Chapter

Chapter 3. Strengthening IMF program support and crisis resolution

Author(s):
International Monetary Fund
Published Date:
September 2005
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The provision of temporary financial support, in the form of loans of foreign exchange, to member countries with balance of payments difficulties is one of the IMF's main responsibilities. Its financial assistance is provided under a variety of policies and lending instruments (Table 3.1). Most forms of IMF financing are made conditional on the adoption by the recipient country of policies of adjustment and reform designed to correct the problems that gave rise to its need for support. Such conditionality is important also to ensure that the IMF's resources are safeguarded for the use of members in future need.

Table 3.1IMF financial facilities
Repurchase (repayment) terms3
Credit facilityPurposeConditionsPhasing and monitoring1Access limits1Charges2Obligation schedule (Years)Expectation schedule (Years)Installments
Credit tranches and Extended Fund Facility4
Stand-By Arrangements (1952)Medium-term assistance for countries with balance of payments difficulties of a short-term characterAdopt policies that provide confidence that the member's balance of payments difficulties will be resolved within a reasonable periodQuarterly purchases (disbursements) contingent on observance of performance criteria and other conditionsAnnual: 100% of quota; cumulative: 300% of quotaRate of charge plus surcharge (100 basis points on amounts above 200% of quota; 200 basis points on amounts of 300%)53¼-52¼-4Quarterly
Extended Fund Facility (1974) (Extended Arrangements)Longer-term assistance to support members' structural reforms to address balance of payments difficulties of a long-term characterAdopt 3-year program, with structural agenda, with annual detailed statement of policies for the next 12 monthsQuarterly or semiannual purchases (disbursements) contingent on observance of performance criteria and other conditionsAnnual: 100% of quota; cumulative: 300% of quotaRate of charge plus surcharge (100 basis points on amounts above 200% of quota; 200 basis points on amounts above 300%)54½-104½-7Semiannual
Special facilities
Supplemental Reserve Facility (1997)Short-term assistance for balance of payments difficulties related to crises of market confidenceAvailable only in context of Stand-By or Extended Arrangements with associated program and with strengthened policies to address loss of market confidenceFacility available for one year; frontloaded access with two or more purchases (disbursements)No access limits; access under the facility only when access under associated regular arrangement would otherwise exceed either annual or cumulative limitRate of charge plus surcharge (300 basis points, rising by 50 basis points a year after first disbursement and every 6 months thereafter to a maximum of 500 basis points)2½-32-2½Semiannual
Compensatory Financing Facility (1963)Medium-term assistance for temporary export shortfalls or cereal import excessesAvailable only when the shortfall/excess is largely beyond the control of the authorities and a member has an arrangement with upper credit tranche conditionality, or when its balance of payments position excluding the shortfall/excess is satisfactoryTypically disbursed over a minimum of six months in accordance with the phasing provisions of the arrangement45% of quota each for export and cereal components; combined limit of 55% of quota for both componentsRate of charge3¼-52¼-4Quarterly
Emergency AssistanceAssistance for balance of payments difficulties related to:None, although post-conflict assistance can be segmented into two or more purchasesGenerally limited to 25% of quota, though larger amounts can be made available in exceptional cases
(1) Natural disasters (1962)Natural disastersReasonable efforts to overcome balance of payments difficultiesRate of charge; however, the rate of charge may be subsidized to 0.5 percent a year, subject to resource availability3¼-5Not applicableQuarterly
(2) Post-conflict (1995)The aftermath of civil unrest, political turmoil, or international armed conflictFocus on institutional and administrative capacity building to pave the way toward an upper credit tranche arrangement or PRGF
Facility for low-income members
Poverty Reduction and Growth Facility (1999)Longer-term assistance for deep-seated balance of payments difficulties of structural nature; aims at sustained poverty-reducing growthAdopt 3-year PRGF arrangements; PRGF-supported programs are based on a Poverty Reduction Strategy Paper (PRSP) prepared by the country in a participatory process and integrating macro-economic, structural, and poverty reduction policiesSemiannual (or occasionally quarterly) disbursements contingent on observance of performance criteria and reviews140% of quota; 185% of quota in exceptional circumstances0.5%5½-10Not applicableSemiannual

Except for PRGF, the IMF's lending is financed from the capital subscribed by member countries; each country is assigned a quota that represents its financial commitment. A member provides a portion of its quota in foreign currencies acceptable to the IMF–or SDRs–and the remainder in its own currency. An IMF loan is disbursed or drawn by the borrower purchasing foreign currency assets from the IMF with its own currency. Repayment of the loan is achieved by the borrower repurchasing its currency from the IMF with foreign currency. See Box 5.1 on the IMF's Financing Mechanism. PRGF lending is financed by a separate PRGFTrust.

The rate of charge on funds disbursed from the General Resources Account (GRA) is set at a margin over the weekly interest rate on SDRs (from May 1, 2005, the margin is expressed in basis points over the SDR interest rate; prior to that the margin was expressed as a proportion of the SDR interest rate). The rate of charge is applied to the daily balance of all outstanding GRA drawings during each IMF financial quarter. In addition, a one-time service charge of 0.5 percent is levied on each drawing of IMF resources in the GRA, other than reserve tranche drawings. An up-front commitment fee (25 basis points on committed amounts up to 100% of quota, 10 basis points thereafter) applies to the amount that may be drawn during each (annual) period under a Stand-By or Extended Arrangement; this fee is refunded on a proportionate basis as subsequent drawings are made under the arrangement.

For purchases made after November 28, 2000, members are expected to make repurchases (repayments) in accordance with the schedule of expectation; the IMF may, upon request by a member, amend the schedule of repurchase expectations if the Executive Board agrees that the member's external position has not improved sufficiently for repurchases to be made.

Credit tranches refer to the size of purchases (disbursements) in terms of proportions of the member's quota in the IMF; for example, disbursements up to 25 percent of a member's quota are disbursements under the first credit tranche and require members to demonstrate reasonable efforts to overcome their balance of payments problems. Requests for disbursements above 25 percent are referred to as upper credit tranche drawings; they are made in installments as the borrower meets certain established performance targets. Such disbursements are normally associated with a Stand-By or Extended Arrangement. Access to IMF resources outside an arrangement is rare and expected to remain so.

Surcharge introduced in November 2000.

Except for PRGF, the IMF's lending is financed from the capital subscribed by member countries; each country is assigned a quota that represents its financial commitment. A member provides a portion of its quota in foreign currencies acceptable to the IMF–or SDRs–and the remainder in its own currency. An IMF loan is disbursed or drawn by the borrower purchasing foreign currency assets from the IMF with its own currency. Repayment of the loan is achieved by the borrower repurchasing its currency from the IMF with foreign currency. See Box 5.1 on the IMF's Financing Mechanism. PRGF lending is financed by a separate PRGFTrust.

The rate of charge on funds disbursed from the General Resources Account (GRA) is set at a margin over the weekly interest rate on SDRs (from May 1, 2005, the margin is expressed in basis points over the SDR interest rate; prior to that the margin was expressed as a proportion of the SDR interest rate). The rate of charge is applied to the daily balance of all outstanding GRA drawings during each IMF financial quarter. In addition, a one-time service charge of 0.5 percent is levied on each drawing of IMF resources in the GRA, other than reserve tranche drawings. An up-front commitment fee (25 basis points on committed amounts up to 100% of quota, 10 basis points thereafter) applies to the amount that may be drawn during each (annual) period under a Stand-By or Extended Arrangement; this fee is refunded on a proportionate basis as subsequent drawings are made under the arrangement.

For purchases made after November 28, 2000, members are expected to make repurchases (repayments) in accordance with the schedule of expectation; the IMF may, upon request by a member, amend the schedule of repurchase expectations if the Executive Board agrees that the member's external position has not improved sufficiently for repurchases to be made.

Credit tranches refer to the size of purchases (disbursements) in terms of proportions of the member's quota in the IMF; for example, disbursements up to 25 percent of a member's quota are disbursements under the first credit tranche and require members to demonstrate reasonable efforts to overcome their balance of payments problems. Requests for disbursements above 25 percent are referred to as upper credit tranche drawings; they are made in installments as the borrower meets certain established performance targets. Such disbursements are normally associated with a Stand-By or Extended Arrangement. Access to IMF resources outside an arrangement is rare and expected to remain so.

Surcharge introduced in November 2000.

To ensure that IMF financing operations and instruments are well designed, up-to-date, and sufficiently flexible to support country-driven adjustment and reform efforts in a wide range of circumstances, the Fund undertook a broad review of program design and conditionality during the financial year. The review, which covered the design and effectiveness of programs during 1995–2000, as well as the initial experience with programs formulated under new conditionality guidelines adopted in 2002, gave the Fund valuable insights that will inform its operations and set a broad agenda for further work. The adequacy of program design was also examined as part of ex post assessments of programs in 18 member countries during the period.

Besides this wide-ranging reexamination of its policies on conditionality, the Board reviewed its policy on access to the Fund's financial resources. The amount of borrowing to which a country has access is linked both to its quota in the Fund (a reflection of the country's economic size, openness to the global economy, and other factors) and to the terms of the particular lending window. In FY2005 the Board looked at the access policy limits under the credit tranches, the Extended Fund Facility (EFF), and the Poverty Reduction and Growth Facility (PRGF). Also during FY2005, the Trade Integration Mechanism—a way to make new IMF resources more predictably available to qualifying member countries under existing Fund facilities—was activated.

Finally, during FY2005 the Fund continued to work with other concerned parties to promote mechanisms aimed at the orderly resolution of crises, such as the inclusion of collective action clauses (CACs) in sovereign bonds, the development of the Principles for Stable Capital Flows and Fair Debt Restructuring in Emerging Markets, and the evolution of the so-called Evian approach adopted by the Paris Club for restructuring the debt of non-HIPC countries.

For more details about developments in IMF financial operations and policies during the financial year, see Chapter 5.

2004-05 Conditionality Review

An IMF-supported program is a package of economic policy measures that, combined with approved financing from the IMF, is intended to accomplish specific economic objectives such as orderly adjustment of the balance of payments, lower inflation, and stronger, sustainable growth and poverty reduction. Conditionality relating to implementation of the agreed policies, usually in a phased way, gives the country confidence that it will continue to receive financing from the IMF through the duration of the program as long as it implements the policies agreed, while also safeguarding the IMF's resources.

During the Fund's previous, 2000–02 Conditionality Review, Executive Directors requested that the next review address broad issues of program design. In response to this request, the 2004–05 Conditionality Review had two parts. The first was a critical review of the design and effectiveness of IMF-supported programs over 1995–2000, and the second considered the Fund's initial experience with new conditionality guidelines introduced in 2002, which replaced previous guidelines adopted in 1979.

Design of IMF-supported programs

The first part of the review, conducted by the Board in December 2004, examined key features of IMF-supported programs over 1995–2000.1

Objectives and outcomes. Directors agreed that a viable balance of payments and medium-term external debt sustainability remain a core objective of IMF-supported programs.

For programs supported by nonconcessional lending under the General Resources Account (GRA), targeted external adjustment has been broadly in line with this objective, and IMF support seems to have mitigated the short-term negative effect of adjustment on growth. But in a number of cases, especially but not exclusively those of capital account crises, external adjustment has been sharper and larger than needed to stabilize external debt. Directors encouraged the IMF staff to undertake further analysis of the optimal mix between financing and adjustment in situations of capital account pressures as well as of the determinants of private capital flows and of the catalytic effects of IMF-supported programs.

For programs supported by concessional lending under the PRGF, targeted improvements in current account balances have, on average, been smaller than those required to stabilize external debt ratios. In addition, actual improvements have tended to be smaller than targeted. Directors called for further reflection on how to correct this phenomenon. Program outcomes for growth and inflation have been broadly favorable. Directors stressed that the design of programs in low-income countries should be based on full consideration of the implications of policies for poverty reduction.

Analytical frameworks. No single model or analytical framework is universally applicable to policy formulation in IMF-supported programs. Directors welcomed the fact that, in advising national authorities, IMF country teams normally draw on a variety of models and methods for policy formulation and combine them with economic judgment. The IMF's financial programming framework provides a useful consistency check on policies. This eclectic approach to policy formulation has generally worked well in practice. However, medium-term growth projections have been overly optimistic, which risks undermining the reliability of debt sustainability assessments and the credibility of programs. More analytical “reality checks” on growth projections, more systematic comparisons with forecasts by other analysts, and greater use of cross-country analysis were recommended.

Exchange rate policies. Directors noted that exchange rate regimes are no more likely to be altered at the outset of an IMF-supported program than at other times, and drew from this finding a variety of inferences. Coherence between the exchange rate regime and macroeconomic and structural policies is critical, and Directors emphasized that the IMF should avoid supporting policy mixes that do not sufficiently underpin the exchange rate regime. Disinflation has been achieved equally successfully under fixed or flexible exchange rate strategies, and success has depended instead mainly on whether the targeted fiscal adjustment was achieved. At the same time, countries with more flexible exchange rates have tended to achieve external adjustment with fewer adverse effects on output.

Emergence post-conflict assistance

The IMF provides emergency assistance (see Table 3.1) to member countries with urgent balance of payments financing needs in the wake of natural disasters and armed conflicts. (For a discussion of emergency natural disaster assistance, see Chapter 4.) Emergency financial assistance is designed to be disbursed rapidly and is supported by policy advice and, in many cases, technical assistance.

Beginning in 1995, emergency assistance was made available to countries emerging from conflict that are unable to develop and carry out a comprehensive economic program because their capacity has been damaged by the conflict but that still have the capacity for planning and policy implementation. IMF assistance is designed to help them expedite their economic recovery by rebuilding and strengthening their administrative and institutional capacity and by catalyzing additional funds from international donors for reconstruction. The rate of charge on loans for low-income countries eligible for assistance under the Fund's Poverty Reduction and Growth Facility is subsidized by grant contributions made by other members (see Chapter 5).

During FY2005, the Board approved emergency post-conflict assistance for three countries: the Central African Republic ($8.2 million), Haiti ($15.6 million), and Iraq ($436 million).1 In February 2005, the IMF's Board discussed the provision of technical assistance to post-conflict countries (see Chapter 6).

1 Details are available on the Fund's website: www.imf.org/external/np/sec/pr/2004/pr04158.htm, www.imf.org/external/np/sec/pr/2005/pr0504.htm, and www.imf.org/external/np/sec/pr/2004/pr04206.htm.

Monetary policies. Monetary policies have been broadly aligned with program objectives, and there is no evidence that monetary policies have been too tight.

Fiscal policies. Directors observed that program practice in fiscal policy has been significantly more diverse and has matched overall economic objectives more systematically than is commonly assumed. Fiscal slippages have often occurred, especially in the later years of a program. Directors stressed the need for greater focus on fiscal consolidation in program design, with an emphasis on high-quality fiscal measures that are politically feasible and sustainable. Attention should also be paid to contingent liabilities, including those stemming from financial sector restructuring costs. Fiscal consolidation has generally contributed to improvements in the external current account balance, while generally not being associated with lower output growth, suggesting that confidence effects play a significant role. Directors underscored the importance—in the context of the PRGF—of elements that help to reduce poverty and of analysis of the distributional impact of policies.

Structural policies. Structural reforms are often necessary to buttress adjustment efforts by enhancing efficiency and eliminating structural distortions that inhibit long-term growth, and to reduce vulnerabilities to financial crises. Broad alignment was found between structural measures and the objectives of IMF-supported programs. Measures intended to underpin demand management seem to have contributed to sustained fiscal adjustment, and measures geared toward enhancing efficiency have been associated with higher growth. While these initial indications were seen as useful, Directors underscored that the linkages between structural reforms and macroeconomic performance remain uncertain, and a more detailed analysis will be required.

Recognizing the changes the Fund made after the Argentine crisis, the Board agreed that the discussion following the assessment by the Independent Evaluation Office (IEO) of the Fund's role in Argentina during 1991–2001 also provided important insights (Box 3.1).

To ensure that the lessons learned during the review are applied, a number of internal seminars and training initiatives have been planned to raise awareness of the issues within the IMF, including disseminating information on best practices in some specific areas, such as forecasting growth. These internal education efforts will be complemented by significant efforts at external outreach to stimulate a wider debate on some key issues.

Box 3.1IEO review of the Fund's role in Argentina, 1991-2001

In July 2004, the Executive Board discussed the Independent Evaluation Office's review of the IMF's role in Argentina from 1991 to 2001–a period that began with the introduction of the convertibility regime that pegged the Argentine peso at par with the U.S. dollar and ended with the regime's collapse, which was accompanied by a default on Argentina's public debt. The 2001 crisis was one of the most severe in any country in recent years and brought considerable hardship to the Argentine people.

Recognizing the progress that had already been achieved since the Argentine crisis, Directors agreed that the report provided valuable insights for the Fund's financing and surveillance frameworks.

The following are among the key conclusions related to policy recommendations from the Executive Board discussion:

  • Where the sustainability of a country's debt or the exchange rate is threatened, the Fund should clearly indicate that its support is conditional upon a meaningful shift in policies. Up-to-date and comprehensive information is critical for the Board to make necessary judgments in such cases. The debt sustainability template and procedures on exceptional access provide important support in this regard.
  • Further reflection is needed on the issue of contingency planning in the context of Fund assistance to countries in crisis. There is potential value in such planning from the outset of a crisis, but also a need to establish what can constructively be done in ways that enhance confidence.
  • Directors emphasized the importance of, and recent progress in, ensuring that medium-term exchange rate and debt sustainability analysis are the focus of IMF surveillance. While the choice of the exchange rate regime must remain with the member's authorities, the Fund is obliged to exercise firm surveillance to ensure that other policies and constraints are consistent with that choice. Directors saw a need for greater candor in the treatment of exchange rate policy in the context of Article IV discussions, but most also stressed the need to strike an appropriate balance between candor and confidentiality. Analytical work on medium-term debt sustainability has also supported a reassessment, in the Fund and more broadly, of what level of debt is sustainable for emerging market countries, with the concept of “debt intolerance” playing an important role.
  • Directors noted the possible risks associated with precautionary Fund arrangements, especially where there are serious political obstacles to needed policies and reforms. Directors reiterated the value of precautionary arrangements as a tool for supporting sound policies. They confirmed the importance of ensuring that program standards and requirements for precautionary arrangements are the same as those for all other arrangements, and most did not think that precautionary arrangements tended to be weaker than other arrangements, noting that, in some cases, precautionary arrangements signaled superior performance.
  • The Fund is continuing to reflect on how to strengthen further the role of the Board during a crisis, including through improvements in the provision of full information on all issues relevant to decision making and open exchanges of views between management and the Board on all topics, including the most sensitive ones.
  • In all cases of use of Fund resources, particularly those involving exceptional access, close cooperation with the country authorities should be presumed, and the Board kept fully informed of the state of policy discussions.

Experience with 2002 Conditionality Guidelines

In September 2002, the Board adopted new guidelines to encapsulate ongoing efforts to streamline and focus IMF conditionality. An important objective of the new guidelines was to enhance country ownership and improve the prospects for sustained implementation of Fund-supported programs, most importantly by concentrating the IMF's policy conditions on areas critical to their success.

The second part of the Fund's 2004–05 Conditionality Review examined the initial experience with applying these new guidelines, which had replaced guidelines that dated back to 1979. When Directors met in March 2005,2 they noted that the new guidelines emphasized national ownership of policies, parsimony in conditions, tailoring of policies to member circumstances, coordination with other multilateral institutions, and clarity in the specification of conditions. Although it was too soon to draw definitive conclusions on experience with the guidelines, the review highlighted a number of preliminary findings focusing on structural conditionality and on processes of program development:

  • There is evidence that considerable progress has occurred in streamlining the breadth of coverage (though not the number) of structural conditions and in clearly identifying program-related conditions.
  • There are some encouraging signs of stronger program implementation in the form of fewer permanent program interruptions—although there has been little change in the rate at which programs are temporarily interrupted because of failures to meet conditions.
  • The shift of conditionality away from growth- and efficiency-related structural reforms is a sign of stream-lining, but it will need to be monitored and the implications studied when program outcomes are known. Effective World Bank–IMF collaboration remains crucial in this connection.
  • Care should be taken not to specify conditions at a level of detail that could be seen as unwelcome micro-management—although detailed specification can sometimes be helpful to the authorities.
  • Focusing on the linkages between program goals and conditions is critical, Directors emphasized, as are specifying and explaining in staff reports the strategies underlying conditionality and the basis for deeming measures to be critical. Directors considered that improvements in the elaboration and presentation of clear strategies—which tailor conditionality to country circumstances and capacity and clearly link conditions to program goals in the context of the authorities' broader objectives—can enhance program ownership and implementation.
  • Directors noted that overly ambitious timetables appear to be a major reason for the high waiver rate—the failure of countries to meet performance criteria—and encouraged realistic, but still appropriately ambitious, implementation timetables.
  • In light of the difficulty of gauging program ownership, some Directors saw a role for conditionality, and especially prior actions, as a screening device. However, other Directors observed that higher numbers of prior actions did not bring subsequent program implementation up to the Fund-wide average.

An assessment of structural conditionality in IMF-supported programs by the IEO is scheduled for early 2006. The project is expected to shed further light on these issues. However, Directors agreed that a more comprehensive assessment of the appropriateness of the new guidelines would have to await the availability of data on program outcomes, in both the short and the medium terms, and instructed the staff to return to this issue in 2008. The staff will explore how it can help the Board monitor the application of the guidelines in the interim.

Ex post assessments

In addition to the conditionality review, the adequacy of program design was examined in the course of the IMF's “ex post assessments” of experience in countries in which the IMF has been providing program support over a longer term. Ex post assessments have proven to be a useful vehicle for distilling lessons from experience, for both program design and implementation. The first ex post assessments were conducted in 2003 as part of the IMF's response to the IEO assessment of the prolonged use of IMF resources. A total of 27 ex post assessments have been conducted so far, including 18 during FY2005 (for Albania, Armenia, Benin, Bolivia, Bulgaria, Cambodia, Cameroon, Ethiopia, Guinea, Guinea-Bissau, Kazakhstan, the Kyrgyz Republic, Lesotho, Malawi, Niger, the former Yugoslav Republic of Macedonia, Uruguay, and Vietnam). The lessons drawn from ex post assessments are often widely applicable. For example, a key lesson from the ex post assessment of the PRGF arrangements with Vietnam was the importance of allowing sufficient time for the institutional changes that underpin structural reforms. A comprehensive review of experience with ex post assessments will take place later in 2005. A forthcoming IEO evaluation of IMF assistance to Jordan is also expected to yield insights into program design.

Financial facilities and policies

Following major changes to its lending policies in recent years, the IMF has continued to review many aspects of its lending facilities to ensure that they meet members' needs, including those related to members' growing financial interdependence.

Access policy

In April 2005, the Board conducted its biennial review of members' access to financing from IMF resources in various circumstances, including in the credit tranches (see Table 3.1), under the EFF, and under the PRGF. The review included consideration of the limits on lending by the IMF from the General Resources Account (GRA)—currently 100 percent of a member's quota each year up to a cumulative maximum of 300 percent of quota—as well as the conditions and circumstances that may lead to lending beyond those limits, as set out in the framework for exceptional access. The Board also considered the policies for lending under the PRGF, under which the IMF makes concessional loans to its low-income members.

The Board considered that the criteria for access in individual cases, the access limits in the GRA, and the access limits and norms applying to PRGF resources all remain broadly appropriate. However, a number of Directors felt that member countries' quotas, which provide the basis for determining access, may not always faithfully reflect the size of an economy and, accordingly, should not be viewed as the best metric in all cases.

The review also revisited the policy on exceptional access. Directors recognized that requests for exceptional access can come from members not experiencing capital account crises. Some Directors felt that there would be merit in considering changes to the exceptional access policy to provide greater clarity on the IMF's actions in such cases. However, most Directors believed that, overall, changes to the existing framework of exceptional access were not needed, particularly considering the flexibility to grant access under the exceptional circumstances clause, including in those rare cases where a member could not be expected to meet all criteria. Most Directors agreed that a discussion of exit strategies in program documents would help foster better communication with capital markets and facilitate earlier reaccess, with many Directors calling for a strong presumption that exit strategies would be formulated in the context of a single IMF arrangement.

The Board also conducted a review of maturities and charges in FY2005, which is discussed in Chapter 5.

Activation of Trade Integration Mechanism

The Trade Integration Mechanism (TIM) was established in April 2004 to help developing countries address the short-term effects on their balance of payments of multilateral trade liberalization. The TIM is not a new lending facility but a mechanism making IMF resources more predictably available to qualifying member countries under existing IMF facilities. A major concern in this financial year was the effect that the expiration in January 2005 of the World Trade Organization's Agreement on Textiles and Clothing would have on some developing countries. Bangladesh became the first member country to obtain support in accordance with the TIM, in July 2004, followed by the Dominican Republic in early 2005. At end-April, discussions were under way with a number of other members. The availability of assistance under the TIM should also help assuage concerns of some developing countries that an ambitious outcome to the Doha Round could place undue adjustment pressures on them. (The TIM is also discussed in Chapter 2, Box 2.1.)

Crisis resolution

Despite the best efforts of both member countries and the IMF, not all financial crises stemming from debt-servicing difficulties can be prevented. The Fund has therefore continued its work on improving techniques to resolve such crises, particularly those stemming from debt-servicing difficulties (Box 3.2). The Fund's crisis resolution efforts continue to promote the use of collective action clauses in international sovereign bond contracts; encourage a broadening of the consensus on the draft Principles for Stable Capital Flows and Fair Debt Restructuring in Emerging Markets promoted by the Institute for International Finance; and consider other ways to resolve financial crises in an orderly fashion. The Executive Board issued progress reports to the IMFC on crisis resolution in September 2004 and April 2005.3

Zambia

In April 2005, Zambia became the seventeenth country to reach the completion point under the Heavily Indebted Poor Countries (HIPC) Initiative. Full delivery of HIPC assistance by all creditors will reduce Zambia's debt by $2.5 billion, in net present value terms, allowing Zambia to save about 2 percent of GDP in debt-service payments annually over the next 10 years.

Since Zambia reached the HIPC decision point in December 2000, its economy has grown by an average of 4½ percent a year–a marked turnaround from the economic decline of the previous two decades. Inflation has remained high, however, and the government's domestic debt rose substantially, largely because of expenditure overruns. In 2004, initially under a staff-monitored program and then under a new PRGF-supported program, the authorities achieved a substantial fiscal adjustment, which cut the government's net domestic borrowing by more than 4 percent of GDP, to less than 1 percent of GDP. The fiscal adjustment eased pressure on inflation and interest rates and allowed for a substantial expansion of bank credit to the private sector.

Zambia-IMF activities in FY2005
June 2004Approval of a new three-year arrangement for Zambia under the PRGF
December 2004Completion of the first review of Zambia's PRGF-supported program
February 2005Publication of the Report on Observance of Standards and Codes (module on data transparency)
April 2005Completion of the second review of Zambia's PRGF supported program
Zambia reaches the completion point under the enhanced HIPC Initiative
Publication of joint IMF-World Bank advisory note on the Poverty Reduction Strategy Paper (PRSP) Progress Report

Box 3.2Debt restructuring in the Caribbean: Dominica, Dominican Republic, and Grenada

In the past year, a number of countries in the Caribbean decided to approach their creditors for restructurings of their sovereign debt. The origins of the problems and the degree of debt restructuring differed across countries. In all cases, the IMF has played a key role in the design and implementation of the macroeco-nomic adjustment policies, provided financial assistance, and helped ensure that the restructuring process remains orderly and consistent with best practices. This has included providing–at the country authorities' request–assessments to creditors and donors of the countries' economic conditions, adjustment policies, and prospects.

Dominica determined in late 2003 that its public debt, at about 120 percent of GDP, was unsustainable and, based on this assessment, embarked on a strategy to restructure sovereign debt preemptively, with a view to avoiding unilateral default. Substantial progress has been made–as of end-May 2005, creditors (official and private) holding over 70 percent of eligible debt have agreed to the restructuring. In the case of nonparticipating creditors, although payments on original terms have stopped, good faith efforts continue to be made to reach understandings–the authorities are committed to paying into escrow accounts on restructured terms for such creditors. The Fund is providing financial support to Dominica under a three-year PRGF arrangement approved in 2003. Policy implementation under the program has been strong and macroeconomic outcomes have been favorable–after contracting sharply during 2001-02, the economy grew by 3½ percent in 2004.

The Dominican Republic's economy experienced a crisis in 2003 that was triggered by problems in the banking sector, among other things. The currency depreciated sharply from 20 to nearly 55 pesos to the dollar, and GDP declined by 2 percent during 2003, while inflation accelerated to 29 percent during 2004. Following the country's 2003 Stand-By Arrangement with the Fund, which went off track because of poor policy implementation, the Dominican Republic embarked in 2004 on a robust adjustment program supported by a new Stand-By Arrangement approved in January 2005. Part of the authorities' strategy for addressing macroeconomic imbalances and resolving the country's liquidity problem involves a debt restructuring. Following a period of discussions with creditors, an offer launched in April 2005 to exchange external bonds was well received, with almost 94 percent participation. The country has indicated that it will continue to service debt to nonparticipating creditors. It is also engaged in discussions to reschedule debts to external commercial banks and suppliers. Paris Club creditors provided relief during 2004 and could provide additional relief in 2005.

Hurricane Ivan devastated Grenada in September 2004, causing destruction amounting to over 200 percent of GDP. IMF emergency financial assistance was provided in the wake of the hurricane. Soon after the hurricane, the authorities publicly announced that they could no longer service their public debt, which had reached almost 130 percent of GDP. Supported by donor-financed legal and financial advisors, they are developing a debt-restructuring strategy and maintaining a dialogue with both official and private creditors. Fund staff are assisting the authorities in the design of an economic adjustment program aimed at restoring medium-term viability and debt sustainability.

Collective action clauses

The IMF has taken an active role in promoting the inclusion of CACs—which prevent small minorities of creditors from blocking restructuring deals to which large majorities agree—in international bond issues in all markets, through increased dialogue with sovereign issuers (including during Article IV discussions) and with private market participants. Partly as a result, the use of CACs has become the market standard in international sovereign bonds issued under New York law. In addition, the inclusion of CACs in New York-law bonds has had no observable effect on pricing: no premium seems to have been associated with it. Sovereign issues containing CACs represented over 90 percent of the total value of bonds issued between March 2004 and April 2005. The share of issues with CACs in the total value of the outstanding stock of sovereign bond issues from emerging market countries grew from 39 percent at the beginning of 2004 to 48 percent at the end of April 2005.

Principles for Stable Capital Flows and Fair Debt Restructuring

In November 2004, the Institute for International Finance (IIF) published draft Principles aimed at developing a market-based, voluntary, and flexible framework that would outline standards of behavior and responsibilities for sovereign debtors and their private creditors.4 The draft Principles—whose origins can be traced to earlier proposals for a Code of Conduct—are the result of extensive consultations since early 2003 between several emerging market countries and private groups, notably the IIF. The draft Principles are based on four pillars: (1) transparency and timely flow of information; (2) close debtor-creditor dialogue and cooperation to avoid restructuring; (3) good faith actions during debt restructuring; and (4) fair treatment of all parties.

The draft Principles have received support from a number of emerging market issuers and private creditor associations, although market views are varied. While supporting the drafting of such Principles, the Fund has left their specification to sovereign debtors and their creditors, since the effectiveness of voluntary rules hinges critically on their acceptability to the affected parties.

While the draft Principles can be applied in a manner consistent with the Fund's lending into arrears (LIA) policy, in practice, differences arise in a few areas. For example, the draft Principles call for a resumption of partial debt service, to the extent feasible, as a sign of good faith to facilitate a restructuring. However, such payments are not a feature of the Fund's good faith criterion under the LIA policy. Despite these differences, the draft Principles are, in most respects, consistent with IMF policies. Looking ahead, while there is uncertainty on how the process of further broadening the consensus among issuers and the investor community would evolve, efforts to integrate the draft Principles into policies adopted by debtors and creditors would be welcome.

Evian approach

The Evian approach—a flexible approach adopted by the Paris Club in October 2003, following the agreement reached at the G-8 Summit of June 2003 in Evian, France, for addressing debt sustainability concerns of non-HIPC countries—continued to evolve in FY2005. Under the Evian approach, Paris Club creditors agreed that they would participate in a comprehensive debt treatment for non-HIPC countries that have debt deemed to be unsustainable by the Paris Club, that are committed to policies that will secure an exit from the Paris Club in the framework of their Fund arrangements, and that will seek comparable treatment from their other external creditors, including the private sector. The Paris Club decision on the appropriate extent of debt relief to be provided will be informed by the Fund's debt sustainability analysis.

In April–July 2004, the Paris Club provided flow reschedulings to the Dominican Republic, Gabon, and Georgia under the Evian approach. In November 2004, Paris Club creditors reached an agreement with Iraq on a comprehensive restructuring of its public external debt. And, in March 2005, the Kyrgyz Republic received a comprehensive debt treatment from the Paris Club.

In another move, Paris Club creditors decided in January 2005 to offer a temporary deferral of debt payments to countries affected by the December 2004 earthquake and tsunami. Creditors emphasized that they expect the resources freed by this deferral to benefit directly the populations affected by the tsunami. Given the exceptional circumstances, traditional Paris Club principles will not apply to the deferral. More specifically, there is no requirement of an accompanying Fund arrangement, nor is there any expectation of comparable treatment from other creditors.

Looking forward

The IMF's lending function continues to make an essential contribution to the reestablishment of external viability and economic stability and therefore to sustainable growth in member countries. The institution's traditional role of providing financing to help smooth the adjustment of temporary current account imbalances remains vital for many countries, while for others the IMF's main task is to help prevent or mitigate capital account crises and contagion. Strong ownership and institutional backing remain key for the success of IMF-supported programs, while the IMF, for its part, needs to be selective in supporting only programs that put members firmly on the road to external viability.

In their March 2005 discussion of the Fund's medium-term strategy, Directors looked forward to further reflection on how the needs of members could be met through Fund arrangements, and whether new instruments or revisions to existing facilities were needed. Many felt that further progress needed to be made toward reaching clearer understandings on the appropriate circumstances and scale of IMF lending, and a number of Directors stressed the importance of specifying eventual exit strategies from IMF financial support. Directors also exchanged views on instruments that could meet the needs of members who wished to signal their adherence to sound policies or that could provide a degree of insurance against potential crises. Regarding the appropriate role of the IMF in helping to resolve financial crises, there was recognition of the role of market-based mechanisms as well as interest by a number of Directors in a clearer and more consistent role for the IMF in sovereign debt restructuring and assessment of the adequacy of the instruments available for this purpose. In particular, some Directors called for an early discussion of the Fund's policy on lending into arrears.

1The Board's discussion is summarized in Public Information Notice No. 05/16, www.imf.org/external/np/sec/pn/2005/pn0516.htm; the staff papers include “The Design of Fund-Supported Programs—Overview,” www.imf.org/external/np/pdr/2004/eng/design.htm; “Fund-Supported Programs—Objectives and Outcomes,” www.imf.org/external/np/pdr/2004/eng/object.htm; and “Macroeconomic and Structural Policies in Fund-Supported Programs: Review of Experience,” www.imf.org/external/np/pdr/2004/eng/macro.htm.
2The Board's discussion is summarized in Public Information Notice No. 05/52, www.imf.org/external/np/sec/pn/2005/pn0552.htm; the staff papers include “Review of the 2002 Conditionality Guidelines,” www.imf.org/external/np/pp/eng/2005/030305.htm; and “Review of the 2002 Conditionality Guidelines—Selected Issues,” www.imf.org/external/np/pp/eng/2005/030405.htm.
3“Progress Report to the International Monetary and Financial Committee on Crisis Resolution,” September 28, 2004, www.imf.org/external/np/pdr/cr/2004/eng/092804.htm, and “Progress Report to the International Monetary and Financial Committee on Crisis Resolution,” April 12, 2005, www.imf.org/external/np/pp/eng/2005/041205.htm.
4For the current version of the Principles, see www.iif.com/data/public/Principles.pdf.

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