the past year, the economic programs of two countries-Bangladesh and The Gambia-were monitored by the Board under the revised guidelines for enhanced surveillance. Under enhanced surveillance,3 there is a closer relationship between the Fund and a member country than is customary in Article IV consultations but less close than under Fund arrangements. Enhanced surveillance procedures were initiallyestablished in 1985 to facilitate some members’ multiyear rescheduling arrangements with commercial banks and were revised at the time of the 1993 surveillance review. The main features of the revised procedures are as follows.

Statistical Issues—1993 System of National Accounts’ Harmonization with the Fund’s Statistical Manuals

The Fund, the European Union, the Organization for Economic Cooperation and Development, the United Nations, and the World Bank have jointly published a revision of the System of National Accounts (1993 SNA). The new SNA represents a major advance in national accounting over the previous version, which was published in 1968, and reflects many of the economic concerns and changes in economic structures that have occurred over the past twenty-five years. Development of the 1993 SNA involved unprecedented cooperation over the last decade by staff from the five organizations and input from experts in more than 50 countries in all stages of economic development.

The 1993 SNA is expected to become the key conceptual framework for national accounts in almost all countries. Many developed and developing economies have already established timetables for conversion of their existing national accounts to the new SNA. It will be the basis of the system that will be used by all members of the European Union. The United States, which has used its own system of National Income and Product Accounts, has also decided to adopt the new SNA. It will be particularly useful for countries in transition to market-oriented economies to replace their existing System of Material Balances.

The Fund has played an active role in the development of the new SNA. The two main objectives of the Fund’s involvement were improvement of national accounting in Fund member countries and harmonization of national accounts with the other key statistical systems (including balance of payments, government finance, and monetary and financial statistics) for which the Fund has major responsibility. The Fund will assist in implementing the new system through technical assistance and training, and a new course on national accounts will be offered at the IMF Institute in November 1995. Harmonization with other related statistical systems benefits both compilers and users of these data.

In September 1993, the Fund published the fifth edition of the Balance of Payments Manual. One of the major achievements of this revision was the almost complete harmonization of balance of payments concepts and measures with the relevant SNA concepts and measures. Work is currently being carried out on revision of the Manual on Government Finance Statistics and on development of a new Manual on Monetary and Financial Statistics. In both cases, harmonization with the new SNA is a major guiding principle. When this work is completed, compilers and users of the major systems of macroeconomic statistics will benefit substantially from the greater harmonization and integration.

Committee on Balance of Payments Statistics

The IMF Committee on Balance of Payments Statistics completed its first year of operation in 1993. This standing Committee, composed of senior balance of payments compilers from industrial and developing countries and representatives from international organizations, was formed in 1992 to oversee the implementation of recommendations contained in two Fund Working Party reports,1 foster greater coordination of data collection among countries, and assist the Fund’s Statistics Department in keeping pace with the statistical consequences of the changing international environment. In its first year, the Committee focused its program of work on selected capital account statistics, namely, nonbank claims on nonresident banks and portfolio investment. The global balance of payments statistics published by the Fund reveal large discrepancies in these types of capital flows. The Committee’s program of work is described in detail in its first Annual Report, which was published in April 1994.

1IMF, Report on the World Current Account Discrepancy (Washington, 1987) and Report on the Measurement of International Capital Flows (Washington, 1992).

A member would request the Fund to monitor its macro-economic and structural policies, usually at the time of the Article IV consultation. The Board would approve the request on a case-by-case basis, taking into account, among other things, the member’s track record of adjustment and the strength of its quantified economic policy program. Approval to apply the procedure would not. however, signal Fund endorsement of the member’s program or its implementation. Approval would remain in effect until the time of the next Article IV consultation with the member (or for a 12-month period), when the member could ask for a further application of the procedures. A mid-term review by the Board of the program’s progress would be required, irrespective of actual performance under the member’s program.

Enhanced surveillance procedures could be used in several types of situation. For instance, the procedures could include cases in which a member could ask for monitoring to help secure external financial support, particularly if it had a good record of economic performance and was no longer using Fund resources. Another use could be in some cases in which there was no direct link to efforts at mobilizing external support, but a member that has a strong track record of performance could request the procedures with a view to boosting domestic and external confidence in its adjustment policies.

Directors, in December 1993, approved Bangladesh’s request that its program for 1993/94 be monitored under the enhanced surveillance procedure. Approval was based on the authorities’ good track record under Fund arrangements and was seen as a means of providing confidence to donors that Bangladesh would continue to pursue sound economic policies. Directors observed that the program for 1993/94 would allow for a consolidation of the macroeconomic gains of earlier years and, with full implementation, achieve progress in a range of important structural areas. The mid-term review of the program took place in April 1994.

Also in December 1993, Directors approved a request by The Gambia that its 1993/94 program be monitored under enhanced surveillance procedures for the period through June 1994. The Gambia had maintained a good track record of successful reforms under the Fund’s enhanced structural adjustment facility through 1991 and subsequently under the authorities’ 1992/93 program.

However, economic growth had faltered because of poor weather, which had been followed by a severe disruption of re-export trade owing to regional developments. Directors commended the authorities for their speedy and decisive response to those exogenous shocks, as evidenced by the measures taken to reduce government expenditures, improve the revenue effort, and help contain demand pressures.

At the time of the 1993 review on surveillance, Directors expressed concern that the temporary shift in Article IV consultation.cycles (introduced in 1991-92 to cope with the additional workload emanating from the unprecedented challenge of absorbing a large number of new members into the Fund) and the bicyclic consultation procedures,4 had led to gaps in surveillance that could have adverse effects on its effectiveness. The Board also noted that the savings in staff and Board time expected when the bicyclic procedure had first been introduced had not been achieved. In addition, concerns were expressed that there had been undue delays in some instances in holding consultations with certain members.

Against this background, the Board agreed in May 1993 to terminate the bicyclic consultation procedure and to shift members under the procedure to the 12-month consultation cycle. The Board also, at that time, agreed to new procedures for conducting Article IV consultation. Under the new procedures, a comprehensive discussion by the Board of Article IV staff reports would take place each year for most countries and, at a minimum, every two years. However, in those cases where a report was not seen as raising any significant issues in the context of the Fund’s surveillance responsibilities and there was broad agreement with the staff report, a summary Board discussion could be held which would be expected to be limited mainly to an endorsement of the main thrust of the staff appraisal. In these cases, the consultation would be concluded by a “short-form” summing up.

Acceptance of Article VIII

The Fund assists in the establishment of a multilateral system of payments in respect to current transactions between members and in the elimination of foreign exchange restrictions that hamper the growth of trade. Accordingly, Article VIII, Sections 2(a) and 3 prohibit members, except with the approval of the Fund, from imposing restrictions on the making of payments and transfers for current international transactions or from engaging in multiple currency practices or discriminatory currency arrangements.

About half of the countries have not yet accepted the obligations of Article VIII and are availing themselves of transitional arrangements under Article XIV, which permits them, without seeking Fund approval, to continue to maintain the restrictions on international payments and transfers in effect on the date of their membership in the Fund. When a country accepts the obligations of Article VIII, it may no longer avail itself of the transitional arrangements of Article XIV.

Historically, Fund members have been slow to accept the obligations of Article VIII and have accepted at a rate of less than two members a year since the Fund’s start of financial operations in 1947. In early 1993, the staff intensified its efforts to encourage members to accept the obligations of Article VIII. As a result, 13 more members had accepted Article VIII status by the end of April 1994, bringing the total of members accepting these obligations to 89.

The new Article VIII members are Bangladesh, Barbados, The Gambia, Ghana, Grenada, Israel, Lebanon, Mauritius, Micronesia, Morocco, Sri Lanka, Trinidad and Tobago, Tunisia, and Uganda, A complete list of Article VIII members with their dates of acceptance can be found in Article VIII, Appendix II, Table II.16

Table II.16

Exchange Arrangements as of March 31, 1994

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In all countries listed in tins column. The U.S dollar was the currency against which exchange rates showed limited fexibility.

This category consisit of countries participating in the exchange rate mechanism of the European Monetary System. In each case, the exchange rale is maintained with in a margin of 15 percent around the bilateral central rales against other participating currencies, with the exception of Germany and the Netherlands in which case the exchange rate is maintained within a margin of 2.25 percent.

Member maintains exchange arrangements involving more than one exchange market. The arrangement shown is that maintained in the major market.

The exchange rate is maintained within margins of ±25 percent.

Exchange rates are determined on the basis of a fixed relationship to the SDR. within margins of up to ± 7.25 percent. However, because of the maintenance of a relatively stable relationship with the U.S. dollar, these margins are not always observed.

The exchange rate is maintained within margins of ±10 percent on either side of a weighted composite of the currencies of the main Trading partners.

Country uses peg currency as legal lender.

The exchange rate, which is pegged to the ECU, is maintained within margins of ± 2.25 percent.

The exchange rate is maintained within margins of ±2.25 percent.

The exchange rate is maintained within margins of ±5 percent.

The exchange arrangement shown relates to the rate determined at the auctions, which is used tor most transactions. The official exchange rate is still pegged to the U.S dollar.

The exchange rale is maintained within margins of ±3 percent.

Following the termination of the bicyclic consultation procedure in May 1993,169 countries—out of a total Fund membership of 179—are currently on the 12-month consultation cycle. Nine members are on the longer 18- or 24-month consultation cycles.

In the past year, considerable progress was made in another area of Fund surveillance, namely, the move by members to adopt current account convertibility and accept the obligations of Article VIII (see Box 8). During the surveillance review, Directors noted that many members were availing themselves of the transitional arrangements under Article XIV for long periods and agreed that these countries should take appropriate steps to remove remaining exchange restrictions and accept the obligations of Article VIII. They emphasized the importance of a greater commitment of members to current account convertibility. In this regard acceptance of the obligations of Article VIII is viewed by the international community as an important demonstration of the convertibility of a country’s currency.

Article IV Consultations

Article IV consultations, usually held annually, follow a standard procedural pattern. A staff team visits the country, gathers pertinent economic and financial information, and holds discussions with officials on economic developments and policies. Upon return to headquarters, the staff prepares a report, which forms the basis for discussion by the Board. The Managing Director of the Fund, in his capacity as Chairman of the Board, summarizes the views of Directors and this assessment by the Board is then passed on to the country authorities. Table 2 lists the Article IV consultations concluded by the Fund in 1993/94.

Table 2

Article IV Consultations Concluded in 1993/94

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Consultation discussions with Aruba are held in the context of the consultation with the Kingdom of the Netherlands.

Consultation discussions with Hong Kong are held in the context of the consultation with the United Kingdom,

Interim consultation under the tricyclic consultation procedure.

In the section below, the consultation discussions of selected countries, both industrial and developing, are described briefly. In addition, overviews are presented for smaller industrial countries, economies in transition, and developing countries. Within these groups, individual countries have been chosen on the basis of their importance in the world or regional economy. For each of these countries, the Annual Report includes for the first time—in addition to a summary of the conclusion of the Board discussion—summaries of salient macroeconomic and structural developments, and a table of data available to the Board at the time of the consultation. Subsequent revisions to data have not been taken into account, except as indicated in a few cases.

Major Industrial Countries

United States

In August 1993, Directors considered the 1993 Article IV consultation with the United States, in light of economic developments over the previous year (Table 3). These are described briefly below, followed by a summary of Directors’ discussion.

Table 3

United States: Selected Economic Indicators

(Annual percent change unless otherwise noted)

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Note: Data in the table reflect information available at the time of the Board discussion.

In percent of GOP or NNP.

Year over year.

Yearly average.

The recovery of economic activity in the United States began slowly in the second quarter of 1991, but the pace picked up during the second half of 1992 before slowing somewhat in the first half of 1993. Private domestic demand led the recovery, offsetting the effect of lower defense spending. In 1992 and the first half of 1993, strong growth in consumption accounted for most of the increase in GDP. Improvements in household debt service and net worth, consumer confidence, and, to a lesser extent, employment growth contributed to the growth in consumption, and by mid-1993 the personal savings rate had fallen to 4 ¼ percent. Business fixed investment also showed robust growth during the recovery. Employment growth was relatively weak, although there were signs of strengthening in the first half of 1993, and the unemployment rate, which reached a cyclical peak of 7¾ percent in June 1992, fell only gradually and in June 1993 stood at about 7 percent. While inflation had generally been declining since 1991, at the time of the Board discussion in August 1993 the recent data had been mixed. In July 1993, the 12-month change in the core rate of inflation was 3.2 percent. Subsequently, this measure continued to decline, reaching 2.8 percent in April 1994.

The external current account deficit as a percentage of GDP rose to 1.1 percent in 1992 and to 1.4 percent in the first quarter of 1993 because of a rising merchandise trade deficit. The increase in the current account deficit in 1992 was associated with a significant decline in national saving and a small increase in private investment. Both saving and investment have declined markedly in relation to GDP since the 1970s.

In their discussion, Directors noted that policies for sustained economic expansion in the United States should focus on fiscal strengthening and price stability, as well as measures to raise saving and investment, improve domestic resource allocation, and foster an open international trading system. Directors noted that such policies would also support noninflationary growth abroad.

Directors welcomed the enactment of the Omnibus Budget Reconciliation Act of 1993, and observed that although the budget for fiscal year 1994 was a major step toward fiscal consolidation, the planned deficit reduction was to be attained only over an extended period and would rely to a large extent on cuts in discretionary spending that were as yet unspecified. Directors were also concerned that the federal fiscal deficit and the debt-to-GDP ratio would remain high and that outlays for entitlement programs were expected to continue to grow rapidly. Directors agreed that a comprehensive reform of the health care system would be an integral element of the fiscal consolidation effort and that it should be designed and implemented in a way that would support fiscal adjustment in the long term without worsening the fiscal problem in the short term.

Even if the budget plan were implemented fully and there were some recovery in private saving, the national saving rate would remain well below its historical norm. Directors agreed, therefore, that further fiscal consolidation measures might be warranted over the medium term so as to raise national saving to a level consistent with increased domestic investment and productivity growth, thereby reducing reliance on foreign saving. In particular, they suggested that once the effects of health care reform could be evaluated, the authorities would need to consider whether additional fiscal measures would be necessary, including possibly a federal consumption tax.

Directors supported the conduct of U.S. monetary policy over the past several years, with the Federal Reserve first turning back the rise in inflation and then following a course that permitted the economy to recover while gains were made in reducing inflation. They agreed with the Federal Reserve that the most productive function it could perform in pursuing sustainable economic growth would be to maintain price stability, and supported its reliance on a range of indicators to evaluate monetary conditions. Directors noted, however, that the present level of short-term interest rates had remained unchanged for a full year, and they observed that it could not be maintained for long in an expanding economy without jeopardizing price stability. Directors therefore agreed with the Federal Reserve that it would need to move ahead of the actual emergence of inflationary pressures.

Directors noted the view of the U.S. authorities that exchange rates should reflect fundamentals and observed that the real effective exchange rate of the U.S. dollar had been relatively stable in recent years. Since the U.S. current account deficit had increased and was expected to remain relatively large over the medium term, a number of Directors stressed that policies that promoted national saving would be most effective in ensuring a sustainable external position and cautioned against reducing the deficit through protectionist measures. In this context, they therefore urged the authorities to implement the recently negotiated Framework Agreement with Japan in a manner that emphasized its “most-favored-nation” principle and that avoided the introduction of distortions or any weakening of multilateral principles in resolving trade disputes.

Directors noted that some elements of U.S. trade policy, in particular the use of unilateral actions in trade disputes, protection in the textile and apparel industry, and the imposition of antidumping and countervailing duties, could have a negative effect on the functioning of the international trading system and on the environment for multilateral negotiations.

Directors agreed with the emphasis given by the U.S. authorities on structural policies as a means of improving productivity growth and also agreed that along with reform of the health care system, initiatives in education and job training would be beneficial. In conclusion, Directors praised the United States for its wide-ranging assistance to developing countries—notably in debt-reduction operations—but voiced their concern about the trend of U.S. economic assistance and the prospects for such aid in a situation of fiscal consolidation.

* * *

Since the time of the Article IV consultation, the recovery gained further momentum, particularly in the fourth quarter of 1993. Real GDP increased by 3.0 percent in 1993, owing to strong growth in domestic demand, largely related to a surge in investment. This offset a substantial decline in net exports, as the current account deficit rose to 1.7 percent of GDP. As a result, the output gap had narrowed considerably by the end of 1993. Economic activity appears to have slowed some what in the first quarter of 1994, owing to weak foreign demand for domestic products and the effects of severe winter storms and the earthquake in California.

Policy-related developments in early 1994 included the release in February of the administration’s budget for fiscal year 1995, which included various measures to comply with the expenditure ceilings required under the August 1993 budget legislation. The proposed budget would decrease the deficit from 3.5 percent of GDP in 1994 to 2.5 percent in 1995. In addition, the Federal Reserve began to tighten monetary conditions, causing short-term interest rates to rise by¾of 1 percentage point by the end of April.

Japan

The Board considered the 1993 Article IV consultation with Japan in July 1993, which was described in the 1993 Annual Report (pages 35-36).5 Subsequently, the Board reviewed economic developments in Japan in the context of two discussions on the World Economic Outlook—in September 1993 and in April 1994 (Table 4), Directors’ views on the Japanese economy expressed during these two reviews were mentioned in the previous chapter of this report. Some of the issues raised by Directors during the discussion of the 1993 consultation report and more recent economic developments are summarized below.

Table 4

Japan: Selected Economic Indicators

(Annual percent change unless otherwise noted)

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Note: Data in the table reflect information available at the time of the Board discussion of the April 1994 World Economic Outlook.

1985 = 100.

In July 1993, Directors noted that over the past two years the Japanese economy had experienced its sharpest downswing since the mid-1970s, mainly because of the correction of factors that had characterized the earlier boom and had led to its unsustainable pace. These included a sharp run-up in asset prices, a large increase in the stock of capital and consumer durables, and excessive lending to the real estate sector. Most Directors felt that despite some signs of recovery, the economy had yet to turn the corner fully and that downside risks persisted at thatstage of the cycle. Directors agreed that the main policy issue for Japan would be to solidify the momentum of the recovery, maintain its excellent price performance, and pursue structural reforms. While welcoming the authorities’ response to the cyclical downswing—on both monetary and fiscal fronts—some Directors thought that earlier and more forceful actions had been warranted. The implementation of the economic stimulation packages were commended by Directors, and most Directors believed that once recovery was firmly established medium-term fiscal consolidation efforts should resume.

As regards the widening current account surplus, most Directors commented that as the economy recovered the surplus would decline. Directors believed that more transparency, quicker action to deal with nonperforming loans, and greater disclosure of asset quality were needed to cope with the risks posed by problems in the financial system. They urged Japan to continue its efforts to open up markets, and reform of agricultural trade was seen as a priority. Directors commended Japan for the high absolute amount of its official development assistance.

Economic activity in Japan remained subdued in 1993, with growth of real GDP being barely positive. Balance sheet adjustments, weakness in the financial sector, the persistent strength of the yen, and depressed levels of consumer and business confidence contributed to the sluggishness of output. Although the downturn appeared to have bottomed out toward the end of 1993, and there was evidence that confidence in the economy had improved, recovery remained uncertain.

To spur recovery, the Japanese Government has implemented four economic stimulus packages since 1992. These packages, together with the large reduction in official interest rates since mid-1991, have helped to moderate the downturn. The latest package, which was announced in February 1994, includes a tax cut for 1994 in central and local government personal income taxes amounting to 1 ¼ percent of GDP for 1994. The tax cut is an interim measure toward a full-fledged tax reform to be realized later in the year. The stimulus package also proposes a further increase in public investment of ¾of 1 percent of GDP. Other measures include increased allocations for land purchases and loans for housing, small and medium-sized enterprises, and equipment investment in new businesses. Subsidies for employment development and various measures for strengthening the financial sector and the securities markets are also provided for in the package.

Germany

The 1993 Article IV consultation with Germany was considered by Directors in July 1993. After almost a decade of uninterrupted growth, the west German economy reached a cyclical peak in mid-1992. Clear signs of overheating emerged in the latter phase of the upswing, mainly owing to the major fiscal expansion that followed unification. The downturn that began in the second half of 1992 was far more pronounced than had been anticipated at the time of the 1992 Article IV consultation. It was accompanied by a rise in the unemployment rate, the emergence of large spare capacity in industry, and a considerable widening of fiscal imbalances (Table 5).

Table 5

Germany: Selected Economic Indicators

(Annual percent change unless otherwise noted)

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Note: Data in the table reflect information available at the time of the Board discussion.

Preliminary figures for 1992; projected for 1993.

Projected figures for 1993.

West Germany until June 1990; united Germany from July 1990.

April 1993.

Data for general government are on a national account basis and incorporate east Germany from 1991.

Monetary data include east Germany from the end of June 1990.

First three months compared with same period a year earlier. 8 Average January-May.

Average January-May.

Apart from normal cyclical factors, the steepness of the decline in activity also reflected a sharp deterioration in business and consumer confidence since mid-1992. GDP is estimated to have declined at an annual rate of about 4 percent over the three quarters to the first quarter of 1993 with the fall in output particularly pronounced in the manufacturing sector. The onset of recession abruptly ended the post-unification boom in domestic demand and exports to the east. As employment growth slowed down in 1991-92 and immigrants joined the labor force, the unemployment rate in west Germany rose to about 7 percent in early 1993, compared with 5 ½ percent in mid-1991.

A large shift in the pattern of saving and investment followed unification. The external current account swung from a surplus of 4 ¾ percent of GNP (for west Germany) in 1989 to a deficit of 1 ¼ percent of GNP (for all of Germany) in 1991. Because of transfers to east Germany—amounting to about 4-5 percent of GNP since 1990, the general government finances moved from approximate balance in 1989 to a deficit of about 3 percent of GNP in 1992, despite restrained federal expenditures and tax increases.

Official interest rates were increased substantially in 1990–91 to counter the inflationary pressures that arose mainly from the excess demand on resources arising from unification. After the turbulence in the ERM in late summer 1992 and first clear signs that the pressure on prices were abating, the discount and Lombard rates were lowered by ¼ and ½ of 1 percentage point, respectively, and three-month market rates declined to just below 9 percent. These cuts marked the beginning of gradual monetary easing by the Bundesbank. Long-term interest rates had peaked at the beginning of 1991 and declined substantially over the following years.

In east Germany, output fell by one fourth in the 18 months after unification, stabilized toward the end of 1991, and rose by an estimated 7 percent in 1992. The turnaround was concentrated in the construction and service sectors; manufacturing output had not yet recovered. Rapid wage growth in the labor market led to a more than doubling of labor costs since unification, and, at the end of 1992, 14 percent of the labor force was unemployed.

In their discussions, Directors were concerned about the worsening German economic and financial situation, with its adverse spillover effects on trading partners, especially in Europe. Output and business investment had fallen sharply, unemployment had grown, and the public sector borrowing requirement was high by German standards. Underlying cost and price pressures, however, were much lower because of the considerable slack in the economy and lower import prices, and, in the view of many Directors, inflation was likely to fall significantly in the coming months.

Although recent data were more favorable, Directors feared that given the depressed level of business and consumer confidence the recession could become prolonged, with damaging effects on both the German and the international economy. Directors therefore urged the authorities to strengthen their macroeconomic and structural adjustment policies so as to foster an early economic recovery. Most Directors supported the continuation of gradual lowering of short-term interest rates, along with measures to tackle the structural budget deficit and to make labor and product markets more flexible.

Directors noted that the fiscal deficits had arisen because of the large intra-German transfers associated with unification and, in their view, even though the magnitude of these transfers made it impossible for the deficits to be financed in the short run through tax increases or spending cuts, the authorities had relied excessively on borrowing. Further, despite the consolidation plan set out in the Solidarity Pact, the deficits were likely to continue over the medium term. Directors supported the initiatives to contain the size of the federal deficit in 1994 to its estimated 1993 level, but viewed these initiatives as insufficient, since they did not address fully such issues as subsidies to ailing sectors and excessive social spending.

Directors emphasized the crucial role of monetary policy in fostering noninflationary growth and orderly functioning of foreign exchange markets, especially in the EMS. Most Directors suggested continued monetary easing and further reductions in short-term interest rates. Some Directors agreed with the German authorities that a too aggressive approach to lowering interest rates could be risky in terms of undermining confidence in the deutsche mark. Another view, however, was that interest rates were too high, requiring early and strong action to ease monetary conditions.

A number of Directors doubted whether M3 was useful as a leading indicator of inflation for several reasons, including distortions associated with the effects on monetary demand of German unification and the lack of stability in foreign exchange markets. Several Directors emphasized that because of the increasing integration of ERM countries and given the special role of Germany in the ERM, monetary conditions needed to be considered—to a much greater extent than earlier—from an ERM perspective. Directors considered that some depreciation of the deutsche mark against non-ERM currencies was not a cause for concern since that was to be expected following a substantial real appreciation of the currency.

The importance of structural policies in improving economic performance over the medium term was emphasized by Directors. They recommended, in particular, labor market reforms, further deregulation, and cuts in industrial subsidies in the western states and privatization and the resolution of property rights problems in the eastern states. They also stressed institutional changes in labor markets so that wage adjustments would be linked more closely to productivity and a firm’s ability to pay—which are necessary for attracting private investment and without which reliance on costly and inefficient subsidies would continue. Directors agreed that more flexibility in implementing collective agreements on wages and work practices were also needed.

Directors praised Germany for its generous development assistance, especially to Eastern Europe and countries of the former Soviet Union, and urged it to take a leadership role in dismantling EU barriers to exports from these countries.

* * *

In the period since the Article IV consultation, economic activity in Germany remained subdued, with unemployment continuing to rise. Weakness in domestic demand persisted, partly because of low consumer confidence and poor job prospects, and also because of higher fuel and social security taxes and cuts in public spending in 1994. These fiscal measures may have helped long-term interest rates to decline even further in the second half of 1993, reaching long-term lows by the end of the year. Inflation continued to fall and, excluding the impact of increases in indirect taxes, began to approach the authorities’ medium-term objective. Monetary policy continued to follow a path of cautious easing that was begun in September 1992. In early 1994, long-term interest rates rose—albeit less than in other important markets—while short-term interest rates continued to fall. Subsequent developments indicated that economic prospects were improving.

France

In November 1993, Directors considered the staff report for the 1993 Article IV consultation with France, which took place at the end of the worst economic slowdown for the French economy since the Second World War.

This economic slowdown was caused by a combination of factors. These included cyclical reversal of the effects of fiscal stimulus associated with German unification—along with the tight monetary policies pursued in order to maintain stable exchange rates within the ERM and, in particular, vis-à-vis the deutsche mark; declining consumer confidence; and, to a lesser extent, asset price declines and balance sheet problems (Table 6).

Table 6

France: Selected Economic Indicators

(Annual percent change unless otherwise noted)

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Note: Data in the table reflect information available at the time of the Board discussion.

Projected.

National accounts basis.

The large drop is associated with data problems due to a lack of customs data (or the first quarter of 1993.

Based on the Fund’s multilateral exchange rate model.

First half of 1993 over the first half of 1992

Average to October 26,1993.

Over the year prior to the Board discussion, earlier gains in competitiveness derived from the strategy of disinflation in the context of the ERM were reversed partially but abruptly. The exit from the ERM by the pound sterling and the Italian lira and their depreciations in September 1992, and the depreciations of the Spanish peseta, the Portuguese escudo, and the Irish pound all led to a substantial loss of competitiveness relative to EMS partner countries.

Real GDP grew by only 1.4 percent in 1992, and there was negative growth in the fourth quarter of 1992 and the first quarter of 1993. In the second quarter of 1993, GDP ceased to decline, suggesting that the recession had bottomed out. Unemployment rose throughout 1992, and in August 1993, the unemployment rate reached 11.7 percent of the labor force, with particularly high youth unemployment. Inflation continued at a moderate pace, and in September 1993, the rate of change of consumer prices on a 12-month basis was 2.3 percent. The general government deficit was projected to reach about 6 percent of GDP in 1993, compared with 2 percent in 1991.

Between September 1992 and July 1993, substantial use was made of interest rate policy in successfully maintaining the franc’s exchange rate parity with the deutsche mark, consistent with economic fundamentals. However, as tensions rose within the ERM in July 1993, and despite large-scale intervention, central banks were unable to keep currencies within fluctuation margins. On August 2, 1993, the obligatory intervention threshold in the ERM was widened to plus or minus 15 percent around existing bilateral central rates. Since then, the Bank of France has been lowering interest rates cautiously but regularly.

In their discussion, Directors observed that the medium-term strategy of French economic policy over the previous decade, based on a firm anti-inflationary stance and fiscal prudence, had resulted in substantial gains in such areas as competitiveness and inflation. However, over the previous years economic growth had stalled, unemployment had risen, and the fiscal improvements of the past decade had been reversed. Directors were therefore concerned about prospects for recovery, especially the outlook for unemployment.

As regards issues related to the enlargement of the ERM bands of exchange rate fluctuation and its implications for monetary policy, Directors noted that the franc had depreciated only moderately since July 1993 and that short-term interest rates were slightly above German rates. A number of Directors favored the French authorities’ cautious approach to monetary policy and agreed that a faster reduction in these rates would have little effect in stimulating the recovery of economic growth and could indeed be counterproductive if it led to inflationary expectations and a rise in long-term interest rates.

Most Directors supported the staff view that too high domestic interest rates might be regarded as unsustainable and could damage credibility. A number of Directors therefore suggested that the authorities should test the market further to lower short-term interest rates. Some other Directors advocated a much faster reduction in these rates, along with a more flexible approach to exchange rate policy. In the view of these Directors, lower interest rates—and hence a more credible policy mix—might lead the economy toward growth and convergence by reducing the budget deficit and unemployment and creating conditions conducive to structural reforms.

Recent and prospective fiscal developments were of major concern to Directors. Because of the unfavorable cyclical position, as well as an increase in the structural deficit, the fiscal deficit had widened considerably over the preceding year. Directors welcomed the 1994 budget, which was prepared in the context of a multiyear program that envisaged reducing the central government deficit to—or below—2.5 percent of GNP by 1997. While some Directors believed that the assumptions underlying the program were overly optimistic, a number of other Directors wondered whether the medium-term target was ambitious enough, in view of longer-term demands on general government expenditures stemming from such factors as the aging of the population. Further, given that large deficits had emerged in the Government’s health care and unemployment insurance, Directors urged the authorities to ensure that the social security system was balanced over the medium term.

Directors were also concerned about high and persistent unemployment, stemming from severe structural problems in the labor market because of excessive social charges, high minimum wage, lack of training, and various administrative restrictions on hiring practices. They encouraged the authorities to increase labor market flexibility, reduce unemployment benefits, and to replace part of employers’ social charges with a general tax on all incomes, A number of Directors also recommended flexibility in wages for young workers.

Many Directors encouraged the authorities to adopt a firmer stance in resisting pressures from special interest groups and in defending the principle of free trade. They called on the authorities to take a lead role in opening EU markets to goods from other countries, including Central and Eastern European countries In conclusion, Directors praised France for its strong commitment to official development assistance and for its efforts to reduce the debt of low-income countries.

United Kingdom

In the period covered by this Annual Report, the Fund did not hold an Article IV consultation with the United Kingdom, owing to a change in the United Kingdom’s budget cycle that resulted in a shift in the timing of the consultation discussions. The last consultation (concluded in February 1993) was described in the 1993 Annual Report (pages 40-41), and the 1994 consultation will be held later in the year. In the intervening period, Directors reviewed economic developments in the United Kingdom in the context of discussions on the World Economic Outlook, as mentioned in the previous chapter of this report. A summary of Directors’ views on these occasions and economic developments subsequent to the last consultation discussion follows (Table 7).

Table 7

United Kingdom: Selected Economic Indicators

(Annual percent change unless otherwise noted)

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Note: Data in the table reflect information available at the time of the Board discussion of the April 1994 World Economic Outlook. All figures are actuals.

In February 1993, Directors’ discussions took place in the context of the suspension of the pound sterling from the ERM in September 1992, which had ushered in a new framework for economic policy. The challenge for policy in the period ahead was to pursue the objective of price stability while promoting recovery. Directors observed that monetary policy had been eased sufficiently and that the overall stance of policies was to ensure that the inflation objective was not put at risk as the recovery got under way. Directors expressed concern about the medium-term prospects for public finances, as indicated by the erosion of the tax base and discretionary increases in public spending. They noted that the sharp depreciation of the pound sterling after September 1992 should facilitate the correction on the underlying external balance, provided the gain in competitiveness was maintained and the fiscal position was strengthened.

As regards economic developments, recovery has been under way in the United Kingdom since mid-1992. Led by growth in private consumption, the recovery gathered momentum throughout 1993, particularly in the final quarter when investment spending began to pick up. Debt-income ratios of households have fallen from earlier peak levels, and sharply lower short-term interest rates have reduced mortgage payments and have raised disposable incomes of households. During 1993, unemployment dropped by about 1 percent of the labor force to below 10 percent for the first time since August 1992. Because of weak demand in key export markets, the external sector has not contributed to the recovery. Underlying inflation has recently fallen to 2 ½ percent and is expected to stay well within the authorities’ target range of 1-4 percent in 1994-95. The March 1993 budget announced a tightening of fiscal policy, with phased tax increases, and in the November 1993 budget, the authorities set out a medium-term fiscal consolidation program that aims to eliminate public borrowing by the end of the decade. The program is based on restrained growth in government spending over the period and on phased tax increases to be implemented over the next three years. Within the authorities’ monetary policy framework, official interest rates were reduced slightly in the period under review.

In April 1994, Directors discussed the United Kingdom in the context of the discussion on the World Economic Outlook. They noted that the United Kingdom was among the group of industrial countries where recovery was either well established or clearly under way. Directors also welcomed the adoption by the United Kingdom of a medium-term fiscal consolidation program. On the conduct of monetary policy, while some Directors believed that more experience would be needed before a judgment could be made about the merits of the policy framework, other Directors observed that the United Kingdom’s adoption of an explicit inflation target had helped to reduce uncertainty about the authorities’ policy objectives.

Italy

Directors met in February 1994 to discuss the staff report for the 1993 Article IV consultation with Italy. The discussions took place against the background of a pervasive slowdown in the Italian economy, marked by a decline in economic growth, with mounting unemployment, and a drop in private consumption (Table 8).

Table 8

Italy: Selected Economic Indicators

(Annual percent change unless otherwise noted)

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Note: Data in the table reflect information available at the time of the Board discussion, except as otherwise indicated.

Fund staff projections.

Excluding workers in the Wage Supplementation Fund. Figure for 1993 is based on a new methodology and is not comparable with earlier years.

Customs basis. Figure for 1993 is based On data available until November 1993.

Revised figure based on data available subsequent to the Board discussion.

Based on the IMF’s multilateral exchange rate model. The NEEH series compiled by the Bank of Italy show a depreciation of 16.6 percent for the same period.

End of November.

The economic uncertainty since the financial crisis in late 1992 affected the behavior of both households and businesses. This uncertainty, together with the drop in real disposable income resulting from lower wage increases, higher taxes, and the fall in employment, led to a decline in private consumption of nearly 2 percent in 1993, the first such fall in the postwar period. The weak economy also moderated price and wage inflation, which fell to 4.4 percent in 1993. Employment (in terms of units of labor) in the third quarter of 1993 was 2.4 percent below the level in the same period of 1992, while unemployment rose in October 1993 to 11.3 percent of the labor force.

The trade balance improved dramatically as a result of weak domestic demand and a decline in the value of the lira by more than 15 percent in nominal effective terms compared with 1992. The strong performance of exports also moderated the impact of the economic slowdown on overall GDP.

Despite the improved current account position, pressure on the lira continued during the year and the value of the lira fluctuated substantially, precluding an early return to a fixed rate regime. Monetary policy, guided by a number of indicators, broadly aimed at reducing interest rates from the crisis levels of late 1992 and early 1993 without exacerbating financial market tensions or underlying inflationary pressures. At the end of the year, the growth in broad money (M2) was 8.2 percent, exceeding the target growth rate of 5-7 percent. Interest rates were lowered by some 4 percentage points during the year.

In contrast to previous budgets, the Government’s 1993 budget provided for longer-lasting savings, including in particular, some structural measures to curtail entitlements. In response to an emerging budget shortfall, these measures were supplemented by additional revenue increases and spending cuts later in the year, although the primary surplus target was lowered from 3.1 percent to 2 percent, and the overall deficit target was raised to 9.7 percent of GDP. The medium-term fiscal targets were also revised, including postponing the target of stabilizing the debt-to-GDP ratio from 1995 to 1996.

The 1994 budget aimed at reducing the overall deficit-to-GDP ratio to 8.7 percent, which represented a further decline in the underlying deficit, and envisaged savings of nearly 2 percent of GDP relative to an otherwise deteriorating trend balance. The revenue-to-GDP ratio was expected to decline by 1.5 percentage points of GDP from 1993.

In their discussion, Directors commended the Italian authorities on the significant steps toward economic reform that the country had taken since 1992, despite difficult economic and political circumstances. Rehabilitation of public finances had begun, a new wage negotiating process had been agreed upon, the full and formal independence of the Bank of Italy had been achieved, and the privatization program had been initiated successfully. Nevertheless, Directors agreed that additional measures were needed to bring about the required turnaround in the fiscal accounts and to reduce interest rates on a lasting basis. Given that since mid-1992 the lira had remained vulnerable to shifting market sentiment and consumer and business confidence had also continued to be weak, it was essential to resolve uncertainties about the course of policies over the medium term. Directors concurred on the desirability of keeping the economy on a firm path of fiscal consolidation, disinflation, and structural reform.

The 1993 budget had been successful in limiting the fiscal deficit despite the recession, but Directors noted that additional measures might be needed to meet the Government’s fiscal targets for 1994. Further, since Italy’s public indebtedness was continuing to rise, from a level already close to 120 percent of GDP, and the stabilization of the debt-to-GDP ratio had again been delayed, Directors unanimously urged the Government to return to the earlier aim of stabilizing the ratio by 1995 and to lower it substantially there after.

Directors emphasized that the budget targets for 1994 were the minimum necessary and suggested that contingent measures be prepared to offset slippages. They also supported the approved measures for restraining entitlements, such as pensions, and stressed the continued importance of the quality of the adjustment measures, including the broadening of the tax base and the improvements in enforcement.

The country’s progress in carrying out the privatization program, such as the sale of state enterprises according to an announced timetable, as well as financial market reforms, were welcomed by Directors. Further, they noted the predominantly structural nature of the country’s unemployment situation and stressed the need for comprehensive reforms to enhance labor market flexibility, especially with regard to employment protection.

The importance of monetary policy in the disinflation process was emphasized by Directors. They agreed that, in the absence of the exchange rate anchor, the Bank of Italy’s approach of basing policy on a number of indicators had successfully permitted interest rates to fall while inflation remained subdued. They advocated a cautious approach to further monetary easing in the context of accelerated fiscal consolidation. They generally viewed the emphasis of monetary policy on the objective of price stability as particularly important at a time when uncertainties remained as to the future course of economic policies in other areas.

Directors stressed the need for continuing the process of trade liberalization and urged Italy to foster efforts within the EU to lower trade restrictions against third countries. Several Directors also noted that the urgency of domestic reforms and fiscal adjustment should not detract from the need to provide an adequate level of development assistance.

Canada

The 1994 Article IV consultation with Canada in May 1994 was held against the background of a slow but strengthening recovery. Real GDP grew by 2.4 percent in 1993 after contracting in 1991 and growing by less than 1 percent in 1992. But the pace of recovery was slow relative to previous cyclical upswings, and activity in some areas of the economy remained sluggish during the year leading up to the Board discussion (Table 9).

Table 9

Canada: Selected Economic Indicators

(Annual percent changes unless otherwise noted)

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Note: Data in the table reflect information available at the time of the Board discussion.

Slack employment conditions and limited income growth adversely affected consumer confidence and restricted private spending. The unemployment rate continued to rise following the end of the 1990/91 recession and has remained above 11 percent since early 1992, as capital deepening and industrial restructuring increased productivity relative to the growth of employment.

Investment was boosted by a continued decline in interest rates. During 1993, the authorities eased monetary conditions for a third successive year as inflation subsided to levels in the bottom part of the target ranges established in 1991 by the Government and the Bank of Canada. Since February 1994, interest rates rose in response to increases in U.S. interest rates and exchange and financial market pressures.

The merchandise trade surplus doubled in the two years to 1993 as real exports grew strongly, reflecting higher levels of economic activity in the United States and gains in competitiveness from cost-cutting measures by firms and the depreciation of the Canadian dollar. In nominal effective terms, the Canadian dollar fell by about 15 percent in the two years to the end of 1993, a decline that is closer to 20 percent in inflation-adjusted terms.

In their review of the Canadian economy Directors supported the budget deficit reduction proposals in the February 1994 budget as a needed step toward fiscal consolidation. They underscored the importance of forcefully implementing the fiscal program, which aimed to reduce the budget deficit to 3 percent of GDP in 1996/97 from an estimated 6½ percent of GDP in 1993/94. Directors noted, however, that even if the 3 percent target were achieved, the debt-to-GDP ratio still would be very high. Given this high projected level of debt and the unsettling effect that the fiscal situation appeared to be having on exchange and financial markets, Directors urged the authorities to intensify their fiscal consolidation efforts, taking full advantage of economic expansion to achieve a faster reduction in the deficit and in the debt-to-GDP ratio.

Directors noted with concern the high rate of structural unemployment in Canada, but were encouraged by the authorities’ plans for comprehensive reform of the unemployment insurance system and social programs. They agreed that these reforms should be coordinated with the provinces and should reduce the adverse effects of the unemployment insurance system on the economy and help generate fiscal savings for both levels of government.

While acknowledging the short-term costs in terms of economic activity, Directors commended the authorities for their success in reducing inflation and agreed that this achievement had laid the foundation for sustained growth. They affirmed that a strengthened fiscal consolidation effort would contribute to the attainment of Canada’s monetary policy objectives. The use of inflation targets had helped to define the authorities’ commitment to a stable monetary policy framework, although the true test of the targets’ credibility would be the maintenance of stable prices during the upturn in the economic cycle.

Smaller Industrial Countries

After a temporary change in consultation cycles, the Fund during 1993-94 held Article IV consultation with all the smaller industrial countries. Differences in cyclical positions, macroeconomic imbalances, and structural policies led to specific policy recommendations in individual cases. Nevertheless, two concerns clouded medium-term prospects and predominated in Board discussions: the need for fiscal consolidation and the need to address problems of high structural unemployment.

For many of the smaller industrial countries, large budget deficits were expected to persist even after excess capacity had been absorbed. Directors noted the need for credible fiscal consolidation in particular for Finland, Greece, Portugal, Spain, and Sweden in order to meet inflation objectives, safeguard stability in financial and foreign exchange markets, and permit monetary conditions that support recovery. For Belgium, some Directors, while commending the track record of steady adjustment over a number of years, stated that in light of high public indebtedness further fiscal measures were needed.

In addition to urging fiscal restraint, many consultations commended present and encouraged future structural reforms of the fiscal system. Foremost among these were reducing the public sector and rationalizing tax systems and tax administration. In some cases, Directors addressed structural factors that had contributed to revenue weakness, indicating the need for subsidy reforms, social security reforms, and further privatization efforts, often in the transportation and communication sectors.

Besides concern over fiscal policy, Directors drew attention to high unemployment rates and labor market rigidities in many countries. Over the past two decades, structural unemployment rose in industrial countries, especially in Europe. To reverse this increase as well as the latest surge in cyclical unemployment, the Board urged further reforms to improve labor market flexibility and responsiveness to changes in demand. Reform measures included strengthening productivity through education, differentiating wages more widely, tightening unemployment benefits, eliminating wage indexation mechanisms, and decentralizing wage decision making.

On the positive side, monetary and exchange rate tensions had abated significantly. With a few exceptions, notably Spain, the smaller industrial countries enjoyed low inflation levels. Nevertheless, Directors were cautious in recommending an easing of monetary conditions, although in a few cases they suggested that the authorities explore the opportunities for interest rate cuts. In general, Directors expressed satisfaction with exchange rate and trade policies, though Greece’s large structural trade deficit was noted. Those countries that had newly granted their monetary authorities more autonomy were commended.

Directors commended several of the smaller industrial countries for taking steps to liberalize the trade regime in general and for supporting the successful conclusion of the Uruguay Round in particular. Directors also praised some countries for the generosity of their official development assistance and encouraged others to raise their contributions.

Australia

In January 1994, the Board reviewed the Australian economy. In 1992/93, Australia experienced its second year of recovery—economic growth accelerated, with real GDP rising by 2.75 percent, mainly on the strength of public and private consumption and residential construction. Consumer price inflation fell from an average rate of 8 percent in 1989/90 to 1 percent in 1992/93. This reflected continued wage restraint, lower inflationary expectations, and the opening of the economy to greater competition. Despite the recovery, labor market conditions remained weak during 1992-93 with flat employment and very slow labor force growth. As a result, the unemployment rate held at around 11 percent, a postwar peak. However, in the last few months of 1993, the recovery appeared to have strengthened and employment growth was running at an annual rate of around 3 percent(Table 10).

Table 10

Australia: Selected Economic Indicators

(Annual percent change unless otherwise noted)1

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Note: Data in the table reflect information available at the time of the Board discussion.

Fiscal year begins July 1

Official projections.

Gross national expenditure.

September quarter: percentage change over year to September quarter

The Fund’s Information Notice System index.

October 1993.

Data are not fully comparable with earlier periods owing to reclassification of deposits and institutions.

December 22, 1993.

The external current account deficit rose slightly, to 3.9 percent of GDP in 1992/93 from 3.2 percent in 1991/92, reflecting the growth in domestic demand and a sizable deterioration in Australia’s terms of trade. Although the private sector reduced its external debt, total net externa) debt increased substantially because of valuation changes arising from depreciation of the Australian dollar, increased foreign borrowing by state governments, and a decline in official reserves.

Monetary and fiscal policies were used at first to cushion the impact of the recession and later to promote recovery. The Commonwealth budget, which had improved steadily to a surplus position in the later 1980s, reverted to a deficit of 3.6 percent of GDP in 1992/93, with state and local governments also posting sizable deficits. Two interest rate cuts of 0.5 percentage point each were made in March and July 1993. The combination of lower short-term interest rates, reduced inflationary expectations, and lower international interest rates resulted in a substantial decline in Australian long-term interest rates, with the ten-year government bond yield standing at 6.6 percent in December compared with 12 percent in 1990/91.

Reviewing these developments, Directors noted that economic growth had continued uninterrupted for two years and might be gaining momentum, while inflation performance remained excellent. They observed, however, that Australia’s unemployment rate remained high and was likely to decline only gradually. They also noted that the level of external debt was substantial and might rise further.

In these circumstances, Directors strongly endorsed the authorities’ plans to reduce the Commonwealth budget deficit to about 1 percent of GDP by 1996/97, noting that this would increase national savings and support an investment revival without adding significantly to the external debt burden. At the same time, they stressed the importance of a strong performance in private savings and emphasized the need for other public sector entities, particularly the state governments, to improve their savings performance. Several Directors suggested that the Australian authorities give renewed consideration to increases in indirect taxes. As regards monetary policy, Directors were of the view that the gradual reduction in interest rates had been appropriate in light of the movements in foreign interest rates, sluggish domestic economic conditions, and the apparent absence of inflationary pressures.

Directors emphasized that the economy’s ability to generate a lasting reduction in unemployment and improved living standards over the longer term would depend importantly on raising the growth of productivity. This, in turn, would require further progress in the implementation of structural reforms. In particular, most Directors encouraged the authorities to undertake more farreaching reforms of the labor market.

Directors commended the Australian authorities for reducing import protection, noting that this had contributed to the strong performance of manufactured exports in recent years. While welcoming the authorities’ plan to reduce tariff rates on most products to no more than 5 percent by mid-1996, some Directors suggested that the pace might be accelerated. Directors encouraged the authorities to persevere with their reform efforts in other areas, including privatization, introducing greater competition and efficiency in transportation and telecommunications, and harmonizing standards among state governments.

Finland

The Board’s Article IV consultation took place in August 1993, at a time when Finland continued to experience its most severe recession in this century.

Following a 1980s boom in domestic demand, fueled in part by financial deregulation and a surge in asset prices, economic activity began to weaken in early 1990. Consumption and investment declined in response to a drop in house and stock prices, increased indebtedness, high interest rates, and a deteriorating economic outlook. Cumulatively, GDP declined about 10 percent between 1990 and 1992, while domestic demand fell 13.5 percent. The unemployment rate surged, reaching 17.5 percent in April 1993 from an average of about 5 percent during the 1980s. Inflation, which had accelerated to 6.6 percent in 1989 as output exceeded capacity, substantially moderated to annual rates of less than 3 percent (Table 11). Wage costs also moderated significantly during 1991-93.

Table 11

Finland: Selected Economic Indicators

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Note: Data in the table reflect information available at the time of the Board discussion.

Official projections.

Includes statistical discrepancy.

The initial economic weakness was transformed into a recession in part by external shocks, notably the collapse of trade with the former Soviet Union and a reversal of favorable movements in the terms of trade for forest products and basic metals that had earlier supported the boom. Strains surfaced most clearly in the foreign exchange market. The markka, devalued in November 1991, was allowed to float in September 1992; by July 1993, it had depreciated about 15 percent against the ECU. This depreciation, combined with subdued inflation and strong productivity performance in manufacturing, greatly enhanced Finland’s international competitiveness. Domestically, however, the depreciation along with high interest rates contributed to balance sheet pressures that resulted in a banking crisis and further depressed demand.

The fiscal situation, which had deteriorated rapidly with the onset of the recession as higher transfer and interest payments drove up the expenditure-to-GDP ratio, continued to worsen in early 1993, prompting new policy initiatives. In addition to the expenditure reduction target established the previous year, in March 1993 the authorities set an additional target of stabilizing state debt at less than 70 percent of GDP by 1997. The authorities also stressed the need for a restrictive incomes policy so that the sharp markka depreciation would not translate into higher inflation. Monetary policy set the target of bringing the rate of core inflation to 2 percent by 1995, to ensure that any unwinding in the real exchange rate would occur through a nominal appreciation rather than through domestic inflation.

For the longer term, Finland has been implementing a major program of structural reform to enhance the flexibility of the economy and align Finland with the countries of the EU. Progress has been made in reforming the tax system, liberalizing foreign direct investment, and prohibiting certain anticompetitive practices. Fiscal reforms have also been made on the expenditure side and in the system of transfers to municipalities.

In their discussion, Directors observed that the latest data pointed to continued weakness in activity and a slow and uneven recovery. Finland continued to face a number of complex economic problems, including an unsustainable fiscal deficit. Directors commended the authorities for the steps already taken to address the fiscal imbalances and agreed that containing the level of real government expenditures and stabilizing the debt-to-GDP ratio were appropriate objectives. Directors expressed concern, however, that to improve public confidence, the Government needed to strengthen its fiscal plans, specify the precise measures to be adopted, and enact implementing legislation as quickly as possible.

As to the serious crisis in the financial sector, Directors commended the steps that had been taken to bolster confidence by improving supervision and ensuring that financial institutions faced appropriate incentives. At the same time, Directors noted that financial institutions should be encouraged to recognize losses in their loan portfolios promptly.

The evidence that wage restraint would continue was welcomed by Directors, who regarded it as fundamental to alleviating unemployment and avoiding a resurgence of inflation. Directors welcomed also recent changes to the unemployment insurance system as an important first step in improving labor market incentives.

Directors agreed that the authorities’ low inflation target would provide monetary policy with a needed focus under the floating exchange rate regime and ensure that the large markka depreciation did not feed through to inflation. In this connection, they were cautious about any loosening of monetary conditions absent more decisive actions to reduce the fiscal deficit and restrain wages. Some Directors concurred that additional cuts in interest rates should only be considered in the context of a strengthening of the exchange rate.

Directors encouraged the authorities to continue with their efforts to align the Finnish economy more closely with those of the EU. Among other structural reforms, government efforts to overhaul the tax system and strengthen competition policy were singled out as particularly noteworthy. Some Directors noted the high level of protection afforded to the agricultural sector, which detracted from Finland’s otherwise good record of open trade relations.

* * *

Since the Board discussion, there has been growing evidence that the decline in economic activity has finally bottomed out, and that an export-led recovery has begun. Unemployment, however has continued to rise to about 20 percent of the work force. Due to the rapid growth in exports, the external current account balance improved sharply and the markka strengthened on balance in the second half of 1993, while inflation moderated further.

Sweden

Directors met at the end of August 1993 for the Article IV consultation with Sweden. At the time, Sweden was beginning to emerge from its worst economic crisis since the 1930s. The crisis, highlighted in the fall of 1992 by strong speculative attacks on the krona, was characterized by a marked decline in output and employment, a ballooning fiscal deficit, and a banking system under severe strain, as discussed below.

Following a period of overheating, including an asset price boom in the latter half of the 1980s, the Swedish economy entered into recession beginning in 1990. Real GDP declined by about 8 percent from its peak in the first quarter of 1990 to the trough early in 1993. The banking sector was especially affected, necessitating state support to three important banks. Employment declined by about 10 percent between 1990 and mid-1993. As a result, wage and price inflation decelerated sharply. From a peak of 10 percent in 1990, consumer price inflation slowed to slightly over 2 percent by the end of 1992, although it picked up again in early 1993. The latter pick-up reflected changes in taxes and subsidies at the end of 1992 as well as the pass-through of a currency depreciation that followed the floating of the krona in November 1992 (Table 12).

Table 12

Sweden: Selected Economic Indicators

(Annual percent change unless otherwise noted)

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Note: Data in the table reflect information available at the time of the Board discussion.

Official projections.

The floating of the krona marked a substantial change in the Swedish monetary policy framework, which had been based on a fixed exchange rate policy for most of the last century. Sweden was forced to abandon its fixed rate following large-scale outflows of foreign exchange, despite record-high interest hikes and substantial exchange market intervention financed by heavy external borrowing. At the same time, private sector borrowing in foreign currencies was repaid at a fast pace. The substantial krona depreciation that followed the floating, together with the rising share of krona-denominated debt owned by foreigners, contributed to a significant worsening in the balance on net interest payments abroad. Moreover, in connection with this currency turbulence, export performance fell sharply in the fourth quarter of 1992 after having picked up earlier in the year. As a result, Sweden’s external current account deficit widened slightly, to the equivalent of 2.1 percent of GDP in 1992.

The weakening in economic activity was accompanied by a major deterioration in public finances. From a small surplus in 1989/90, the Government’s overall borrowing requirement rose to more than 13 percent of GDP in 1992/93. Beyond the effects of the cycle, the weakening of public finances resulted from support to the banking sector, a less than fully funded tax reform, and the impact of disinflation on real public expenditures, especially transfer payments. The resulting increased transfer payments, together with cyclical conditions, raised public sector spending to more than 70 percent of GDP in 1992.

In April 1993, the Government presented a revised budget proposal designed to reconstruct Sweden’s finances over the medium term. Real public consumption was to be progressively reduced by 1 percent a year, while additional saving of SKr 10 billion a year beginning in 1994/95 were to be made, primarily through reductions in transfer payments and strengthened tax collections. Long-run reform of the supplementary pension system was also in progress.

Between November 1992 and the end of June 1993, monetary conditions significantly eased. Not only did the krona depreciate substantially, but short-term interest rates were also reduced in successive small steps by a cumulative 4 percentage points.

In the August 1993 Board discussion, Directors were of the view that a durable solution to Sweden’s severe economic crisis would require an early correction of the substantial imbalance in the public finances. It was noted that the very high level of public expenditure had contributed to an unsustainably large public sector deficit and to a level of taxation that weakened incentives to work and save, as well as generating doubts about Sweden’s commitment and ability to maintain low inflation.

Directors underscored the importance for fiscal policy credibility of an early specification of the medium-term proposals outlined in the April 1993 budget, but felt that further measures of budget consolidation were required. In light of the already high level of taxation, Directors considered that these measures should focus on cutting back public spending in general and transfer payments in particular, observing that Sweden’s public spending exceeded that in EU member countries.

The announcement of a 1995 inflation target of 2 percent (with a margin for variation of plus or minus 1 percent) as the key target for monetary policy under the floating exchange rate regime was welcomed by Directors. They observed that a balanced recovery of the Swedish economy would require a sustainable further reduction in interest rates. Nevertheless, noting the large krona depreciation since November 1992 and the corresponding substantial easing of monetary conditions, they stressed that any future interest rate reductions should be implemented very gradually, with most Directors counseling that interest rates should be reduced only in the context of a strengthening krona.

Directors stressed that increased labor market flexibility could reduce the employment and output costs of Sweden’s present economic transition while leading to wage differentials that more adequately reflected productivity differences. Moreover, they noted that an early resolution of Sweden’s banking crisis was necessary for sustained economic recovery.

Sweden was commended by the Board for maintaining a generous external development program despite its economic difficulties, and for focusing aid on the world’s poorest countries.

Switzerland

The Board’s January 1994 review of the Swiss economy completed the first Article IV consultation with Switzerland since it joined the Fund in May 1992.

Following a third consecutive year of shallow recession in 1993, the contraction of output affected all sectors of the Swiss economy. Declining private consumption reflected consumers’ concerns about falling real wages, faltering job security, and tighter fiscal policy.

Employment had dropped by about 5 percent since activity reached its most recent peak—a sharper fall relative to the dip in output than in earlier downswings (Table 13). Employment declined thereafter first in the industrial and construction sectors, and subsequently in services, which had not been much affected in previous downturns. By late 1993 the Swiss unemployment rate had reached an unprecedented 4 ¾ percent.

Table 13

Switzerland: Selected Economic Indicators

(Annual percent change unless otherwise noted)

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Note: Data in the table reflect into Information available at the time of the Board discussion.

Preliminary.

IMF staff projections.

October1993.

Average January-November.

After exceeding 6 percent during 1991, inflation declined for the next two years following a renewed tightening of monetary policy in mid-1991 to counteract a fall in the exchange rate. The response of inflation to the monetary tightening has been slow compared with previous experience, partly reflecting the effects of the exchange rate depreciation in 1990-91.

A combination of cyclical conditions and mildly expansionary fiscal policy resulted in a widening of budget deficits at all levels of government. The finances of the general government moved from a position of near balance in 1990 to a deficit expected to exceed 4 ½ percent of GDP in 1993.

Unlike previous Swiss recessions, the latest downturn in the economy was not caused primarily by a deterioration in export performance. Indeed, the external sector offset the decline in domestic demand in 1992 when a rise in exports, which coincided with a fall in imports, left the trade account in near balance. This contributed to a cyclical uptrend in the current account surplus.

In their review, Directors commended the Swiss authorities on their generally successful conduct of an independent monetary policy, which had kept inflation very low and had contributed to making Swiss interest rates the lowest in Europe. Directors expressed, however, concern that prospects for sustained medium-term growth were now clouded by the emergence of a significant fiscal deficit and by structural rigidities in the economy.

Directors considered that restoring stability to the fiscal accounts presented the greatest immediate policy challenge. They supported the authorities’ medium-term target of achieving budget balance over the cycle but observed that, on current policies, the structural deficit would increase over the medium term and measures already announced might not forestall that tendency. They felt that a detailed consolidation program to reduce the general government structural deficit in 1995-96 should be announced as soon as possible.

Directors recognized the steps taken to reduce structural rigidities in the economy. Directors stressed that there remained considerable scope for efficiency improvements in other sectors and they emphasized that the momentum of reform needed to be accelerated. In particular, they noted the authorities’ proposed reform of the competition law, the creation of an internal market in Switzerland, and immigration reform. Nevertheless, noting the increase in unemployment to historically high levels, Directors argued that there was a need to pursue more active labor market policies, including the improvement of work incentives by phasing out unemployment benefits that were overgenerous.

Directors commended Switzerland for its generally liberal trade policies and especially the market access it had granted to the products of economies in transition. Most Directors noted, however, that there had been little progress toward reducing agricultural trade distortions and urged that steps be taken to ease the adverse effects of excessive producer subsidies.

Developing Countries

Many developing countries-ranging from newly industrialized to low-income—were commended by the Board during Article IV consultation for significant strides they had made with mac-roeconomic and structural reforms, many with the financial support of the Fund. In most cases, however, some further macroeconomic and structural adjustment was required.

In the framework of adjustment efforts, Directors frequently stressed the importance of cautious fiscal policies. During 1993 consultations, Directors commended the strong fiscal position of a number of countries while urging tighter policies in others. Together, tight fiscal and monetary policies had in some countries contributed to reduction in the rate of inflation and to attaining noninflationary growth. Adhering to fiscal targets also helped to narrow external imbalances, to meet monetary objectives, and to reduce the threat of exchange market pressures. In a number of cases, Directors said authorities should take action to strengthen the fiscal effort over the near term, especially if the budget turned out to be weaker than expected.

Although often recommending expenditure control, Directors at the same time recognized the need for investment—sometimes substantial—in infrastructure development, social services, and environmental protection. On the expenditure side, Directors often cited the need for better control, and frequently also pointed to the need for additional revenue measures. They underscored the importance of fiscal reforms designed to enlarge the revenue base and, in some cases, raise a low tax-to-GDP ratio. An improvement in the budget position helped to foster private sector investment and to generate adequate public sector savings to finance valuable public investment.

Directors said action on the fiscal front should be supported by appropriate monetary policies, often with additional steps to liberalize the financial system. Many developing countries were commended for pursuing prudent monetary policies, and in some cases where Directors believed that monetary policy was too easy, a tightening was urged. In general, Directors underlined the importance of monetary policy in ensuring that the authorities’ inflation objectives would be attained. To this end, they noted that the implementation of monetary policy could sometimes be facilitated if instruments were diversified.

In circumstances where an accommodating monetary policy was pursued to provide support for economic recovery, Directors emphasized the importance of getting inflation down and strengthening competitiveness. Directors stressed that the authorities should exercise firm control over the credit and monetary aggregates so as to ease pressures on domestic prices and the balance of payments. Although prudent financial policies had frequently resulted in a significant reduction in inflation in many countries, in others the rate of inflation remained above that of main trading partners or had accelerated. Where deterioration on the inflation or balance of payments fronts occurred, this called for a corrective tightening of policies and a deepening of structural reforms. Just as with fiscal discipline, strong monetary policies were seen as essential for achieving greater exchange rate stability.

In the area of monetary policy, Directors welcomed the structural improvements that had been introduced in many developing countries, particularly the introduction—or maintenance—of interest rates at positive levels in real terms. Monetary objectives should be supported by the introduction or continuation of banking and capital market reforms, and the need for greater use of open market instruments was often noted. Monetary policy needed to be geared toward providing adequate credit to the private sector to allow it to play a leading role in the growth process.

Directors welcomed the considerable progress in structural reform in many developing countries, highlighting in these cases such policies as the adoption of measures to foster the role of the price mechanism and improve the allocative efficiency of the economy, privatization, improved financial management and accountability in public enterprises, and capital market liberalization. In general, Directors noted that structural reforms helped to improve confidence, spur private investment, and strengthen economic competitiveness.

Board members considered that although developing countries generally had undertaken significant structural reforms to increase the supply of productive resources and enhance economic efficiency and competitiveness, deficiencies persisted in some areas. These pointed to the need for elimination of labor market rigidities, incentives, subsidies, and price supports. Directors also emphasized the need to promote the diversification of production and of exports, improve the competitiveness of the economy, and strengthen the role of the private sector.

In a number of countries, Directors also urged the authorities to pursue labor market reforms—including reform of labor legislation to facilitate mobility and promote more flexible employment conditions—to enhance the economy’s flexibility.

Social safety nets are increasingly becoming an important component of countries’ efforts to shield the most vulnerablen segments of their populations from the short-term effects of corrective policies. In encouraging governments in their efforts to alleviate poverty through safety nets, Directors sometimes suggested that existing programs be strengthened or their targeting improved.

On the external front, a large number of countries were commended by Directors for the progress made toward balance of payments viability, but Directors observed that in many cases further adjustment efforts would be needed to establish external viability over the medium term. It was recognized that while capital inflows could be beneficial to developing countries in stimulating higher investment and growth, there was the risk that sudden surges in inflows could threaten macroeconomic stability (see section on Experience with Surges in Capital Inflows, above).

Directors considered that the successful December 1993 conclusion of trade talks under the Uruguay Round should help to stem protectionist pressures and contribute to enhancing global business confidence and the prospects for world economic growth. The more open markets should also serve as an important complement to the structural adjustment efforts undertaken by Fund member countries for sustainable growth.

Directors welcomed the opening of the domestic economy in many developing countries to external competition through the elimination of exchange and trade restrictions. Where there was scope for further trade reform, Directors urged the authorities to phase out the remaining barriers to imports, ease marketing restrictions, resist calls for protection of new industries, and reduce regulatory hurdles to foreign investment. Directors welcomed the steps being taken by some countries to promote regional integration and trade. They stressed, however, the importance of ensuring the consistency of such agreements with multilateral trade liberalization efforts.

In some countries, Directors expressed the importance of eliminating quickly external arrears and of remaining current on debt and other external obligations. This would help such countries regain access to voluntary market financing. For most low-income countries, substantial financial support from the international community, on concessional terms, would continue to be necessary. The value of improved access to industrial country markets was stressed by Directors during many discussions.

Exchange rate policy continued to be an important component of Article IV discussions with developing countries. The Fund’s advice in this area depends on the circumstances of each country. A few countries were urged to unify exchange rates at a realistic, market-determined level. Directors noted that the objective of achieving exchange rate stability had been and would continue to be elusive without a concomitant—and significant—tightening of fiscal and monetary policies.

Finally, in order better to guide policymakers in reformed economic environments, Board members asked a number of countries to improve the quality, coverage, and timeliness of their economic and financial data, in some cases with technical assistance from the Fund.

Côte d’lvoire

In March 1994, Directors discussed the Article IV consultation with Côte d’lvoire and approved its request for arrangements under the ESAF. The discussion took place against a background of the authorities’ decision to join other member countries of the CFA franc zone in adopting a comprehensive macroeconomic strategy encompassing the devaluation of the CFA franc against the French franc with effect from January 12, 1994.

For some time before the devaluation, Côte d’lvoire had made serious efforts to reduce financial disequilibria and implement structural reforms against the back-ground of a sharp drop in the world market prices of its major exports and a sizable nominal appreciation of the CFA franc, together with a number of structural and sectoral problems. However, in view of the crisis in competitiveness, the internal adjustment policies implemented were not adequate to restore growth and external viability, and, for seven consecutive years, domestic output had contracted, and considerable amounts of domestic and external payments arrears had been accumulated. With declining rates of saving and investment, and growing capital flight, the prospects for an early return to economic growth and balance of payments viability without external adjustment had become increasingly uncertain.

Economic performance in 1993 was marked by a continuation of the relative stagnation of the Ivoirien economy seen since 1991, and real GDP growth was -1.1 percent (Table 14). The significant improvement in fiscal imbalances achieved in 1992 was not repeated in 1993; preliminary data indicated a 12 percent drop in tax revenue, in the areas of direct and import taxation, reflecting the worsening of the overall economic climate. The authorities were, however, more successful in keeping government expenditures under control. Nevertheless, on a commitment basis, the Government’s primary deficit increased to 3 percent of GDP in 1993 from 1.4 percent in 1992. With a marked increase in interest obligations, the overall fiscal deficit widened to the equivalent of 16.2 percent of GDP in 1993 from 12.9 percent the year before.

Table 14

Côte d’lvoire: Selected Economic Indicators

(Annual percent change unless otherwise noted)

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Note: Data in the table reflect information availabie at the time of the Board discussion.

Preliminary.

Of goods, in constant 1989 prices.

Excluding import tariffs.

After 1992, based on changes in projected inflation in the main trading partners and changes in the domestic consumer price index.

Reflecting the increasing liquidity crisis of public finances, the Government again experienced difficulties in meeting its financial obligations, which led to further accumulation of domestic and external payments arrears. The evolution of the main monetary aggregates was greatly affected by the Treasury’s increased recourse to central bank advances, which caused net bank credit to the Government to expand by almost 8 percent. Total net domestic credit of the banking system, on the other hand, declined marginally, as credit demand in the private sector continued to fall.

Côte d’lvoire’s trade surplus strengthened markedly in 1993 because of a decline in imports, although the current account deficit narrowed by only a small margin due to the increase in the deficit of the services account resulting from the higher interest obligations on the external debt. The country’s external financing situation deteriorated sharply after the expiration in 1992 of the Paris Club rescheduling, and substantial external payments arrears were accumulated.

In their discussion of Côte d’lvoire, Directors welcomed the broadening and strengthening of the adjustment strategy represented by the devaluation of the CFA franc, a step they had for some time considered to be a necessary condition for the return to sustainable economic growth and financial viability over the medium term. Directors commended the authorities for their determination in implementing the immediate actions and the accompanying measures of their program for 1994 and the medium term. However, Directors emphasized that the authorities would need to adhere strictly to the tight financial policies foreseen in the program and proceed with far-reaching structural reforms if the devaluation was to have its intended positive effects.

Noting the program’s objectives. Directors stressed that the achievement of the fiscal targets was essential. They strongly supported the restructuring of the tax and tariff system introduced under the program, as well as the cautious stance of wage policy and the reorientation of public expenditure in favor of investment and the development of human resources. They expressed satisfaction with recent progress in restructuring the public domestic debt, and observed that the success of the program would also depend on prudent monetary policy.

Directors considered it crucial for Côte d’lvoire to vigorously implement the structural reforms envisaged under the program since these would promote economic efficiency and the development of the private sector, as well as reinforce gains in the external sector.

Directors also observed that the implementation of social safety net measures would be important for the success of the program. Côte d’lvoire, they felt, would need substantial external financial assistance and debt relief in the years ahead.

Kenya

In December 1993, Directors completed the Article IV consultation with Kenya and approved its request for a loan equivalent to SDR 45.23 million under the ESAF in support of the Government’s economic and financial program covering October 1993-September 1994.

The discussion took place against the background of the implementation, April 1993, of a macroeconomic framework to restore balance to the economy and resume the economic reform process. By the time of the Board discussion, monetary policy had been tightened and steps taken to stabilize the financial system; the exchange and trade system and maize marketing system had been substantially liberalized; and civil service reform had been initiated. As a result, important progress had been made toward stabilizing the economy.

Since the early 1990s, Kenya’s economic situation had worsened. Economic growth fell from 4.4 percent in 1990 to 0.4 percent in 1992, inflation accelerated, and external payments arrears emerged (Table 15). By March 1993, the economy was in serious difficulty with severe shortages of foreign exchange; inflation rose to 58 percent on an annual basis in the first quarter of 1993. Several factors contributed to this situation: a series of exogenous shocks, including a large influx of refugees from neighboring countries and unfavorable export prices; unsettled social and political conditions during the democratization process; and the suspension of balance of payments assistance from donors in late 1991.

Table 15

Kenya: Selected Economic and Indicators

(Annual percent change unless otherwise noted)

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Note: Data in the table reflect information available at the time of the Board discussion.

Estimated

Projected.

December-to-December variations in official exchange rate.

In their discussion, Directors noted the progress made toward re-establishing stable macro-economic conditions and resuming economic liberalization, but stressed that this progress and the proposed financial program should be seen only as the beginning of a process to re-establish an environment conducive to sustained economic growth. They emphasized the importance of implementing the program in full. Directors also emphasized that accountability, transparency, and financial responsibility should be the guiding principles in the public sector and urged resolute action to bolster public confidence at home and abroad in Kenya’s economic management.

Directors stressed that in 1994 the highest priority should be given to the objective of consolidating the gains in macroeconomic stabilization, as evidenced by single-digit inflation and relative exchange rate stability. While interest rates were relatively high, it appeared that a decline in interest rates required further progress on the fiscal front and further deceleration of inflation. Directors stressed that the key consideration guiding monetary policy was to ensure that the inflation objective would be attained. To this end, they noted that the implementation of monetary policy could be facilitated if monetary policy instruments were diversified. They also welcomed the substantial progress made in rehabilitating and strengthening the banking system.

Directors underscored that a key component of the adjustment strategy was to reduce the government budget deficit, primarily through cuts in expenditure in relation to GDP. Stressing the value of improving the quality of expenditure, Directors attached considerable importance to implementing recommendations of the Public Expenditure Review being carried out with the assistance of the World Bank. In order to create enough room for the much-needed expenditure on operations and maintenance, as well as development projects, the civil service reform program should be strengthened and implemented vigorously, and encompass a government restructuring to avoid duplication and to allow privatization of certain functions currently being carried out by the Government. In addition, direct and indirect subsidies and payments to public enterprises should be phased out.

Directors welcomed the actions planned to liberalize domestic markets. In particular, they considered it critical to move ahead with the full elimination of price controls and of restrictions on maize as soon as possible. Directors also supported the planned liberalization of the petroleum market.

Directors welcomed the abolition of import licensing and the scaling back of exchange restrictions. They noted with satisfaction that progress was being made in attaining exchange rate stability and that the liberalized exchange and trade systems appeared to be functioning well. Directors strongly supported the authorities’ intention to remove the remaining exchange restrictions soon, and also welcomed the steps being taken by Kenya and other countries to promote regional integration and trade. Directors noted the Government’s decision to seek multilateral rescheduling of external payments arrears on nonconcessional terms, thereby regularizing Kenya’s relationship with its creditors.

South Africa

In December 1993, Directors conducted the Article IV consultation with South Africa and approved its request for a drawing equivalent to SDR 614.43 million under the CCFF. The drawing, which was South Africa’s first use of Fund credit since 1982, was to help compensate for a shortfall in merchandise export earnings and a drought-related increase in cereal imports for the 12-month period ended June 1993.

The consultation took place as the South African economy began to emerge from the exceptionally harsh and long-lasting recession that it had entered in mid-1989. Real GDP had fallen by more than 3 percent, and nearly half of the labor force was unable to find work in the formal sector.

Inflation, which had been stuck at around 15 percent in the first two years of the recession, began to come down in 1992 and, by September 1993, consumer price inflation had fallen to 9 percent (of which 2 percentage points were attributable to an increase in the value-added tax rate) and producer price inflation had dropped below 6 percent (Table 16).

Table 16

South Africa: Selected Economic Indicators

(Annual percent change unless otherwise noted)

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Note: Data in the table reflect information available at the time of the Board discussion.

Official projections.

Fiscal discipline was eased considerably after 1990, but the budget for 1993/94 sought—by means of higher indirect taxes, some fiscal drag, and a reduction in drought-related expenditure—to cut the deficit to 7 percent of GDP from 8 ½ percent in 1992/93. This deficit objective appeared to be attainable.

Monetary policy remained restrictive during the recession, and interest rates were positive in real terms for the whole of this period. The balance of payments had been severely constrained by the dearth of external financing stemming from financial sanctions. Foreign exchange and gold reserves, which had peaked in August 1992, had fallen by the time of the Directors’ discussions to levels that the authorities regarded as inadequate. The current account was weakened in 1992 by the effects of a severe drought and by a continuation of the prolonged unfavorable trend in the terms of trade.

South Africa’s macroeconomic management in recent years had aimed at achieving financial stability in difficult circumstances. The country had maintained a constructive policy dialogue with the Fund through regular consultations and staff visits. For the period ahead, the authorities were resolved upon a cautious fiscal and monetary stance that was broadly supported by South Africa’s major political groups.

In their discussion, all Directors congratulated South Africa on the bold political transformation under way. They considered that the economic potential of South Africa, properly employed, could improve living standards in the country and have a powerful and beneficial economic influence on the southern Africa region. Directors noted the challenges faced by the economy and welcomed the consensus that was being forged on many of the economic issues facing the country through a participatory approach among the various groups involved in the political dialogue.

Directors believed that, in the short term, underlying real growth—that is, aside from the effects of the recovery from the drought—was likely to be modest and that, although this might help consolidate the gains on inflation, it could entail further deterioration of an already grave unemployment problem.

Directors concurred with the view of the authorities and the principal nongovernmental groups that more expansionary demand management policies would be counterproductive in the current circumstances. They noted that the origins and special characteristics of the recession were not conducive to successful countercyclical macroeconomic policies: the drought would be self-correcting, the weakness of investment was related to political uncertainty, and the recovery of growth in South Africa’s major trading partners was slow. Unemployment was seen as being more structural than cyclical. Directors added that the scope for fiscal initiatives was limited by the large deficit, the scarcity of domestic savings, and the fast growth of government debt.

Directors noted that monetary policy had been circumscribed by exchange rate developments and concurred with the staff’s judgment that the scope for easing monetary policy in the circumstances prevailing at the time of the Board discussion was limited. Looking ahead, it appeared that an easing of monetary conditions in the future could be facilitated by wage restraint, a strengthening of the fiscal position, and a building up of confidence in the authorities’ macroeconomic program.

Directors emphasized the importance of implementing policies that would raise productive investment, both domestic and foreign, and strengthen competitiveness. They stressed that in order to unleash market forces in this manner, macroeconomic policies would need to promote confidence in financial stability, and the authorities would have to encourage wage restraint and devise an effective anti-trust policy. In addition, South Africa would need to adopt a more liberal, outward-looking policy on trade.

On the labor market, Directors believed that future policies to alleviate unemployment would have to include wage restraint, including possibly some form of social contract, some further improvement in competitiveness, the removal of the anti-export bias in the trade regime, measures to enhance productivity, and, more generally, measures to create an economic environment that would be conducive to investment and growth.

Directors recognized the imperative to remove racial discrepancies in social spending that were a feature of apartheid. They observed, however, that the need to respect economic and financial constraints placed limits on the overall level of social spending.

Directors were supportive of the envisaged trade reform, and specifically of the plans for lower and more uniform tariffs, the abolition of import licensing restrictions and formula duties, and the introduction of mechanisms to ensure that exporters had access to inputs at world prices. They urged that the financial rand system be abolished and the exchange market unified as soon as circumstances permitted, and they welcomed the final agreement with foreign creditor banks, which eliminated the exchange restriction that was implicit in the debt standstill.

China

Directors met in April 1994 to discuss the Article IV consultation with the People’s Republic of China. The discussion took place against a background of the remarkable performance of the Chinese economy, which had grown by over one fourth in the space of just two years as a result of double-digit growth in both 1992 and 1993 (Table 17).

Table 17

China: Selected Economic Indicators

(Annual percent change unless otherwise noted)

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Note: Data in the table reflect information available at the time of the Board discussion.

Projected.

In 35 cities.

Fund staff estimate

Based on swap rate, in terms of the basket of currencies used in the Fund’s Information Notice System. A decline in the index indicates a depreciation

As of October 1993.

End of September 1993

During 1992, there was a decisive strengthening in the political commitment to transforming the economy to one based fully on market mechanisms, aimed at attaining rapid gains in output, productivity, and living standards. In response to the leadership’s call for accelerated reform and faster development, and in an environment of accommodating financial policies, there was a boom in aggregate demand, especially investment, which led to intensifying macroeconomic imbalances.

Real GNP grew by an annual rate of 13 percent in 1992 and 14 percent in the first half of 1993. The leading demand component was fixed investment by state-owned units, which soared by more than 40 percent during 1992 and at a 70 percent annual rate in the first half of 1993 in nominal terms. Toward the end of 1992 and into the first half of 1993, increasing strains on the economy—including shortages, higher inflation, a growing trade deficit, and a decline in official exchange reserves—were evident. Intensifying macroeconomic imbalances were accompanied by disorderly conditions in financial and exchange markets.

By mid-1993, these developments prompted the central authorities into taking decisive action. A two-pronged strategy was adopted in July 1993 to stabilize the economy and to speed up structural reforms, with the aim of achieving a “soft landing.” Known as the 16-point program, the stabilization effort consisted of a broad range of market-based and administrative measures that produced notable results during the second half of 1993. Orderly conditions returned to the financial and exchange markets; there was a significant improvement in public finances; the exchange rate in swap centers stabilized; and there was a significant deceleration in the growth of fixed investment. As a result of a lagged response, the trade deficit, however, widened further.

In their discussion, Directors were unanimous in praising the impressive growth of the Chinese economy over the past two years and in welcoming the comprehensive reform program that was being implemented to achieve a breakthrough in China’s effort to establish a market-based economy.

Directors emphasized that macroeconomic stability was essential for the successful implementation of the reform agenda for 1994. In this connection, they observed that the initial positive results of the 16-point program were not sustained in the final months of 1993. They regretted that, as a result, the rate of inflation had remained high in early 1994. Directors stressed that the macro-economic situation prevailing at the time of their discussions called for the steadfast pursuit of sound financial policies. In particular, it was crucial for the People’s Bank of China to firmly control its lending to banks so as to limit the expansion of monetary and credit aggregates. Directors noted that fiscal policy should also contribute to containing demand pressures and urged that a better-than-budgeted revenue performance in the first few months of 1994 not be allowed to feed into additional expenditure.

In the discussion of the structural reform, Directors welcomed the priority placed on building the infrastructure for conducting market-based macroeconomic policies. In particular, the strengthening of the People’s Bank as a central bank with greater autonomy, the termination of the ability of the local branches of the People’s Bank to extend credit, and the commercialization of the specialized banks were viewed as key steps toward this goal.

Directors considered that the fiscal reform was bold and well focused on the major factors underlying the weakness in public finance, namely, the lack of overall revenue buoyancy and the erosion of central control over fiscal revenue and policy.

Directors urged the authorities to intensify efforts to improve the poor financial performance of state-owned enterprises. In this context, they supported the focus on “corporatizing” state-owned enterprises, that is, turning them into fully autonomous enterprises. Some Directors recommended that the Chinese authorities give renewed consideration to the possibility of privatization.

Directors welcomed the new exchange system introduced at the beginning of this year, but noted the potential segmentation of the foreign exchange market. Directors urged the authorities to ensure that the implementation would be fully consistent with the objectives of the exchange reform to establish a unified exchange rate, an integrated national foreign exchange market, liberalized access to foreign exchange for trade and trade-related services transactions, and full transparency of the exchange system.

Directors stressed that further substantial and accelerated progress in trade liberalization would be needed to derive maximum benefits from the new exchange system and to open the Chinese economy more effectively to the outside world. Some Directors added that this further progress in trade liberalization should also be helpful to the negotiations under way on China’s reaccession to the GATT.

India

Directors met in April 1994 to discuss India’s Article IV consultation. The discussion took place against a background of a program of fiscal consolidation and structural reform put in place during 1991/92-1992/93 that had been effective in restoring external confidence, reducing inflation, and limiting the economic slowdown in the face of a severe initial balance of payments crisis. Notwithstanding these positive developments, some aspects of recent macroeconomic performance gave cause for concern (Table 18).

Table 18

India: Selected Economic Indicators

(Annual percent change unless otherwise noted)

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Note: Data in the table reflect information available at the time of the Board discussion.

Provisional.

Refers to composite exchange rate.

After reforms were carried out, exports responded to the improved incentives, a major expansion in inflows of private capital took place, and a comfortable cushion of external reserves was rebuilt. In addition, the process of economic restructuring began to make inroads into longstanding distortions and rigidities. Nevertheless, at the time of the Directors’ discussions, much remained to be done to ensure that stabilization gains were not reversed and that India moved onto a more dynamic growth path that could be sustained over the longer term.

There had been considerable fiscal slippage in 1993/94, which, combined with its partial monetary accommodation, helped to reverse the downward trend in inflation. This rise in prices was worrisome because it had occurred despite a favorable monsoon. Moreover, a heavy government borrowing requirement had contributed to the slow growth of credit to the private sector and had kept medium- and long-term interest rates quite high.

Monetary developments in 1993/94 were dominated by the large Reserve Bank financing of the Central Government’s deficit and, in the latter months, by a surge in capital inflows. The expansion in broad money resulting from these developments would have been even greater but for an increase in the currency-to-deposit ratio.

At the time of the Directors’ discussion, the exchange rate of the rupee had been broadly stable since March 1993 as the Reserve Bank took advantage of the strong balance of payments to repay short-term debt and rebuild foreign exchange reserves.

The authorities had made progress in articulating a broad framework for structural reform in many of the “core” areas—namely, trade and financial sector liberalization and tax reform. However, progress had been slower in restructuring public enterprises and in increasing the flexibility of markets for labor and land.

At their discussion, Directors welcomed the impressive progress made since 1991. Notwithstanding these positive developments and the strength of the external position, Directors expressed concern over several aspects of macroeconomic performance. They noted in particular the considerable widening of the budget deficit in 1993/94, the persistence of high domestic interest rates, and the sluggishness of the industrial recovery, as well as the related surge in capital inflows that had complicated monetary management and added to inflationary pressures.

In these circumstances, Directors urged the authorities to return quickly and decisively to the path of fiscal adjustment. Directors noted that the fiscal stance embodied in the 1994/95 budget proposals would fall short of what was needed to ensure a sound budgetary position over the medium term. The quality of the fiscal adjustment would also be important, and greater attention should be given to raising revenue and containing current expenditure in order to allow room for increased investment in vital infrastructure and human resources. Directors welcomed the tax reforms envisaged in the 1994/95 budget, which they said should lay the basis for a less distortionary and more revenue-elastic tax system.

Directors noted that progress toward fiscal sustainability would help to alleviate pressures on domestic interest rates, which had played a role in attracting capital inflows. Lower interest rates would promote the recovery of private investment, facilitate progress in financial sector reform, and help to strengthen bank portfolios. Directors recommended that the remaining interest rate controls be eliminated and urged the authorities to reduce the scope of priority sector credit and other burdens on financial intermediation.

Indications that the authorities would pursue structural reforms in several sectors to improve efficiency were welcomed by Directors, but they recommended a more vigorous approach to removing structural weaknesses, notably in public enterprises and factor markets, in order to encourage a rapid investment response by the private sector.

Directors also strongly recommended accelerated liberalization of the trade and exchange system, noting that the strength of the balance of payments offered an excellent opportunity for rapid liberalization. Directors commended India for the recent further reduction in import tariffs but advocated early action to replace quantitative restrictions on consumer goods imports with appropriate tariffs.

Directors welcomed India’s intention to use the opportunity presented by the recent improvement in the balance of payments to make advance repurchases to the Fund. However, they cautioned that external viability was not yet assured, underscoring yet further the importance of continued fiscal and structural reform to ensure that the balance of payments remained strong.

Indonesia

When Directors met in February 1994 to discuss Indonesia’s Article IV consultation, it was against a background of an incipient revival of domestic demand growth, following a year of consolidation of the economy in 1992/93. The emergence of overheating in 1990/91 had prompted a tightening of monetary and public debt management policies. As domestic demand pressures abated, monetary and credit conditions began to be eased.

The external position strengthened markedly in 1992/93 in response to the weakening of domestic demand, but with continued rapid growth in exports, the slowdown in GDP growth was modest (Table 19). Although the growth in exports had since eased, domestic demand had started to revive and the economy appeared to have entered a renewed phase of expansion.

Table 19

Indonesia: Selected Economic Indicators, 1990/91-93/94

(Annual percent change unless otherwise noted)

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Note: Data in the table reflect information available at the time of the Board discussion.

Estimated

Actual data as of December 1993.

The Fund’s Information Notice System.

Twelve-month rate of change to October 1993

Actual data as of the end of September 1993.

While inflation had also been reduced, there remained a danger of a renewal of overheating pressures that was an important risk in the outlook. The underlying base of inflation at the start of the economic upturn was already relatively high and could be built up with the revival in activity.

In the area of monetary policy, Bank Indonesia had recently taken steps to improve monetary management, including more flexible intervention practices in the money and foreign exchange markets. In 1992/93, the authorities were able to offset the liquidity effects of capital inflows—which had become a persistent feature of the economy—through large-scale open market sales of Bank Indonesia securities. However, the cost of these operations was very high.

In the fiscal area, substantial strides had been made in reducing the Government’s dependence on oil revenue since the mid-1980s. However, there were slippages from the original budget target during the first half of 1993/94, owing in part to the decline in international oil prices. In view of the central role fiscal policy has to play in shaping the Indonesian economy as oil revenues continue to decline over the medium term, the authorities were likely to face difficult policy decisions in the period ahead, including how to strengthen the revenue effort and contain the growth of development expenditure.

In their discussion, Directors commended the authorities for their successful record of economic management, noting that when inflationary pressures. intensified in the early 1990s, the authorities had responded appropriately by tightening monetary policy and curbing publicly related external borrowing. By early 1993, the weakening of credit and investment growth in the face of an incipient decline in external demand shifted the focus of policy to supporting growth. Against this background, many Directors observed that the authorities’ moves to ease monetary and credit conditions in 1993 had been appropriate, while in the view of some others, the authorities might have moved too quickly.

Looking to the future, Directors cautioned against excessive relaxation of monetary policy, especially in light of the buoyant conditions in asset markets, strong growth in the monetary and credit aggregates, and given an inflation rate that was high at the then early stage of the recovery. A vigilant policy aimed at bringing inflation into line with the low single digit rates prevailing in Indonesia’s major trading and regional partners was necessary, the more so because the renewal of overheating pressures remained an important risk in the outlook.

Directors noted that monetary management had recently been rendered difficult by the surge in capital inflows. A number of them pointed to the substantial quasi-fiscal cost of the large sterilization operations; they considered that, given Indonesia’s attractiveness to foreign investors, the trend of strong capital inflows might well persist for some time to come, and a more flexible and differentiated approach to monetary management would therefore be appropriate. In this connection, Directors welcomed the recent steps to increase the flexibility of domestic money market rates and to rationalize intervention practices in the foreign exchange market. Furthermore, a number of speakers favored greater responsiveness of the exchange rate to market pressures.

Directors commended Indonesia’s record of fiscal adjustment and urged the authorities to make every effort to meet the target of a small overall budget surplus in 1993/94. As regards the 1994/95 budget, Directors encouraged the authorities to implement the budget to ensure that the target of a small overall surplus is met even if, as appeared possible, oil receipts turned out to be lower than projected. At the same time. Directors recognized the continuing need for substantial investment in infrastructure development, social services, and environmental protection.

Directors welcomed the authorities’ commitment to structural reform, as evidenced by measures to deregulate the trade and investment regimes. However, there remained substantial scope for further reform in those areas, and Directors urged the authorities to phase out the remaining barriers to imports, ease marketing restrictions, resist calls for protection of new industries, and reduce regulatory hurdles to foreign investment.

While commending the authorities for Indonesia’s exemplary record of servicing its foreign debt, Directors noted that the level of external debt remained uncomfortably high. Efforts to contain publicly related borrowing had been relatively effective in recent years and continued caution was required in this area in the period ahead.

Korea

Directors’ discussion in February 1994 on Korea’s Article IV consultation took place against a background of a growing awareness in Korea that the traditional policy framework, which included detailed intervention at the micro-level, had become outdated and that the existing net of regulations and controls, notably in the financial sector, was becoming an impediment to continued rapid growth. The then-new Government had thus made deregulation, in particular financial sector liberalization, a key priority of its agenda in addition to macro-economic stability.

Economic policies in 1993 were consistent with the Government’s medium-term agenda, and significant progress was made in both macroeconomic stabilization and structural reform (Table 20). Notwithstanding uncertainties about the strength of the recovery, macroeconomic policies avoided the strongly expansionary course pursued in the previous downturn, thus improving the prospects for sustaining growth with low inflation. The introduction of the “real name system” in financial transactions (a ban on the use of false names), together with the announcement of the blueprint for financial sector liberalization and capital account opening, the subsequent implementation of a number of measures relating to the deregulation of foreign exchange transactions, and the partial liberalization of deposit and lending rates boosted the credibility of the structural reform program.

Table 20

Korea: Selected Economic Indicators

(Annual percent change unless otherwise noted)

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Note: Data in the table reflect information available at the time of the Board discussion.

Estimated.

January-November 1993.

In their discussion, Directors noted the remarkable success of Korea’s economic development and that the country was rapidly transforming itself into an advanced industrial economy. Against that background, Directors welcomed the authorities’ intention to promote deregulation on a broad scale, and agreed that continued maintenance of macro-economic stability would be essential for a smooth implementation of structural reforms.

Directors noted that the 1993 economic recovery, while initially slow, was likely to gain momentum in 1994. In these circumstances, a policy mix combining fiscal restraint and accommodating monetary policy would provide moderate support for the recovery, but Directors emphasized the importance of keeping inflation low and strengthening competitiveness. While noting the conservative fiscal posture the Korean Government traditionally had maintained, many Directors felt the need for a further restraint to meet cyclical requirements. Without such restraint, monetary policy would have to assume a greater burden in keeping demand growth under control, with possible implications for capital flows.

Directors observed that the policy of targeting M2 growth had encountered difficulties in 1993 as a result of large portfolio shifts, and they noted that the authorities’ flexible response to these shifts was warranted. With financial sector liberalization proceeding, monetary targeting would have to be approached with greater flexibility, and other monetary indicators, including interest rates, were likely to become more important. Many Directors emphasized that a faster pace of financial sector reform and capital account opening would be in Korea’s own interest, notably in reforming the system of policy loans and developing more sophisticated and efficient money and foreign exchange markets.

Directors observed that the steady improvement in the current account and the substantial capital inflows in 1992-93 were accompanied by considerable accumulation of foreign exchange reserves from rather low levels reached in 1991. While the authorities were able to deal effectively with the liquidity effect of reserve accumulation by the issuance of monetary stabilization bonds in 1992-93, several Directors, looking ahead, saw the exchange rate as being important in keeping inflation under control.

Egypt

In September 1993, Directors discussed the Article IV consultation with Egypt and its request for a three-year credit under the extended Fund facility, authorizing drawings up to the equivalent of SDR 400 million through September 1996 to support the Government’s medium-term economic and financial reform program. The discussion took place against the background of the substantial progress made by Egypt under an adjustment program supported by a stand-by credit, which expired in May 1993 after a six-month extension.

During the period of the standby arrangement. Egypt implemented a major stabilization effort that focused on reducing the fiscal deficit, supported by prudent credit policies. As a consequence, the overall fiscal deficit was sharply reduced, and financial system pressures were eased. Interest rates, after rising when liberalized, started to decline, and the pace of monetary expansion slowed. The external account moved into a large overall surplus over the program period, in part reflecting capital repatriation and confidence in the new financial and foreign exchange systems. However, the recovery of growth and private investment had still to pick up by the time of the Board discussion (Table 21).

Table 21

Egypt: Selected Economic Indicators

(Annual percent change unless otherwise noted)

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Note: Data in the table reflect information available at the time of the Board discussion.

Preliminary actuals.

End of calendar year.

In their discussion, Directors welcomed the considerable progress in macroeconomic stabilization and structural reform achieved during the previous two years under the stand-by arrangement. Directors considered that a strong foundation had now been laid for creating in Egypt a private-sector-led and outward-oriented economy guided by market signals.

It was generally recognized that the breadth of the Egyptian structural reform program was ambitious. The authorities’ continuing adjustment program over the next three years, which was received positively by Directors, aimed at further reducing macroeconomic imbalances while deepening key structural reforms. They noted, however, that initially during the period of the extended arrangement, economic growth would continue to be modest. Most speakers believed that determined action to implement the macroeconomic and structural reforms embodied in the three-year arrangement would be critical to the overall success of the program in terms of private sector investment, economic growth, and employment generation.

The authorities’ commitment to continue cautious macroeconomic policies, including further progress in reducing the fiscal deficit, monetary expansion, and inflation, was seen by Directors as a key element in restoring noninflationary growth. These policies would also contribute to improving external competitiveness, which was seen as important to the authorities’ goal of an outward-oriented economy.

Pakistan

In February 1994, Directors discussed the Article IV consultation with Pakistan and approved its request for an extended arrangement and ESAF arrangement totaling SDR 985.7 million over the next three years in support of the Government’s medium-term economic adjustment and reform program. The discussion took place against the background of this medium-term strategy, which sought an early strengthening of the external position while pursuing comprehensive structural reforms that were aimed at sustaining high-quality economic growth in the context of domestic and external financial stability.

Pakistan initiated a comprehensive economic reform program in 1988 under which important gains have been achieved (Table 22). The program included measures to liberalize domestic activity and the external trade and payments system, to reform the financial sector, and to implement a wide-ranging privatization program. This had contributed to stronger economic and export growth, greater output diversification, higher domestic and foreign investment, and increased vitality of the private sector. The country, however, had remained vulnerable to external developments, and in 1992/93 it was affected by widespread floods and unfavorable terms of trade, which compounded the impact of weak financial policies and political uncertainties.

Table 22

Pakistan: Selected Economic Indicators

(Annual percent change unless otherwise noted)

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Note: Data in the table reflect information available at the time of the Board discussion.

Preliminary.

At the time of the discussion the Board was advised that these projections were likely to be revised in light of developments affecting the cotton and wheat crops.

Refers to annual averages based on monthly data reported by the Fund’s Information Notice System; decrease means depreciation.

In their discussion, Directors commended the authorities for the decisive policy measures they had taken during the first half of 1993/94 to tighten financial policies and intensify structural reforms. Directors observed that the authorities’ medium-term economic strategy was comprehensive and appropriately focused, with sound macroeconomic policies supporting structural reforms. Directors expressed the view that such policies, if implemented fully on a timely basis, would enhance the economy’s supply responsiveness, reduce its vulnerability to shocks, strengthen the environment for sustained capital inflows—in particular, for foreign direct investment—and improve the country’s social indicators.

In discussing the outlook, Directors emphasized that the success of the adjustment and structural reform program would depend crucially on sustaining the ongoing fiscal deficit reduction effort. In that context, it was emphasized that the projected strengthening of GDP might not be fully realized, and the strengthening of the fiscal effort over the near term was emphasized. Directors therefore welcomed the then recent steps taken to extend the direct tax net to agriculture, which, it was noted, not only addressed a key fiscal reform issue, but also signaled a willingness to tackle long-standing structural weaknesses in the economy. They also welcomed the progress toward transforming the general sales tax into a modern broad-based value-added tax.

On the expenditure side, Directors noted the heavy burden of defense expenditures, and they welcomed the programmed reduction in defense outlays in 1993/94; also, Directors called for more effective prioritization in order to reduce low-productivity expenditures. Directors welcomed the increased emphasis being laid on improving development-oriented expenditures in the social sectors, including in the context of the Social Action Program.

Directors were of the view that adjustments in rates of return and the curtailment of some government-directed credit schemes were central to reducing macro-economic imbalances. Directors emphasized the importance of the programmed further reduction in directed credits and, more generally, the further development of the money and financial markets and a market-determined structure of rates of return. This issue assumed added importance in the context of Pakistan’s increased integration with international capital markets and its foreign currency deposit liabilities. Directors welcomed the steps taken recently to increase the autonomy of the State Bank of Pakistan.

Directors noted that the devaluation of the rupee at the outset of the fiscal year had been followed by several small adjustments, which had been made in the context of the authorities’ desire to strike an appropriate balance between maintaining competitiveness of the tradable goods sector, reflecting market trends, and containing inflation. Directors welcomed the progress made by Pakistan in liberalizing its trade regime and removing all exchange restrictions that were maintained under the transitional arrangements of Article XIV. They welcomed the authorities’ intention to remove remaining restrictions and accept the obligations of Article VIII by the end of the then-current fiscal year.

Turkey

Directors met in April 1994 to discuss Turkey’s Article IV consultation. The discussion took place against a background of deteriorating economic performance, despite a robust growth in GNP, as the problem of persistently high inflation was compounded by a sharp widening of the current account deficit (Table 23).

Table 23

Turkey: Selected Economic Indicators

(Annual percent change unless otherwise noted)

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Note: Data in the table reflect information available at the time of the Board discussion.

Preliminary.

October

In 1993, when GNP is estimated to have grown by around 7 percent, rising real wages and increased access to consumer credit resulted in a marked expansion of private consumption. At the same time, private investment grew rapidly, contributing further to an increase in domestic demand that was increasingly satisfied from abroad, with the result that the current account deficit widened further.

The growing deterioration of the public finances was not arrested in 1993, when fiscal adjustment fell short of what the authorities had planned. This shortfall in adjustment occurred mostly at the level of the consolidated budget (the deficit of the central government). The bulk of the deviation came on the expenditure side, where personnel expenditure and interest payments exceeded the budget by a substantial margin. The increase in interest payments reflected mainly the rising stock of domestic debt and a shift toward higher-cost debt instruments. The higher-than-expected budget deficit resulted in increased recourse to central bank advances and external borrowing beyond that required to meet principal repayments.

In the absence of fiscal adjustment, monetary developments continued to be dominated by the need to finance the public sector borrowing requirement (PSBR). In view of the major uncertainties surrounding the fiscal program, the monetary authorities decided against announcing a monetary program for 1993. Instead, the central bank was to focus on targeting the nominal exchange rate. The rate of nominal depreciation increased steadily through the year, with a notable acceleration in the second half of 1993 as concerns about competitiveness became apparent, and in line with the lowering of short-term interest rates on government securities. These developments, together with rising inflation, led to a significant shift out of Turkish lira deposits into foreign exchange deposits.

Reflecting the strong growth of import demand, Turkey’s external current account has deteriorated, moving from a surplus of 0.3 percent of GNP in 1991 to a deficit of 5 percent in 1993.

In their discussion, Directors agreed that the successful introduction of market-oriented reforms in Turkey since the mid-1980s had contributed to impressive results in terms of economic growth. However, they observed that macroeconomic imbalances had increased, reflecting primarily a worsening fiscal situation. They noted that in 1993—and despite continued strong growth of GNP—Turkey’s economic performance had seriously deteriorated, with persistently high inflation being compounded by a sharp widening of the external current account deficit.

The considerable pressure on the lira during the first quarter of 1994, and other developments, had heightened concerns about the precariousness of the economic situation, and, as a result, a comprehensive reorientation of economic policy, led by a durable fiscal retrenchment, had become urgent to restore macroeconomic balance, avoid slipping into hyperinflation, and establish a basis for sustained noninflationary growth.

Directors welcomed the introduction, just before their discussions, of a package of measures to deal with the situation. In particular, they supported the emphasis given in the package to a pronounced strengthening of the fiscal position. Directors expressed the hope that the measures would prove commensurate with the required adjustment, and that the authorities would stand ready to take additional measures if the situation demanded them. Because of their concerns about the feasibility of targets included in the budget for 1994, Directors welcomed the adoption of much more ambitious fiscal targets and urged the authorities to take all the measures required to achieve them.

Directors stressed the importance of articulating the fiscal adjustment effort in the context of a medium-term program and, accordingly, they welcomed the then-recent reform of the tax system and urged the authorities to push ahead with the privatization program. The latter needed to be supported by further progress in enterprise restructuring and in developing a well-targeted social safety net. The authorities were also cautioned about using privatization revenues as a short-run method of reducing the budget deficit.

Directors were concerned about the easing of monetary conditions during 1993, observing that policy would need to be kept tight until progress in fiscal consolidation was established. With respect to the exchange markets, Directors noted that the then-recent depreciation of the lira had addressed emerging concerns regarding external competitiveness. At the same time, it was important not to allow the exchange rate to fall too far, and interest rates needed to be kept high in order to check inflationary expectations and arrest currency substitution.

Directors emphasized that Turkey’s current situation was critical and would require a steady implementation of the measures in the recently introduced package, and a reinforcement of that package with a broader-based program of fiscal adjustment and further structural measures.

Argentina

Directors met in July 1993 to discuss Argentina’s Article IV consultation and the fifth review under the country’s extended arrangement with the Fund. The discussion took place against a background of the considerable progress in stabilization and structural reform that Argentina had made since the introduction of the convertibility law in March 1991, The public finances strengthened, the economy was liberalized, and the privatization process accelerated. The successful implementation of these policies prompted strong inflows of capital, which in turn supported a sharp recovery in domestic demand and an upsurge in economic activity, with real GDP growing by about 9 percent a year in 1991 and 1992 and by a projected 4 percent in 1993 (subsequently revised to 6 percent) (Table 24).

Table 24

Argentina: Selected Economic Indicators

(Annual percent change unless otherwise noted)

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Note: Data in the table reflect information available at the time of the Board discussion unless otherwise indicated.

Data revised subsequent to the Board discussion

The economic upswing continued in the first four months of 1993, with most indicators showing year-on-year growth. Private capital inflows remained strong, reflecting continued interest rate differentials and improved confidence following a short-lived run of the peso in November 1992, continued expenditure restraint in the public sector, and the closing of the debt- and debt-service-reduction operation with commercial bank creditors in April 1993.

In the fiscal area, the primary surplus of the nonfinancial public sector was 2.2 percent of first quarter 1993 GDP. The strong growth of deposits, reflecting the rapid pace of monetization and the reduction in bank reserve holdings during March-April 1993, allowed broad money to grow at a 60 percent annual rate, and bank lending capacity to expand significantly, during the first four months of 1993. These developments maintained a rapid crowding in of private sector credit that had been a feature of the previous two years. The rate of monetization, however, was still below its historical levels.

The initial public offering in international and domestic markets of shares, representing 58 percent of voting share capital of the state oil company YPF, was made in July 1993. The proceeds from the sale in excess of $3 billion were used to further reduce public indebtedness and the monetary impact of the injection into the economy of the net receipts from abroad was sterilized.

In their discussion, Directors commended the authorities for their substantial progress made under the program and emphasized that priority at this stage should be given to raising domestic saving, thereby improving control over aggregate demand in order to improve the current account position and reduce the reliance on capital inflows in financing investment.

Noting that strengthening of the public finances and public saving should play a critical role in government strategy, Directors felt further improvements in tax administration, especially in the area of social security taxes, and continued expenditure restraint were essential. Directors also urged the authorities to continue with structural reforms and expressed disappointment at a delay in approving the reform of the social security system.

Many Directors believed monetary policy was too easy and urged the authorities to curb the overly rapid pace of expansion of credit. Several Directors noted that although inflation had remained above industrial country levels, it also had been declining significantly since the inception of the exchange rate anchor provided by the peso’s unitary peg to the U.S. dollar. Directors expressed concern about the appreciation of the real effective exchange rate of the peso since the convertibility law but noted that deregulation measures, the behavior of wages, and tax changes had substantially offset the loss of international competitiveness. A number of Directors noted the positive effects of the fixed exchange regime on monetary and fiscal discipline and in dampening wage demands and stressed the importance of maintaining its credibility. In that context, Directors emphasized that measures to reduce rigidities in the economy were also essential, in particular a reform of labor legislation to facilitate labor mobility and promote more flexible employment conditions.

Brazil

Directors met in July 1993 to discuss Brazil’s Article IV consultation. The discussion took place against a background of persistent high inflation, despite several attempts to bring inflation down rapidly in the second half of the 1980s and early 1990s. Starting in late 1991. the authorities sought a more gradual but sustained reduction of inflation through the pursuit of fiscal and monetary restraint. The program was supported by a stand-by arrangement approved by the Fund on January 29,1992.

In the event, monthly inflation declined to 19 percent in April 1992 from 27 percent in January 1992 but subsequently rose to an average of 28 percent during the first four months of 1993 and then to 32 percent in May. This rise was more pronounced than the market had anticipated, and the real interest rate in the overnight market for government securities dropped to about 4 percent (on an annual basis) for January-May 1993, compared with 30 percent in 1992. Real GDP in the first quarter of 1993 was estimated to be 4.4 percent higher than in the first quarter of 1992, reflecting in part a sharp increase in demand induced by tax incentives and lower real interest rates (Table 25).

Table 25

Brazil: Selected Economic Indicators

(Annual percent change unless otherwise noted)

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Note: Data in the table reflect information available at the time of the Board discussion.

Preliminary.

Includes reinvested earnings

In the external sector, Brazil’s strengthened performance in 1992 largely continued into 1993. The trade surplus for January-April 1993 was estimated at US$4.4 billion, with both exports and imports up about US$1.5 billion from the same period a year earlier. Net international reserves, however, fell about US$1.4 billion, owing in part to capital movements induced by the decline in domestic real interest rates and uncertainties regarding the course of economic policy. However, reserves subsequently rose sharply. In May 1993, Brazil reached a final debt-restructuring agreement with the Bank Advisory Committee of commercial banks; a comprehensive debt-rescheduling agreement with Paris Club creditors had been reached in 1992. Progress continued in the areas of trade liberalization and privatization.

In their discussion, Directors expressed much concern about the negative effects of continued high rates of inflation on investment, economic growth, and income distribution in Brazil in recent years, which had severely affected the credibility of economic stabilization policies. They were encouraged that it was now generally recognized in Brazil that fiscal imbalance was the main cause of inflation, and they welcomed the authorities’ intention to implement an economic program that would deal with this problem, although many Directors doubted whether this plan would prove adequate.

Directors stressed that a major strengthening of public finances clearly was indispensable, and in general urged the authorities to design and implement a more ambitious program of revenue enhancement and expenditure restraint. They noted that a forthcoming revision of the Constitution provided a crucial opportunity for addressing the structural obstacles that have thwarted past Brazilian efforts to strengthen public finances on a sustained basis.

Directors remarked that a tightening of credit policy would provide an unequivocal signal of the authorities’ commitment to fight inflation, even though it was likely to result in high real interest rates until the strengthened fiscal policy took hold. In view of previous experience, Directors agreed that such a credit policy stance might induce large capital inflows. The best response to these inflows would be a rapid improvement of the public finances whereas intensifying capital controls was likely to be effective only transitorily.

Directors noted the strength of Brazilian export growth and the comfortable level of external reserves, observing that the policy of adjusting the commercial exchange rate in line with domestic inflation had been successful in maintaining an adequate degree of competitiveness and had been an important factor in the expansion of Brazilian exports. They welcomed and further encouraged the continuation of a multiyear trade liberalization program. They also commented favorably on the progress that had been made in re-establishing orderly relations with external creditors.

While agreeing with the authorities that the most important contribution to the alleviation of poverty would come from a lasting reduction of inflation, a number of Directors welcomed a decision by the authorities to improve the targeting of Brazil’s social programs, which would help alleviate the situation of the poorest. Directors also commended the authorities for the progress in the implementation of structural reforms, noting advances made in the privatization of public sector enterprises and welcoming the authorities’ plans to accelerate and broaden the scope of the program.

* * *

In the event, economic performance during the remainder of 1993 following the Article IV consultation was mixed. Real GDP grew by close to 5 percent, the public sector finances strengthened as the primary balance rose from 2.2 percent of GDP in 1992 to 2.9 percent of GDP in 1993, and the balance of payments remained strong, with gross international reserves reaching nearly US$32 billion, or one year of imports of goods and nonfactor services. Structural reforms continued, particularly in the areas of trade reform and privatization. However, monthly inflation rose sharply, from 24 percent in December 1992 to 36 percent in December 1993, reflecting in part a relaxation of monetary policy.

In late 1993, the Brazilian authorities embarked on an economic program aimed at reducing inflation to close to international levels. The program should be seen as having three phases. The first one focused on establishing the basis for eliminating the operational deficit in the public finances. The second phase was initiated on March 1, 1994, with the creation of a new unit of account, the Real Unit of Value, which was to be used in denominating practically all prices. This phase focused on setting the conditions for the elimination of inertial inflation replacing backward looking indexation with virtual contemporaneous indexation. The third phase of the plan was launched on July 1, 1994 with the issuance of a new currency, the real, at parity with the U.S. dollar. On April 15,1994, Brazil completed a comprehensive debt-restructuring agreement with commercial bank creditors, which involved debt and debt-service reduction.

Mexico

Directors met in February 1994 to discuss Mexico’s Article IV consultation which took place against a background, during 1993, of a continued surplus of the public finances, a reduction in inflation, and further progress in structural reform, as well as a decline in the external current account deficit by more than 1 percentage point to 5.7 percent of GDP, which was more than fully covered by capital inflows (Table 26).

Table 26

Mexico: Selected Economic Indicators

(Annual percent change unless otherwise noted)

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Note: Data in the table reflect information available at the time of the Board discussion.

Based on the Fund’s Information Notice System

In real terms.

During 1993 there had also been a sharp slowdown in real GDP growth to 0.6 percent. With domestic investment and consumption registering declines in real terms, growth during the year reflected solely the rise of exports of goods and services. Significant tensions developed in financial and foreign exchange markets for a brief period when questions arose about the fate of the North American Free Trade Agreement (NAFTA), but the use of exchange rate flexibility and credit tightening by the authorities served to deal with these problems.

In their discussion, Directors expressed admiration for the dramatic transformation of Mexico’s economy in recent years but, against that very positive background, expressed their concern about the deceleration in economic activity during 1993. They agreed with the staff assessment that important contributing factors to the slowdown were the restructuring of firms, the remaining structural obstacles and some aspects of the regulatory environment, and, particularly in 1993, the uncertainties about the NAFTA.

Directors supported the authorities’ view that the continued strong growth in exports—along with an expected recovery in investment and a new pact with labor and business—should be a basis for reactivating the economy in 1994. Directors were also in general agreement with the decision of the authorities to shift the overall fiscal balance from a small surplus in 1993 to equilibrium in 1994 in support of the recovery effort, and they welcomed the increased priority being accorded to social programs and the steps to improve income distribution. Nevertheless, there was a broad consensus among Directors regarding the need for a continued cautious fiscal policy. They observed that given the fiscal stance, monetary policy would have to play a central role in ensuring further progress toward price stability and the convergence of the inflation rate toward that of the main trading partners.

Directors expressed satisfaction with the narrowing of the external current account deficit in 1993, which was attributed in part to the economic slowdown and the unwinding of the consumption boom of the past few years, as well as to the rapid growth of non-oil exports. In order to reduce the economy’s vulnerability to a sudden reversal in capital flows, Directors stressed the need to lower the external current account deficit further with the aid of policies designed to strengthen private savings and to maintain high levels of public savings.

While some Directors expressed concern about the outlook for Mexico’s competitive position, it was generally noted that, notwithstanding the real appreciation of the peso in recent years, Mexico’s manufacturing exports continue to register strong gains. As further real appreciation of the peso could pose risks to continued export expansion, Directors emphasized the importance of lowering inflation and increasing wage restraint and continued structural steps to ensure export competitiveness and labor market flexibility.

Directors commended the authorities’ efforts to consolidate the structural reform process through the further opening up of the economy, the formal removal of most restrictions to foreign investment, and the approval of laws granting autonomy to the Bank of Mexico.

Economies in Transition

Central and Eastern European Countries

During the year, the Board had Article IV consultations with all the Central and Eastern European countries. In addition, Directors met in April 1994 to review the experience of the countries in transition and the work of the Fund in that context.

Discussions were held against a backdrop of improving economic performance. A particularly welcome development was the resumption of growth in several countries—notably, the Czech Republic, Poland, and aside from the effect of two years of severe drought, Hungary. Albania, whose starting position was probably the most dire in Central Europe, recorded the highest rate of growth in 1993, albeit from a severely shrunken production base. Inflation, although too high, was sharply reduced in almost all cases from the levels experienced immediately following price liberalization. Nevertheless, substantial risks and uncertainties remained.

In their April 1994 general review, Directors felt that Fund policy advice had been pragmatic, tailored to such individual circumstances as the size of the country, initial conditions, progress to date, and linkages to other regions. Directors also felt it was important not to be overly concerned about the optimal sequencing of stabilization and structural reform. Many Directors made the point that rapid implementation of both stabilization and structural measures was desirable. Macro-economic stabilization often required an acceleration of institutional reform—particularly in budgeting, taxation, monetary policy, and financial sector development—to enable stabilization policies to be implemented and to have their intended effect.

Another theme that emerged was the desirability of having broad public support for the transition strategy in each country, especially because the benefits of reform were often slow in coming while the pain of output declines and the attendant political and social tensions were swift. In that context, a number of Directors stressed the importance of developing social safety nets that would target assistance to those most adversely affected, noting that the burden of inflation that typically followed liberalization fell primarily on low-income groups, thereby undermining support for reform.

Concerning policy instruments, Directors felt that budget discipline was key. At the same time, they noted that demands on the budget grew as governments took over responsibilities previously borne by public enterprises. Such circumstances put a premium on tax, tax administration, and expenditure allocation reforms to support budget discipline. Of course, an important rationale for budget discipline was to reduce the domestic monetary financing of the deficit and thus inflationary pressure. A number of Directors stressed the importance of developing the financial sector and financial instruments to enable the government to tap into domestic savings and, thus, ease the burden on the central bank.

The role of exchange rate policy was also discussed in this context and the Fund’s pragmatic approach was noted. In some cases, Fund-supported programs incorporated floating exchange rates; in some cases, a fixed nominal peg; in others, an adjustable nominal peg. In appropriate circumstances, the exchange rate played an important role as an anchor for domestic stabilization policies.

As to structural reforms, Directors reiterated that price and trade liberalization as well as public enterprise reform were key success elements. Besides these factors, the fostering of new private enterprises was identified by a number of Directors as deserving more attention. Specifically, invigorating the private sector would require clear rules of the game on the assignment of rights and responsibilities; clearly defined rights and obligations in the public sector; and the development of the financial sector. Another problem deserving further examination was that of communities dependent on a single enterprise for employment and social services.

On the issue of how the rest of the world could help transforming economies, many Directors said that open markets provide the opportunity for trade, which supports transition. Clearly, external finance was also vital. The point was made that it is appropriate not to finance countries that were not yet ready to take basic reform measures. Equally, when a critical mass of policies was in place, large, up-front financing should be forthcoming. It was suggested that tools to provide such up-front financing need to be identified. Some Directors also called for more targeted foreign financing, for example, financing to promote social safety nets. Finally, the role of institutions other than the Fund was seen as critical, and Directors agreed that the Fund should not take on all the responsibility for supporting the reform process in the transition economies.

Czech Republic

The Board’s 1993 Article IV consultation with the Czech Republic took place at the end of July 1993, approximately half a year after the dissolution of the former Czech and Slovak Federal Republic and their currency union.

At the time of the Board’s discussion, the output decline that had begun in 1991 had bottomed out, though the rebound had faltered somewhat in the early months of 1993 (Table 27). Registered unemployment, after falling throughout most of 1992 to 2.6 percent in December, reversed trend temporarily in January 1993, in part in response to a new health and social insurance law. Inflation, which had been on a downward trend from a high of 56 percent in 1991, rose sharply in January 1993 following the introduction of a value-added tax (VAT) on January 1, but the rate had come down to ½ of 1 percent a month by March 1993. While real wages rose by about 10 percent in 1992, the authorities’ rein-troduction of targeted taxation of excessive wage increases from July 1, 1993, was expected to guard against unjustified wage expansion.

Table 27

Czech Republic: Selected Economic Indicators

(Annual percent change unless otherwise noted)

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Note: Data in the table reflect information available at the time of the Board discussion.

Projected.

Comprises central government, local authorities, Czech share of Federation (for 1992), health contributions, and extrabudgetary operations.

Economic developments in the external sector were dominated by the dissolution of the Czech and Slovak Federation and the early termination of the monetary union between the two countries. The balance of payments was strong in the first half of 1992, but increased imports and a climate of uncertainty, which adversely affected inflows of direct foreign investment and also prompted some flight of capital abroad, resulted in a sharp decline in reserves in the latter half of 1992. Faced with a continued loss of reserves in January 1993, the authorities put forth a policy package designed to place the economy back on the track of stabilization; it was supported by a precautionary stand-by arrangement with the Fund. By June 1993, the external reserves position had strengthened to $2.1 billion from $433 million in February of that year. Trade with the Slovak Republic declined substantially in the early part of the year but did not lead to severe disruptions in economic activity.

On the structural side, substantial progress was made in the area of ownership transformation. The first wave of large-scale privatization was completed in May 1993, and proposals for enterprises scheduled for the second wave were being reviewed at the time of the Board discussion. Trading began on the Prague Stock Exchange in early April 1993, and an amended bankruptcy law went into force later that month.

Developments in the monetary and fiscal sectors were also favorable following a period of uncertainty. Starting in September 1992, as the external reserves situation began to deteriorate and in light of concerns over excessive growth of the money supply, the authorities tightened monetary policy. By the end of May 1993, in response to improved external and inflation performance, they eased refinancing policy and lowered the discount rate and reserve requirements. Fiscal policy, in the wake of sweeping tax reforms as well as dissolution of the Federal Republic, had sought to stabilize financial conditions while at the same time limiting the role of government in the economy. In the event, fiscal performance in the first four months of 1993 surpassed expectations, registering a surplus of close to 2 percent of annual GDP, though a large carryover of tax revenues contributed much to that result.

In their review, Directors commended the authorities for having coped remarkably well with the uncertainties and repercussions of the split of the former Czech and Slovak Federal Republic and dissolution of the currency union, though they noted the need for continued monitoring of developments. Directors observed that the improvements in the external reserves position and inflation, as well as the upgrading of Czech bonds to investor grade, demonstrated that the authorities had reestablished confidence and strengthened credibility in their commitment to firm stabilization policies.

The Board was encouraged by the strengthening of the external situation and noted that Czech exporters had succeeded in redirecting trade from their former CMEA markets to Western markets at a time of weak demand in major partner countries and of restrictions on Czech imports. A number of Directors stressed the importance of open markets, especially EU markets, for Czech exports; in that context, attention was drawn to important market-opening measures that had been taken by the EU.

Directors welcomed the revival of investment inflows, noting the helpful progress made in privatization—particularly the completion of the first wave of large-scale privatization—as well as the opening of the stock market. They further commended the authorities for introducing the bankruptcy law. They remarked that these steps laid the basis for transforming corporate governance and enterprise restructuring and stressed the importance of additional strengthening of the financial system, including its supervisory arrangements; improving the health of bank portfolios; increasing competition among banks; and regulating the securities market.

Directors also welcomed the Czech Republic’s stronger than expected fiscal performance, but noted that it reflected special factors and expressed concern that there were weaknesses in tax administration and other costs of transformation had not yet appeared fully. The anticipated rise in the financing needs of the budget also called for caution in further easing of monetary policy. Directors commended the authorities for their tax initiative restricting wage increases beyond those justified by productivity gains.

Poland

The Board met in March 1994 to discuss Poland’s Article IV consultation. The discussion took place against the background of Poland’s dramatic economic rebound, which had been supported by a stand-by arrangement with the Fund.

After a substantial decline in measured output in the previous two years, the Polish economy staged a remarkable turnaround in 1992-93, with conservative estimates putting growth of real output in 1993 at 4 percent, following 1.5 percent growth in 1992 (because of systematic underreporting, actual growth might have been higher in both years). The recovery was broadly based, with a turnaround in agriculture and a boom in industrial output. Inflation receded to about 35 percent a year (Table 28).

Table 28

Poland: Selected Economic Indicators

(Annual percent change unless otherwise noted)

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Note: Data in the table reflect information available at the time of the Board discussion

Estimates.

Including transactions with former CMEA (Council for Mutual Economic Assistance) area for 1991 and 1992.

GDP in zloty terms is converted into U.S. dollars at the commercial exchange rate.

The recovery was testimony to the power of macroeconomic policy, supported by significant structural reform, to induce economic transformation. Sweeping measures, initially implemented by the Mazowiecki Government in January 1990, aimed specifically at coping with an economy bordering on hyperinflation and facing pervasive shortages. Tough stabilization measures centered on fiscal and monetary contraction, as well as on reducing inflation by pegging the zloty to the U.S. dollar. Price controls were eliminated; currency convertibility was introduced; and restrictions on foreign trade were removed. The reforms resulted in a sharp shift in trade toward Europe and in export-led growth.

Subsequently, the focus shifted to structural measures. Enterprise taxes and subsidies were replaced with a VAT and income taxes. Enterprise governance was enhanced by imposing positive real interest rates on bank credit and hard budget constraints on state-owned enterprises. The resulting improvement in performance, including in public sector enterprises, was a keyfactor in the expansion of output.

At the end of 1993, private enterprises accounted for over 35 percent of industrial output. Although this represents a substantial achievement, progress with respect to privatization was hampered by the political complexity of the issue. Financial sector reform was slow, leaving banks, the larger of which were still state owned, with a heavy burden of bad loans. While bankruptcies of large firms were limited, privatization and restructuring proceeded through management and employee buyouts and through an ongoing process of selling off assets to the emerging private sector.

In the external sector, while the trade balance deteriorated in 1993, by early 1994 it also had turned around, and Poland’s international reserve position had strengthened. Although Poland’s external debt burden was unusually heavy, it had made progress in normalizing relations with its creditors.

In their discussion, Directors commended the Polish authorities for their pursuit over the past four years of policies to secure macro-economic stabilization and to further the transformation process to a market-based economy. Noting that Poland was beginning to reap the benefits of its efforts, they pointed to the strength of and turnaround in economic activity, based on both a vibrant private sector and a more efficient state enterprise sector. At the same time, Directors observed that Poland continued to face challenges in the areas of inflation, fiscal pressures, and social costs of transformation.

Directors welcomed the 1994 budget as evidence of the Government’s commitment to fiscal discipline but underscored the high priority that should be assigned to additional budgetary reform. An envisaged elimination of the import surcharge was seen as a desirable step. Policies to reduce public sector dissavings and increase private sector savings were urgent. One means of bolstering national savings with important fiscal and social benifits as well was to develop a plan for retargeting and reforming the social security system.

Directors observed more generally that cost-push pressures would need to be forestalled, and in that regard the Board welcomed the Government’s intention to introduce a new form of incomes policy. It was important also to ensure the credibility of the crawling peg exchange rate mechanism; the authorities should stand ready to adjust interest rates in a flexible way so as to ensure a competitive return on zloty-denominated assets. Some Directors suggested that consideration be given to slowing the exchange rate crawl to serve as a drag on inflation.

As to Poland’s external prospects over the medium term, a number of Directors expressed concern, noting the high levels of government debt and debt service. It was pointed out, however, that Poland’s external competitiveness had greatly strengthened and that access to foreign markets, including the EU, was improving. An agreement in principle had been reached for a debt-restructuring operation between Poland and its commercial bank creditors. In addition, the successful completion of the review under a March 1993 stand-by arrangement with the Fund triggered the second tranche of a Paris Club debt-reduction agreement, which improved the prospect for increased foreign capital flows that Directors saw as critically important.

Directors also stressed the critical role of continued structural reform, noting the strong supply response and productivity growth it had engendered. They urged that privatization efforts be rein-vigorated, competition in the financial sector encouraged, and the balance sheet problems of financial institutions addressed.

Baltic Countries

The Board’s 1994 Article IV consultation discussions with Estonia and with Lithuania took place in April 1994 against a background of stabilization and reform. The Board did not have an Article IV consultation with Latvia during the period covered by this report.

Estonia

Since gaining independence in 1991, Estonia has been engaged in a massive effort to transform its economy into a full-fledged market economy. Real output, after falling some 30 percent during the period 1991 to 1993, began to recover during 1993. The main sources of the recovery have been exports and foreign direct investment. There are also signs that the overstaffing of enterprises has diminished considerably and that productivity growth is picking up, providing a sound base for a further increase in real incomes. Despite the transition from a rigid system of constitutional employment guarantees to a labor market determined by market forces, unemployment has not become a social problem. While output declined in 1992, prices soared. Inflation, when measured year-on-year, reached over 1,000 percent in 1992, but declined to less than 90 percent in 1993 (Table 29).

Table 29

Estonia: Selected Economic Indicators

(Annual percent change unless otherwise noted)

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Note: Data in the table reflect information available at the time of the Board discussion

Fund staff estimates and projections

Excluding official transfers.

The deficit on Estonia’s current account (excluding official transfers) is estimated to have widened to some $45 million in 1993 from $12 million in 1992, a result of the increasing trade deficit, which more than doubled. Following the introduction of the kroon and the establishment of the currency board in June 1992, the reorientation of trade from the states of the former Soviet Union to industrial countries accelerated sharply through mid-1993. Owing to Estonia’s competitiveness and increasing confidence in its mac-roeconomic policies, foreign direct investment increased sharply in the second half of 1992 and 1993, reaching 7 percent of GDP in 1993. Gross reserves reached $379 million or almost five months of imports by the end of the year.

Regarding structural policies, progress has been slower in some areas than anticipated. Large-scale privatization has encountered problems because of the complexity of the process and inefficiencies in the legal framework, and privatization in general was held up by the property restitution process. Although confidence has been increasing with improved prudential regulations and banking supervision, Estonia’s banking system remains fragile.

Macroeconomic policies have remained sound. Monetary policy is determined by the currency board arrangement, and the growth of monetary aggregates reflects the underlying demand for money in the economy. The strong overall balance of payments caused base money to grow at a brisk pace of 109 percent during 1993. After a decline of 20 percent in real terms in the first four months of 1993—reflecting the fall in output, but also amplified by the banking crisis-increased real economic activity led demand for broad money to grow by 45 percent in real terms over the rest of the year. The Government continued to keep fiscal policy tight, and during 1991-93 the general government accounts have not involved domestic credit financing. This was supported by improvements in revenue collection, although the stock of tax arrears remained broadly constant in nominal terms.

The Board welcomed the continued implementation of the economic stabilization and reform program and noted that all program performance criteria had been met. Directors commended the output recovery, the expansion of trade with industrial countries, and the virtual full convertibility of the kroon. Although inflation had come down significantly since the currency reform, it had risen recently. Directors stressed that the appropriate policy response to the recent pickup in inflation would be to enhance supply-side policies in order to improve the flexibility of prices and wages and the efficiency with which labor and capital were utilized.

Despite the adoption of new prudential standards and provisioning for nonperforming loans, in view of the fragile confidence in the banking system, Directors stressed the importance of further strengthening banking supervision.

Directors, however, were disappointed about the slow pace of privatization. A more rapid progress of structural reform was seen necessary to preserve the gains from stabilization and to move the Estonian economy to a situation of low inflation with strong and sustainable growth.

Directors noted that Estonia maintained a very liberal trade regime, and that there were virtually no restrictions on international current and capital account transactions. In this respect, the Board praised Estonia’s achievements in liberalizing trade and capital movements and welcomed the Government’s intention to accept the obligations of Article VIII of the Articles of Agreement.

Lithuania

Lithuania has been involved in a wide-ranging transformation of its economy, following independence in 1991. After declining by some 38 percent in 1992, real output contracted further by an estimated 16 percent in 1993 (Table 30). However, first signs that a recovery was on its way appeared in mid-1993, when trade volumes increased considerably. In spite of the sharp fall in output during the last couple of years, open unemployment was curtailed by the large fall in real wages, migration to the private sector, and the pace of privatization. Monthly inflation, which had averaged 24 percent during 1992, came down significantly through the pursuit of prudent financial policies. The introduction of the litas on June 25, 1993 enhanced the policy credibility of the Government further and was reflected in price and exchange rate developments. Monthly inflation continued to decelerate to less than 5 percent during the second half of 1993, and the exchange rate, after some depreciation in the early part of the year, strengthened considerably.

Table 30

Lithuania: Selected Economic Indicators

(Annual percent change unless otherwise noted)

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Note: Data in the table reflect information available at the time of the Board discussion

Fund staff estimates and projections

NMP for 1990, GDP thereafter.

Official rate.

Average wages deflated by retail/consumer price index

Excluding official transfers.

Rates on operating credits for state enterprises from the Bank of Lithuania through 1991, on 30-90 day credits thereafter.

The current account (excluding official transfers) turned into a deficit of $192 million in 1993, caused by a reversal in the trade balance from a surplus in 1992 to a deficit of $267 million in 1993. There has been a profound shift in the direction of Lithuania’s exports and imports. In volume terms, both industrial exports to and imports from the countries of the former Soviet Union are estimated to have contracted by roughly 40 percent in 1993, although trade with this area still dominated; trade with the rest of the world rose by 24 percent for exports and 38 percent for imports.

Privatization of state enterprises moved forward at a reasonable pace, while progress in land reform has lagged. Reform of the commercial banking system has also been slow, and a strong regulatory system is still lacking. Training in modern commercial banking techniques is sorely needed in all commercial banks.

Pursuit of a tight fiscal stance, as well as the effectiveness of expenditure control mechanisms, resulted in general government financial surpluses in 1991-93. The strong performance on the financial balance through 1993 occurred despite a sharp decline in the share of tax revenues in GDP, a trend that has persisted for some years. Revenues, as a proportion of GDP, are estimated to have declined from some 33 percent in 1992 to around 25 percent in 1993.

During most of 1993, Lithuania maintained a tight monetary policy. Substantial tightening since April 1993 led to a sharp deceleration of inflation and an appreciation of the exchange rate. As a result of intervention in the foreign exchange market to accommodate the de-dollarization which was taking place in the third quarter of 1993, reserves increased to $410 million by year-end, exceeding two months of imports. On April 1, 1994, Lithuania fixed the exchange rate at litas 4 to the U.S. dollar under a currency board arrangement.

Directors welcomed the progress that had been made by Lithuania in effecting economic stabilization and structural reform, which they hoped would catalyze the economic recovery that was beginning to take hold. In particular, they welcomed the deceleration in inflation and the restoration of tight monetary policy and congratulated the authorities for the successful introduction of the currency board arrangement. Directors also praised the authorities’ track record on financial discipline, noting especially the achievement of a surplus in the general government financial balance in 1993. However, they pointed out that further action to strengthen tax compliance and reform the tax system was still needed.

The Board noted that the banking system remained weak and regretted the delays in enterprise reform, recommending that reforms be accelerated. Directors also expressed concern about the lack of progress in reforming the social safety net and unemployment benefits. However, the significant progress in trade reform earned praise from Directors who stressed that an open trading system was in the long-term interest of a small, open economy such as that of Lithuania.

Russian Federation

An Article IV consultation with Russia was held in April 1993 and is described in the 1993 Annual Report. The Board discussed economic developments in the Russian Federation most recently in April 1994 in connection with its request for a second purchase under the STF.

At the time of the April 1994 Board discussion, the economic situation in Russia remained difficult. Real GDP was estimated to have fallen 12 percent in 1993 after dropping 19 percent in 1992 (Table 31). Then, during the first quarter of 1994, real GDP dropped 17 percent over the same period in the preceding year. Inflation remained high, though it was on a declining trend after late summer 1993, falling to about 7 ½ percent a month by March 1994. As the nominal exchange rate remained broadly stable during the second half of 1993, the persistence of high inflation resulted in a substantial real appreciation of the ruble. Average wages broadly kept pace with inflation through the year, but the stock of wage arrears grew sharply, approaching a third of the monthly wage bill in industry by the end of February 1994. Registered unemployment barely increased, although hidden partial unemployment in the form of forced vacations and shortened worktime rose noticeably.

Table 31

Russian Federation: Selected Economic Indicators

(Percent change over the corresponding period in previous year, unless otherwise noted)

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Note: Data in the table reflect information available at the time of the Board discussion.

Estimates.

An increase in the index reflects an appreciation of the ruble.

Includes the federal and local governments and the extrabudgetary funds

Includes the general government and unbudgeted import subsidies associated with foreign disbursements.

Quoted uncompounded annual rate.

The Government pursued a relatively tight fiscal policy during the first half of 1993. However, large-scale slippage on expenditures and the failure to adopt planned revenue measures (envisaged under the first purchase of the STF) led to a sharp deterioration in the second half of the year. Toward the end of the year, the Government moved to address the difficult fiscal situation by containing cash expenditures. While this probably helped to reduce the level of inflation in the first quarter of 1994, it triggered a substantial accumulation of budgetary arrears. The cash deficit for 1993 amounted to 8 percent of GDP, of which about two thirds was financed from domestic sources; external financing came mainly in the form of tied credits and debt-service relief.

During 1993, monetary policy was directed at lowering monetary growth by setting quantitative limits on domestic credit to the government, to commercial banks, and to central banks in other countries of the former U.S.S.R. The Central Bank of Russia substantially raised its lending rate in 1993, and, by the end of the year, the Central Bank’s refinance rate and the interbank money market interest rate exceeded the rate of inflation.

On the external front, the current account of Russia’s balance of payments improved and registered surpluses with the other countries of the former U.S.S.R. and with the rest of the world. This outcome reflected in part a sharp fall in imports, though import demand was strengthened in late 1993 by the real appreciation of the ruble. Net international reserves increased by over $3 billion during 1993, while accrued debt-service obligations in 1993 amounted to nearly $32 billion. Recorded foreign investment flows remained modest, amounting to less than $1 billion in 1993.

Russia’s social safety net was only moderately effective during 1993 and was inadequate in the case of unemployment benefits and child allowances. Beginning in November 1993, the Government introduced a new system of pension indexation designed to protect low-income pensioners fully. Outlays on unemployment benefits remained very low, owing to low real benefits and few claimants. Child allowances, tailored to reach some of the most vulnerable groups, amounted to only 0.6 percent of GDP in 1993.

The base money growth profile changed during 1993. Base money increased 88 percent in the second quarter of 1993 because of an accumulation in net international reserves. In the second half of the year, growth in reserves slowed significantly; base money growth of 61 and 55 percent, respectively, was dominated by credit expansion to the Government.

In their April 1994 discussion, Directors welcomed the commitment of, and policy actions taken by, the Russian Government to stabilize the economy within the framework of a macroeconomic and structural reform program that could be supported by the systemic transformation facility. Recognizing that the Russian authorities faced a very difficult situation, many Directors praised their efforts, noting the maintenance of liberal exchange rate and price regimes, substantial progress in privatization, and budgetary and credit restraint in early 1994. However, many Directors felt the program was less comprehensive than was desirable.

At the same time, huge challenges remained, not least in arresting the fall in output and providing for vulnerable groups so as to contain social pressure to relax financial policies. The strong evidence from other countries’ experiences was that resuming growth required achieving financial stability. As tight fiscal and monetary policies took effect, strong pressures from enterprises and other sectors could be expected to materialize and would need to be resisted forcefully. Other critical elements in the strategy to arrest inflation decisively would be parliamentary approval of an appropriate budget for 1994 as well as submission of a sufficiently tight budget for 1995. In regard to inflation, several Directors cautioned that the pace of monetary expansion should be kept under close review to ensure the attainment of objectives; tight interest rate policies in Russia were welcome.

Another key to successful adjustment, Directors stressed, was progress on structural reforms, especially enterprise reform, where financial discipline on managers must be imposed and the legal framework for owners, creditors, and shareholders regularized. Since restructuring state-owned enterprises would inevitably result in rising unemployment, many Directors emphasized the need for significantly greater efforts to strengthen the social safety net even beyond the steps already taken to increase unemployment benefits.

Directors commended the Russian authorities’ undertakings to maintain the liberal exchange and price regimes and urged further reductions in both the level and dispersion of tariffs. A number of Directors stressed the importance of an environment conducive to the return of flight capital and increased foreign direct investment, which were expected to make a growing contribution to the future expansion of the Russian economy.

Looking to the future, Directors recognized significant risks and uncertainties. The 1994 budget and several important revenue measures had yet to be adopted by the Parliament. Another uncertainty was the impact on Russia of the agreement with Belarus for a monetary union; Directors concurred on the dangers of using a monetary conversion rate between the Russian ruble and Belarussian rubel that would depart significantly from the market rate. Directors, therefore, stressed the importance of early consultations with the Fund to ensure the monetary union was implemented in a manner compatible with program objectives. The future also held opportunities: the Board encouraged the Russian authorities, with the active support of Fund staff, to pursue the introduction of government debt instruments, which Directors viewed as important to securing noninflationary financing of the fiscal deficit and to mobilizing domestic savings.

Many Directors noted that the effort needed to overcome Russia’s economic problems would require assistance from other countries to facilitate access to markets for Russian exports, and to ensure that the reform program remained fully financed through the provision of debt relief and other financing.

Other Countries of the Former Soviet Union

During the period covered by this Annual Report, Article IV consultation reports were discussed by the Board for Belarus, Georgia, the Kyrgyz Republic, Turkmenistan, Ukraine, and Uzbekistan. The Board also examined the broader topic of payments imbalances and trade relations among countries of the former U.S.S.R. in December 1993.

In the Article IV discussions, it was noted that reforms were taking place in a difficult external environment, with ongoing disruptions to trade with neighboring countries and even armed conflict. Nevertheless, Directors were generally disappointed with the pace of reform. While they commended several governments for their determined efforts to implement reform and stabilization policies, and noted that a few countries had made progress in key policy areas, they regretted that other countries still relied excessively on state intervention and controls.

Directors emphasized the need to tackle financial imbalances by tightening fiscal and monetary policies. They recommended that countries phase out budgetary subsidies and transfers to state enterprises, cut other expenditures, reform and widen the tax base, and focus on long-term improvements in tax administration. Improvements in the transparency of fiscal operations were also welcomed, as were efforts to make available national accounts and other data.

Concerned about the slow progress of structural reform, Directors encouraged several governments to renew and intensify their efforts. Privatization was slower than anticipated, and private land ownership in agriculture was constrained in several countries. The Board urged authorities to act promptly and vigorously to dismantle remaining price controls, phase out the system of state orders, resist pressures to bail out enterprises, and carry out land reform. Vigorous application of bankruptcy laws was also in order.

In the monetary area, progress differed by country. Generally, Directors observed the need to underpin new national currencies with coherent and forceful fiscal and monetary policies. Stressing the importance of removing trade distortions, they urged authorities to eliminate remaining restrictions on foreign trade and external account transactions, and noted the exchange rate should be unified in practice—not just in name. The Board welcomed a growing reliance on auctions to allocate foreign exchange in some cases and also the progress made toward establishing a market for treasury bills. Directors also commended steps to strengthen and modernize banking activities.

Directors saw an urgent need in virtually every state to target better social outlays to the most needy groups, moving away from overwhelming reliance on generalized subsidies and social benefits. They noted that such reforms were especially important if un-employment rose as anticipated.

Kyrgyz Republic

The first Article IV consultation with the Kyrgyz Republic took place in September 1993 against a background of deepening trade disruptions, adverse shifts in the terms of trade, and unforeseen shortfalls and delays in foreign financing.

Recorded output fell sharply in the first half of 1993, although increased reliance on barter and the underrecording of private production made the official statistics incomplete. Enterprises were reluctant to shed workers and so open unemployment remained low. Consumer price increases were higher than programmed, reflecting the delayed departure of the Kyrgyz Republic from the ruble area, substantial corrective price adjustments, and the higher prices of imports from other countries of the former Soviet Union(Table 32). Cash transfers were raised in order to compensate the poor for the sharp rise in bread prices.

Table 32

Kyrgyz Republic: Selected Economic Indicators

(Annual percent change unless otherwise noted)

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Note: Data in the table reflect information available at the time of the Board discussion.

Fund staff projections as of August 1993.

Trade data are limited; nevertheless, it appears that there was a contraction in the volume of trade with other states of the former Soviet Union. However, trade with nontraditional partners increased, in large part owing to the amount of humanitarian assistance to the Kyrgyz Republic. A substantial proportion of trade was conducted through barter by state agencies, which perpetuated the system of state orders. The som appreciated after its introduction as a freely floating currency on May 10, 1993, but this was reversed subsequently.

Privatization often occurred in the form of transformation into closed joint-stock companies with the Government as the majority holder, or collectivization with ownership transferring to workers. The constitution of May 1993 did not allow private ownership of agricultural land. The state order system was not dismantled as envisioned because of the strains that emerged with the introduction of the som.

Monetary and budgetary policies prior to the introduction of the som were somewhat uneven. Only 27 percent of cash rubles were exchanged for som, and thus recorded reserve money and broad money plunged. The banking system extended substantial credits to the economy, particularly to meet agriculture’s seasonal requirements. Interest rates for refinance credit and treasury bills more than doubled during the first half of 1993. The substantial interenterprise arrears that had appeared in 1992 were cleared through budgetary transfers prior to the introduction of the som. They reappeared, however, as the economic situation became more difficult. The consolidated general government deficit was 9.4 percent of GDP in the first half of 1993. Revenues were well below expectations, VAT being the most important source, necessitating expenditure cuts.

In concluding the Article IV consultation, Directors commended the Kyrgyz authorities for their determined efforts to implement reform, in particular, the introduction of the som by which they assumed full responsibility for monetary policy, thereby enhancing the prospects for an early stabilization of the economy. Recognizing that the Fund-supported program was being implemented in a very difficult external environment, it nevertheless appeared that price stabilization measures were beginning to take hold. Directors welcomed the growing reliance on auctions to allocate foreign exchange and refinance credit among banks. They stressed the need for the continued development of market-based instruments, more rapid progress toward positive real interest rates, and the fostering of private savings.

Noting the large fiscal revenue shortfall, Directors emphasized the need to develop permanent revenue sources and improve tax administration. The Board saw a need to focus on the social safety net and to replace the generalized bread subsidy with targeted transfers. Open unemployment could not remain at its current level without exacerbating the financial difficulties of enterprises.

Directors were concerned with the recent slowing of progress on structural reform and regretted that privatization had not resulted in more far-reaching changes in management practices. The Government was urged to renew and intensify its reforms and to continue to resist pressures for a bail-out of enterprises that had accumulated arrears.

The need for continuing financing support from partners in the former Soviet Union was stressed by the Board in view of the Kyrgyz Republic’s low income and weak balance of payments position. The considerable progress in institution building was noted, and Directors called for a strengthening of the statistical base with the help of technical assistance.

* * *

Economic developments in the Kyrgyz Republic following the Article IV consultation differed somewhat from those that were expected based on information available at the time of the Board meeting. Monthly inflation, which had declined during the summer, accelerated to more than 30 percent during September-October 1993. Thereafter, however, a tight monetary policy resulted in a steady decline in monthly inflation rates through March 1994, when inflation dropped to about 7 percent. The external current account deficit for 1993 was substantially less than originally projected, owing to lower than expected imports resulting largely from continued shortfalls and delays in foreign financing.

Ukraine

At the time of the Article IV consultation with Ukraine in June 1993, the Ukrainian economy was facing a terms of trade shock associated with the increased cost of imported energy supplies as well as the disintegration of supply and customer links with other countries of the former Soviet Union. Ukraine’s GDP, having fallen by 14 percent in 1992, continued to decline (Table 33). Inflation was accelerating, averaging 20 percent to 30 percent a month. Ukraine’s balance of payments was deteriorating, with the large deficit with other countries of the former Soviet Union only partly offset by a small surplus with the rest of the world. At the same time, structural reforms were making little progress.

Table 33

Ukraine: Selected Economic Indicators

(Annual percent change unless otherwise noted)

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Note: Data in the table reflect information available at the time of the Board discussion unless otherwise indicated.

Data revised subsequent to the Board discussion.

Real NMP in 1990; real GDP in 1991-92.

Retail price index for 1990.

Fund staff estimates of GDP in 1992.

In this context, the Board underlined the urgent need for stabilization and policy con-sistency if further disruption and instability were to be averted. Directors emphasized three critical and related tasks that faced the Ukrainian authorities: the establishment of financial stabilization, the restoration of a sustainable balance of payments position, and the adoption of a broad and consistent approach to market reform. A prerequisite was the quick resolution of current uncertainties regarding the responsibility and authority for economic policy, which should be followed by the establishment of clear policy priorities and objectives.

Directors agreed that a decisive reduction in inflation was essential and that this required a substantial tightening of budget and credit policies. They welcomed moves by the National Bank of Ukraine to raise interest rates substantially and to begin auctioning central bank credit to the banking system. The authorities were urged to limit strictly the volume of such credits and to end the central bank’s participation in their allocation as it would be vulnerable to special interests.

The authorities’ goal of containing the budget deficit in 1993 to about 6 percent of GDP was commended. However, this would require considerably stronger measures than those envisaged in the current budget. Directors stressed the importance of free prices in promoting market development. Progress in the area of systemic reform was viewed as disappointing.

Directors underscored the seriousness of the balance of payments situation and expressed concern regarding the prospective deterioration in Ukraine’s terms of trade, particularly in the energy field. They also cautioned against a rapid buildup of foreign currency debt. Ukraine would require substantial external financing in the period ahead and Directors regretted that political events and the absence of a consensus on a coherent economic strategy had held up negotiations toward assistance under the STF.

Directors encouraged the authorities to adopt policies that the Fund could support and to build on them to catalyze the widest possible financial support from the international community.

* * *

In the event, limited policy progress was made following the Article IV consultation, and the disruption and instability deepened. The rate of decline of GDP accelerated. Inflation reached an average of 50 percent to 60 percent a month by the end of 1993, before abating. Thereafter, however, a tight monetary policy resulted in a steady decline in monthly inflation rates through March 1994, when inflation dropped to less than 10 percent. The balance of payments remained under extreme strain, while structural reform continued at a slow pace.

Payments Imbalances and Trade Relations

In December 1993, the Board discussed the trade and financial relations among the Baltic countries, Russia, and other countries of the former Soviet Union. Large imbalances existed in most energy-importing countries in the region because of the deterioration in the terms of trade, due to the movement by Russia of its energy and raw material export prices toward world market levels. The combined external shock to these countries attributable to the further terms of trade deterioration and the expected decline in official financing from Russia may amount to some $15 billion between 1992 and 1994, or around 15 percent of their combined GDP.6

The adjustment facing most countries in this region is formidable and the significant reduction in explicit financing from Russia and the breakdown of organized trade among the various states of the former Soviet Union must be overcome. Directors agreed that orderly and efficient adjustment in these countries would be facilitated by a combination of strong macroeconomic policies—which would provide a stable environment for needed structural change and encourage both official external assistance and foreign direct investment—and accelerated structural reforms (including those to increase energy efficiency) so as to ensure that the costs associated with the cushioning of adjustment are accompanied by an expansion of future productive capacity. It was suggested that Russia would continue to provide financial assistance to the other countries of the former Soviet Union, in coordination with other bilateral and multilateral donors and creditors and consistent with the requirements of financial stabilization in Russia itself.

Directors also noted that donors outside the region should step up their financial support of those countries undertaking strong macroeconomic policies and implementing structural reforms. Directors supported continued use of the consultative group mechanism and other traditional means of coordinating external assistance. It was especially important that donors should support financing under the systemic transformation facility. Programs proposed by several countries of the former Soviet Union were being reviewed and deserved careful consideration from all members. The external financing problems for those countries were severe, and the success of their adjustment efforts would depend on adequate financial support. Ultimately, such financing should attract much-needed private capital.

In the area of interstate payments arrangements, the Board agreed that the Interstate Bank, constituted in December 1993, could be useful as a multilateral clearing facility but should be a transitional mechanism only. The Interstate Bank would facilitate interstate payments, carefully allocate scarce reserves, and reduce the inefficiencies of the current bilateral payments arrangements. Directors cautioned, however, that the Bank should not be used to extend balance of payments financing to the states of the former Soviet Union. For that purpose, the development of commercial banks and foreign exchange markets was crucial. The Fund, together with the World Bank, should stand ready with technical assistance to support these latter reforms.

Rapid trade liberalization was seen by the Board as critical to the transformation of the economies of the region and the successful resolution of the payments imbalances. Such liberalization required a complementary package of reforms, including price liberalization, macroeconomic stabilization, and institution building. Immediate priorities must be the dismantling of direct state involvement in trade and the removal of remaining export controls and import subsidies. In addition, export taxes should be phased out quickly. Tariffs, although helpful in raising revenue, should be kept low and uniform.

Directors stressed that liberalization on a most-favored-nation basis was the best way to reap the benefits of trade liberalization. The removal of existing barriers between the Baltic countries, Russia, and other countries of the former Soviet Union was particularly important, given the considerable interdependence inherited from the past system. Creation of a new economic union among the states could also be helpful in this regard, and a framework treaty for comprehensive economic union was signed by nine states in September 1993. The treaty provided for a “gradual deepening of integration” through the progressive establishment of a free trade zone, customs union, and common market, as well as monetary coordination. Internal tariffs would be phased out, and external tariffs and customs procedures would be harmonized.

In the Board’s view, an economic union must not perpetuate the historical patterns of inefficient resource allocation nor delay the region’s integration into the world economy, since an outward-oriented strategy was more likely to lead to high and sustainable growth. In this regard, improved access to industrial markets would also help to support reform in the Baltic countries, Russia, and other countries of the former Soviet Union.

The Board also noted the near-complete introduction of separate currencies in the countries of the region. Although the common currency area that was initially attempted (the ruble area) might have simplified payments among the countries, the system proved hard to manage, owing to large trade imbalances—particularly with Russia—and divergent credit policies across the region. Consequently, by late 1993, almost all of the states had introduced their own national currency in an effort to delink from the ruble. Only Tajikistan did not have its own currency by the end of 1993. It was noted, however, that strong supporting policies—budgetary and monetary—are necessary to reap the benefits of a separate currency.

In the end, the Board’s discussion underscored several basic principles in resolving the trade and payments problems among the Baltic countries. Russia, and other countries of the former Soviet Union. First, the countries must cooperate in resolving their disputes. Second, reforms should support the development of market-based commercial banking and foreign exchange markets. And third, steps to improve trade and financial relations should work to integrate these transitional economies into the global economy.

Asian Countries

Mongolia

In June 1993, Directors discussed the Article IV consultation with Mongolia and approved its request for a three-year ESAF arrangement equivalent to SDR 40.81 million (110 percent of quota) to support the Government’s economic and financial program for 1993-96. The discussion took place following intensified efforts from October 1992 by the then newly elected Government to formulate and implement policies to address a deterioration in the economic situation.

After decades of relative isolation and dependence on the former Soviet Union, Mongolia in 1990 initiated sweeping political and economic changes, including its transition to a market economy. These changes occurred against a background of severe external shocks, notably the breakup of the CMEA and its associated trading arrangements, and the virtual cessation of financial and technical assistance from the former Soviet Union. Declining prices for key exports and generally weak demand in convertible currency markets compounded the economic difficulties.

During 1991-92, under the reform program supported by a Fund stand-by arrangement, economic performance was mixed. Progress was made in structural reform, but output declined steeply, inflation accelerated sharply, and net international reserves declined. Economic performance improved during the latter part of 1992 and into 1993 as the authorities intensified their reform efforts (Table 34). Monetary expansion slowed considerably, inflation declined, and output and the external position showed signs of improving.

Table 34

Mongolia: Selected Economic Indicators

(Annual percent change unless otherwise noted)

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Note: Data in the table reflect information available at the time of the Board discussion.

Estimated.

Projected.

In their discussion, Directors commended the authorities for the adjustment measures that had been initiated to reduce macro-economic imbalances and to accelerate the transformation to a market-based economy. Directors emphasized, however, that continued economic and structural adjustment was crucial to fostering price stability, achieving external viability, and laying a basis for sustained economic growth over the medium term. They stressed the importance of developing the administrative and institutional capacity of the economy and welcomed the improvements in this area.

While welcoming the emerging indications of moderation in price pressures, Directors urged the authorities to maintain tight financial policies in view of the fragility and vulnerability of the external position and of the need to contain inflation. In this context, Directors underlined the importance of public expenditure restraint and the need to limit borrowing from the banking system to finance the budget. While recognizing the need for infrastructure improvements, they stated that the level of public sector investment should be tailored to the availability of domestic and external resources, as well as the absorptive capacity of the economy.

Directors supported the reforms of the exchange system, including the adoption of a unified, market-determined exchange rate. They cautioned against intervention to influence the exchange rate and emphasized that exchange rate stability should be pursued through the adoption of the appropriate financial policies. Directors noted that significant progress had been made in liberalizing external trade and payments, but urged the authorities to reduce the role of the state in trade and distribution and to avoid the introduction of new export taxes or restrictions.

Directors commended the authorities for the implementation of structural measures to foster the role of the price mechanism and improve the allocative efficiency of the economy. They stressed the importance of further progress in structural reform, including privatization, financial system reform, and encouragement of foreign direct investment.

The midterm review of the first year ESAF-supported program was completed in March 1994. Directors commended the authorities for the strong progress that had been made in economic reform. In expressing satisfaction with the economic performance, they noted that output, inflation, and balance of payments objectives for 1993 had been achieved, and structural measures had been implemented fully in accordance with the program.

Exchange Rates and Economic Fundamentals

The Board discussed a staff paper “Approaches to Assessing the Consistency of Exchange Rates with Economic Fundamentals” at a seminar in March 1994, This paper updated and strengthened the staff’s earlier analytical work on the assessment of exchange rates—a topic that remains an integral part of the Fund’s surveillance activities involving Article IV consultation, the World Economic Outlook, and International Capital Markets reports, as well as the Board sessions on World Economic and Market Developments.

Most Directors considered that the paper provided a useful survey of the main methodologies used to assess the relationship between economic fundamentals and the exchange rate. These Directors agreed with the staff that the macroeconomic balance approach highlighted in the paper had the advantage of relating the exchange rate to key economic fundamentals in a systematic fashion and thus provided a promising framework for the assessment of exchange rate developments. This approach involved identifying exchange rates consistent with positions of internal and external balance over the medium term, where the former corresponded to output being at its potential level and inflation at a low and nonaccelerating rate and the latter corresponded to a current account position generated by sustainable levels of national saving and investment.

A number of Directors, however, drew attention to the difficulties of applying this internal-external balance approach. The problems included the difficulty of agreeing on a definition of macroeconomic balance and on maintaining it over time in the face of structural changes in individual economies and the world economy. It was noted that greatly varying current account and exchange rate positions had been sustained by some countries over long periods of time, which pointed to the difficulty of specifying macroeconomic balance for any country at a particular juncture. Thus, most Directors emphasized that this approach could not yield a precise estimate of exchange rates consistent with economic fundamentals, as the uncertainties in the underlying calculations implied some range in the estimates. In light of these considerations, a few Directors were skeptical about the practical usefulness of the techniques outlined in the paper.

Moreover, several Directors also observed that an assessment of the causes of particular developments in an economy was often more crucial to successful diagnosis of exchange rate developments and policy prescription than a firm grasp of what the macroeconomic balance exchange rate should be. Therefore the exchange rate could not be assessed in isolation, but needed to be seen through the macro-economic prism of the entire economy. In the view of some Directors, the clear message in this regard was that exchange rate surveillance really involved macroeconomic surveillance. Finally, while the macroeconomic balance approach was generally seen as playing the primary role in assessing the consistency of exchange rates with economic fundamentals, it needed to be supplemented by other methodologies, such as indicators of international competitiveness and purchasing-power-parity considerations; these measures remained useful in many circumstances and continued to provide insights into key economic relationships. More generally, Directors cautioned that an appraisal of exchange rates needed to be made on the basis of all available information and that a considerable degree of judgment was necessary in interpreting exchange rates derived from the macro-economic balance approach.

A number of Directors commented that the staff had not paid enough attention to the role of capital movements in exchange rate fluctuations. Capital flows currently exerted the primary influence on exchange rates and were no longer an adjunct to trade flows, they said. A related development was that markets seemed to be increasingly forward looking, and therefore the role of expectations in capital movements and exchange rate changes needed to be studied in more detail in assessing exchange rate developments.

International Liquidity and SDR Allocation

A primary purpose of the Fund is to facilitate the expansion and balanced growth of international trade. For member countries, effective participation in the international trade and payments system requires adequate levels of international reserves. The SDR is an international reserve asset the Fund can create as and when it determines that there exists a long-term global need to supplement existing reserves.

Acting on a request expressed in the Interim Committee Declaration of April 30,1993. the Board met in July 1993 to continue its discussion of the question of an SDR allocation and related issues, including the issue of a post-allocation redistribution. In addressing the case for an allocation, Directors assessed both the long-term global need for a supplement to existing reserve assets and the potential economic and monetary effects of an allocation. The Board presented its report of the discussion to the Interim Committee in September 1993.

The Question of an SDR Allocation

At the discussion in July 1993, most Directors supported an allocation. Directors who perceived a long-term global need based their assessment partly on staff projections that the demand for reserves would expand substantially during the sixth basic period (1992 through 1996)and on the fact that many developing countries and countries in transition to market-based economies had very low levels of reserves according to commonly applied measures. A number of Directors also pointed to the relatively high costs for most countries of acquiring reserves through borrowing or through compression of domestic demand and net imports. For lowincome countries and countries in transition, the economic and financial costs of acquiring the additional reserves necessary to protect their growth and transformation efforts would substantially exceed the economic opportunity cost of creating reserves through an allocation.

In the view of other Directors-representing a substantial minority of the Board—who did not support an allocation, there was not convincing enough evidence of a long-term global need to supplement existing reserve assets at that time. These Directors emphasized that ratios of reserves to imports were currently at relatively high levels for developing countries as a group, and at normal levels for industrial countries, and that shortages of reserves in individual or groups of countries did not constitute a long-term global need. In their view, credit from private capital markets was in general a sufficient source for meeting reserve needs of countries that followed sound macro-economic and financial policies. For the economies in transition and low-income developing countries in need of adjustment, several Directors considered that the resources needed were of a different kind and should come from the STF, the ESAF, or other official sources of finance conditional on the implementation of appropriate macroeconomic adjustment and stabilization policies.

In discussing the role and future of the SDR as a reserve asset, it was generally agreed that from both the technical and operational points of view the SDR is a well-constructed and competitive asset that serves its purposes well. A number of Directors noted the increasing concentration of SDR holdings relative to cumulative allocations among relatively few creditor members, which reflected not only their reserve asset preferences but also the reluctance of some of them to release SDRs or to make them available under two-way arrangements with the Fund. A number of Directors held the view that the increasing concentration of SDR holdings had resulted in a relative shortage of SDRs in the system that had given rise on occasion to some operational difficulties; in particular, net users of SDRs had found it difficult to rebuild their SDR holdings as quickly as their other reserve assets. There was general agreement that in a world of managed floating exchange rates, the standard basket form of valuing the SDR remained appropriate.

An SDR Allocation and the Equity Issue

At the request of the Interim Committee in September 1993, the Board met in March and April 1994 to continue its consideration of an SDR allocation and related matters. Directors addressed concerns about the situation of those members that had never received an SDR allocation or had not participated in each allocation of SDRs since the first allocation in January 1970. Directors considered three possible remedies: (1) a selective allocation of SDRs specifically directed to new members of the Fund; (2) a reallocation of SDRs through a simultaneous cancellation of existing SDRs, combined with a new allocation of SDRs in proportion to members’ current quotas; and (3) a straightforward new allocation of SDRs of significant size.

Directors concluded that, under the Articles of Agreement, the Fund does not have authority at present to make a selective allocation of SDRs to new members, nor to reallocate SDRs through a cancellation of existing SDRs combined with a new allocation. The granting of such authority to the Fund would require an amendment of the Articles, which most Directors did not support. Nevertheless, a few Directors favored consideration of an amendment for the specific purpose of addressing the equity issue.

A traditional allocation of SDRs to all participants would reduce the degree of inequity in members’ ratios of cumulative allocations to quotas. Many Directors were of the view that, practically speaking, the problem of inequity would be resolved most effectively by offering new members an appropriate stake in the SDR system through a new allocation.

Many Directors noted that a traditional allocation of SDR 36 billion would raise the ratio of allocations to quotas for new members to 60 percent of the average ratio for the participants in previous allocations. Under the proposal, the allocation would be phased over a new five-year basic period (July 1, 1994-June 30, 1999), with a first allocation amounting to SDR 16 billion, to be followed by four subsequent annual allocations of SDR 5 billion each. Apart from the issue of equity, most Directors continued to express support for an allocation of SDRs, based on a perceived long-term global need to supplement reserves.

A number of Directors, however, representing a substantial minority of the voting power, believed that an allocation of SDRs was not at present warranted either because, in their view, there was no long-term global need to supplement reserve assets, or because such a need had not been adequately demonstrated. These Directors stressed the role of the Fund’s conditional resources in meeting the financing needs of the transition economies, and that credit from private capital markets would provide sufficient reserves to countries that followed sound macroeconomic and financial policies.

Post-Allocation Redistribution of SDRs

While many Directors supported a post-allocation redistribution scheme at the March 1994 meeting, some Directors felt that such a scheme did not need to be considered in conjunction with a new allocation of SDRs. Other Directors felt that a post-allocation redistribution scheme raised very considerable practical and legislative difficulties that would effectively preclude their countries from participating.

At the April 1994 discussion, most Directors agreed not to pursue at that time further schemes for post-allocation redistribution of SDRs. However, there was some support for the development of instruments that would better enable members to transfer resources, including newly allocated SDRs, for purposes of providing balance of payments financing to members requiring such financing in support of strong adjustment programs.

In the view of some Directors, such arrangements would help spread the risks of additional lending to low-income countries and countries in transition between the Fund and participating creditor countries. Many Directors expressed interest in developing the concept of Cofinancing Trust Accounts (CTAs) which would be administered by the Fund. Such CTAs would not be linked directly with an allocation of SDRs, and resources for the proposed CTAs could come from members’ existing reserves, from new SDR allocations, or from other sources. Resources from CTAs would be disbursed pari passu with Fund disbursements, ensuring appropriate conditionality. While the modalities of the accounts would have to be worked out more fully, the main principles underlying such an approach attracted the support of a number of Directors.

A number of Directors, including several from developing countries, indicated a willingness to consider making resources available through CTAs. However, several other Directors, representing potential contributors to the CTAs, expressed doubts about some features of the proposed scheme.

In April 1994, the Interim Committee requested the Board to continue to work on SDR issues and to make recommendations at the next Committee meeting in October 1994.

Fund Support of Member Countries

As a cooperative monetary institution, the Fund provides financial assistance to members undertaking economic reforms. An important characteristic of this assistance is its catalytic effect in generating additional financing from other sources, both official and private. Fund financial assistance reassures donors and lenders that a country is pursuing sound economic policies and that its adjustment and reform efforts are deserving of support.

The Fund provides financial assistance through different facilities and under various policies. The first part of this section describes the financing the Fund provided in 1993/94 and adjustment and reform efforts it supported. Next is a review of the Board discussion that led to an enlargement of the enhanced structural adjustment facility—the Fund’s special facility for loans to low-income countries. This is followed by a summary of the Board’s views on an important aspect of the Fund’s policy advice, namely, the implications of reform measures on vulnerable groups in society and how social safety nets can be integrated into economic programs. The section concludes with a discussion of the Fund’s role in resolving external debt-related difficulties of members, an important area of Fund concern since the emergence of debt problems in the early 1980s.

In 1993/94, the Fund approved new stand-by arrangements for 18 countries, extended arrangements for 2 countries, and ESAF arrangements for 7 countries. Thirteen countries made purchases under the STF, and 4 countries obtained financing under the CCFF. Fund financial facilities and policies are described in Box 9.

Policies in Member Countries

Albania’s emergence from communist rule was accompanied by a severe economic crisis that its Government addressed quickly and decisively. On July 14,1993, the Fund approved a three-year ESAF arrangement for Albania for SDR 42.36 million to support its economic and financial program for 1993-96, which aims at a sustained revival of growth, further improvements in inflation performance, and progress toward external viability. This followed nearly a year of successful implementation of the program supported by the 1992 stand-by arrangement, under which the authorities took steps to establish fiscal and monetary control, introduced comprehensive price and trade system reforms, and unified and floated the exchange rate.

Key elements of Albania’s adjustment strategy are a further reduction of the public sector’s domestic borrowing requirement, monetary restraint (complemented by a firm incomes policy in the public sector), and a broad multiyear agenda of structural reforms. The latter includes the privatization of agricultural land, public enterprise reform coupled with the divestiture of virtually all public enterprises, financial sector reform, the implementation of a targeted social safety net, and the establishment of the legal framework for a market economy and private sector activity. Compensation from the budget has been provided to some groups of workers, those dependent on the social safety net, and poor farmers to cushion part of the impact of price reforms under the program. Growth and inflation performance turned out better than the program objectives for 1993, with real GDP estimated to have rebounded by 11 percent (following a decline of 45 percent over the previous three years) while retail prices rose by 31 percent (compared with 237 percent in 1992).

Since its independence, Belarus has begun the process of transforming its economic system toward one based on market mechanisms. To support the Government’s economic and financial program over the 12 months through June 1994, the Fund on July 28, 1993 approved a first STF purchase of SDR 70.1 million. That STF purchase was the first use of Fund financing by Belarus since it joined the Fund on July 10,1992.

The main objectives of the STF-supported program were to reduce the rate of inflation, improve the balance of payments position, and limit the decline of GDP. In the area of systemic reforms, the STF program aimed to develop market structures, further liberalize domestic prices and the exchange and trade system, improve competition, and continue to expand the role of the private sector in the economy.

Bulgaria launched its transformation to a market economy in 1991 by freeing most prices and liberalizing the exchange system. Progress continued during 1992, particularly in reducing inflationary pressures. However, privatization of state-owned enterprises and other structural reforms proceeded slowly. During 1993, there was considerable deterioration in the fiscal and the current account balances, and inflation remained high.

The Fund on April 11,1994 approved financial assistance to Bulgaria for an amount equivalent to SDR 185.96 million in support of the Government’s economic and financial program for 1994. Of the total, SDR 69.74 million was made available under a 12-month stand-by arrangement, and a further SDR 116.22 million was available immediately as the first drawing by Bulgaria under the STF.

Bulgaria’s 1994 program was designed to achieve a turnaround in the economy by combining structural measures to revitalize and accelerate the transformation process with financial stabilization measures. The main objectives of the program were to create the conditions for sustainable growth, to considerably reduce inflation, and to strengthen international reserves in anticipation of a debt- and debt-service-reduction operation with commercial bank creditors. To these ends, the overall budget deficit will be sharply contracted. Monetary and incomes policies will be oriented toward achieving an improvement in inflation performance.

The structural reforms for 1994 include acceleration of the program through the implementation of a mass privatization plan for about five hundred medium and large-scale state enterprises. In addition, the Government is undertaking a recapitalization of banks and is in the process of finalizing a debt- and debt-service-reduction agreement with commercial bank creditors.

Cambodia has suffered from war and internal strife since the 1970s, causing massive loss of life and human capital, as well as a serious deterioration in economic and social infrastructure. More recently, the economy has also had to face the disruption of the previously close links with the countries of the former Soviet Union. Market-oriented reforms began in 1985-86 and, although they have accelerated in recent years, have still to yield their full benefits. From October 1992 to October 1993, the authorities implemented a package of stabilization policies under an informal monitoring arrangement with the Fund staff. With the improvement of the political situation and the adoption of substantial economic measures, recent developments have been favorable, reflecting renewed confidence.

On October 1,1993, the Fund ended the limitation on Cambodia’s use of its general resources and the suspension of its right to use SDRs following clearance of its arrears to the Fund and, on October 4,1993, approved a first purchase under the STF of SDR 6.25 million to support the Government’s 1993–94 economic and financial program. This is designed to be a transitional program, laying the foundation for a more comprehensive medium-term program to be adopted in the course of 1994. To achieve the objectives of the 1993-94 program, fiscal policy was geared toward eliminating the excessive monetization of the deficit that had been the root cause of Cambodia’s high inflation, through improvements in tax enforcement, and containment of current expenditures. Monetary policy was also designed to reduce inflationary pressures. The program envisaged unification of the official and parallel market exchange rates and progressive dismantling of most foreign exchange restrictions.

Structural reforms, which were pursued on several fronts, included the formulation of a detailed program for the restructuring and downsizing of the remaining state enterprise sector by the end of 1993. The Government also defined a detailed time-table of systemic reforms to strengthen the central institutions of macroeconomic management. In late 1993, the authorities requested that the Fund consider an ad hoc increase in Cambodia’s quota in the Fund, which became effective in early 1994.

Cameroon’s economy declined steadily from the mid-1980s onward, owing to a worsening of its terms of trade, a sharp appreciation of its currency in real effective terms, and falling oil production. Although the authorities tried to respond to these worsening conditions by tightening fiscal management, it had become clear by 1993 that a strategy based solely on internal adjustment measures had run its course, and was unlikely to restore competitiveness in the foreseeable future. Accordingly, the Government supported the decision of CFA franc zone countries to devalue the currency against the French franc on January 12, 1994.

The Fund on March 14, 1994 approved an SDR 81.06 million stand-by arrangement to support the Government’s economic policies over the next 18 months. With the devaluation as a key initial measure, the Government’s medium-term strategy aims at securing permanent gains in competitiveness and bringing the economy back to a sustainable growth path, a rapid return to the low inflation that prevailed before the devaluation, and eventual balance of payments viability. Fiscal adjustment lies at the heart of the program. Monetary policy, which is carried out at the regional level, aims at supporting fiscal policy, with a view to countering inflationary pressures and improving the net external position of the BEAC.

Structural measures centered on trade and price liberalization, streamlining the regulatory framework, rationalizing and downsizing the civil service, setting the stage for further restructuring of the financial sector, and resuming public enterprise reform. A social safety net to protect those most disadvantaged by the adjustment process is an integral part of the program.

After 1990, the Central African Republic suffered from a disintegration of public administration and a weakened capacity to carry out macroeconomic policies. As a result, government revenue collapsed and domestic and external arrears accumulated, including arrears on civil service salaries. Responding to the critical state of its finances, the Government acted to cut the public wage bill in 1993, which together with the sharp fall in expenditures, and especially investment expenditures, resulted in a narrowing of the budget deficit.

The Central African Republic’s economy has suffered a sizable loss of competitiveness over the past ten years, as the real effective exchange rate, relative to other developing countries, rose by more than 50 percent since the mid-1980s. Accordingly, the Government supported the decision of the CFA franc zone countries to devalue the currency against the French franc on January 12, 1994.

The Fund on March 28, 1994 approved an SDR 16.48 million stand-by arrangement to support the Government’s economic policies over the year ahead. To buttress the devaluation, the Government immediately started carrying out adjustment measures that should allow a return to sustainable economic growth and financial viability over the next few years. The main macro-economic objectives for 1994-96 are achieving real economic growth of 5 percent a year; reducing in a sustainable way the external current account deficit; and keeping inflation below 2 percent, once devaluation-induced price increases have been absorbed. These objectives will depend, in addition to the devaluation, on raising the savings and investment rates during the period, on implementing appropriate fiscal and credit policies, and on restructuring the economy to increase production efficiency and encourage private investment.

Structural measures under the program are focused on the liberalization of the regulatory framework, the restructuring of the public enterprise sector, and the implementation of a new civil service statute. The Government is developing a stronger program of structural reforms that would enhance productivity and enable the productive sector to derive maximum benefit from the change in exchange rate parity.

The rural population is expected to benefit rapidly from the devaluation. The urban population may be more adversely affected but the better control over public finances will enable the Government to pay civil servants regularly and restore public services. In addition, price increases for some essential goods have been limited during a transitional period.

Chad adopted an emergency economic plan in 1992 that sought to improve the tax system and reduce recurrent budgetary outlays, including the wage bill and military spending. Although demobilization of the army progressed satisfactorily, the fiscal crisis continued, accompanied by an expansion in public sector credit and stagnation in private sector lending.

Against this background, the Government resolved to broaden and strengthen its adjustment strategy, and accordingly, supported the decision of the CFA franc zone countries to devalue the currency against the French franc on January 12, 1994.

The Fund on March 23, 1994 approved a stand-by arrangement for Chad of SDR 16.52 million to support the Government’s economic policies over the next 12 months. This program sought to restore order in the public finances and to establish wage and price policies aimed at raising supply incentives and consolidating the competitive advantage brought about by the devaluation. It would also increase spending in priority programs for health and education and for essential infrastructure maintenance. In 1994, the program aims for a positive growth rate of about 1 ½percent and the return to single-digit inflation at the end of the year.

Structural reforms were begun by streamlining the tax system and by raising the efficiency of the public sector through an improvement in incentive systems for civil servants. A number of public enterprises were to be privatized and the private sector was to be strengthened by liberalizing existing rules and regulations. A social safety net to protect those most disadvantaged by the adjustment process is an integral part of the program.

Since 1985, Côte d’lvoire’s economic and financial situation has deteriorated markedly as a consequence of a sharp drop in the world market prices of its major exports and a sizable real appreciation of the CFA franc. At the same time, the country was handicapped by a number of structural and sectoral problems. Côte d’lvoire’s serious efforts to reduce financial disequilibria and implement structural reforms were not enough to restore growth and external viability in view of the crisis in competitiveness the country faced. Accordingly, the Government supported the decision of the CFA franc zone countries to devalue the currency against the French franc on January 12, 1994.

The Fund approved a three-year ESAF arrangement for Côte d’lvoire of SDR 333.5 million on March 11, 1994 to support the Government’s economic and financial program for 1994-96, The strategy over these three years is aimed at achieving positive economic growth for 1994, followed by an increase in output of some 6 percent in 1995 and 1996. For 1995-96, inflation is expected to average about 6 percent a year. To achieve the full positive effects of the devaluation, the program calls for implementation of rigorous macroeconomic policies, coupled with an acceleration of structural reforms. Social safety net measures were envisaged to mitigate the immediate impact of the exchange rate adjustment.

The Dominican Republic has successfully pursued a comprehensive economic program of adjustment and structural reform since 1990. Public finances shifted from a deficit of 5 percent of GDP in 1990 to a surplus of over 1.5 percent two years later, and major structural reforms were implemented, including the unification and liberalization of the exchange rate system, decontrol of exchange and interest rates, introduction of realistic public sector pricing policies, a lifting of price controls, and initiation of a trade reform.

The Fund approved on July 9, 1993 an eight-month stand-by arrangement of SDR 31.8 million for the Dominican Republic and, to cover a shortfall in merchandise export receipts, a purchase under the CCFF of SDR 34.6 million was available immediately. The action followed the Dominican Republic’s successful implementation of its earlier 19-month economic program, supported by a Fund stand-by arrangement that expired on March 27,1993.

The Government’s 1993 economic program aimed at real GDP growth of about 5 percent, an annual rate of inflation in the 5-8 percent range, and a further strengthening of the country’s net international reserves. To achieve these objectives, the program sought to maintain external competitiveness and to consolidate a sound fiscal position. In this context, the 1993 program called for a balanced public sector financial position (following small surpluses in the previous two years), while allowing for a moderate increase in public investment spending, consistent with the path of medium-term fiscal adjustment. Monetary policy underpinned the program’s inflation and balance of payments objectives, while allowing for a substantial increase in banking system credit to the private sector.

Egypt made substantial progress under a program supported by a Fund stand-by arrangement that expired in May 1993, laying a strong foundation for a market-based economy led by the private sector. During the program period, Egypt implemented a major stabilization effort that succeeded in reducing the fiscal deficit, supported by prudent credit policies. The external accounts moved into a large overall surplus over the program period.

On September 20, 1993, the Fund approved a three-year extended arrangement, totaling SDR 400 million, to support Egypt’s medium-term economic and financial reform program. In view of Egypt’s comfortable reserve position and favorable economic outlook, the authorities saw the extended arrangement as being precautionary in nature.

The overall objective of Egypt’s medium-term reform program is to create a decentralized, outward-oriented market economy with sustained growth. To achieve the desired improvement in investment, growth, and employment, the Government’s comprehensive program involves structural reforms supported by prudent fiscal, monetary, and external borrowing policies and policies to improve the economy’s export competitiveness.

To achieve these objectives, the authorities intend to reduce the fiscal deficit further and maintain prudent monetary policies to reduce the pace of inflation and ensure external competitiveness. At the same time, they will make adequate resources available to the private sector for investment. On the structural side, reforms are keyed to the decontrol of production, investment, and trade; a progressive shift to consumption and income taxes; accelerated action on privatization and public enterprise reform; and completion of banking sector and foreign exchange reforms. Additionally, regulatory reforms are planned, along with steps toward labor market flexibility and capital market and rent decontrol. The program includes further price liberalization, while providing a social safety net to alleviate any short-term adverse effects of planned reforms.

After two years of solid progress, El Salvador faced serious challenges in managing its economy during 1992 following a slump in international coffee prices, a drought, and an increase in public expenditure related to the peace accord of January 1992 that ended 12 years of civil war. Although real GDP grew by an estimated 4.5 percent, the fiscal deficit rose considerably, inflation jumped to 20 percent, and the accumulation of international reserves slowed.

On May 10,1993, the Fund approved a ten-month stand-by arrangement of SDR 34.55 million to support El Salvador’s financial and economic program for 1993, which aimed at reducing inflation and strengthening the balance of payments, while maintaining real GDP growth of about 4.5 percent. The program also sought to consolidate structural reforms, to expand social programs, and to increase public outlays under El Salvador’s National Reconstruction Plan. The arrangement was later increased to SDR 47.11 million, and extended by ten months.

The fiscal effort was the centerpiece of the program, calling for an improvement in the savings performance of the nonfinancial public sector and an increase in tax revenues. On the expenditure side, the program provided for a reduction in central government outlays that includes a decline in military expenditures. Monetary policy was to rely on credit restraint and continued interest rate flexibility to attain the program’s balance of payments and inflation objectives.

The structural reform program focused on three main areas: public sector modernization through sustainable tax reform and a streamlining of the civil service; financial restructuring through the rationalization of public expenditure management and the unification of the ordinary and extraordinary budgets; and the restructuring and privatization of the remaining state-owned commercial and savings banks, as well as an accelerated effort to divest the few remaining nonfinancial state enterprises. The Government’s social strategy focused on providing temporary employment, income, food supplements, and expanding social services.

The Fund on October 27, 1993 approved the use of Fund resources totaling SDR 23.25 million for Estonia, half of which was available through March 1995 under a stand-by arrangement to support the Government’s 1993/94 economic and financial reform program. The other half was available as a first purchase under the STF.

The authorities’ main objectives during the 1993/94 program period are to consolidate the gains already made in the transformation of the economy, while maintaining macroeconomic stability. Output is expected to grow by 6 percent in 1994. The current account deficit is projected to increase, however, largely because of an expected increase in investment and imports, with gross foreign reserves being maintained at about four months of imports throughout the program period.

A tight fiscal policy remains at the center of Estonia’s stabilization effort, while monetary policy will focus on maintaining the integrity of the currency board arrangement and improving the ability of the banking system to support the transition. The authorities intend to continue to strengthen and rationalize the social safety net to ensure that assistance is channeled effectively to the neediest segments of the population.

Gabon’s economic and financial situation has become increasingly difficult in the past few years because of a fall in oil revenues and a heavy debt burden. Access to external financing was sharply curtailed in the past two years, with a buildup of large domestic and external payments arrears. Slow progress was made in containing public spending, strengthening non-oil receipts, and reforming public enterprises. Financial strains and the lack of competitiveness deterred non-oil private investment and held back the country’s growth. Faced with this situation, the Gabonese Government formulated a program to turn the economy around and restore adequate and balanced growth. The key element of this program was the Government’s support of the decision of the CFA franc zone countries to devalue the currency against the French franc on January 12, 1994.

The Fund on March 30, 1994 approved the use of Fund resources for Gabon equivalent to SDR 60.1 million to support the Government’s economic and financial program for 1994. Of the total, SDR 38.6 million was available under a one-year stand-by arrangement, and a further SDR 21.5 million under the CCFF for an export shortfall.

To strengthen competition, Gabon’s trade liberalization policy was to be continued. In this context, the Government sharply reduced customs duties as part of its comprehensive reform of the tariff structure. To protect the poorest population groups, the Government has introduced measures to limit the price increases for energy products and necessities and to improve the availability of basic social services.

The Fund approved on July 14, 1993 a purchase by Ghana of SDR 47 million under the CCFF to offset a shortfall in export earnings in the 12 months prior to March 1993 that was due largely to a temporary fall in the exported value of cocoa beans and other cocoa products.

In mid-1990, Hungary adopted a medium-term stabilization and structural transformation program that was supported by a three-year extended arrangement from the Fund. During the program, the authorities liberalized prices and external transactions, made significant progress toward establishing a market-based economy, reformed the budget and the financial system, and continued the privatization process. As a result, Hungary’s creditworthiness strengthened significantly, its international reserves were rebuilt, and the trend of rising inflation was reversed. Nevertheless, the country continued to face difficulties owing to the widening state budget deficit and a larger-than-expected contraction of output that was exacerbated by the collapse of the CMEA market and depressed levels of domestic demand.

On September 15, 1993, the Fund approved a stand-by arrangement for Hungary of SDR 340 million over 15 months to support its economic and financial program through the end of 1994. This program envisaged an annual growth rate of 2 percent in 1994, reducing the rate of inflation and stabilizing the current account balance of payments deficit. To these ends, the Government was to reduce the state budget deficit through a combination of revenue and expenditure measures. Monetary and credit policy was to be consistent with the balance of payments objectives and the strategy of reducing inflation. In the area of structural reforms, the process of transforming the productive sector—mainly through bank and enterprise debt consolidation and continued privatization—was accelerated.

During 1992 and early 1993, Kazakhstan made significant progress in implementing economic and systemic reforms and succeeded in containing macro-economic imbalances. The country took important steps to strengthen and modernize the banking system as well as the central bank’s legal basis and instruments for the conduct of monetary policies. Systemic reforms included a wide-ranging liberalization of prices, the reduction of direct state intervention in the economy, the establishment of a legal and institutional framework for political and economic decision making, and the start of a comprehensive and ambitious privatization program.

The Fund approved on July 23, 1993 Kazakhstan’s first use of Fund financing, a first purchase under the STF of SDR 61.875 million to support its economic and financial program for 1993/94. The central objectives of this program were to contain the decline in output in 1993, to sharply reduce the monthly inflation rate by the end of the year, and to accelerate the momentum of structural and institutional reforms. The program also envisaged a strengthening of the balance of payments and a significant increase in the level of official international reserves.

The Fund approved on January 26, 1994, a further use of its financial resources totaling SDR 185.625 million to support Kazakhstan’s program of economic and financial reforms for 1994. Of the approved amount, SDR 123.75 million was made available under a 12-month standby arrangement and SDR 61.875 million in the form of a second purchase under the STF. This program included measures to accelerate market-oriented reforms and to ensure that the new national currency, the Tenge, introduced with technical support from the Fund in November 1993, would support a stronger economy. At the same time, particular attention was directed at providing a social safety net. The program had the strong support of the international financial community, which made commitments exceeding $1 billion to meet its external financing requirements; in particular. Japan announced it would provide parallel financing with the Fund to Kazakhstan, the first time that this had been done in conjunction with a stand-by arrangement.

The Government’s 1994 program of macroeconomic stabilization and systemic reforms sought to sharply reduce the monthly inflation rate through a combination of tight fiscal and monetary policies; contain the decline in output and incomes through liberalized trade and prices; and accelerate the restructuring and privatization of enterprises coupled with banking system reforms. Fiscal policy in 1994 seeks to reduce the overall 1994 budget deficit to 4 percent of GDP. The credit and monetary program took advantage of the National Bank’s ability to conduct an independent and coherent monetary policy after the introduction of the Tenge and was reformulated to meet the program’s overall objectives, especially with regard to inflation and exchange rate policy.

The Government’s structural policies will continue to focus on mass privatization, the sale of several major enterprises, anti-monopoly measures, banking system reforms, and a reduction of the role of the state in foreign trade. These policies will be reinforced by specific measures to deal with enterprise arrears and implement improvements in interstate trade and payments.

Since the early 1990s, Kenya’s economic situation worsened as economic growth fell from 4.4 percent in 1990 to 0.4 percent in 1992, inflation accelerated, and external payments arrears emerged. By March 1993, the economy was facing severe shortages of foreign exchange and prospects of factory closings and layoffs adding to already high unemployment; inflation rose to 58 percent on an annual basis in the first quarter of 1993. In April

1993, the Government adopted a macroeconomic framework to restore balance to the economy and resume the economic reform process. Monetary policy was tightened; steps were taken to stabilize the financial system; the exchange and trade system and maize marketing were substantially liberalized; civil service reform initiated; and expenditure controls strengthened. As a result, progress was made toward stabilizing the economy.

On December 22,1993, the Fund approved an additional one-year ESAF arrangement of SDR 45.23 million to support Kenya’s 1993/94 economic and financial program, which sought to achieve economic growth of 3 percent in 1994; reduce the rate of inflation to 10 percent; attain relative exchange rate stability; lower the external current account deficit, excluding official transfers, to 1.5 percent of GDP; and raise the level of gross international reserves.

To achieve these objectives, fiscal policy was designed to reduce the overall budget deficit primarily through cuts in government expenditure. Monetary and credit policies were formulated to support the inflation objectives.

On the structural side, the program envisaged a broad reform to improve the efficiency of government operations, rationalize the structure of government, reduce civil service, and privatize at least twenty nonstrategic public enterprises. Procedures for trade licensing and investment will be simplified: the pricing and marketing of maize will be decontrolled; and the Government will withdraw from agricultural processing to allow the private sector to expand into these activities.

To alleviate the adverse impact of the maize price liberalization, the Government put in place a program to assist the poor and introduced programs to help laid-off civil servants start their own small-scale businesses or find alternative employment in the private sector.

Decades of central planning had left the Kyrgyz Republic with a distorted economy, an excessively specialized pattern of production, and growing macroeconomic imbalances. Disruptions to trade with the other countries of the former Soviet Union were exacerbated in 1992 by a sharp increase in the cost of petroleum imports, the further loss or shrinkage of traditional export markets, and an increasingly inefficient payments system within the former Soviet Union. As a result, real GDP is estimated to have declined by a further 25 percent in 1992, led by a sharp drop in industrial production.

On May 12,1993, the Fund approved the Kyrgyz Republic’s first use of Fund financial resources, totaling SDR 43.21 million to support the Government’s 1993 economic and financial program, including the introduction of the national currency, the som. Of the total, SDR 27.09 million was available to the Kyrgyz Republic under an 11-month stand-by arrangement. A further SDR 16.125 million was provided as a first purchase under the STF, making the Kyrgyz Republic the first member of the Fund to use this facility. On September 20, 1993, the Fund approved the second STF purchase.

In approving these credits, Directors strongly supported the far-reaching adjustment efforts of the Kyrgyz Republic and the introduction of the som, which began on May 10, 1993. The program for 1993 aimed to limit the decline in real GDP, sharply reduce the monthly rate of inflation, and improve the international reserve position.

In the structural area, the program called for a legal framework for commercial activity to be implemented; privatization to be accelerated and state orders eliminated; price liberalization to be completed; and reform of the banking sector to be pursued.

Following the considerable economic progress made by the Lao People’s Democratic Republic under a SAF arrangement approved in 1989, the country requested ESAF arrangements from the Fund for SDR 35.19 million, which were approved on June 4, 1993, to support its economic and financial program for 1993-95. The objectives of this program are to sustain average real GDP growth at 6-7 percent; reduce the average annual rate of inflation to the rate prevailing in the country’s major trading partners (about 5 percent); contain the annual average external current account deficit, excluding official transfers, to about 9 ½ percent of GDP; and increase gross official reserves to the equivalent of about three months of imports by the end of 1995.

To these ends, the Lao authorities will intensify their efforts to reduce fiscal imbalances, redress structural weaknesses, and strengthen institution building. In the fiscal field, the Government’s medium-term objectives include attaining an overall budget deficit, excluding grants, of 8 percent of GDP by 1995. On the revenue side, the authorities aim at increasing the tax-to-GDP ratio by about 3 percentage points through tax measures and intensified collection efforts. They will pursue cautious monetary policies, with greater reliance on indirect policy instruments. Structural policies will include an acceleration of privatization, trade and tariff reform, and a strengthening of the banking sector.

Latvia’s 1992/93 economic program, supported by the Fund, achieved a significant degree of macroeconomic stabilization. A key element of the program was the introduction of a national currency in July 1992, which enabled the Bank of Latvia to pursue an independent monetary policy.

The Fund on December 15, 1993 approved financial assistance to Latvia totaling SDR 45.75 million in support of the Government’s 1993/94 economic program. Of this total, half was under a 15-month stand-by arrangement and half was a first purchase under the STF. The program was designed to continue macroeconomic stabilization efforts and to reinforce the economic reform process within a medium-term perspective. The main objectives of the program were to consolidate earlier gains and to create the basis for sustained growth with a viable balance of payments, while keeping the underlying average monthly rate of inflation at about ½ of 1 percent through the program period. Positive GDP growth may be achieved in 1994, assuming the economy can absorb the large amount of foreign financing that may become available. On these assumptions, the current account of the balance of payments would move into deficit equivalent to 7 percent of GDP next year, compared with an estimated surplus of 1 percent of GDP this year.

To attain the program’s objectives, the authorities continued to pursue restrained fiscal policies and limit the general government financial deficit. To put public finances on a more sustainable basis over the medium term, comprehensive tax legislation was approved by Parliament in October 1993, and the Government has adopted measures to improve tax administration. The program also called for tight monetary policy and rationalization of the trade regime.

During the program period, structural reforms, particularly in the area of privatization, are to be accelerated. The Government is setting up a State Property Fund to oversee all state property and a Privatization Agency with authority over the privatization of large-scale enterprises. The process of restituting land and residential property to former owners is to be simplified and accelerated.

While incurring a large drop in total output, Lithuania made significant progress under a 1992/93 economic program supported by a Fund stand-by arrangement. Following a decline of more than one third in 1992, output stabilized during 1993 and the rate of inflation also fell. Lithuania adopted a new trade regime, achieved monetary independence by withdrawing from the ruble area in October 1992, and introduced the new national currency, the litas, in June 1993.

On October 22,1993, the Fund approved financial assistance to Lithuania totaling SDR 51.75 million, half of which was under a 17-month stand-by arrangement and the other half of which was a first purchase under the STF: a second STF purchase of SDR 25.875 million was made on April 13, 1994. The Fund resources supported the Government’s stabilization program for 1993/94, which was designed to continue the country’s transformation to a market-based economy and to establish a sound basis for growth in a low-inflation environment. The authorities decided to implement monetary policy consistent with the aim of reducing inflation and protecting the value of the litas on foreign exchange markets (a currency board arrangement was later adopted, with effect from April 1. 1994), and to limit the general government’s financial deficit, to reform the structure of taxation, and to establish expenditure priorities in place of broad-based expenditure cuts. Trade policy measures under the program included the elimination of most export taxes in 1994 and introduction of a uniform import tariff structure, with a few exceptions, by the end of 1993. Structural reforms under the program focused on privatization.

The economic performance of the former Yugoslav Republic of Macedonia deteriorated significantly since independence as inflation accelerated to levels verging on hyperinflation. By early 1994, falling output had brought economic activity to about half of its 1989 level and unemployment rose to 28 percent. While, in part, these imbalances had their origin in the regional crisis, they were compounded by the deep-seated structural weaknesses in the labor and financial markets of the former Yugoslav Republic of Macedonia and by a weak balance of payments position.

On February 11, 1994, the Fund approved a first purchase under the STF totaling SDR 12.4 million for the former Yugoslav Republic of Macedonia to support the Government’s economic program for 1994, the main objective of which was to reduce the rate of monthly inflation to 2 percent by the end of the year, as a precursor to comprehensive structural reform. The program’s anti-inflationary thrust relied on wage controls, tightening of monetary policy, and stricter budgetary discipline. In order to halt the growth in public sector arrears and to continue to avoid public sector recourse to the banking system, the 1994 budget and accompanying laws entail a significant tightening of fiscal policies.

Following a particularly difficult year in 1992, Moldova continued to experience a deteriorating situation in 1993, with economic activity declining sharply and inflation remaining high. These difficulties reflected the ongoing restructuring of the economy, much lower than expected volume of energy imports, and persistent difficulties in obtaining key raw materials from other countries of the former Soviet Union.

The Fund on September 17, 1993 approved a first purchase under the STF totaling SDR 22.5 million for Moldova to support the Government’s economic and financial program over the 12 months to June 30, 1994, which aimed at breaking with past economic policy and moving rapidly toward a market economy and monetary independence. On December 17, 1993, the Fund approved a 15-month stand-by arrangement of SDR 51.75 million, together with a second purchase under the STF, of SDR 22.5 million.

The economic program supported by the stand-by arrangement sought to reduce substantially the monthly level of inflation and to achieve price stability in 1994; to contain the decline in output to 3 percent of GDP in 1994; and to build up the level of gross international reserves. Achieving these objectives called for appropriate monetary and credit policies and reducing the overall budget deficit in 1994. Exchange rate policy sought to achieve and maintain a unified, market-determined, official exchange rate (a new currency, the leu, was introduced on November 29, 1993), and a review of foreign exchange regulations was provided to ensure they were consistent with current account convertibility.

The program also envisaged a broad range of structural reforms: further trade and price liberalization; privatizing most state-owned enterprises; and reducing considerably direct state intervention in economic activity. Special measures were incorporated in the program to protect the most vulnerable segments of the population from the immediate effects of price liberalization and the elimination of open-ended subsidies.

Following decades of relative isolation and dependence on the Soviet Union. Mongolia in 1990 initiated sweeping political and economic changes designed to further its transition to a market economy. During 1991/92, under a Fund-supported economic program. progress was made in structural reform, but output declined steeply, and inflation accelerated sharply, and net reserves declined. Economic performance improved during the latter part of 1992 and also 1993 as the authorities intensified their reform efforts. Monetary expansion slowed considerably, inflation declined, and output and the external position showed signs of improving.

The Fund approved on June 25, 1993 a three-year ESAF arrangement for Mongolia equivalent to SDR 40.81 million to support its economic and financial program for 1993-96, which sought an average annual growth of GDP of 3.5 percent; a reduction in the annual rate of inflation to single digits by the end of 1995; and a strengthening of Mongolia’s net international reserves. The medium-term strategy emphasized strengthening macro-economic management through the development of indirect instruments of monetary management and improvements in the financial and fiscal systems, reinforcing structural reforms to remove impediments to production and trade through further privatization, additional steps to develop the legal framework for a market economy, and measures to strengthen corporate governance. In addition, the program contemplates completion of price liberalization and removal of the remaining restrictions imposed by the system of state orders and rationing.

By late 1993, Niger’s government finances were in a crisis that involved an accumulation of substantial arrears on both domestic and external debt. The economy was at a virtual standstill, and the external position was under great pressure. In view of this situation, the Government supported the decision of the CFA franc zone countries to devalue the currency against the French franc on January 12,1994.

On March 4, 1994, the Fund approved a SDR 18.596 million one-year stand-by arrangement, to support the Government’s program for 1994-96, which is designed to preserve the improvements in competitiveness brought about by the devaluation and to strengthen economic activity. To achieve these objectives, the Government’s program for 1994 will seek to limit the current budgetary deficit (excluding grants) to 5.7 percent of GDP and reduce the overall budgetary deficit (including grants) to 2 percent of GDP. Monetary and credit policies have been designed to promote economic recovery and a speedy return to price stability. In 1994 the increase in bank credit to the Government will be modest, allowing for an expansion of credit to the private sector.

Structural reforms concentrate on reducing costs and improving the financial position of the uranium sector. In the public enterprise sector, the program called for key enterprises to be restructured and interenterprise debts settled. The labor market was to be liberalized and a new simplified customs tariff structure introduced in 1994. Emphasis would be placed on improving primary school education, and basic health care. Niger has adopted a social safety net to mitigate the short-term effects of the devaluation on vulnerable groups.

The Fund on September 16, 1993 approved a 12-month standby arrangement for Pakistan of SDR 265.4 million to support the Government’s 1993/94 economic and financial program, which, formulated within a medium-term framework, seeks to bolster foreign exchange reserves, minimize the risks of disruptive capital outflows, and allow for strong economic growth to continue in the context of financial stability.

On February 22,1994, the Fund approved the use of its financial resources totaling SDR 985.7 million over the next three years by Pakistan in support of the Government’s medium-term economic adjustment and reform program. Of this total, SDR 606.6 million is financed under ESAF arrangements and SDR 379.1 million through an arrangement under the extended Fund facility.

Pakistan’s medium-term strategy, supported by the ESAF arrangement and the extended arrangement, seeks an early strengthening of the external position while pursuing comprehensive structural reforms aimed at sustaining high-quality economic growth in the context of domestic and external financial stability. The main objectives of the three-year program are to sustain economic growth at 6 ½ percent a year, reduce the annual rate of inflation to 5 percent by the end of the period, strengthen gross official international reserves, and reduce the ratios of domestic and external debt to GDP. These will be accompanied by additional improvements in the structural aspects of the economy to strengthen its supply responsiveness, reduce its vulnerability to adverse external shocks, and improve social indicators.

Within this medium-term framework, the economic program for 1993/94 is designed to bring about a recovery in economic growth, reduce the rate of inflation, lower the external current account deficit, strengthen international reserves, and contain domestic and external debt. The Government’s structural policies are also designed to achieve further progress in the liberalization of economic activity in order to enhance the supply responsiveness of the economy, generate sustainable employment growth, and improve the country’s social indicators.

Emphasizing its commitment to address the shortfalls in basic social services, the Government has developed a social action program that focuses on four main areas: primary education; primary health care; population; and rural water supply and sanitation.

The Fund on June 30,1993 approved a first purchase under the STF totaling SDR 1,078.275 million for the Russian Federation to support the Government’s economic and financial program. The STF purchase was the second use of Fund financing by the Russian Federation. The central objectives of the STF-supported program were to reduce the monthly rate of inflation, while increasing the role of market forces in the allocation of financial resources and reducing Russia’s large fiscal imbalance. The program also sought to improve the efficiency of the domestic economy and to speed up its integration into the world economy, notably through continued privatization and trade liberalization.

Structural measures under the program aimed at further liberalization of the exchange and trade system, including extending the November 1992 decision to introduce current account convertibility for residents to nonresidents, and broadening further the interbank market in foreign exchange. Also contemplated were a deepening of the privatization effort, and an acceleration of efforts to develop a legal framework that is fully compatible with a market economy.

This program was introduced against the background of the severe disruptions and imbalances that have characterized the Russian economy since the breakup of the former Soviet Union. A second purchase of SDR 1,078.275 million under the STF was approved by the Fund on April 20,1994.

Senegal experienced a serious worsening of its financial situation in 1992 and the first half of 1993, when its external current account deficit widened and the Government ran up arrears on both its foreign and domestic debts. There was, at the same time, an increase in the Government’s budget deficit, a flight of capital from the country, and a sharp fall in the money supply. Although the Government has succeeded in narrowing the budget deficit with a package of measures announced in August 1993 to increase revenue and contain expenditure, there has been little improvement in Senegal’s external position. These measures were not enough to restore sustained growth and external financial viability. Thus, after consulting other members of the CFA franc zone, the Government decided to broaden and strengthen its strategy of economic adjustment by devaluing the CFA franc against the French franc on January 12, 1994.

On March 2,1994, the Fund approved a one-year stand-by arrangement of SDR 47.56 million to support Senegal’s economic policies over the next 12 months. The Government’s strategy over the next three years aims at stimulating economic growth, returning to low inflation by 1996, and cutting the current account deficit of the balance of payments after a temporary increase in 1994. The Government hopes to achieve these goals through the devaluation, together with the pursuit of tight fiscal and monetary policies, and faster structural reform of the economy.

Structural reforms will concentrate on promoting private sector growth and export competitiveness. Senegal has taken steps to limit the adverse impact of the devaluation on the poor by controlling price increases of essential staples, while improving basic social services. In addition to government measures to improve the social safety net, a program targeting the poorest social groups will be put in place.

The Fund on March 28, 1994 lifted Sierra Leone’s ineligibility to use its financial resources and also approved use of resources totaling SDR 115.8 million following the clearance of the country’s arrears to the Fund of SDR 85.5 million, which was facilitated by bridge financing provided by France, Norway, and the United States. Of the total, SDR 88.8 million was provided under a three-year ESAF arrangement and a further SDR 27 million under a one-year SAF arrangement in support of the Government’s economic and financial reform program for 1994-96.

The Slovak Republic joined the Fund on January 1, 1993 through succession to the membership of the Czech and Slovak Federal Republic. The newly independent country faced enormous challenges. The ending of fiscal transfers from the Czech lands revealed large underlying fiscal and external imbalances; the lack of a developed institutional framework significantly complicated the task of economic management; and though a participant in the Czech and Slovak Federal Republic’s prudent and effective policies over the previous two years, the Slovak Republic started without a policy track record of its own.

On July 27, 1993, the Fund approved the Slovak Republic’s first use of Fund financial resources, a first purchase of SDR 64.35 million under the STF.

The Slovak Republic’s economic program for 1993 aimed at an inflation rate of 30 percent, consistent with an underlying inflation rate of 1 percent a month in the remainder of the year; a substantial reduction in the underlying current account deficit of the balance of payments; and containment of the decline in real GDP to 9 percent. Strong fiscal action was the cornerstone of the program designed to meet these objectives, while monetary policy remained tight. A 10 percent devaluation of the Slovak koruna in July 1993, supported by continued wage restraint and a flexible exchange rate policy under the program, was undertaken to facilitate an improvement in the Slovak Republic’s external payments position.

The program called for accelerated structural reforms, including the second wave of large-scale privatizations, upgrading the supervisory capacity of the National Bank, creating a financial information system, and privatizing remaining state-owned banks.

South Africa’s macroeconomic management in recent years has been aimed at achieving financial stability in difficult circumstances. South Africa has maintained a constructive policy dialogue with the Fund through regular consultations and staff visits. For the period ahead, the authorities are resolved upon a cautious fiscal and monetary stance that is broadly supported by South Africa’s major political groups.

The Fund on December 22, 1993 approved a CCFF purchase by South Africa of SDR 614.43 million, which was the country’s first use of Fund resources since 1982. The CCFF purchase was to help compensate for a shortfall in merchandise export earnings and an unexpected increase in cereal imports for the 12-month period ended June 1993. Earnings from exports of various minerals such as gold and platinum had declined sharply, primarily because of lower world market prices. In addition, export earnings from agricultural crops dropped as a result of the severe drought, one of the worst this century, that swept southern Africa in early 1992.

Since Viet Nam began dismantling its centrally planned economic system in 1986, major progress has been made in moving toward a market-oriented system. During 1989-92, output grew by an average of 6 ½ percent and inflation declined from triple-digit levels to 38 percent on an annual average basis. Toward the end of this period, however, there was a slowdown in some areas of systemic reforms. In addition, the adoption of more expansionary fiscal and monetary policies in the first half of 1993 led to a buildup of demand pressure that manifested itself mainly in a marked deterioration in the external position.

Following Viet Nam’s clearance of its arrears to the Fund, SDR 100.2 million, the Fund on October 6,1993 lifted Viet Nam’s ineligibility to use its general resources and approved use of Fund resources totaling SDR 157.08 million. Of this amount, SDR 12.08 million was a first purchase under the STF. while a further SDR 145 million was made available over 12 months under a stand-by arrangement designed to support the Government’s 1993-94 economic and financial program.

Viet Nam’s economic program for 1993-94 is designed as a bridge to a new phase of economic development, in which its relations with the international community will be normalized and its economic policies supported by concessional assistance from multilateral and bilateral sources. To achieve the program’s macro-economic objectives, fiscal policy is geared toward limiting the overall budget deficit—while accommodating a strong acceleration of infrastructure investment—through a substantial expansion in government revenue, as well as through containment of the growth in current expenditures. Monetary policy is designed to restrain domestic demand with a view to keeping inflation under firm control and strengthening the balance of payments. Under the economic program, structural reforms will move forward on several fronts.

Enhanced Structural Adjustment Facility

With the enhanced structural adjustment facility proving to be an effective instrument for the Fund to support the economic reform efforts of the poorest countries, the Interim Committee at its April 30,1993 meeting invited the Board to complete its work on a “successor facility” by the end of November 1993, which had been the cutoff date for loan commitments under the ESAF.

It had been proposed that the general characteristics of the ESAF would be maintained. Concessional loans would be provided to low-income countries in support of three-year structural adjustment programs. The list of 72 eligible countries would be retained, and consideration would be given to expanding eligibility based on the criteria that had been used to date, namely, per capita income, and taking into account International Development Association (IDA) eligibility. ESAF loan commitments would be made during 1994-96, with disbursements during 1994-99.

At their meeting in September 1993, Directors concentrated on the funding modalities of the enlarged ESAF. Projected lending was seen to be SDR 5 billion and subsidy requirements to be about SDR 2,1 billion on an “as-needed” basis. The projected lending figure did not allow for the potential use by some members with serious and protracted arrears to the Fund.

With regard to the funding mechanism for the loan element of the enlarged ESAF, Directors expressed widespread support for extending and enlarging the ESAF Trust, based on loans from contributors. This would facilitate the use of all resources already committed to the present ESAF Trust, build on the experience already gained under the current Trust, and preserve the special nature of the Trust’s operations in poorer member countries.

Directors considered that the funding of the subsidy element would need to come from donor contributions if the facility was to continue to represent a truly international cooperative effort. Management, recognizing the budgetary constraints facing many potential contributors, proposed that the Fund could provide a subsidy contribution, namely, the uncommitted resources in the Special Disbursement Account (SDA). With such a Fund contribution, remaining subsidies from bilateral contributors would be about SDR 1.5 billion.

On November 29,1993, to ensure the continuity of ESAF operations and to facilitate the process of putting the enlarged and extended ESAF in place, Directors agreed to extend the ESAF loan commitment period until December 31,1993. The commitment period was subsequently extended through February 1994. Directors agreed on the following items, pending review by member governments before formal adoption in December 1993.

First, to the extent feasible, the enlarged and extended ESAF would continue to operate on the basis of the existing provisions of the ESAF Trust and related decisions. Changes in the existing ESAF Trust and related decisions would be introduced mainly to accommodate the extension and enlargement of the ESAF Trust. The limit for borrowing by the ESAF Trust would be increased from SDR 6 billion to SDR 11 billion, and the loan commitment period would be extended to December 31,1996.

Second, Directors agreed that no new commitments from the SAF in conjunction with ESAF arrangements should be made and to transfer up to SDR 400 million from the SDA to the ESAF Trust Subsidy Account. It was noted that after the transfer of resources from the SDA, and the retention in the SDA of resources for existing commitments and possible SAF arrangements for Sierra Leone and Zambia, no other SDA resources would be immediately available, and therefore other SAF arrangements would not be envisaged.

Third, in light of this, Directors noted that a number of provisions of the SAF that were applicable to the ESAF needed to be incorporated in the ESAF Trust instrument, so as to enable the ESAF to operate on a “stand-alone” basis.

Directors agreed to extend eligibility for assistance under the ESAF to include seven additional countries: Armenia, Cameroon, Georgia, the Kyrgyz Republic, Tajikistan, Eritrea (following its membership in the Fund), and the former Yugoslav Republic of Macedonia. Eligibility for the first five countries would take effect when the enlarged ESAF became effective; for Eritrea and the former Yugoslav Republic of Macedonia, decisions would be adopted on a lapse-of-time basis at the appropriate time.

Since the basic operational modalities of the ESAF had worked well, Directors agreed that they should be retained. These were the qualifications for assistance, access policy, conditionally, and program monitoring. Directors stressed that with regard to conditionality, programs supported by the enlarged and extended ESAF would continue to be set in a three-year framework, including a policy framework paper, and would aim at promoting both balance of payments viability and growth.

On December 15, 1993, the Board formally adopted the decisions taken on the enlarged and extended ESAF Trust. The following aspects may be noted.

Fund Facilities and Policies

The facilities and policies through which the Fund provides financial support to its members differ, depending on the nature of the macroeconomic and structural problems they seek to address and the degree of conditionality attached to them.

Regular Facilities

  • Tranche policies. The Fund’s credit under its regular facilities is made available to members in tranches or segments of 25 percent of quota. For first credit tranche purchases, members are required to demonstrate reasonable efforts to overcome their balance of payments difficulties. There are no performance criteria and the total amount is repurchased in 3 ¼to 5 years. Upper credit tranche purchases are normally associated with stand-by arrangements. These typically cover periods of one to two years and focus on macroeconomic policies—such as fiscal, monetary, and exchange rate policies—aimed at overcoming balance of payments difficulties. Performance criteria to assess policy implementation—such as budgetary and credit ceilings, reserve and external debt targets, and avoidance of restrictions on current payments and transfers—are applied during the period of the arrangement and purchases are made in installments. Repurchases are made in 3 ¼ to 5 years.

  • Extended Fund facility. Under this facility, the Fund supports medium-term programs through extended arrangements that generally run for three years (up to four years in exceptional circumstances), and are aimed at overcoming balance of payments difficulties stemming from macro-economic and structural problems. Typically, a program states the general objectives for the three-year period and the policies for the first year; policies for subsequent years are spelled out in program reviews. Performance criteria are applied, and repurchases are made in 4 ½ to 10 years.

Special Facilities

  • Systemic transformation facility. This is a temporary facility created in response to the needs of Russia and the other economies in transition. It provides financial assistance to eligible members experiencing balance of payments needs resulting from severe disruptions in traditional trade and payments arrangements. It was created in April 1993 and is in effect through 1994. Access to the facility is limited to not more than 50 percent of quota and can be in addition to any financing obtained under other Fund facilities.

  • Compensatory and contingency financing facility (CCFF). The purpose of this facility is twofold. The compensatory element provides resources to members to cover shortfalls in export earnings and services receipts and excesses in cereal import costs that are temporary and arise from events beyond their control. The contingency element helps members with Fund arrangements to maintain the momentum of reforms when faced with a broad range of unforeseen, adverse external shocks, such as declines in export prices, increases in import prices, and fluctuations in interest rates. Repurchases are made in 3 ¼ to 5 years.

  • Buffer stock financing facility. Under this facility the Fund provides resources to help finance members’ contributions to approved buffer stocks. Repayments are made within 3 ¼ to 5 years, or earlier.

Emergency Assistance

In addition to balance of payments assistance under its tranche policies and special facilities, the Fund provides emergency assistance in the form of purchases to help members meet balance of payments problems arising from sudden and unforeseeable natural disasters. Such purchases do not involve performance criteria or the phasing of disbursements and must be repurchased in 3 ¼ to 5 years.

Facilities for Low-Income Countries

  • Structural adjustment facility (SAF) arrangements. These enable the Fund to provide resources on concessional terms to support medium-term macro-economic adjustment and structural reforms in low-income countries facing protracted balance of payments problems. The member develops and updates, with the help of the Fund and the World Bank, a medium-term policy framework for a three-year period, which is set out in a policy framework paper. Within this framework, detailed yearly policy programs are formulated and are supported by SAF arrangements, under which annual loan disbursements are made. The programs include quarterly benchmarks to assess performance. The rate of interest on SAF loans is 0.5 percent and repayments are made in 5 ½ to 10 years.

  • Enhanced structural adjustment facility (ESAF) arrangements. The objectives, conditions for eligibility, and program features under these arrangements are similar to those under SAF arrangements. However, ESAF arrangements differ in the scope and strength of structural policies, and in terms of access levels, monitoring procedures, and sources of funding. As mentioned above, there was broad consensus among Directors at an April 1993 meeting that an ESAF-type facility should continue to be available for a further period and that such a successor facility should be introduced in a timely manner to provide continuity after resources available under the current ESAF are fully committed. There was also broad support for a time frame of three years from December 1, 1993 for commitments under the successor facility. Directors also agreed that the basic modalities for the current ESAF had worked well and should be retained. See section on the Enhanced Structural Facility.

  • The decisions provide for a review of access limits and operations of the enlarged ESAF Trust not later than June 30,1995.

  • With respect to a “second round” of commitments to past ESAF users, the decisions preserve the Board’s ability to determine appropriate access and conditionality in individual cases.

  • When a clear commitment is made by the authorities to implement policies that will make the objectives of the program attainable, an extension of the three-year commitment period may be recommended.

Operations under the enlarged ESAF Trust began on February 23,1994, when the Board determined that sufficient contributions to the Loan and Subsidy Accounts had been committed or were in firm prospect. As of that date, the Fund had secured nearly 95 percent of the targeted bilateral subsidy resources and over 90 percent of the targeted loan resources, with discussions continuing with other potential contributors. Directors noted the broad support of the membership: 43 countries had announced their participation, compared with 25 for the original ESAF. Of the 43 countries, about half were developing countries and they accounted for approximately 20 percent of the total bilateral subsidy contributions, compared with 6 developing countries with an 8 percent share under the original ESAF.

The broad support for the enlarged ESAF was a reflection of the membership’s assessment that the ESAF had been an effective and appropriate instrument for the Fund to support its poorer members. Contributing to the ESAF Trust was considered an investment in high-quality structural adjustment and the constructive framework of ESAF programs was seen as helping to ensure good use of bilateral assistance. Effective and timely use of available ESAF resources remained a challenge, Directors agreed, and they encouraged eligible countries to adopt and implement ambitious and comprehensive structural adjustment programs deserving of ESAF assistance.

Social Safety Nets During Economic Reform

Through its technical and financial assistance, the Fund has continued to help member countries address concerns for the poor and vulnerable groups in carrying out Fund-supported economic reform programs. Recognizing the importance of this issue, in June 1993, the Board considered a staff paper that discussed social safety nets in the context of economic reform. Moreover, in adopting a decision on the enlarged and extended ESAF facility, the Board emphasized the need to mitigate the adverse effects of program measures on the poor.

The Fund’s Role in Social Safety Nets

In considering the issue of social safety nets, the Board stressed that promoting sound macro-economic policies and economic reforms are the best way for the Fund to make its contribution to a country in achieving sustained economic growth and reducing poverty. At the same time, the Board reaffirmed its recognition that some policy measures may have important distributional implications, that such distributional effects can undermine public support for the reforms, and that the design of Fund-supported reform programs should evaluate and seek to mitigate the short-term adverse effects of policy measures on vulnerable groups.

While suggesting caution about the implications of increasing Fund involvement in social safety nets, the Board generally took the view that Fund staff, in discussions with program countries, should continue to analyze the implications of reform measures for vulnerable groups and to advise the authorities on how to integrate social safety nets and their financing into the programs. This work should be carried out by Fund staff, drawing on the resources of the World Bank whenever possible and of other institutions when available.

However, a number of Directors believed that the Fund should be extremely cautious in extending its involvement in areas that were not central to its fundamental tasks and that the World Bank should take the leading role in poverty alleviation and other structural policies. All Directors agreed that Fund staff should strengthen collaboration with the World Bank and avoid any overlap or conflict in advice offered in the area of social safety nets. Directors also believed that the staff should continue to refine analytical techniques to strengthen its advice, including through ex-post evaluations. They stressed the importance of discussing social safety nets and their financing in program documents.

Policy Advice on Social Safety Nets

To the extent feasible, Fund-supported reform programs have sought an appropriate mix and phasing of economic policies to reduce the adverse effects of reform measures on the poor. For example, programs have attempted to avoid, at least in the short-run, large tax increases on basic food items. Limited subsidies on essential goods have been retained in some instances. Despite these efforts, there are still likely to be some adverse effects on prices and employment for the poor. In the context of Fund-supported programs, these effects have been addressed with the help of social safety nets, which have comprised permanent social protection measures, adapted for the transition, and temporary instruments put in place specifically for this purpose.

Policy Advice in Fund Supported Programs

Reform programs have assigned a high priority to reducing unproductive expenditures, through such steps as a gradual phasing out or elimination of generalized subsidies on food, fertilizers, and energy (e.g., in Algeria, Ethiopia, and the economies in transition). Such generalized subsidies are both inefficient and inequitable: they are inefficient because the resulting distortion in relative prices leads to inappropriate production decisions; and they are inadequate in achieving equity objectives because they benefit high-income households more than poor ones. From the safety-net perspective, a gradual phasing out of subsidies allows consumers time to adjust. Limited subsidies for selected food items and medicines have been retained in some programs (e.g., in the CFA franc zone countries). In some instances, generalized subsidies have been replaced by specific subsidies on items that are normally consumed by low-income households (such as low-grade maize in Zambia). Targeted subsidies have also been provided through cash compensation to certain population groups, like pensioners, the unemployed, and children, in lieu of a subsidy benefit accruing to recipients (such as those for bread in Kazakhstan and the Kyrgyz Republic). Cash compensation was also given when the impact on low-income households of a price change—for instance, stemming from an exchange rate depreciation—was considered significant in the initial months of the adjustment program. An example would be compensation in Romania for heating. A reduction in import taxes on food items and an adjustment of minimum wages was used to counter the initial impact of devaluation, as in the CFA franc zone countries.

In addition to targeted subsidies, social safety net measures have focused on cash benefits provided through existing social security arrangements. In some instances, benefits extended by formal social security arrangements had to be restructured to ensure social adequacy and fiscal sustainability.

The adverse employment effects of reform have been dealt with in different ways, depending on the availability of instruments and the administrative capacity of the country. For those losing jobs in the government sector, severance payments have been given and their cost integrated in the budget, as was the case in Barbados, the Republic of Congo, the Lao People’s Democratic Republic, and Sri Lanka. In another instance, Romania, a list of contingency measures was prepared to meet the cost of providing unemployment compensation to a larger number of unemployed. Social safety nets have also included labor-intensive public works to create job opportunities for the poor and special retraining programs aimed at retrenched public workers, as in Barbados. Such programs have been particularly effective in targeting benefits to the poor or unemployed, as in Bangladesh and India, as they have offered low wages and required workers to tie their time to receive benefits.

Technical Assistance in Social Safety Nets

Technical assistance in social safety nets has usually been provided in connection with Fund-supported adjustment programs. The focus of this assistance has been on advising member governments on the assessment of the macroeconomic and budgetary implications of the various social safety net options so that efficient and cost-effective social safety nets could be integrated into programs.

Technical assistance has been provided in several transition economies experiencing large changes in prices and employment (such as Kazakhstan, Moldova, and the Russian Federation) both to make subsidies more targeted and to restructure pensions, unemployment compensation, and other social benefits. In another transition economy, the Lao People’s Democratic Republic, the objective was to provide an adequate safety net for the retrenched civil servants and other workers who had lost jobs as a result of privatization of state enterprises. The underlying rationale has been to provide social protection to those most affected during the reform period while ensuring fiscal sustainability. Assistance was also provided to countries seeking to mitigate the immediate adverse effects of an adjustment program—in particular, devaluation, as in Algeria and Romania. In response to a request, the Fund also provided technical assistance on improving Peru’s public expenditure management, particularly of those programs aimed at reducing poverty.

Financing Flows and Debt

Progress in resolving debt-related difficulties has continued to be made by a number of countries in the past year. Sixteen countries, representing about 80 percent of the bank debt of developing countries that rescheduled in the 1980s, restructured their bank debt. Fourteen also concluded debt renegotiations with Paris Club creditors. In its September 1993 meeting to review the progress made under the debt strategy and the experience with financial flows to developing countries, the Board welcomed this progress and agreed that it confirmed the overall effectiveness of the debt strategy.

The resurgence of private spontaneous financing flows to a group of economically successful developing countries had continued, and a number of countries that had suffered from debt difficulties had regained market access. Despite this progress, the Board found that the experience across countries had been uneven, which underlined the need for sound economic policies and structural reforms that would reduce the risks attached to foreign investor involvement and increase market transparency and efficiency.

Many countries continued to face very difficult debt situations that required close attention from the international community and the debtor countries themselves. For these countries, particularly the poorest, the prospects of attracting private financing on appropriate terms still seemed remote. Inevitably, their reliance on official funding from bilateral and multilateral sources will remain heavy. A decisive improvement in their prospects would require strong adjustment programs supported by substantial debt-reduction operations and increased financing on concessional terms.

Directors observed that, with respect to commercial bank debt, debt restructurings in the context of strong policy implementation had helped a number of middle-income countries normalize relations with creditors and regain access to spontaneous forms of new financing. They emphasized, however, that countries that had still to negotiate debt packages faced particularly difficult external situations. For those countries, finding a lasting solution to their debt problems would require some adaptation of the instruments used in debt and debt-service-reduction operations, within the overall framework of market-related restructuring.

To facilitate this process, the majority of Directors favored the elimination of the segmentation provisions in the guidelines covering Fund support for debt packages (see Box 10 on Modification of Guidelines on Debt and Debt Service). When applying this new flexibility, the Board would ensure that an appropriate balance between debt-reduction and debt-service-reduction operations be achieved.

As for the official debt of low-income countries, Directors noted that, with the adoption of the menu of enhanced concessions for low-income developing countries, Paris Club creditors had established a framework that provided these countries with the prospect of graduation from the rescheduling process, provided that they could sustain strong policy performance. Directors considered that the phased approach to the stock of debt reduction currently followed by these creditors, if implemented with sufficient flexibility, should be adequate to deal decisively with the situations of most of the low-income countries. For some countries, even with ambitious and sustained adjustment programs, many Directors considered that substantially deeper debt reduction would be required to reduce debt payment to manageable levels.

Directors felt that early exit restructurings for countries that have made significant progress under Fund-supported programs could help alleviate concerns about the countries’ prospects and foster an environment conducive to sustained growth.

Modification of Guidelines on Debt and Debt Service

In January 1994, the Board agreed to modify the guidelines on the Fund’s involvement in the debt strategy that had been established in May 1989 (Annual Report, 1989. pp. 25-26). To facilitate commercial bank debt restructuring for some countries with difficult debt situations, the Board decided to eliminate the previous segmentation requirements.

Under these requirements, the proportions of Fund resources committed under a stand-by or an extended arrangement that were set aside could be used only to support operations involving principal reduction, such as cash buy-backs and discount exchange, while additional resources provided through augmentation could be used only for interest support for debt or debt-service reduction and for col-lateralization of principal in reduced-interest bond exchanges. The elimination of segmentation makes it possible to use both set-asides and additional resources from augmentation to support operations involving debt reduction, interest support for debt and debt-service reduction, and principal collateral for reduced interest par bonds, provided that such operations satisfy the Fund’s criteria.

Decisions by the Fund to support particular debt- and debt-service-reduction packages would continue to be made on a case-by-case basis. The Board would evaluate any proposed package in light of the following criteria as set out in the May 1989 guidelines:

  • the strength of the member’s economic policies;

  • the likelihood that the package would help the country regain access to credit markets and attain external viability with growth; and

  • an assessment that the package represents an efficient use of scarce resources.

In evaluating a proposed package, the Board would take into account the appropriate balance between debt and debt-service reduction by considering a number of elements, including the following:

  • whether the resulting debt-service profile on restructured debt is consistent with a country’s likely medium-term debt-service capacity;

  • whether the package, taken as a whole, is cost effective;

  • whether the package would imply continued commercial bank involvement with the debtor country, where such involvement would be appropriate and can be expected to provide the basis for subsequent return to spontaneous financing; and

  • whether the menu of options included in the package provides a sufficiently broad range of alternatives to ensure a high rate of participation in the package.

As before, a member and its banks would be able to allocate the options in a package between debt and debt-service reduction so as to tailor them to the needs of each case. If Fund support for debt operations was likely to be requested, set-asides would generally be expected to be included in an arrangement.

Directors agreed that exit restructurings should be implemented in such a way so as to not jeopardize direct financial assistance to these countries. For the few lower middle-income countries heavily indebted to official bilateral creditors, a number of Directors noted that resolving these countries’ problems was likely to require concessional treatment of their debt in the context of strong adjustment programs.

With regard to the Fund’s policy on financing assurances, Directors recognized that in the presence of ongoing discussions on bank debt restructuring, the Fund had to balance the need to maintain incentives for agreements to be completed on a timely basis with a recognition that negotiations take time. Reaffirming the May 1989 guidelines in this respect. Directors agreed that the Fund should generally continue to give countries the benefit of the doubt in assessing progress in debt negotiations with bank creditors, provided that a cooperative negotiating framework was sustained. In those cases where progress had been limited over a prolonged period, the Fund could delay the financing assurance review until it was satisfied that the country had made its best efforts to move toward a satisfactory conclusion.

Directors observed that the recent shortfalls in official financing for countries with Fund-supported programs, including those in the early stages of systemic transformation, also raised issues for financing assurances policy. In cases of systemic transformation, the importance of prompt Fund support for policy reforms and the difficulty of arriving at precise estimates of external financing justified some flexibility for the Fund to proceed on the basis of broad indications of support from creditors and donors. Directors stressed that this did not preclude the need for programs to be based on realistic expectations and for authorities to be prepared to take appropriate steps in the face of financing shortfalls. It was thought that earlier and closer coordination between recipients and creditors, as well as improved information flows, would be helpful. Nevertheless, most Directors emphasized that, outside the special and temporary circumstances associated with the early stages of systemic transformation, satisfactory assurances of the adequacy of new financing over the program period should be firmly in place before use of Fund resources would be approved.

Finally, Directors stressed that as progress continued in resolving debt problems the basic presumption underlying orderly international relations should be reaffirmed, namely, that financial contracts should be honored. The normalization of relations with all creditors, including nonguaranteed suppliers and non-Paris Club official bilateral creditors, also should not be forgotten. To encourage this progress with creditors, Directors decided that an assessment of such progress would be made where relevant as an element of financing assurance reviews and that Fund-supported programs would include sufficient allowance for resources to be used in connection with the normalization of relations with these creditors.

In the meeting on the World Economic Outlook in April 1994, the Board recognized the daunting challenges facing low-growth countries and stressed that sustained adjustment efforts would be required for several years. The success of these domestic policy efforts would also depend on the timeliness of external financial assistance and the realism of debt relief efforts, especially for low-income countries. Although Directors generally welcomed the development that private capital flows now accounted for a major proportion of financial flows to developing countries, they emphasized the importance of sound macroeconomic policies to ensure that the capital flows were invested efficiently and to limit the risk of sudden changes in sentiment.

Technical Assistance and Training

Since the inception of the Fund, the provision of technical assistance and training has been an important aspect of its relations with members. At the heart of the Fund’s technical assistance and training efforts is the Fund’s experience in helping member countries formulate and implement sound financial and economic policies. The scope of technical assistance and training has broadened over the years to take into account the evolving needs of member countries. The purpose and scope of the Fund’s technical assistance was reviewed by the Board in February 1994.

Technical assistance activity has expanded rapidly in recent years and is playing an increasingly important role in the Fund’s dialogue with its member countries. The need for the Fund to respond to the problems facing countries undergoing systemic transformation and structural adjustment has created new challenges for the technical assistance program and has had a profound impact on its size, structure, funding, and management. This activity has also acquired a further dimension: it has begun to complement and underpin macro-economic and structural adjustment efforts, whether or not supported by Fund programs. The timely provision of technical assistance has been recognized as greatly assisting a country in the detailed design of key policy and institutional reforms in the monetary, fiscal, and statistical areas and in the sustained implementation of those reforms. In August 1992, a Technical Assistance Secretariat was set up in the Fund to advise management on all aspects of technical assistance and to provide a focal point for the coordination of technical assistance both within the Fund and with other international agencies.

Review of Technical Assistance

At a review of technical assistance in February 1994—the first since 1989—Directors unanimously recognized its critical importance as well as the need to reconcile the growing demand for this activity with diminishing resource availability. They agreed that no lessening of demand is to be expected in the next few years, either from countries in transition or from those developing countries that are the traditional main recipients. Efforts to prioritize requests for such assistance are therefore particularly important, and Directors supported the principle that technical assistance should continue to focus on areas in which the Fund has a comparative advantage—central banking, exchange markets, fiscal affairs, and statistics. The Fund should not hesitate to take the lead in these areas, when requested to do so.

Although it was often difficult to measure and appraise the effectiveness of technical assistance, several Directors noted that the main determinant of effectiveness is a country’s commitment to adjustment and reform. This commitment should extend to systemic or structural changes in those areas to which technical assistance is directed. Directors emphasized the importance of adequate staff involvement in member countries that are committed to reform, even when the country does not have a program with the Fund: technical assistance can stimulate the reform process and strengthen a country’s commitment to the goals of adjustment and reform.

Directors stressed the importance of sustained follow-up assistance to help governments implement the advice of technical assistance missions. Sufficient resources should also be devoted to comprehensive technical assistance assessments, which could take place during Article IV consultation discussions or during periodic country-level reviews of technical assistance programs.

In assessing the criteria for prioritizing requests for technical assistance, some Directors stressed the need to take into account a recipient’s past track record in making effective use of technical assistance, while others cautioned that past performance was not necessarily a useful guide for the future, particularly in a rapidly changing macroeconomic environment. In this respect, broad support was expressed for paying close attention to the linkages between the provision of technical assistance and the Fund’s support of adjustment programs through its various facilities. Several Directors, however, noted the importance of ensuring that technical assistance not become part of conditionality.

Directors supported the efforts being made to achieve better coordination of technical assistance with other donors and, in particular, called for improved coordination with the World Bank to avoid duplication and to maximize “institutional synergy.”

Views diverged on the impact of the demand for technical assistance on the Fund’s budget in this period of budget consolidation. Directors supported attempts to mobilize additional resources and expressed universal appreciation of the financial contributions by Japan and the United Nations Development Program (UNDP), which in 1993 had amounted to $5.1 million and $6.9 million, respectively, as well as for efforts to encourage potential donors for help in this area.

A number of Directors observed that technical assistance is perceived by recipients as a “free good” and favored introducing charges for technical assistance services, but as yet there was no clear consensus on the practicalities of achieving this. The difficulty of achieving equity was emphasized. If charges were introduced, they could be applied only to those countries that were better able to pay, since it was considered that further burdening of low-income members should be avoided. Some support was expressed for requesting countries to bear part of the local costs, even if this were only in the form of “in kind” contributions.

The increased membership of the Fund and the enormous demand for training in new member countries, as well as the fast pace of reforms in a growing number of other countries, have led to an acceleration of efforts to provide technical assistance and training either directly or in conjunction with other agencies or regional and national authorities. In addition, the Fund has acted as a catalyst for the provision of such assistance by other donors, by lending its expertise to programs financed by others or by setting up cofinancing arrangements.

The transformation of many economies from centrally planned to market-oriented economic systems has demanded training and technical assistance to meet not only short-term needs but also longer-term education of younger officials through scholarship programs. The Fund has assisted national authorities in setting up regional and national training facilities and provided advice and lecturing assistance in such ventures. It collaborates with regional and other multilateral agencies in the provision of technical assistance. In addition, the Fund helps member countries to set up an institutional base for providing training locally.

The Joint Vienna Institute (JVI), a cooperative venture of the Fund and several other international institutions to train officials and private sector managers from former centrally planned economies of Europe and Asia, symbolizes the Fund’s recent approach to technical assistance and training. The Fund’s IMF Institute is also working with central banks of Eastern and Southern Africa to examine the possibility of setting up a training institute in that region.

In the following sections, technical assistance and training provided by individual departments are described briefly. Further details appear in Appendix III.

Fiscal Affairs Department

The provision of technical assistance by the Fiscal Affairs Department increased significantly during 1993/94. As in the previous year, the increase was largely accounted for by further expansion in assistance to the Baltic countries, Russia, and other countries of the former Soviet Union. But the department also remained heavily involved in providing technical assistance to the countries of Africa and Asia. In 1993/94,119 countries were provided with assistance. The department undertook 295 missions providing advice and other forms of technical assistance, including ten missions to provide external training mainly to government officials from Central and Eastern Europe, the Baltic countries, Russia, and other countries of the former Soviet Union. The department also assigned long-term experts primarily in the areas of tax administration and budget. Technical assistance activity, in terms of person-years, was 9 percent higher than in the previous year. Externally financed assignments, principally by the UNDP and the Japan Administered Account, also increased, accounting for 49 percent of total funding for panel experts on short- and long-term assignments.

The department’s technical assistance activities were principally concentrated in the areas of tax policy, tax and customs administration, treasury systems, budgetary accounting, public expenditure management, social safety nets, and social security (see section on Social Safety Nets During Economic Reform, above). Institution-building projects, particularly the development of computerized systems for tax administration and treasury operations, have been an especially crucial aspect. The department met requests for such assistance from a wide spectrum of members, including many from countries in transition to a market-based economy. The department has increased its effort to integrate its technical assistance activities with area departments to ensure that technical assistance complements the goals of Fund programs. It has also worked with other agencies and bilateral donors to improve the coordination of technical assistance being provided to countries in transition.

IMF institute

The IMF Institute trains officials from member countries through residential courses at its headquarters and at the Joint Vienna Institute; shorter overseas courses and seminars; lecturing assistance for other training institutions; scholarship programs for younger officials: and briefings for visiting officials in Washington. It works closely with area departments in identifying countries in need of training programs and in selecting candidates for such programs. In addition, the Institute helps organize and administer training courses or seminars offered by the Monetary and Exchange Affairs, Fiscal, Legal, and Statistics Departments.

During 1993/94, the Institute provided training to some 1,035 persons through its courses and seminars at headquarters and the Joint Vienna Institute. This training was complemented by 28 external training courses and 7 seminars for senior officials, largely financed by the UNDP, the EU, and the Government of Portugal, and lecturing assistance for 6 other training institutions covering some 1,100 participants. A scholarship program provided young officials an opportunity to study at universities in Japan and Australia (see Appendix III for details).

In 1993/94. there was continued emphasis on training officials from economies in transition. Eleven courses and two seminars were organized within Central and Eastern Europe, the Baltic countries, Russia, and other countries of the former Soviet Union. Seminars for senior officials, as well as shorter courses on financial analysis and programming, usually at the regional level, continued to be offered in the rest of the world, mainly for countries that either had Fund-supported programs or were in the process of preparing such programs-reflecting the Institute’s emphasis on working closely with area departments and on ensuring that its training efforts are tied into the operational work of the Fund.

The Institute offered its longer technical courses and policy-oriented courses in Washington but expanded its menu of overseas training, particularly regional courses. Such overseas training is often shorter and more specific, and often serves as a precursor for later training at the JVI or in Washington. Longer-term investment in the education of officials is being made by the Japan-IMF Scholarship Program for Asia, enhanced by an introductory course in Beijing for Asian economies in transition, to prepare candidates for both the Scholarship Program and for the comprehensive (five-month) JVI courses. Both the Scholarship Program and the introductory course are financed by the Japanese authorities. Cofinancing arrangements have also been set up with the EU to provide training in Africa, the Caribbean, and the Pacific region, and with the Arab Monetary Fund for regional seminars.

Legal Department

During 1993/94, the Legal Department provided technical assistance in the areas of central banking, commercial banking, foreign exchange, fiscal affairs, bankruptcy, and foreign investment law. This assistance included drafting legislation, commenting on draft legislation prepared by authorities of members, drafting implementing regulations, and providing other legal advice in these areas of the law. Much of this assistance was to members with economies in transition from central planning that are seeking advice to establish an appropriate legal framework for a sound fiscal structure, modern financial sector institutions, and market-oriented financial transactions. During the financial year, the department participated in 42 missions to a total of 26 member countries.

Monetary and Exchange Affairs Department

During 1993/94, the Monetary and Exchange Affairs Department maintained an active technical assistance program of missions, seminars and workshops, and expert assignments, while increasing its role in the coordination of technical assistance with other organizations. Major areas of technical assistance advice included new currency issue and reform, foreign exchange management and operations, central bank organization and management, central bank accounting, clearing and settlement systems for payments, monetary operations and money market development, monetary analysis and research, and banking regulation and supervision.

The department continued to provide assistance to African, Asian, and Latin American countries, and maintained a comprehensive technical assistance effort in Central and Eastern Europe, the Baltic countries, Russia, and other countries of the former Soviet Union, devoting around half of its missions and expert assignments to these countries with the support of 23 cooperating central banks.

In addition, the department undertook 114 advisory missions, 467 short-term expert assignments, and 15 technical assistance workshops, of which 12 were delivered to participants from the Baltic countries, Russia, and other countries of the former Soviet Union. The program of subject-specific technical assistance workshops, begun in the previous year, was expanded, and proved to be highly successful in improving the effectiveness of technical assistance in this region. The combination of technical assistance and skill development in the interactive learning environment of the workshop provided increased opportunities for the cross-fertilization of ideas and strategies, facilitating the subsequent implementation of reforms.

Activities relating to the coordination of technical assistance with cooperating central banks and other multilateral and bilateral institutions increased sharply in the second half of 1993/94. The department has assumed a major coordination role in the reforms of the Russian payment system, involving the mobilization and supervision of a large volume of parallel assistance from other institutions.

In 1993/94, measures to integrate the analysis, review, and jurisdiction functions of the department with technical assistance were intensified. The department coordinated efforts to ensure members’ compliance with the Fund’s jurisdiction over exchange systems and, in collaboration with other departments, advised on technical aspects of these systems and on issues of transition to Article VIII status and full convertibility. Among the new activities of 1993/94 was the department’s formal involvement in the Fund’s review process. During the year, the department reviewed all country reports and briefings on Article IV consultations and the use of Fund resources from the perspective of the structural and institutional aspects of monetary and exchange policy; operational research on these aspects was also increased. External financing for the department’s technical assistance is provided by UNDP and the Japan Administered Account.

Statistics Department

The needs of the countries in transition continued to have a significant impact on the scope and composition of the technical assistance program of the Statistics Department. As in 1992/93, the countries of the former Soviet Union and Central and Eastern Europe absorbed a substantial proportion of the resources devoted to technical assistance in 1993/94. The Statistics Department mounted 152 technical assistance missions, including multitopic missions, in 1993/94, with the largest share—68 percent—directed to Central and Eastern European countries, the Baltic countries, Russia, and other countries of the former Soviet Union. Missions to this group of countries involved nearly two thirds of total staff and headquarters-based consultant trips during the year and about 70 percent of the trips undertaken by short-term experts on behalf of the department. However, the Statistics Department continued its strong commitment to other regions, fielding 49 missions involving 106 trips to these regions. Technical assistance was also provided through participation of staff of the Statistics Department in 18 missions of other departments, 6 of which were to Russia and other countries of the former Soviet Union.

A new dimension in the provision of technical assistance to the Baltic countries, Russia, and the other countries of the former Soviet Union in 1993/94 was the placement of long-term multitopic statistical advisors in some countries to work closely with statistical agencies in a number of areas. Two advisors for Russia and the Baltic countries were appointed in late 1993 and one for the Ukraine in March 1994.

The work of the Steering Committee on the Coordination of Technical Assistance in Statistics to the Baltic countries, Russia, and other countries of the former Soviet Union continued in 1993/94. Meetings of the Steering Committee were held in June and October 1993. The Fund continued to provide technical support to the Committee and acted as focal point agency for balance of payments, monetary accounts, government finance, and consumer price statistics. The Steering Committee’s data base, developed by the Fund as a subsidiary to the OECD Register, became operational in 1993/94. The data base provides interactive access to technical assistance activities in statistics, either completed or planned, by the members of the Committee, other international organizations, and bilateral agencies, thereby facilitating technical assistance planning and avoiding duplication of effort. During 1993/94, the Steering Committee continued its efforts to improve coordination, to establish priorities for statistical development in the Baltic countries, Russia, and other countries of the former Soviet Union in the near and longer term, and to identify new modalities for advancing dialogue and implementing recommendations in the future. The Chairman of the Committee has also consulted bilateral providers of technical assistance to keep them abreast of the Committee’s activities.

Treasurer’s Department

The Treasurer’s Department provides technical assistance to members on the establishment and maintenance of the Fund accounts, the Fund’s financial organization and operations, and on matters related to transactions by members with the Fund. Such technical assistance has increased considerably in recent years, primarily reflecting the needs of the new members of the Fund. Treasurer’s Department staff participated in seven technical assistance missions in 1993/94, including a seminar at the Joint Vienna Institute on accounting for Fund transactions for officials of the Baltic countries, Russia and other countries of the former Soviet Union. Staff also prepared several aide-memoire on accounting matters for new members.

Fund Financial Operations and Policies

The pace of the Fund’s financial operations continued at a high level in 1993/94. Membership in the Fund reached 178 countries, and 3 other countries were in the process of completing membership formalities. Payments of quota increases under the Ninth General Review of Quotas were completed by 170 member countries and with the payment of an ad hoc quota increase by one member, total Fund quotas at the end of the financial year amounted to SDR 144.9 billion. In April 1993, the Board of Governors resolved to continue the Tenth General Review of Quotas and asked the Executive Board to submit its proposals by December 31,1994.

The Fund’s liquidity position strengthened in 1993/94. At the end of the financial year, the Fund’s usable resources amounted to SDR 54.3 billion, compared with SDR 52.2 billion a year earlier. In 1993/94. purchases (drawings) from the Fund’s General Resources Account reached SDR 5.2 billion, and repurchases (repayments) amounted to SDR 4.3 billion. The largest purchases were made by Russia (SDR 2.2 billion), Argentina and South Africa (SDR 0.6 billion each), Poland (SDR 0.4 billion), and India (SDR 0.2 billion). Cumulative commitments for arrangements under the SAF and the ESAF amounted to SDR 5.8 billion at the end of the financial year, compared with SDR 4.6 billion a year earlier. In December 1993. the Board approved the enlargement and extension of the ESAF, and operations under the enlarged ESAF Trust began in February 1994. In 1993/94, total Fund credit outstanding under all facilities rose by SDR 1.4 billion.

The Fund adopted a single unified rate of charge for all outstanding use of Fund credit in the General Resources Account and made permanent the procedure of setting the basic rate of charge as a proportion of the weekly SDR interest rate. In 1993/94, the Fund’s net income before the net effect of accounting changes amounted to SDR 87 million. Several longstanding cases of arrears to the Fund were resolved during the financial year, and the level of outstanding overdue obligations fell to SDR 2.9 billion, with five members remaining ineligible to use Fund resources. In 1993/94. the total amount of SDR transfers fell to SDR 10.9 billion, and transfers among participants and prescribed holders also declined to SDR 4.1 billion. During the financial year, SDRs were used extensively in bridging operations to clear members’ overdue obligations.

Membership and Quotas

The Fund’s membership increased to 178 countries in 1993/94, when Micronesia became a member on June 24, 1993, A resolution of membership for Eritrea was adopted by the Board of Governors effective April 11,1994, and on July 6, 1994 Eritrea joined the Fund. Two countries of the former Socialist Federal Republic of Yugoslavia—the Federal Republic of Yugoslavia (Serbia and Montenegro) and the Republic of Bosnia and Herzegovina—have not yet completed arrangements for succession to membership in the Fund. When these two countries become members, the Fund will have 181 members.

Ninth General Review of Quotas

On June 28,1990, the Board of Governors proposed a 50 percent increase in the total of Fund quotas under the Ninth General Review of Quotas. These quota increases began to come into effect in November 1992. Increases in quotas were proposed for all member countries, including those that joined the Fund after June 28, 1990, except for Cambodia, which had not participated in any of the past three general quota reviews. However, following settlement of its arrears and normalization of its relations with the Fund, Cambodia in November 1993 requested an ad hoc increase in its quota, and the Board of Governors approved an increase from SDR 25 million to SDR 65 million on March 28, 1994.

Payments for quota increases amounted to SDR 250.6 million in 1993/94; SDR 61.1 million of this amount represented payments of the reserve asset portion, all of which was paid in SDRs. By the end of 1993/94, payments of quota increases under the Ninth Review had been completed by 170 members and payment of its ad hoc quota increase had been made by Cambodia, bringing the total amount of Fund quotas to SDR 144.9 billion. At the end of April 1994, seven members had overdue obligations to the General Resources Account and therefore could not consent to their quota increases.

Members were required to pay 25 percent of their Ninth Review quota increases in SDRs, in other members’ currencies as specified by the Fund and with the agreement of the respective issuers, or in a combination of both. The balance of the increases was payable in the members’ own currencies. For those members with inadequate SDR holdings or foreign currency reserves to pay their quota increases, borrowing of SDRs from other members with large SDR holdings was facilitated by the Fund. These loans for the purpose of payment of quota increases were repaid on the same day using the proceeds of the purchase of the reserve tranche position created by the quota increase payment. No interest, fee, or commission was charged for the use of this borrowing mechanism by either the Fund or the lenders.

Tenth General Review of Quotas

In accordance with Article III, Section 2(a) of the Fund’s Articles of Agreement, the Board of Governors was required to conduct the Tenth General Review of Quotas not later than March 31, 1993. A Committee of the Whole was established by the Executive Board for this purpose—as required by Rule D-3 of the Fund’s Rules and Regulations—on March 31, 1992. In April 1993, the Board of Governors resolved to continue the Tenth Review and requested the Executive Board to complete its work and submit a report to the Board of Governors, together with appropriate proposals, not later than December31, 1994.

In its Report to the Board of Governors at the conclusion of the Ninth General Review of Quotas in June 1990, the Executive Board noted that it would “further examine the working of the quota formulas in the context of the preparatory work for the next review of quotas, so as to ensure that they would take adequate account of all relevant developments bearing on members’ quotas.” The Committee of the Whole for the Tenth Review met on March 18, 1994 to discuss the quota formulas. Most Directors commented on the long-term downward trend in the share of the non-oil developing countries as a group in the total of formula-based calculated quotas. There was broad support for the principle that the quota formulas should reflect the different economic characteristics of members, and that the dual structure of the quota formulas introduced in the 1960s should be maintained by retaining a Bretton Woods-type formula, which gives a relatively large weight to GDP, along with a formula or formulas that give greater weight to external trade and to the variability of external receipts, which are more prominent in the economies of many developing countries. Many Directors felt that the present quota formulas work reasonably well. Further technical work in connection with the quota formulas is envisaged.

Fund Liquidity, Borrowing, and Members’ Access

The Fund’s liquidity position continued to strengthen in 1993/94, following the major improvement that occurred in the previous year with the payment of the bulk of the quota increases under the Ninth General Review of Quotas. At the end of 1993/94, liquidity was at historically high levels.

Operational Budget

In accordance with principles set out in the Fund’s Articles of Agreement, the Fund’s financial assistance is provided through the use of its own SDRs and the currencies of members whose external positions are considered sufficiently strong for their currencies to be included in the operational budget. These currencies are transferred by the Fund to other members experiencing balance of payments difficulties. The issuers of these currencies are obliged to convert them into one of the five freely usable currencies, if so requested by the member using Fund resources.

The guidelines governing the use of currencies and SDRs are set by the Board and implemented through quarterly operational budgets. The present guidelines take into account members’ gross holdings of gold and foreign exchange reserves and their reserve tranche positions. They also incorporate a floor so that the use of a member’s currency will not be carried beyond the point where the Fund’s holdings of that currency are equal to two thirds of the average level of its holdings of other members’ currencies included in the budget, expressed as a percentage of quota. The Board reviews the guidelines underlying the operational budget from time to time. At the last review (February 1993), it was decided to continue to apply the present guidelines until February 1995.

The liquid resources of the Fund consist of usable currencies and SDRs held in the General Resources Account. Usable currencies, the largest component of liquid resources, are the currencies of members whose balance of payments and reserve positions are considered sufficiently strong to warrant the inclusion of their currencies in the operational budget for use in the financing of Fund operations and transactions (see Box 11). At the end of April 1994, the Fund’s liquid resources amounted to SDR 68.7 billion, compared with SDR 68.0 billion a year earlier, primarily reflecting the inclusion of three currencies in the operational budget.

In assessing the adequacy of the Fund’s liquidity, the stock of usable currencies is adjusted downward to take into account the staff’s assessment of the need to maintain working balances of currencies and the possibility that the currencies of some members in relatively weak external positions could become unusable in financing Fund operations and transactions. Undrawn balances of commitments of resources are also taken into account in assessing the Fund’s liquidity. After these adjustments were made, as of April 30,1994, the Fund’s adjusted and uncommitted usable resources totaled SDR 54.3 billion, compared with SDR 52.2 billion a year earlier.

The Fund’s liquid liabilities decreased from SDR 33.7 billion as of the end of April 1993 to SDR 32.4 billion as of the end of April 1994, representing a decline in reserve tranche positions from SDR 30.3 billion to SDR 29.3 billion, and a fall in outstanding Fund borrowing from SDR 3.4 billion to SDR 3.1 billion. The ratio of the Fund’s adjusted and uncommitted usable resources to its liquid liabilities—the liquidity ratio—increased from 154.9 percent to 167.6 percent over the same period. (The evolution of the liquidity ratio since calendar year 1978 is shown in Chart 6.) Thus, since the quota increases under the Ninth General Review of Quotas, the Fund’s liquidity position has continued to strengthen. The Fund is at present in a position to meet the projected substantial demands on its resources over the next few years, while holding adequate liquidity as cover against any encashment of liquid liabilities.

Chart 6
Chart 6

The Fund’s Liquidity Ratio, 1978-93

(In percent; end of period)

The Fund does not have a need for borrowing at present, and there are no unused lines of credit. However, the Fund can borrow under the General Arrangements to Borrow (GAB) (up to SDR 17.0 billion) and under an agreement with the Saudi Arabian Monetary Agency in association with the GAB (SDR 1.5 billion) when supplementary resources are needed to forestall or to cope with an impairment of the international monetary system.

The Fund’s policy on access and access limits to its resources was last reviewed in October 1993, at which time the access limits were left unchanged at the levels agreed in November 1992 in connection with the quota increases under the Ninth General Review. The access limits are temporary in nature and will be reviewed annually in the light of all relevant factors, including the magnitude of members’ payments problems and developments in the Fund’s liquidity.

Financial Transactions and Operations

During 1993/94, members’ purchases from the General Resources Account, excluding reserve tranche purchases, 7 amounted to SDR 5.2 billion, about the same level as in 1992/9: (Table 35 and Appendix Table II.8). A decrease in purchases under stand-by and extended arrangements was offset by a significant rise in purchases under the CCFF and STF. Of the total, SDR 1.1 billion was purchased under stand-by arrangements (compared with SDR 2.8 billion in 1992/93), SDR 0.7 billion under extended arrangements (SDR 2.3 billion in 1992/93). SDR 0.7 billion under the CCFF (SDR 0.1 billion in 1992/93), and SDR 2.7 billion under the STF.

Table 35

Selected Financial Indicators

(In millions of SDRs)

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Excluding reserve tranche purchases

Excludes gold tranche repurchase of SDR 5 million.

Includes Saudi Fund for Development associated loans of SDR 20 million.

Table II.8

Purchases from the Fund, Financial Year Ended April 30, 1994

(In millions of SDRs)

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The largest amounts were purchased by Russia (SDR 2.2 billion), Argentina and South Africa (SDR 0.6 billion each), Poland (SDR 0.4 billion), and India (SDR 0.2 billion). Purchases by countries of the former Soviet Union and Central and Eastern European countries amounted to SDR 3.2 billion, while African countries purchased SDR 0.8 billion, Asian and Middle Eastern countries SDR 0.4 billion, and countries in the Western Hemisphere SDR 0.7 billion.

Repurchases in the GRA during 1993/94 amounted to SDR 4.3 billion, compared with SDR 4.1 billion in the previous financial year (Appendix Table II.9). The actual level of repurchases in 1993/94 was higher than the scheduled level of SDR 3.5 billion owing to voluntary advance repurchases made by the Czech Republic (SDR 70 million) and India (SDR 805 million), and a repurchase under the early repurchase policy by Mexico (SDR 68 million). Also, as part of the clearance of arrears to the Fund by Cambodia, Sierra Leone, and Viet Nam, overdue repurchases of SDR 11 million, SDR 42 million, and SDR 28 million, respectively, were made. Scheduled repurchases, which peaked in 1987/88 following a significant expansion of Fund credit in the early 1980s, have declined in recent years, reflecting the lower use of Fund credit during the latter part of the 1980s (Chart 7). Given the revolving nature and medium-term maturity of the Fund’s balance of payments assistance, scheduled repurchases will soon begin increasing again as a result of the relatively higher level of purchases in the past few years.

Table II.9

Repurchases from the Fund, Financial Year Ended April 30, 1994

(In millions of SDRs)

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Gold tranche repurchase

lncludes supplementary financing facility repurchase or SDHR 6.45 million.

Chart 7
Chart 7

General Resources: Purchases and Repurchases, Financial Years Ended April 30, 1982-94

(In percent; end of period)

1 Excluding reserve tranche purchases

Taking into account both purchases and repurchases, there was an increase in Fund credit outstanding in the GRA from SDR 24.6 billion as of April 30, 1993 to SDR 25.5 billion as of April 30, 1994. (Details are provided in Appendix Tables II.7 and II.10.) If net disbursements under the SAF and ESAF are also included (see below). Fund credit outstanding under all facilities expanded by SDR 1.4 billion in 1993/94 (Chart 8). Total Fund credit outstanding is expected to continue increasing in the period ahead as a result of the projected strong demand for use of Fund and ESAF Trust resources by members.

Table II.7

Summary of Disbursements, Repurchases, and Repayments, Financial Years Ended April 30, 1948-94

(In millions of SDRs)

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Purchases include reserve tranche purchases.

ESAF loans include SDR 414 million of SAF resources disbursed under ESAF arrangements.

Repurchases exclude sale of currency and adjustments that have the effect of repurchase.

Includes gold tranche repurchase of SDR 5 million

Table II.10

Outstanding Fund Credit by Facility and Policy, at End of Financial Years Ended April 30, 1988-94

(In millions of SDRs)

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Includes outstanding first credit tranche and emergency purchases

Includes outstanding associated loans from the Saudi Fund tor Development.

Chart 8
Chart 8

Total Fund Credit Outstanding to Members (Including Trust Fund, SAF, and ESAF), Financial Years Ended April 30,1982-94

(In percent; end of period)

Stand-By and Extended Arrangements

Eighteen stand-by arrangements totaling SDR 1.4 billion and two extended arrangements totaling SDR 0.8 billion were approved during 1993/94 (Appendix Tables II.1, II.3, and II.4). This compares with 11 stand-by arrangements (SDR 2.0 billion) and three extended arrangements (SDR 1.2 billion) approved in the previous financial year. Eight of the standby arrangements (SDR 0.7 billion) approved in 1993/94 were with countries of the former Soviet Union and Central and Eastern European countries (Bulgaria, Estonia, Hungary, Kazakhstan, the Kyrgyz Republic, Latvia, Lithuania, and Moldova). Six arrangements (SDR 0.2 billion) were with African members of the CFA franc zone (Cameroon, the Central African Republic, Chad, Gabon, Niger, and Senegal) and were concluded following the realignment of the CFA franc in early 1994, and two arrangements (SDR 0.1 billion) were with countries in the Western Hemisphere (the Dominican Republic and El Salvador). Two stand-by arrangements (SDR 0.4 billion) were approved for Asian countries (Pakistan and Viet Nam). The arrangement with Pakistan was subsequently canceled and replaced by an extended arrangement (SDR 0.4 billion). The other extended arrangement approved in 1993/94 was for Egypt (SDR 0.4 billion). As of April 30, 1994, a total of 16 countries had stand-by arrangements with the Fund, with total commitments of SDR 1.1 billion and undrawn balances of SDR 0.8 billion (Appendix Table II.2). Another six countries had extended arrangements, with total commitments of SDR 4.5 billion and undrawn balances of SDR 1.8 billion.

Table II.1

Arrangements Approved During Financial Years Ended April 30, 1953-94

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Includes amounts previously committed under SAF arrangements that were replaced by ESAF arrangements.

Table II.2

Arrangements in Effect at End of Financial Years Ended April 30, 1953-94

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Induces arrangements where the three-year commament period has expired but the third annual arrangement remains in effect (three cases in 1991, two cases in 1992. and one case in 1993). The committed amounts exclude these cases, includes amounts previously committed under SAF arrangements that were replaced by ESAF arrangements.

Includes amounts previously committed under SAF arrangements that were replaced by ESAF arrangements.

Table II.3

Stand-By Arrangements in Effect During Financial Year Ended April 30, 1994

(In millions of SDRs)

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Canceled prior to original expiration date of August 25, 1993.

Extended from November 30,1992, March 1, 1993, and March 22, 1993, and amount decreased from SDR 278.00 million.

Amount increased from SDR 34.55 million, and extended from March 9, 1994.

Extended from August 25, 1993.

Canceled prior to original expiration date of September 15. 1994.

Amount decreased from SDR 93.68 million, and extended from December 23, 1993.

Extended from March 7, 1994

Table II.4

Extended Fund Facility Arrangements in Effect During Financial Year Ended April 30, 1994

(In millions of SDRs)

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Amount approved includes augmentation for interest support of SDR 333.90 million.

Canceled prior to original expiration date of February 19,1994

Amount approved includes augmentation for interest support of SDR 466.20 million. Extended from May 25, 1992.

New commitments of Fund resources under both stand-by and extended arrangements decreased for the second year in a row, from SDR 3.2 billion in 1992/93 to SDR 2.2 billion in 1993/94. This reduced level of commitments was largely due to a continued improvement in economic performance in a number of developing countries, particularly in Asia and the Western Hemisphere, combined with relatively slow progress by several of the economies in transition, which initially made use of Fund resources under the STF, in formulating macroeconomic and structural reform programs that could be supported under a standby or extended arrangement.

Special Facilities

The Fund’s special facilities consist of the compensatory and contingency financing facility, the buffer stock financing facility (ESFF), and the systemic transformation facility.

Four purchases were made under the CCFF in 1993/94 totaling SDR 0.7 billion, compared with SDR 0.1 billion in 1992/93. This increase was mainly due to a purchase made by South Africa (SDR 0.6 billion) toward the end of 1993 on account of a shortfall in export earnings from minerals and metals, along with an excess in cereal import costs as a result of the severe drought of 1991/92. There were no purchases under the BSFF for the tenth consecutive year, and no amounts were outstanding under the facility at the end of 1993/94.

Thirteen members purchased SDR 2.7 billion under the STF in 1993/94, including 8 countries of the former Soviet Union, three Central and Eastern European countries, and two Asian countries. The largest amount was purchased by Russia (SDR 2.2 billion in two drawings).

SAF and ESAF

During 1993/94, the Fund continued to provide financial support on concessional terms to low-income members through the SAF and ESAF. As of April 30, 1994, three SAF arrangements and 22 ESAF arrangements were in effect. A one-year SAF arrangement for SDR 27 million, in conjunction with a three-year ESAF arrangement for SDR 89 million, was approved during 1993/94 for Sierra Leone, following the successful completion of a rights accumulation program and clearance of Sierra Leone’s arrears to the Fund. The SAF arrangement provided Sierra Leone with access to resources approximately equivalent to those that were not disbursed under a previous (1986) SAF arrangement.

Five other new ESAF arrangements were approved in 1993/94 with Albania (SDR 42 million), Côte d’lvoire (SDR 333 million), the Lao People’s Democratic Republic (SDR 35 million), Mongolia (SDR 41 million), and Pakistan (SDR 607 million). An additional one-year arrangement was also approved for Kenya (SDR 45 million), representing the undisbursed balance under an expired three-year ESAF arrangement, and the Board approved increased access under the ESAF arrangements for Benin and Mali. Cumulative commitments under all approved SAF and ESAF arrangements (including arrangements that have expired) totaled SDR 5.8 billion as of April 30,1994, compared with SDR 4.6 billion as of April 30, 1993 (Appendix Tables II.5 and II.6). SAF and ESAF disbursements during 1993/94 totaled SDR 0.7 billion, somewhat above the level of 1992/93, bringing cumulative disbursements through April 30,1994 to SDR 4.0 billion.

Table II.5

Arrangements Under the Structural Adjustment Facility Through Financial Year Ended April 30, 1994

(In millions of SDRs)

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Amounts committed for Guinea. Guinea-Bissau. Haiti. Rwanda, São Tomé and Príncipe, Sierra Leone. Somalia, and Zaire have been reduced owing to the expiration of the three-year commitment period prior to being fully drawn.

SAF arrangement replaced by ESAF arrangement on date shown as SAF expiration date.

Exptration date for third annual arrangement is as follows: Equatorial Guinea, December 3,1992: Lao People’s Democratic Republic. May 4,1993; and Pakistan. December 15,1992.

Table II.6

Arrangements Under the Enhanced Structural Adjustment Facility Through Financial Year Ended April 30, 1994

(In millions of SDRs)

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Expiration date is for three-year arrangement, or of third or fourth annual arrangement, if applicable.

Comprised entirely of ESAF Trust resources.

Financed with drawings under the following ESAF borrowing agreements: Export-Import Bank of Japan (SDR 796.8 million); CFrancaise de Developpement (SDR 455.0 million); Bank of Spain (SDR 216.4 million); Canada (SDR 119.4 million); Bank of Norway (SDR 47.3 million); Korea (SDR 55.1 million); Ufficio Italiano dei Cambi (SDR 158.7 million); Kreditanstalt fur Wiederaufbau—Germany (SDR 350.0 million); and the Swiss Confederation (SDR 200.0 million). Drawings were also made under the associated loan agreement with the Saudi Fund for Development (SDR 19.5 million). The balance of SDR 200.0 million was financed using resources available under the borrowing agreement with the Swiss Confederation.

Amount increased from SDR 258.75 million.

Amount increased from SDR 46.95 million.

Amount increased from SDR 136.05 million.

Amount increased from SDR 368.10 million.

Three-year arrangement expired on March 31,1993. An additional one-year arrangement for the undrawn balance of SDR 45.23 million was approved on December 22,1993.

Amount increased from SDR 55.80 million.

Amount increased from SDR 60.96 million

Three-year arrangement expired on May 23, 1993. An additional two-year arrangement for the undrawn balance was approved on December 9, 1993.

Amount increased from SDR 85.40 million.

Amount decreased from SDR 50.55 million

Amount increased from SDR 179.28 million.

In November 1993, the Board approved an extension of the commitment period for ESAF Trust loans from November 30,1993 to December 31, 1993, and, subsequently, to February 28,1994, so as to assure continuity of ESAF operations until the enlargement of the ESAF became effective. The Board approved the enlargement and extension of the ESAF in December 1993, and operations under the enlarged ESAF Trust commenced on February 23, 1994, when the Board determined that sufficient contributions to the Loan and Subsidy Accounts of the ESAF Trust had been committed or were in firm prospect.

The enlarged ESAF Trust will be financed by a broad cross-section of the Fund’s membership. To date, commitments have been received from more than 40 countries. About half of the contributors are developing countries, and they are providing almost 20 percent of the contributions to the ESAF Trust Subsidy Account (compared with the 6 developing countries that provided 8 percent of the contributions to the original ESAF). Commitments to contribute to the Loan Account have been received from 11 countries, three of which are developing countries, and from the OPEC Fund for International Development.

The terms and conditions of the enlarged and extended ESAF Trust remain basically unchanged. The target lending amount for the enlargement is SDR 5 billion, which would provide total lending under the ESAF Trust of SDR 10.1 billion, including the loan agreements of SDR 5.1 billion approved prior to the enlargement. Together with the enlargement of the ESAF Trust, the Board also agreed to extend the commitment period for ESAF Trust loans through December 31, 1996, with disbursements to be made through the end of 1999.

So far, new loan commitments to the enlarged ESAF Trust amount to about SDR 4.6 billion, and bilateral subsidy commitments to about SDR 1.3 billion. Discussions are continuing with a number of contributors on the possibility of additional contributions. In addition, effective February 23,1994, the Board transferred to the Subsidy Account of the enlarged ESAF Trust the uncommitted balances available in the Special Disbursement Account, excluding the amounts set aside for SAF arrangements for Sierra Leone and Zambia upon successful completion of their rights accumulation programs and clearance of their overdue obligations to the Fund.

As of April 30, 1994, there were no resources available in the SDA to finance new commitments of SAF and the SAF-related portion of ESAF loans (other than to Zambia), Total resources that have been available for disbursement from the SDA in support of SAF and ESAF arrangements, including disbursements already made and existing commitments remaining to be disbursed, amount to about SDR 2.3 billion. Total loan commitments by lenders to the ESAF Trust under agreements approved by the Board as of April 30,1994 amounted to SDR 5.1 billion. Additional agreements were expected to be approved shortly in connection with the enlargement of the ESAF.

To enable all ESAF financing to be provided at low concessional interest rates (currently 0.5 percent), subsidy contributions are received by the ESAF Trust Subsidy Account. Bilateral contributions to the Account take a variety of forms, including direct grants and deposits made at concessional interest rates. Resources available to the Subsidy Account, net of subsidies already paid, rose from SDR 606.3 million as of April 30,1993 to SDR 1,162.2 million as of April 30, 1994, including the transfer of uncommitted resources available in the SDA (SDR 379.7 million) to the Subsidy Account in February 1994. The ESAF Trust made interest payments to lenders in 1993/94 amounting to SDR 69 million, of which SDR 10 million was financed by payments of interest by borrowers and the balance of SDR 59 million was drawn from the resources of the Subsidy Account.

Details on SAF and ESAF arrangements, and on borrowing agreements and subsidy contributions for the ESAF Trust, are provided in Appendix Tables II.5,II.6, and II.11.

Table II.11

Enhanced Structural Adjustment Facility, Estimated Value of Contributions (Commitments as of April 30, 1994)

(In millions of SDRs)

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Where shown in parentheses, the grant element has been calculated on the basis of the loan amount indicated, and was not specified by the contributing country. These grant elements reflect the undiscounted amounts necessary to be paid “as needed” to achieve an effective lending rate of 0.5 percent, based on actual interest rates through April 1994 and an assumed average interest rate of 6.0 percent thereafter on loans to the ESAF Trust Loan Account. The amounts reported for other grant contributions are based on the “asneeded” contribution amount that would have the same present value as the resources committed. Grants committed in local currency are valued at May 31, 1994 exchange rates.

Loan contributions are provided either at concessional interest rates or on the basis of weighted averages of market interest rates in the five currencies comprising the SDR basket.

Some of the contributions listed are subject to parliamentary approval or completion of other internal procedures. On June 30, 1994, a loan commitment of $50 million (equivalent to about SDR 36 million) was received from the OPEC Fund for International Development; this amount is not included in the loan commitment total.

Some contributions are conditioned on others’ efforts, or expressed as a share of final amounts mobilized, and the amounts indicated assume achievement of the funding targets; certain other contributions are to be confirmed.

Total amount of loan was SDR 220 million; however, the disbursement period of the loan expired on June 30, 1993 with an undisbursed amount of SDR 3.6 million.

Estimate does not include income from the temporary investment of the proceeds of the drawing of the Swiss loan pending their use in financing loan disbursements. This income, as well as the 0.5 percent interest paid by ESAF borrowers on loans financed through borrowing from Switzerland, has been transferred to the ESAF Trust Reserve Account.

Corresponds to the associated loan agreement with the Saudi Fund for Development (SFD).

The sum of individual contributions has been adjusted downward to take into account additional loan costs.

Fund Charges, Net Income, and Precautionary Balances

Effective May 1, 1993. the Fund simplified its system of charges by adopting a single unified rate of charge to apply to all outstanding use of Fund credit in the GRA; previously a separate rate of charge had applied to use of credit financed with borrowed resources. During 1993/94, the Fund adopted as a permanent feature the procedure of setting the rate of charge on the use of its resources as a proportion of the weekly SDR interest rate. This practice, which was begun in 1989/90, is intended to ensure that the Fund’s operational income closely reflects its operational costs, which are largely dependent on the SDR interest rate, and thus to avoid the need for large step increases in the rate of charge in order to achieve the target amount of net income. For 1993/94, the proportion for the rate of charge was set at 111 percent of the SDR interest rate. The average rate of charge on the use of Fund resources in 1993/94 was 4.70 percent before adjustments for burden sharing (Appendix Table II.14).

The Fund pays remuneration to a member on the amount by which its norm for remuneration exceeds the Fund’s holdings of its currency, excluding holdings that reflect the member’s use of Fund credit. For each member, the norm is calculated as the sum of 75 percent of the member’s quota on April 1, 1978, plus all increases in quota consented to and paid after that date. For members joining the Fund after April 1, 1978, the norm is calculated as the weighted average of the norms applicable to all other members on the date of admission, plus all increases in the member’s quota consented to and paid after that date. The rate of remuneration, before the adjustments under burden sharing, is set at 100 percent of the SDR interest rate, which averaged 4.24 percent in 1993/94.

The various measures taken in recent years to strengthen the Fund’s financial position against the consequences of overdue obligations were continued in 1993/94. First, a target amount of net income equal to 5 percent of the Fund’s reserves at the beginning of the financial year is to be added to the Fund’s reserves each year. Second, the financial burden of overdue obligations is shared by debtor and creditor members: one half each of the cost of deferred charges (unpaid charges due from members in arrears to the Fund by six months or more) and the allocation to the Special Contingent Account (SCA-1) of 5 percent of reserves at the beginning of the year is borne by members paying charges on the use of the Fund’s resources and by members receiving remuneration by means of adjustments to the rates of charge and remuneration, except that the adjustment to the rate of remuneration cannot reduce that rate to less than 85 percent of the SDR interest rate. These burden-sharing procedures have been extended by the Board for financial year 1994/95.

As part of the strengthened cooperative strategy to resolve the problem of protracted overdue obligations to the Fund, further adjustments (extended burden sharing) are made to the rate of charge and to the rate of remuneration (subject to the floor on the rate of remuneration of 80 percent of the SDR interest rate stipulated in the Articles of Agreement). The resources so generated are placed in a second Special Contingent Account (SCA-2) and are intended to protect the Fund against risks associated with credit extended by the GRA for the encashment of rights earned in the context of rights accumulation programs and to provide additional liquidity to finance those encashments. The extended burden-sharing procedures were adopted in July 1990 and will remain in effect until SDR 1 billion has been accumulated in the SCA-2. In view of the unification of the rates of charge and the application of burden sharing to all uses of GRA resources, the adjustment to the rate of charge for extended burden sharing was reduced from 35 to 26 basis points effective May 1, 1993, in order to maintain constant the amount of resources generated for the SCA-2. The adjustment to the rate of remuneration is fixed so as to yield three times the amount of resources generated by the adjustment to the rate of charge, subject to the floor on the rate of remuneration mentioned above. Effective February 1,1994, the operation of extended burden sharing was modified by lengthening the accumulation period and reducing the adjustment to the rate of charge to 4 basis points, in order to bring contributions to the SCA-2 by debtor and creditor countries more closely in line with the intended contribution ratio.

When deferred overdue charges are settled, the proceeds are paid to members that paid higher charges or received lower remuneration under burden sharing. Settlements of deferred charges amounted to SDR 86 million in 1993/94, compared with SDR 246 million in 1992/93. Cumulative refunds amounted to SDR 644 million as of end-April 1994. Balances in the SCA-1 will be returned to contributors when there are no more overdue obligations, or at such earlier time as the Fund may decide. Balances in the SCA-2 will be distributed to members that paid additional charges or received reduced remuneration when all outstanding purchases related to the encashment of rights have been repurchased, or at such earlier time as the Fund may decide.

For 1993/94, the target amount of net income and the amount to be added to the SCA-1 were set at SDR 88 million and SDR 81 million, respectively. Unpaid charges due by members in protracted arrears and contributions to the SCA-1 resulted in adjustments to the basic rate of charge of 35 basis points, and in adjustments to the rate of remuneration of 38 basis points. Adjustments for extended burden sharing further increased the basic rate of charge by 21 basis points and further reduced the rate of remuneration by 47 basis points to 80 percent of the average SDR interest rate. Shortfalls in the amounts placed in the SCA-2, owing to the 80 percent floor of the rate of remuneration having been reached, amounted to SDR 221 million cumulatively as of the end of 1993/94; this amount will be recaptured when the adjusted rate of remuneration does not reach that floor. For 1993/94, the adjusted rate of charge on the use of Fund resources averaged 5.26 percent and the adjusted rate of remuneration averaged 3.39 percent.

For 1993/94, the Fund’s net income before the net effect of changes in accounting methods amounted to SDR 87 million, SDR 1 million less than the target net income of SDR 88 million. 8 The net income for 1993/94 after taking into account the net effect of accounting changes was SDR 74 million. This was added to reserves, which increased to SDR 1.70 billion as of the end of April 1994 from SDR 1.63 billion a year earlier. The Board determined a net income target of SDR 85 million for 1994/95 and set the proportion for the basic rate of charge for 1994/95 at 115.1 percent of the SDR interest rate.

Total precautionary balances (reserves and balances in the two Special Contingent Accounts) amounted to SDR 2.9 billion as of the end of April 1994, while precautionary balances generally available to protect the Fund’s financial position against the consequences of overdue repurchases in the GRA (reserves plus SCA-1) totaled SDR 2.2 billion, equivalent to 128 percent of credit outstanding in the GRA to countries in arrears to the Fund by six months or more (SDR 1.7 billion). Precautionary balances placed in the SCA-2 totaled SDR 637 million as of April 30,1994.

The Fund’s exposure to credit risk, as well as the required level and adequacy of its precautionary balances, was discussed by the Board in April 1994. Directors agreed that the Fund should continue to aim for a level of precautionary balances sufficient to cover credit outstanding to members in protracted arrears to the GRA. Directors also agreed that the most important safeguard for the Fund’s assets was the adjustment policies of members making use of Fund resources, and a number of Directors considered that additional protection was to be found in the Fund’s preferred creditor status. Directors pointed out that there nevertheless remained some residual exposure to risk of loss. Most Directors favored a generalized approach to taking this factor into account in judging the adequacy of the Fund’s precautionary balances, in which the need for additions to precautionary balances would be related to the total amount of credit outstanding. However, the actual proportion of total credit that should be provided for was a matter of judgment which should take into account all the relevant circumstances.

Overdue Financial Obligations

Continued progress under the Fund’s strengthened cooperative arrears strategy led to the resolution of several longstanding arrears cases and, for the second consecutive year, to a reduction in the level of outstanding overdue obligations, which declined from SDR 3.0 billion on April 30,1993 to SDR 2.9 billion on April 30. 1994. 9 Nevertheless, the amount of overdue financial obligations to the Fund remained high in 1993/94, and a number of cases involving large amounts of arrears failed to be resolved, requiring continued vigilance and the consideration of further remedial action by the Fund.

The number of countries in arrears to the Fund by six months or more decreased from 12 to nine during 1993/94, as Cambodia and Viet Nam eliminated their overdue obligations to the Fund in October 1993, and Sierra Leone completed its rights accumulation program in February 1994 and cleared its arrears in March 1994. One member incurred protracted arrears during the course of 1993/94, but eliminated those arrears in March 1994; a number of short-term cases were also resolved during the year. Of the nine countries still in protracted arrears on April 30, 1994, all were in arrears to the GRA; eight to the SDR Department: four to the Trust Fund: and three were in arrears on SAF obligations. Deferred overdue charges from these countries, which are excluded from the Fund’s current income, amounted to SDR 1,043 million at the end of 1993/94, compared with SDR 1,058 million a year earlier. Selected data on arrears to the Fund are shown in Table 36. and additional information on countries’ overdue financial obligations by type and duration is shown in Table 37.

Table 36

Arrears to the Fund of Countries with Obligations Overdue by Six Months or More

(in millions of SDRs; end of period)

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Table 37

Arrears to the Fund of Countries with Obligations Overdue by Six Months or More, by Type and Duration, as of April 30,1994

(In millions of SDRs)

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Less than SDR 50,000.

As of April 30, 1994, five countries remained ineligible to use the general resources of the Fund, pursuant to declarations under Article XXVI, Section 2(a)—Liberia, Somalia, Sudan, Zaire, and Zambia. Declarations of ineligibility with respect to Viet Nam and Sierra Leone were lifted on October 6, 1993 and March 28, 1994, respectively, following the full settlement of their arrears. As of April 30,1994, the five ineligible countries accounted for 96 percent of total overdue obligations to the Fund. Declarations of noncooperation remain in effect with respect to three countries-Liberia (issued March 30,1990), Sudan (September 14, 1990), and Zaire (February 14, 1992).

Progress Under the Strengthened Cooperative Strategy

The strengthened cooperative strategy on overdue financial obligations to the Fund was formulated in early 1990 and endorsed by the Interim Committee in May 1990. The Board reviews progress made under the strategy annually. At the last review, in April 1994, the Board agreed that the basic thrust of the strategy remained appropriate. The three key elements of the strategy-prevention, deterrence, and intensified collaboration—continued to be implemented in 1993/94, in order to assist overdue countries in finding solutions to their arrears problems and to prevent the emergence of new arrears.

Preventive Measures

Actions to prevent the emergence of new cases of arrears to the Fund are the first line of defense of the strengthened cooperative strategy. In this regard, the risks in extending balance of payments assistance to member countries depend critically on the strength and comprehensiveness of their adjustment policies, the extent of external financial support, and the commitment of the authorities to take further policy action if necessary. These factors are important aspects of the assessments of countries’ external viability and their capacity to repay the Fund made by the staff in connection with all requests for use of the Fund’s resources. Such assessments highlight potential risks and dangers arising, for example, from future financing gaps, a bunching of maturities or an excessive debt burden, possible adverse external shocks, or slippages in policy implementation. Every effort is made to take these risks into account in the design, implementation, and financing of programs.

When large medium-term financing gaps or very heavy debt burdens, or both, are in prospect, the Board is informed of the country’s future financing needs and of how these are expected to be met. In such instances, the Fund may seek additional assurances from the international financial community regarding the availability of financing on appropriate terms over the medium term. In addition, assistance may be provided to strengthen countries’ financial management practices through, for example, the targeting of a higher level of international reserves, the building up of budgetary resources in local currency, or arrangements for voluntary advance acquisition of SDRs combined with a standing authorization to debit the country’s SDR account for amounts as they fall due to the Fund, When a country is no longer making purchases from the Fund but Fund credit remains outstanding, the staff regularly reviews with the authorities the stance of economic policies and the expected evolution of the external position in a medium-term context, paying particular attention to the early identification of emerging problems that could lead to delays in payments, including to the Fund.

Remedial and Deterrent Measures

The preventive element of the arrears strategy is complemented by remedial and deterrent measures, which seek to protect the Fund’s resources from further use by countries that are in arrears to the Fund and set in motion a concerted effort to resolve the problems of newly overdue members. These measures consist of specific actions to be taken in the light of developments in a member’s situation, and in accordance with a timetable agreed by the Board in early 1990. The timetable sets a framework for the Board’s consideration of various measures, which are then implemented in accordance with the Board’s judgment regarding the extent of the country’s cooperation with the Fund and the particular circumstances of the individual member.

With the entry into effect in November 1992 of the Third Amendment to the Articles of Agreement, a further remedial measure—suspension of a member’s voting rights—became available. In view of Sudan’s persistent failure to fulfill its obligations under the Articles of Agreement, its voting rights were suspended on August 9, 1993. At the review of that decision on February 14, 1994, the Board noted that it was intended to initiate promptly the procedure under Article XXVI, Section 2(c) regarding the compulsory withdrawal of Sudan from the Fund. This procedure was initiated with the issuance of a complaint under Article XXVI, Section 2(c) on April 8, 1994. On January 18,1994, the procedure for the suspension of the voting rights of Zaire was initiated by the issuance of a complaint by the Managing Director.

Intensified Collaboration and the Rights Approach

Fund-monitored programs and rights accumulation programs provide a framework for countries in protracted arrears to the Fund to establish a satisfactory track record on policy and payments performance. The availability of the rights approach is limited to the 11 countries that were in protracted arrears to the Fund at the end of 1989. To avail themselves of this approach, these countries must enter into rights accumulation programs by a certain deadline, which has been extended to the spring 1995 meeting of the Interim Committee. A rights accumulation program allows a country in protracted arrears to accumulate rights to future drawings of Fund resources in accordance with a phased schedule, and in amounts up to the level of arrears outstanding at the beginning of the program. Disbursements, however, are not made until after the clearance of arrears and are conditional upon satisfactory conclusion of the rights program and endorsement by the Fund of a follow-up arrangement.

Five of the original 11 eligible countries—Cambodia, Guyana, Honduras, Panama, and Viet Nam—have now cleared their arrears to the Fund without recourse to the rights approach. Cambodia settled its overdue obligations on October 1, 1993, with the assistance of a Support Group co-chaired by France and Japan. On October 4,1993, the Board approved a first purchase by Cambodia under the STF. Viet Nam eliminated its arrears on October 5, 1993, also with the assistance of a Support Group co-chaired by France and Japan, and on October 6,1993, the Board approved a one-year stand-by arrangement for Viet Nam.

Three other members of the original group of 11 eligible countries—Peru, Sierra Leone, and Zambia—have adopted rights accumulation programs. Peru completed its rights program and cleared its arrears to the Fund in March 1993, at which time the Board approved a three-year extended arrangement for Peru. Sierra Leone completed its rights program on February 28,1994. It settled its overdue obligations to the Fund on March 28,1994, and on the same day the Board approved SAF and ESAF arrangements in support of Sierra Leone’s medium-term economic program. In May 1994, Zambia resumed the accumulation of rights under the rights program approved by the Board in July 1992. This resumption followed measures taken to correct slippages with respect to fiscal and external arrears performance criteria which had occurred after the completion of the third program review in August 1993.

For the three other countries in protracted arrears at the end of 1989—Liberia, Somalia, and Sudan—the rights approach remains available, although progress to date has been hindered by a number of factors, including, in the first two cases, political and security problems.

The resolution of several of the cases of countries in protracted arrears to the Fund has required close collaboration between the Fund, the World Bank, and other multilateral financial institutions, and collaboration in this regard continued in 1993/94. Similarly, the Fund has helped resolve cases of arrears to other multilateral institutions by countries remaining current in their financial obligations to the Fund.

SDR Department

The SDR is an international reserve asset created by the Fund under the First Amendment to its Articles of Agreement in July 1969 to supplement existing reserve assets. SDRs were first allocated in January 1970. Since then, a total of SDR 21.4 billion has been allocated and is held by Fund members (all of which currently are participants in the SDR Department), the Fund’s General Resources Account, and official entities prescribed by the Fund to hold SDRs. Although prescribed holders do not receive SDR allocations, they can acquire and use SDRs in transactions and operations with participants in the SDR Department and other prescribed holders under the same terms and conditions as participants. During the financial year ended April 30, 1994, the number of prescribed holders remained unchanged at 15. 10

The SDR is the unit of account for Fund transactions and operations and is also used as a unit of account, or the basis for a unit of account, by a number of other international and regional organizations and international conventions. In addition, the SDR has been used to denominate financial instruments and transactions outside the Fund by the private sector and some governments (private SDRs). As of April 30, 1994, the currencies of four member countries of the Fund were pegged to the SDR.

SDR Valuation and Interest Rate Basket

Since January 1, 1981, the value of and interest rate on the SDR have been determined on the basis of a basket of five currencies, which is revised every five years. The quinquennial revisions are made in order to include the currencies of the five member countries of the Fund with the largest exports of goods and services during the five-year period ending 12 months before the effective date of the revision, and to determine initial weights for these currencies reflecting their relative importance in international trade and finance during the same period. Table 38 shows the initial weights and corresponding amounts of each of the five currencies in the current basket, which was last revised on January 1,1991.

Table 38

SDR Basket

(As of January 1,1991)

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Since January 1, 1981, the rate of interest on the SDR has been calculated using interest rates on selected short-term instruments in the domestic money markets of the five countries whose currencies are included in the SDR basket. With effect from January 1, 1991, these interest rates are the market yield on three-month U.S. Treasury bills, the three-month interbank deposit rate in Germany, the three-month rate for treasury bills in France, the three-month rate on certificates of deposit in Japan, and the market yield on three-month U.K. Treasury bills. The weekly (Monday-Sunday) interest rate on the SDR is computed as the sum, rounded to the two nearest decimal places, of the products of the respective interest rates, the currency amounts, and the exchange rates in effect on the preceding Friday.

SDR Transfers

The total amount of SDR transfers declined considerably to SDR 10.9 billion in 1993/94 from the record level of SDR 34.2 billion in 1992/93, when substantial payments were made in SDRs for quota subscriptions of new members and quota increases under the Ninth General Review. Significant decreases in receipts and uses of SDRs by the GRA during 1993/94 were accompanied by lower transfers among participants and prescribed holders, returning such transfers to closer to the historical norm. Summary data on transfers of SDRs among these groups of holders are presented in Table 39; see also Appendix Table II.12.

Table 39

Transfers of SDRs, January 1,1970-April 30, 1994

(In millions of SDRs)

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The first column covers the period from the creation of the SDR until the Second Amendment to the Articles of Agreement; the second column covers the period of the SDR allocations in the third basic period and the Seventh General Quota increases; and the fourth column covers the period of the Eighth General Quota increases and before the introduction of two-way arrangements to facilitate transactions by agreement.

Table II.12

Summary of Transactions and Operations in SDRs, Financial Year Ended April 30, 1994

(In thousands of SDRs)

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The assets and liabilities of the former Socialist Federal Republic of Yugoslavia were assumed by five successor states. As of April 30, 1994, the Republic of Bosnia and Herzegovina and the Federal Republic of Yugoslavia (Serbia and Montenegro) had not completed arrangements for succession to membership in the Fund.

Transfers among participants and prescribed holders declined from SDR 11.1 billion in 1992/93 to SDR 4.1 billion in 1993/94. As members’ needs to acquire or use SDRs are highly influenced by the level of transfers to and from the GRA. the virtual completion of members’ payments of the reserve asset portion of their quota increases in the previous year led to lower levels of transactions by agreement and prescribed operations in 1993/94, and members’ reduced holdings of SDRs following the quota payments also resulted in lower net interest paid on those holdings. Fund-related operations, which represent uses of SDRs in connection with the SAF, ESAF, Trust Fund, and Supplementary Financing Facility Subsidy Account, more than tripled to SDR 0.4 billion in 1993/94, as more countries used SDRs to discharge their obligations to the Fund under those facilities. 11

Transactions by agreement, while accounting for more than three fourths of transfers among participants and prescribed holders, declined by almost 40 percent to SDR 3.1 billion in 1993/94, Participants acquire SDRs in transactions by agreement mainly to discharge their financial obligations to the Fund, such as charges and assessments, which must be paid in SDRs, and repurchases, quota payments, and obligations under the SAF, ESAF, and Trust Fund, which may be paid in SDRs. Participants also sell SDRs that they receive in purchases from the Fund in transactions by agreement. The declines in financial obligations discharged in SDRs by members to the GRA, from SDR 15.2 billion in 1992/93 to SDR 2.5 billion in 1993/94, and in receipts of SDRs by members from the GRA in purchases, from SDR 5.8 billion in 1992/93 to SDR 2.7 billion in 1993/94, were an important factor behind the reduction in the amount of transactions by agreement.

The smooth conduct of transactions and operations in the SDR Department continued to be facilitated by the standing arrangements to buy and sell SDRs established between a number of members and the Fund (so-called two-way arrangements). Under these arrangements, which increased to 12 as of April 30, 1994, members stand ready to buy or sell SDRs for one or more freely usable currencies at any time, provided that their SDR holdings remain within certain limits. These arrangements have allowed the Fund to accommodate a substantial portion of desired purchases of SDRs and to avoid recourse to the designation mechanism for sales of SDRs. 12 During 1993/94, however, a few members’ requests to acquire SDRs in transactions by agreement could not be met. As SDRs used by the Fund in financing members’ purchases become available for further use by participants, the reduced amount of purchases from the Fund in SDRs in 1993/94 meant that there were fewer SDRs available for sale in transactions by agreement, which constrained the ability of other members to acquire SDRs.

As in previous years, the bulk of SDR transfers in 1993/94, totaling SDR 6.8 billion or 63 percent of the total, have involved the GRA. Receipts of SDRs by the GRA totaled SDR 2.5 billion in 1993/94, consisting mainly of repurchases, charges, and interest on the Fund’s SDR holdings. Repurchases effected in SDRs remained low at SDR 0.6 billion, reflecting the continued limited ability of members indebted to the Fund to acquire SDRs for use in repurchases, and charges decreased from SDR 1.8 billion in 1992/93 to SDR 1.4 billion in 1993/94, mainly as a result of lower interest rates. The Fund’s own SDR holdings averaged SDR 7.1 billion during the financial year, and interest earned on those holdings more than doubled to SDR 0.3 billion.

During 1993/94, SDRs were used extensively by a number of countries in clearing their overdue obligations to the Fund. In some cases, the countries in arrears received SDRs in bridge loans from lenders, used them to settle their arrears to the Fund, received SDRs in new financial assistance from the Fund, and used those SDRs to repay the bridge loans all on the same day or shortly thereafter. In this connection, a grant of SDRs, the first prescribed operation of its kind, was made by a country to assist another country to clear its overdue obligations to the Fund. The use of SDRs in bridging operations, which closely paralleled the same-day SDR loan/repayment mechanisms established by a number of countries to assist other countries with insufficient SDRs or foreign exchange to pay the reserve asset portion of their quota increases under the Ninth General Review, was particularly effective in that it helped avoid exchange risk which might have arisen with the use of currencies in similar operations, and subjected the transfers of funds among the parties involved to better control and coordination.

Transfers of SDRs from the GRA to participants declined from SDR 7.9 billion in 1992/93 to SDR 4.4 billion in 1993/94. More than half of these transfers were accounted for by purchases, which at SDR 2.7 billion were significantly below their level of SDR 5.8 billion in the previous financial year. Repayments of Fund borrowings and payment of interest on borrowings remained essentially unchanged at SDR 0.5 billion. Although remunerated positions of creditor members rose during 1993/94 in step with the increased use of Fund resources, remuneration rose only marginally to SDR 1.0 billion because of lower interest rates.

Pattern of SDR Holdings

The transfers of SDRs during 1993/94 described in the previous section resulted in a significant redistribution of holdings of the asset. In light of the need of members to hold SDRs as reserves and as a means of payment, and taking into account also the Fund’s operational need to hold SDRs, the Fund has taken a decision to aim to reduce its holdings of SDRs to within the range of SDR 1-1.5 billion by the end of 1995. 13 The Fund decreased its holdings by SDR 1.9 billion during 1993/94, to reach SDR 6.0 billion at the end of the financial year. However, with the low level of purchases in SDRs during the year, this was a smaller reduction than had been envisaged. Holdings of SDRs by participants increased from SDR 13.5 billion to SDR 15.2 billion. Mainly as a result of receipts of remuneration: the SDR holdings of the industrial countries increased by SDR 0.7 billion to SDR 11.4 billion during 1993/94, while the holdings of developing countries increased by SDR 1.1 billion to SDR 3.9 billion; in relation to their net cumulative allocations, the holdings of these two groups of countries rose by 4.8 percent to 77.9 percent, and by 14.7 percent to 56.3 percent, respectively (Appendix Table II.13). The SDR holdings of prescribed holders increased from SDR 48 million to SDR 227 million during 1993/94.

Table II.12

Summary of Transactions and Operations in SDRs, Financial Year Ended April 30, 1994

(In thousands of SDRs)

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The assets and liabilities of the former Socialist Federal Republic of Yugoslavia were assumed by five successor states. As of April 30, 1994, the Republic of Bosnia and Herzegovina and the Federal Republic of Yugoslavia (Serbia and Montenegro) had not completed arrangements for succession to membership in the Fund.

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Cover International Monetary Fund Annual Report 1994
International Monetary Fund Annual Report 1994
ISBN:
9781451944938
ISSN:
2227-8915
Publication Date:
01 Jan 1994
Publisher:
International Monetary Fund
DOI:
https://doi.org/10.5089/9781451944938.011
Pages:
284
  • Chart 6
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    Chart 6

    The Fund’s Liquidity Ratio, 1978-93

    (In percent; end of period)

  • Chart 7
    View in gallery
    Chart 7

    General Resources: Purchases and Repurchases, Financial Years Ended April 30, 1982-94

    (In percent; end of period)

  • Chart 8
    View in gallery
    Chart 8

    Total Fund Credit Outstanding to Members (Including Trust Fund, SAF, and ESAF), Financial Years Ended April 30,1982-94

    (In percent; end of period)

Chart 6

The Fund’s Liquidity Ratio, 1978-93

(In percent; end of period)
Chart 7

General Resources: Purchases and Repurchases, Financial Years Ended April 30, 1982-94

(In percent; end of period)
Chart 8

Total Fund Credit Outstanding to Members (Including Trust Fund, SAF, and ESAF), Financial Years Ended April 30,1982-94

(In percent; end of period)