The Fund in 1989/90
- International Monetary Fund
- Published Date:
- January 1990
Fund surveillance over the policies of its members, mainly through Article IV consultations and regular discussions on the world economic outlook, remains the central activity of the Fund. The Fund also continues to monitor the international monetary system and to promote conditions conducive to a healthy world economy.
The Executive Board attributes the moderation in world economic activity in part to monetary policies aimed at easing pressures on productive capacity and controlling inflation. There is concern over inflation in the industrial countries, and a relaxation of the cautious monetary stance is not warranted at this time. Fiscal policy should play a more important role to complement monetary policy. A continued reduction of external imbalances is needed. The fall in saving rates in some industrial and developing countries could have serious implications for economic welfare.
Continued constraints on external financing underscore the importance to developing countries of sustaining sound domestic policies. Heavily indebted developing countries, in particular, must boost saving and investment, and adopt structural reforms. For the Eastern European economies, the transition to market-oriented economies is likely to involve short-term adjustment costs. This process should be accompanied by monetary and fiscal policies to foster a stable economic environment.
The Fund is mandated to “exercise firm surveillance over the exchange rate policies of members” to help assure orderly exchange arrangements and to promote a stable exchange rate system. It carries out this responsibility with the active participation of its member countries. Fund surveillance consists of an ongoing monitoring and analysis of a broad range of domestic and external policies affecting, in particular, members’ price and growth performance, external payments balances, exchange rates, and restrictive systems. At its May 1990 meeting, the Interim Committee reaffirmed the importance of Fund surveillance “as a means for promoting economic policies in members that are conducive to sustainable economic growth and improved global welfare.” The pursuit of sound economic policies by member countries, in the Interim Committee’s view, “is a prerequisite for effective international economic cooperation.”
The Fund fulfills its surveillance responsibilities in two principal ways. First, and primarily, the Board examines in depth each member’s economic policies and performance. These examinations are based on staff reports, which are developed in regular consultations with the authorities of member countries. Second, the Board holds regular discussions on the world economic outlook; these allow for reviews of members’ policies from a multilateral perspective and for systematic monitoring and analysis of the global economic situation. In addition, the Board holds periodic discussions on exchange rate developments in major industrial countries. The Fund also fulfills its surveillance responsibilities through the Managing Director’s participation in Group of Seven meetings—to which he brings a global perspective that helps in analyzing international policy interactions and which encourages national authorities to consider the global consequences of their domestic policies. Technical assistance is given to member countries on exchange rate policies and exchange systems.
Fund surveillance plays a role in fostering more consistent and disciplined economic policies on the part of its members. The Fund contributes to policy coordination among the major industrial countries through its work on key economic indicators and on medium-term scenarios. The Fund staff prepares medium-term projections for a range of indicators that are being used as a basis for monitoring and reviewing the policies and performance of the large industrial countries. These indicators—which the Fund has been working on since 1986—include real growth of GNP or GDP, growth of real domestic demand, gross private investment, GDP deflators, general government financial balances, current account balances, and primary commodity prices. They also include structural policies that are consistent with the central macroeconomic focus of surveillance. The staff prepares, for Board consideration, medium-term scenarios to illustrate the effects of alternative policy paths and to help identify potential conflicts that may need to be addressed by policymakers.
Both the Board and the Interim Committee have directed the staff to continue analyzing developments and key issues in the functioning of the monetary system, with a view toward identifying improvements. At a June 1990 seminar on international monetary issues, Directors reaffirmed this objective. Enhancing the Fund’s role in the monetary system, they agreed, depends mainly on the quality of its surveillance.
Box 2The IMF Executive Board, the Interim Committee, and the Development Committee
The Executive Board (the Board) is the Fund’s permanent decision-making organ, currently composed of 22 Directors appointed by member countries or elected by groups of member countries. Chaired by the Managing Director, the Board normally meets several days a week to conduct the business of the Fund. Prior to reaching decisions, it discusses papers prepared by the Fund management and staff. In 1989, about half of the Board’s time was spent on country matters (Article IV consultations, the review and approval of arrangements) and much of the remaining time on policy issues (such as surveillance, the debt strategy, and quotas).
The Interim Committee of the Board of Governors on the International Monetary System is an advisory body made up of 22 Fund Governors, ministers, or others of comparable rank, representing the same constituencies as in the Fund’s Executive Board. The Interim Committee normally meets twice a year, in April or May and at the time of the Annual Meetings in September or October. It advises and reports to the Board of Governors on the latter’s functions of supervising the management and evolution of the international monetary system, considering proposals by the Fund’s Executive Board to amend the Articles of Agreement, and dealing with sudden disturbances that might threaten the international monetary system; the Interim Committee also advises the Fund’s Executive Board on these matters.
The Development Committee (the Joint Ministerial Committee of the Boards of Governors of the Bank and the Fund on the Transfer of Real Resources to Developing Countries) is composed of 22 members—finance ministers or others of comparable rank—and generally meets in conjunction with the Interim Committee. It advises and reports to the Boards of Governors of the Bank and Fund on all aspects of the transfer of real resources to developing countries.
The Board shared the view that exchange rates alone cannot serve as a nominal anchor against inflation for the international monetary system; rather, the achievement of price stability is mainly the responsibility of the monetary authorities of each country. The growing importance of Europe and Japan precluded a return to a Bretton Woods-type system in which global price stability depended entirely on the United States; a few Directors saw the three largest industrial countries as forming the nucleus of a “low-inflation club,” although others felt this responsibility should be shared more widely. There was broad agreement that a well-disciplined fiscal policy had to be an important ally of monetary policy in promoting sustained, noninflationary growth. There was also wide support for the view that rigid rules to guide monetary policy could prevent adequate responses to unforeseen circumstances.
In discussing the possibility of distinguishing between “good” and “bad” current account imbalances, a number of Directors noted that this depended on the source of the imbalances. Several Directors, however, questioned the feasibility or desirability of identifying good and bad external imbalances, since the multilateral nature of the external adjustment process would inevitably involve adjustment of both types of imbalances. The view was expressed that current account imbalances could not be evaluated without looking at global saving and investment needs. There was concern that policies aimed at reducing imbalances should take into account the need for increased global saving; another view was that it was no less compelling to ensure that the process of external adjustment does not have a deflationary impact on the global economy, and that this suggested the need to adjust both types of imbalances.
In assessing the experience to date with managed floating, some Directors were of the view that exchange rate determination should not be left exclusively—or even predominantly—to the markets, owing to their sensitivity to transitory developments. Advocates of this view pointed to the European Monetary System’s experience with progressively greater exchange rate stability as having positive lessons for managing the monetary system. Other Directors emphasized that exchange market stability was not synonymous with exchange rate fixity, and that such stability had to follow from—instead of lead—internal stability.
On regional integration, the Board welcomed the progress toward monetary and economic union in Europe and toward free trade in North America, with some Directors seeing the international monetary system evolving in a tri-polar direction. The Board cautioned that greater regional integration should be seen as a step toward—and not a substitute for—greater global integration.
Directors reaffirmed the important role that policy coordination had played in sustaining the long-running, noninflationary expansion in the industrial world and in promoting greater exchange rate stability. They share the view that further improvements in the analytical framework underlying policy coordination may be possible through a better understanding of the determinants and macroeconomic implications of international capital flows, and the staff is engaged in work on this issue.
With respect to medium-term scenarios, a number of Board members believed that although these are useful in analyzing and understanding the international implications of major economic developments and policy initiatives, their limitations must be recognized. The Board emphasized the need to continue focusing on structural issues in Article IV consultations and in the analyses for the World Economic Outlook. It also welcomed the staff report’s attention to demographic issues, as these provide a useful long-term perspective on the stance of fiscal policies and the evolution of external imbalances.
Box 3Structural Adjustment Defined
In recent years, policymakers in industrial countries seeking to strengthen the performance of their economies over the medium term have recognized not only that traditional macroeconomic policies need a medium-term orientation, but also that the way their economies function needs to be improved. A number of industrial countries have taken important steps toward improving efficiency, including major tax and financial reforms, privatization, and measures to enhance the flexibility of labor markets. These structural reforms should enhance productive potential and facilitate an improvement in economic performance and in living standards.
Two broad categories of structural measures can be identified:
(1) Measures that eliminate the inefficient use of resources and allow more rapid adjustment to technological innovation and changes in relative prices. Such measures remove rigidities impeding the mobility of resources—such as institutional or regulatory barriers to the mobility of labor—and eliminate price distortions and taxes that distort private saving and investment decisions.
(2) Measures that increase output potential by adding to productive resources (such as capital and labor) or by raising overall productivity. Examples include promoting research and development, and applying technical knowledge more effectively to production.
Article IV Consultations
Fund staff meet regularly with the authorities of each member country to gather current economic and financial information and to review economic policies and developments. These consultations are required under Article IV of the Fund’s Articles of Agreement, or charter. They enable the Fund to analyze economic developments and policies in member countries; to examine members’ fiscal and monetary policies and performance, and balance of payments situation; and to assess the impact of policies—including exchange and trade restrictions—on members’ exchange rates and external accounts. In addition, consultations help draw attention to the international implications of policies and developments in the economies of individual countries. They also permit the Fund to deal promptly with members’ requests for the use of Fund financial resources and with proposed changes in policies or practices that are subject to Fund approval. Article IV consultations enable the staff and the Board to draw on, and learn from, the broad experience of the membership over an extended period of time.
The substance of Article IV consultations depends on the characteristics of the member country and on the prevailing external economic environment. In recent years, increasing attention has been devoted to determining whether a country’s balance of payments position can be sustained over the medium term and to ways that structural policies can enhance economic performance—and, in particular, promote higher savings (see Box 3).
Article IV consultations may be held annually, or at intervals of up to 24 months, depending on the member country. Under the “bicyclic” procedure—introduced in 1987 to help reduce the frequency of Board discussions while ensuring the quality of surveillance—a full consultation, including a Board discussion, is held every second year and an interim staff consultation in the intervening year, with a report submitted to the Board for consideration.
In 1989, 99 full consultations were completed, covering 65 percent of the Fund’s total membership. This compared with 110 consultations in 1988, covering 74 percent of members. The number of consultations declined in 1989 for the fourth successive year, following their peak of 131 in 1985. The decline in the number of full consultations last year reflected in part an increase in the number of countries on the bicyclic schedule (14 simplified interim discussions were held in 1989, as against 11 in 1988); it also reflected a rise in the number of countries without consultations for over two years (10 members, versus 6 in 1988), as efforts to combine consultations with ongoing program discussions involved some delays.
The U.S. economy continued to expand in 1989, marking its seventh consecutive year of growth. Inflationary pressures rose during 1988 and into early 1989, against the backdrop of a high level of resource use. In the second half of 1989, however, such pressures appeared to have abated somewhat. Although the economy showed signs of slowing, a recession did not appear imminent. At its September 1989 meeting to discuss the U.S. consultation report, the Board saw the key challenge facing the United States to be that of laying the basis for sustained growth while pursuing external adjustment and an improved price performance. Policy needed to focus on boosting national savings to facilitate strong growth of net exports and capital formation. At the same time, Directors believed that monetary policy had to be aimed at lower inflation, with additional structural measures required to remove market distortions, particularly those affecting private saving and international trade. The Board stressed the role of decisive fiscal action in raising national savings. While it commended the progress in reducing the fiscal deficit over the past few years, the Board did not envisage a further sizable reduction under the current budget plan, and many Directors saw a need for substantial additional measures. The Board agreed with the authorities that, in formulating measures to reduce the deficit, emphasis should be placed on restraining expenditures. But, owing to the size of the deficit, there was some support for considering measures to raise revenues, for example, by eliminating certain tax preferences. Priority also has to be given to promoting private saving, for example, by eliminating disincentives, and the Board welcomed the authorities’ policy review under way.
The external deficit was a major source of vulnerability. An increase in national savings, achieved mainly through fiscal restraint, was, in the Board’s view, the key to further reductions in the external deficit. Convincing action in the fiscal area would also bolster international policy coordination. With all countries playing their part, policy coordination represents the most effective means for correcting external imbalances in the context of sustained world economic growth and price stability.
The Board commended the U.S. authorities for their flexible and cautious conduct of monetary policy. A majority view held that the Federal Reserve would be well advised to continue focusing mainly on inflation control since the abatement of cost and price pressures was not yet fully confirmed. Directors agreed with the authorities that monetary policy could best contribute to maximum, sustainable growth over time by fostering price stability. At the same time, the Board stressed the need for complementary fiscal action and measures to dismantle obstacles to the freer play of market forces. Such action would help monetary policy achieve price stability without major rises in interest rates, which would hurt investment and exports and pose problems for the highly indebted countries.
The Board was concerned that the Trade Act of 1988 might be implemented in a protectionist manner and urged the authorities to resist protectionist pressures and continue to play a leadership role in global efforts toward multilateral trade liberalization. On the developing country debt problem, the Board welcomed the major role played by the United States—especially the recent initiatives featuring debt and debt-service reduction—but stressed the need for the larger industrial countries to buttress these efforts by ensuring strong growth of the world economy and of international trade.
Japan’s economy continued to experience rapid growth in 1989-90, based on domestic demand, and its external current account surplus declined sharply. At the same time, inflation remained low. The Board, at its July 1990 discussion of Japan, commended the authorities’ pursuit of steady and prudent financial policies, which had supported the economy’s outstanding performance. The financial markets appeared to have stabilized after turbulence in the early months of 1990 and the economic outlook was generally favorable.
Although inflation remained low, Directors urged the authorities to contain upward pressure on prices and maintain steady growth on the strength of domestic demand. At the same time, there was broad support for the view that strong emphasis should be placed on the bold pursuit of structural policies, particularly those that would help improve living standards, improve access to Japanese markets, and reduce rigidities and distortions in the economy and in the financial system. Directors welcomed the rise in interest rates since early 1989. They observed that the rates of money and credit growth had increased markedly in recent months, aggregate demand had continued to rise rapidly, and the labor market remained tight. Thus, continued vigilance was needed in conducting monetary policy.
The Board commended the authorities for achieving their fiscal consolidation targets in the 1990/91 fiscal budget and noted that fiscal policy in the past few years had helped alleviate the pressure on resources in the face of robust growth of private domestic demand. There was wide support for the broadly neutral fiscal stance planned for the current fiscal year. In general, the Board supported a continuation of fiscal consolidation efforts over the medium term in view of the prospective pressure on the fiscal position that would emerge with the aging of the population. Several Directors, however, pointing to the need for investment in social infrastructure, cautioned against a too restrictive fiscal stance.
Directors welcomed the progress made in financial liberalization and tax reform but stressed the need for further deregulation of interest rates and a faster pace of structural reform in other areas. In particular, measures to eliminate distortions in agriculture, land management, and the retail sector would not only increase welfare at home and abroad but would also help reduce trade tensions. In the trade area, Directors looked to Japan to show leadership in helping to reach a successful conclusion of the Uruguay Round of trade negotiations. Directors generally agreed that the social infrastructure of Japan should be improved.
Concerning the role of Japanese savings in promoting global growth and adjustment, the Board saw a need for a further reduction in international payments imbalances and felt that the question of the adequacy and distribution of world saving should be analyzed in a global framework.
The economy of the Federal Republic of Germany continued to expand strongly in 1989, while the role of the deutsche mark as an anchor against inflation was sustained both in the European Monetary System and in a global context. Unemployment fell significantly and an investment boom was providing much-needed new productive capacity. The rapid growth, however, had been mainly export led and had coincided with a stalling of external adjustment; indeed, the external surplus widened in 1989. The strength of exports was largely attributed to buoyant growth in the economies of trading partners and to a real depreciation of the deutsche mark. With prevailing policies, the large external imbalances among the industrial countries were not likely to narrow appreciably. In this connection, the Board, at its July 1989 discussion of Germany, stressed that although responsibility for reducing external imbalances among the industrial countries varied from country to country, all major countries had to contribute to the adjustment.
The German economy was approaching capacity limits, particularly in the export-oriented sectors, and the depreciation of the deutsche mark may have added to inflation. Given the country’s high capacity use, most Directors saw little scope at that time for macroeconomic policies to reduce Germany’s external surplus by stimulating domestic demand. This underlined the importance of effective policy coordination among deficit and surplus countries in the industrial world. Some Directors noted, however, that fiscal policy could still play a role in reducing external imbalances and that monetary caution should not be pushed too far. The Board emphasized the need for vigorous action in the structural policy area. Such action, supported by appropriate macroeconomic policies, could help reduce the external surplus, mitigate inflationary risks, and stimulate jobs.
The tightening of monetary management in the second half of 1988 and the first half of 1989 was seen as appropriate in order to stabilize expectations. There was some Board sentiment, however, that inflation risks not be overstated. On fiscal policy, the Board reiterated its concern about the timeliness of raising taxes in 1989 between two years of significant tax reduction; a number of Directors believed that lowering subsidies would have been a better way to reduce the deficit in 1989. At the same time, the Board welcomed the sizable tax reduction and reform to come into effect in January 1990.
With regard to structural policy, progress was achieved in some areas, but Germany needed to take a leading role in promoting trade liberalization and reducing structural rigidities. The Board called for additional initiatives to reduce trade barriers, remove subsidies, deregulate labor markets and reform financial markets, and proceed further with tax reform. These measures would strengthen the nontraded goods sector and lessen the economy’s dependence on exports to sustain growth. They would thereby enhance the economy’s flexibility in responding to external shocks and boost potential output.
The Board discussion did not take into account the possible consequences of monetary and economic unification between the Federal Republic of Germany and the German Democratic Republic. It is expected, however, that this process will contribute to improved noninflationary global growth and to a reduction of external imbalances. This process would also contribute to positive economic developments in Eastern Europe, which are supported by the international community.
Economic growth in France improved markedly in 1988-89, registering the highest annual growth rates in ten years. This growth was led by a resurgence of private investment and exports and was accompanied by a fall in unemployment; a continued decline in inflation relative to trading partners; a narrowing of long-term interest rate differentials, indicating a gathering of confidence in the franc; and a current account deficit that remained small despite strong domestic demand. The Board, at its August 1989 discussion of France, credited these favorable developments largely to the economic strategy pursued since 1983. This strategy combined wage and financial restraint to curb inflation and restore the profitability of enterprises with supply-oriented structural reforms, particularly in the labor and financial markets. The steadfast implementation of the strategy and its greater market orientation had considerably heightened confidence in the economy.
The Board believed that the authorities’ commitment to maintaining the parity of the franc against the deutsche mark constituted a strong anchor for the economy and an effective device for conditioning domestic policies and private sector behavior. The hard-currency policy was especially suitable in view of the high level of resource use and the incipient inflationary pressures. The Board also supported the authorities’ moderately restrictive fiscal stance.
Continued high unemployment, however, was a problem. It pointed to the need for further structural reforms and policies that stimulated productive investment. It was vital, in the Board’s view, for France to take steps to boost domestic saving. On fiscal policies, the authorities needed to keep the growth of spending below that of GDP—partly to afford room for tax reform—and to make the tax system simpler and more competitive. Similarly, the functioning and economic effects of the social security system merited re-evaluation. Added flexibility of labor markets was also necessary. In the Board’s opinion, labor productivity could be enhanced over the medium term through reforms of official employment schemes and greater emphasis on education and vocational training.
Finally, the authorities needed to strengthen competition within the economy. In domestic markets, the ease of entry for new firms had to be enhanced by removing restrictive regulations and noncompetitive market practices. As for industrial and trade policies, the Board welcomed the authorities’ greater market orientation, but felt that more needed to be done. The authorities were urged to eliminate subsidies to industry and assign a high priority to removing nontrade barriers. In this connection, it was noted by a number of Directors that the agricultural, automobile, and financial services sectors seemed to be exceptions to the multilateral approach. The Board encouraged the authorities to reduce protection of domestic sectors through both national and European Community trade and industrial policies. It also urged France to take a leading role in promoting an open trading system for the single market of the European Community and for the world as a whole. The authorities were commended for their recent debt initiatives and for their intention to raise official development assistance to the internationally agreed target.
U.K. economic activity slowed in 1989, in response to a marked tightening of financial policies aimed at reversing the rise in inflation. Consumption and residential construction slowed; business fixed investment also decelerated but still sustained considerable momentum. While commending the authorities’ efforts to curb excess demand pressures, the Board, meeting in March 1990, expressed concern about continued high inflation and the current account deficit (which widened to 4 percent of GDP in 1989), and, in this context, the sharp drop in household savings. On the basis of existing policies, the Board expected that real growth would fall further in 1990, with real domestic demand remaining broadly unchanged from 1989. This would improve prospects for a significant narrowing in the current account deficit—signs of which had already appeared.
Nonetheless, the Board in its discussion in March expressed concern that inflation had not yet peaked and might not decline as rapidly as envisaged by the authorities. The acceleration of wage increases in 1989 and the cyclical decline in productivity were also noted. In addition, the projected slowdown in labor force growth suggested that the labor market would remain tight for some time, while the sizable depreciation of the pound in 1989 had not yet fully fed through to prices. The Board agreed with the authorities that a quick and substantial reduction in inflation remained the policy priority, especially given the United Kingdom’s commitment to participate fully in shaping European plans for monetary and economic unification.
While monetary policy had been tightened progressively and significantly since mid-1988, the underlying strength of demand had proved stronger than originally forecast. As a result, inflationary pressures had also been stronger than originally forecast. There were, however, mixed views in the Board on the need for further tightening. On the exchange rate, the Board viewed the maintenance of a strong pound over time as an essential element in the effort to reduce inflation.
Although monetary policy was the main instrument for tackling inflation, it needed to be strongly supported by continued fiscal restraint and further structural reform. The Board commended the cautious fiscal stance of recent years. It urged continued caution in 1990/91. Some Directors argued that the authorities should aim for another large budget surplus in 1990/91. This could best be achieved by again postponing significant tax reduction and by introducing measures to promote the ongoing tax reform, particularly broadening the base. The scope for the desired reductions in the tax burden would depend on continued expenditure restraint.
On the structural front, the Board urged the authorities to continue pursuing improvements in the functioning of the labor market and in other areas. The Board welcomed the measures taken to reduce trade barriers in recent years and encouraged further progress in this regard. It also encouraged the authorities to continue working toward a liberal outcome in the Uruguay Round of multilateral trade negotiations and in the formation of a single European market.
Italy’s economy continued to perform well in 1989, sustaining the favorable trend of recent years. Output growth slowed but stayed buoyant; employment increased; investment held strong; and exports grew sharply and expanded their market shares. The current account deficit widened, but it remained manageable. Efforts to strengthen public finances, however, were insufficient. Despite favorable cyclical developments in the economy, the large fiscal deficit fell only modestly relative to GDP.
The Board discussed the Italian Article IV report in March 1990, at which time it commended the stance of monetary and exchange rate policy, which helped ease inflationary pressure and thus contain the fiscal deficit’s negative impact on the economy. Nonetheless, the high real interest rates that were necessary to finance the public deficit, and to restrain aggregate demand, posed risks for private investment and output growth.
Directors welcomed the measures taken in 1989 and 1990 to liberalize capital movements and to move the lira to the narrow band of the exchange rate mechanism (ERM) of the European Monetary System. European integration, however, requires a convergence of performance and harmonization of policies; thus, significant and rapid progress is needed to further reduce inflation differentials between Italy and its major European partners. The constraints imposed on monetary policy by the ERM showed up in high interest rates, heavy net capital inflows in 1988 and 1989, and in a substantial increase in Italian official reserves; the Board cited the authorities’ success in neutralizing the effects on the monetary aggregates of these inflows. It was noted that constraints imposed on monetary policy would increase as the process of European integration proceeded, further underscoring the importance of fiscal adjustment.
The size of the government debt, which was approaching that of GDP, and its short-term maturity, continued to pose financial risks. Although the Board welcomed the authorities’ medium-term fiscal adjustment program, it emphasized that the program’s deficit targets needed to be seen as minimum requirements, with slippages to be avoided. Indeed, Board sentiment favored a faster pace of adjustment, with a greater front-loading of measures. This would help stabilize and bring about a steady decline in the debt-to-GDP ratio. Efforts to reduce the fiscal deficit should focus on reducing government spending, rather than on boosting indirect taxes. The health, pensions, and transport systems were cited as particular sources of imbalance. Privatization could also assist the fiscal adjustment while at the same time helping improve resource allocation. On the tax front, the Board encouraged the authorities to sustain their efforts to improve tax administration and to enhance compliance.
Directors were concerned about Italy’s high and persistent unemployment. The problem was closely related to the increasingly divergent labor market conditions in the north and south of the country. These differences—with near-full employment in the north and high unemployment in the south—could be addressed by regional differentiation in wage rates and the removal of constraints preventing labor market flexibility and labor mobility.
The Board noted that while the saving propensity of households had remained relatively high, it had fallen in the last few years. This would have potentially adverse implications for the foreign accounts in the absence of fiscal adjustment. The Board commended Italian efforts to liberalize imports in 1989 and encouraged continued progress in this area. It also commended the increase in Italy’s official development assistance.
The Canadian economy continued to expand in 1989, paced by strong growth of output and employment. The high level of resource use evident since mid-1988, however, had led to an acceleration of inflation, upward pressure on interest rates, and a widening current account deficit. The authorities responded appropriately by taking steps to curb the momentum of demand growth and to strengthen the economy’s supply potential. These included deficit-cutting measures in the April 1989 budget, continued monetary restraint, and structural reforms in a number of areas.
The Board, meeting in early February 1990, expressed the belief that structural reforms promised a more rapid growth of potential output over the medium term, but that any such growth in line with expectations required an appropriate macroeconomic policy framework. In this connection, measures to bring demand into better alignment with supply had to be intensified, with less of a burden placed on monetary policy and more on fiscal policy. The Board was concerned about Canada’s fiscal prospects. The deficit estimated for 1989/90 was large and, in view of the high level of resource use, could widen further. Therefore, although the fiscal measures in the April 1989 budget were sizable, the Board favored their reinforcement through further substantial action. Canada needed to aim for steady reductions in its fiscal deficit and also at a firm decline in its debt-to-GDP ratio. The budget for 1990/91 presented in February 1990, following the Board discussion, included significant expenditure-reducing measures. Through the Expenditure Control Plan, the substantial expenditure actions taken in the budget reinforce the momentum of earlier measures and help to ensure that the goals of the April 1989 budget will be reached.
The tight stance of monetary policy during 1989 was appropriate given the strong pressure on resources and the upturn of inflation. Interest rates would need to remain high until inflationary pressures showed clear signs of abating. At the same time, heavy reliance on high interest rates could have adverse consequences for the exchange rate and international competitiveness, as well as for domestic investment. This underscores the important need for substantial fiscal action to complement monetary restraint. The recent rise in the current account deficit also points to the importance of corrective fiscal action to curb domestic demand and lessen the upward pressure on the real effective exchange rate of the Canadian dollar.
The Board commended the authorities’ substantial structural policy measures and their plans to press further ahead. The proposed sales tax, for example, promises long-run efficiency gains. Reform of the unemployment insurance system should improve the functioning of labor markets and have a positive budgetary impact, but obstacles to the interregional mobility of labor remained. The trend toward increasing farm subsidies in the 1980s was unfortunate, and Directors favored a greater market orientation in this area.
The Board welcomed the progress in implementing the Canada-U.S. Free Trade Agreement as well as Canada’s commitment to multilateral trade liberalization through the Uruguay Round of multilateral trade negotiations. It urged the authorities to take further steps to reduce trade barriers and hoped that the review of restraints on textile imports would result in reduced protection in this area.
Smaller Industrial Countries
Themes similar to those for the larger industrial countries were raised in Article IV consultations with the smaller industrial countries. Discussions underscored the need for a sustained pursuit of sound macroeconomic policies with effective structural reforms to enhance overall efficiency and competitiveness.
The Board commended most of the smaller industrial countries for achieving relatively strong rates of economic growth with—in most cases—moderate inflation in 1989. Directors welcomed the sustained pursuit of greater financial and price stability by many countries and their efforts to liberalize trade policies and financial markets; for several countries, such efforts were in preparation for the monetary and financial integration under the Europe 1992 program.
A common theme of Board discussions, however, was the need for added fiscal restraint to reduce large deficits. Such restraint—which in most cases needed to be achieved mainly by spending cuts—was necessary to complement the relatively restrictive monetary policy followed by many countries. Another theme was the persistence of high unemployment in many countries, which needed to be addressed by reducing labor market rigidities. On the structural front, a number of countries needed to enhance the productivity of investment and give wider scope to market forces and to continue efforts at financial liberalization and tax reform. For several countries, reductions in trade barriers were necessary, particularly with respect to products imported from developing countries.
The less favorable global environment in 1989 and the continued constraints on external financing underscore the importance for the developing countries of adopting and sustaining sound domestic policies. Accordingly, the Board welcomed the cautious budget and monetary policies followed by many developing countries in 1989, in view of the inflationary risks they confronted. These policies were accompanied, in many cases, by substantive programs of structural and financial reform. A large number of developing countries took steps to achieve more efficient resource management and to give wider scope to market forces. These adjustment efforts in developing countries require the maintenance of a favorable external international environment and an adequate flow of financial resources.
In view of the extent of the structural and financial problems in some developing countries, their limited resources, and, in many cases, rapidly growing populations, economic adjustment has to be sustained and extended. Discussions with a number of countries cautioned against a stop-go or partial approach to making adjustments. At the same time, Article IV consultations in 1989/90 gave increasing attention to the social consequences of corrective policies, and, specifically, to measures that target assistance to the poorest and most vulnerable groups. In this connection, the achievement of high rates of economic growth and better economic conditions is vital to alleviate poverty and to meet basic needs.
In the Board’s view, the situation of most of the highly indebted developing countries remains extremely difficult, which underscores the need for domestic policies aimed at increasing savings and enhancing productive investment. While a number of indebted countries have strengthened domestic policies, in several countries in the Western Hemisphere and Europe the costs of earlier policy slippages are now evident. The indebted developing countries, in general, need to pursue macro-economic policies designed to increase domestic savings, reduce inflation, and foster capital formation and long-term growth. They also need to adopt structural policies to allocate resources more efficiently and to promote stable growth over the medium term. Efforts to liberalize investment regimes and encourage the repatriation of flight capital are important. A reduction of external debt, in conjunction with strong policies, would contribute to a resumption of growth.
The specific policies needed to strengthen economic performance in the developing countries depend, of course, on the circumstances of each country. In general, however, the Board in its Article IV consultations frequently stresses the importance of limiting public spending by restraining public sector wages and employment, reducing subsidies, and cutting back on transfers to public enterprises. In some cases, greater efforts are needed to broaden tax bases, improve tax administration, and lower marginal tax rates. Reduced fiscal deficits are a critical objective in that they help curb inflation and prevent a crowding out of private investment. Also important is the need to sustain structural adjustment to enhance the supply of productive resources. The determined implementation of structural measures helps to encourage a recovery of saving and investment, relieve infrastructural bottlenecks, and make tax systems and public enterprises more efficient. Moreover, structural measures—in addition to giving greater attention to increasing export diversification—help strengthen the external positions of developing countries.
Exchange rate policies remain a central aspect of Article IV discussions with developing countries. In practice, the exchange rate practices and systems of members are quite diverse. Some countries peg their exchange rates to other currencies with high degrees of stability, which serves as an anchor against inflation. If exchange rates get out of line with underlying economic fundamentals, leading to a loss of competitiveness, adjustments are called for. Moreover, exchange rate changes and policies must be supported by adequate macroeconomic policies, otherwise they will not address the problem of competitiveness and may feed a spiral of devaluation, wage increases, and accelerating inflation.
In general, the Board welcomed the greater realism of exchange rate policy in many developing countries, evidenced by measures to unify exchange rates and allow greater scope for market forces in their determination. A more flexible exchange rate policy is important for encouraging export diversification and promoting an efficient allocation of foreign exchange. The positive exchange rate measures undertaken in many countries are often coupled with efforts to eliminate exchange and trade restrictions and improve external debt management. In certain developing countries, however, exchange rate management remains inflexible, with some countries continuing to maintain overvalued currencies and multiple exchange rates. A number of countries need to adopt a more prudent approach to external debt management, while countries with outstanding external payments arrears have been asked to make stronger efforts to eliminate these.
Other common themes of recent consultations with developing countries include the need to adopt flexible and realistic pricing and interest rate policies; increase the profitability of public enterprises or privatize or eliminate unprofitable enterprises; reduce administrative controls and give wider scope to private sector activity; control expenditures; reduce nontargeted subsidies; proceed with financial restructuring to improve financial intermediation; encourage foreign direct investment; and remove exchange and trade restrictions.
Eastern European Economies
In the early postwar period, economic growth in Eastern Europe and the U.S.S.R. was roughly comparable to that in the industrial-market economies. This was due to large increases in labor and capital inputs and to readily available natural resources, rather than to increases in productivity. This pattern of growth was not sustainable, however, as became increasingly apparent in the 1980s. In the latter part of the decade, the relative growth performance of the centrally planned economies deteriorated sharply, with living standards falling even further behind those of the industrial-market economies.
The authorities in Eastern European member countries are keenly aware of the sources of their countries’ economic problems. The impetus for the market-oriented reforms under way, or contemplated, is a concern with longer-term growth prospects. This has also focused attention on the importance of appropriate structural policies.
While no uniform blueprint for market-oriented reform is relevant for all centrally planned economies, the broad features of reform often include:
● Replacing systems of central planning and regulation of economic activity at the microeconomic level with systems of macroeconomic management and control. This implies the creation of markets and an end to price controls and strategies to allocate resources, and the reform—or elimination—of institutions that control prices and allocate resources. To establish a stable, noninflationary macro-economic environment, the authorities need to aim for balance of the government budget, to curb the growth of money and credit and reform the banking and tax systems, and to eliminate open-ended price subsidies.
● Developing the intermediation role of financial markets. This would entail the introduction of market-determined rates of interest to ensure adequate savings and an efficient allocation of capital, and the development of equity markets. Also, prudent oversight and regulation of the financial system are needed to maintain confidence.
● Reducing the size of the public sector and privatizing or streamlining most public enterprises.
● Adopting institutional changes, such as modifying the legal system and commercial codes to allow wider scope for the private sector, establishing a social safety net of unemployment benefits and a system of income transfers to the poor, and reforming pension systems.
● Ending the institutional monopoly over foreign trade through free and open trade and competition, greater currency convertibility (including exchange rate unification), and elimination of domestic price controls and subsidies.
The transition from centrally planned to market-oriented economies is expected to involve considerable short-term costs, as resources are reallocated in response to relative price signals that better reflect forces of supply and demand. The process of reallocation will be promoted if it is accompanied by monetary and fiscal policies that reduce inflationary pressures and help foster the stable economic environment needed to sustain growth. It is also preferable to implement market-oriented reforms rapidly, so as to minimize the buildup of resistance and hasten the emergence of tangible benefits, and to have the authorities clearly explain the motivation for—and objectives of—the reform, as well as its transitional costs. In addition, the reforms need to be comprehensive to ensure that each reinforces the others and that the costs and benefits of the economic transformation are widely shared. The nature and scope of the reforms must also reflect the particular circumstances of each country. As to the sequencing of reforms, this too depends on individual circumstances. In general, however, it is important to establish at an early stage macroeconomic stability and institutional changes, such as modifications to the legal system, the creation of social safety nets, and the establishment of financial discipline of enterprises.
Although the near-term economic outlook for the Eastern European countries has worsened, the economic and structural reforms that have been implemented, or are contemplated, should establish a basis for stronger growth over the longer run. Such reforms must be encouraged and supported, the Interim Committee stated in its May 1990 communiqué, but such support should not be at the expense of the developing countries. The Board cites the need for better data on the Eastern European economies, as well as on the U.S.S.R., in view of the important trade relations between the U.S.S.R. and Eastern Europe.
The authorities in Hungary recognize the need for a consistent implementation of comprehensive structural reforms coupled with sound demand management. They have adopted major structural reforms—including a tax system overhaul, a new company law, a liberalization of the price and the wage systems, and import liberalization. The Board, at its September 1989 deliberations on Hungary, commended these measures and underscored the need for fiscal adjustment accompanied by forceful implementation of supply-enhancing measures. Budgetary spending—including spending for social security and especially for open-ended subsidies—needed to decline to allow resources to be channeled to productive uses. In this connection, increasing the financial discipline of public enterprises was central. The Board emphasized the need to re-establish and maintain tight budgetary and monetary policies. On the exchange rate front, the authorities needed to monitor closely the exchange rate and make timely adjustments to ensure competitiveness. Subsequent to the Board discussion, the authorities devalued the forint by 15 percent against the basket of convertible currencies to which it is pegged prior to the approval of a stand-by arrangement in March 1990 (see Section 3).
During its discussion of Poland in February 1990, the Board commended the authorities for their program of radical transformation, and for the priority given to reducing inflation and eliminating shortages. Directors welcomed the bold measures adopted to liberalize prices, curb wage increases, manage the exchange rate, and reduce the fiscal deficit. They commended the authorities’ pursuit of a credit policy aimed at limiting money growth and ensuring positive real interest rates, and the establishment of a fully independent central bank. The recent decline in output prompted concern and underlined the need for measures to enhance supply. Improving the economy’s supply response, in turn, requires quick action to transform state enterprises (privatizing them, increasing their efficiency, or abolishing them); to break up monopolies in key sectors; to modernize the banking system; and to overhaul the tax system. The Board considered it essential to protect the neediest groups in the population and to retrain and provide unemployment benefits to workers rendered redundant in order to ensure continued political and social support for the reform program. Directors stressed the crucial importance of external assistance in various forms, particularly the provision of timely and generous exceptional financing in 1990. (For a discussion of the stand-by arrangement with Poland, agreed in February 1990, see Section 3.)
With respect to other Eastern European member countries, a fact-finding mission visited Romania in early 1990. The Czech and Slovak Federal Republic and the People’s Republic of Bulgaria have both applied for Fund membership.
A European member in the Mediterranean area that is undertaking major economic restructuring is Yugoslavia. It is, however, distinct, both historically and in its economic and political structure, from the centrally planned economies of Eastern Europe. The Yugoslav authorities intensified structural reforms early in 1989, with the goal of promoting the move toward a market economy over the medium term. The Board, meeting in September 1989, welcomed the devaluation of the dinar and the shift to positive real interest rates, which had helped strengthen the balance of payments. The momentum of inflation and the weak output needed attention. The authorities had to give high priority to reducing inflation and to give added autonomy to the central bank to facilitate the needed tightening of monetary policy. Tighter budget constraint was essential. In this connection, Directors favored measures to control wage increases. Structural and institutional reforms were also vital. The Board welcomed the authorities’ commitment to maintaining a strong external performance and an exchange rate system free of restrictions. Directors commended the import liberalization achieved to date, but encouraged further progress. Subsequent to the Board discussion, the authorities designed and implemented a comprehensive program of disinflation and structural reform supported by a stand-by arrangement approved in March 1990 (see Section 3).
World Economic Outlook
The Board and the Interim Committee conduct regular reviews of the interaction of the economic policies of member countries and their implications for the global monetary system. These reviews are based on the staffs World Economic Outlook report, which analyzes the short-term and medium-term prospects for the world economy, for the major industrial countries, and for various other country groups.
In addition to providing a global framework for the surveillance conducted through Article IV consultations with individual countries, the World Economic Outlook exercise helps identify potential conflicts and tensions that may arise between countries if prevailing economic policies continue unchanged. It also constitutes a framework for monitoring and analyzing other important global issues, such as global savings or the debt problem.
If world economic conditions change dramatically between regularly scheduled discussions of the World Economic Outlook, the Board may hold additional discussions.
At its April 1990 discussion of the World Economic Outlook, the Board attributed the slowdown in world economic activity largely—but not exclusively—to the restrictive monetary stance in most industrial countries. This was aimed at addressing pressures on productive capacity and the upsurge of inflation in 1989. The Board considered the reduced pace of demand growth as necessary to prolong the global expansion and believed that growth in Europe—and especially in Germany—may well be stronger than projected. A central theme of the Board discussion was that, for the 1990s to be a decade of growth, the industrial countries must raise savings to satisfy rising global investment needs.
The Board agreed with the staff projection that growth in the developing countries would remain roughly unchanged in 1990, after having declined in 1989. It cited the impact of the less favorable external environment in 1989-90, particularly the slower growth of world trade, rising international interest rates, and weakening commodity prices. Concern was expressed over the risks of inflation in the developing countries, particularly the sharp rise in certain high-inflation countries. These developments underline the importance of fundamental domestic policy reforms in developing countries to make the best use of existing global opportunities by improving their resource allocation and efficiency.
External imbalances are a cause of serious concern if they are large and persistent, as they can result in a spiral of rising external debt and interest payments, disruptive market reactions and exchange rate swings, and protectionist responses. At its April 1990 session, the Board welcomed the substantial declines in the current account imbalances of the United States and Japan. Although the German surplus remains quite large, it could diminish substantially if investment rises sharply relative to savings in connection with the move toward German unification and market developments in other Eastern European countries. Some Directors emphasized that the expected persistence of large external imbalances raised questions about their sustainability and about possible adverse reactions in financial markets. Many Directors stressed that external deficits in a number of countries reflected an excessive absorption of savings by the public sector, indicating the need for changes in fiscal policy. In surplus countries, structural policy initiatives were needed to improve resource allocation and promote efficient investment.
In discussing developments in international capital markets, the Board noted the rebound in activity in 1988-89 from its low level following the October 1987 stock market drop. The recovery occurred in the context of a continued integration of financial markets, globalization of investment behavior, and the development of new financial instruments. The Board sees challenges for policymakers in these trends. The increased integration of markets poses risks of market volatility and underscores the need for sound policies and reductions in external imbalances to bolster market stability, as well as strengthened supervision of banking and securities industries. Directors commended several initiatives in this area, which are aimed at improving national regulatory systems and increasing the international coordination of such systems. They also cited the need to strengthen clearance and settlement systems and international understandings on the division of responsibility for lender of last resort protection.
Industrial Country Policies
The Board welcomed the more moderate pace of demand growth in most industrial countries. Concern about inflation outweighed fears of recession, although the view was also expressed that the rise in inflation in 1989 was largely transitory and that inflation was contained at the time. Concern was expressed that relaxation of monetary policy might reignite inflationary pressures and require a more severe policy tightening at a later stage, thereby threatening the sustainability of the expansion. The increase in interest rates since early 1989 was primarily attributed to inflation expectations, although it was also related to uncertainties about future economic and political developments in Eastern Europe and to the prospect of heavy investment and higher fiscal deficits associated with the process of German reunification.
The Board stressed that appropriate fiscal and structural policies could reduce the risk of a further rise in interest rates and even pave the way for a gradual decline over time. There was some concern that monetary policy was overburdened and that fiscal restraint should play a more important role. In this view, an excessive reliance on monetary policy—and the associated high levels of interest rates—would have negative consequences for investment and the debt burden of developing countries. The concern was expressed that the progress achieved in fiscal consolidation in a number of industrial countries was insufficient to ensure adequate rates of saving, investment, and potential output growth over the medium term. Indeed, at its May 1990 meeting, the Interim Committee stated that further progress toward fiscal consolidation in these countries is “imperative,” together with the adoption of policies that reduce impediments to private saving.
The Board discussed at length the effects of inflation and the implications of a monetary strategy aimed at achieving price stability. The costs of inflation are substantial, and progress toward price stability will boost confidence in economic policies and bring about lasting efficiency gains that are likely to exceed by far the transitional costs of disinflation. Some Directors favored a program to eliminate inflation, while others felt that the medium-term objective should be low and stable inflation. There was support for the view that, in those countries with high inflation and large fiscal deficits, a tighter fiscal policy would help diminish the costs of reducing inflation while lowering interest rates, thereby helping lighten the debt burden of the developing countries.
In discussing the problem of external imbalances, the Board noted that the rise in domestic spending associated with the move toward German unification, together with the continued need for external financing in developing countries and the additional needs associated with economic reform in Eastern Europe, underscore the urgency of reducing external imbalances by raising saving in the deficit countries rather than by reducing it in the surplus countries. Fiscal consolidation and the removal of distortions affecting private saving in deficit countries would ease pressure on prices, reduce interest rates, and thereby foster conditions conducive to appropriate exchange rate and current account developments.
With respect to the prevailing pattern of exchange rates, the view was expressed that the substantial real depreciation of the Japanese yen since early 1989 did not reflect the fundamental strength of the Japanese economy and would not promote further external adjustment. If the weakness of the yen persists, the Board believed, it could reverse the sizable reduction in Japan’s external surplus that had occurred since 1987. The Board discussed the complex relationship between equity markets, exchange markets, and monetary policy; it concluded that monetary policy remained the central instrument for attaining stability in expectations and markets. At its May 1990 meeting, the Interim Committee noted that policies should “help to foster exchange rates consistent with a better working of the global adjustment process.”
The Board and the Interim Committee share the view that economic performance in all the industrial countries could also be enhanced through more forceful structural policy measures. The removal of impediments to the operation of market forces is seen as essential for raising productivity and achieving higher long-term growth.
Developing Country Policies
Average growth in the developing countries slowed substantially in 1989 and prospects are for little change in 1990, as discussed earlier. The Board, at its April 1990 meeting, took note of the adverse impact on developing countries of the slower growth in world trade, the rise in international interest rates, and the weakening of commodity prices.
Of particular concern in 1989 was the sharp deterioration in the price performance of several countries already experiencing high inflation, which contrasted with the situation in a number of countries whose economic stabilization efforts had begun to bear fruit. The staffs projection of a sharp drop in the average rate of inflation in the developing countries in 1990-91 hinges on the firm implementation of programs of economic stabilization in several key countries, and the Board was uncertain whether this condition would be met in a number of countries.
The less favorable external environment and the expectation of continued constraints on external financing for the developing countries underscore the urgency of a considerable strengthening of macroeconomic and structural policies to improve the efficiency of resource use and to promote higher levels of domestic savings and investment.
The Board took special note of the persistent economic difficulties of most of the heavily indebted developing countries. The Interim Committee, at its September 1989 meeting, termed “urgent” the need to restore growth in the indebted developing countries. It called for stepped-up efforts to boost saving and investment, adopt structural reforms to enhance efficiency, curb inflation, encourage the return of Bight capita), and promote foreign direct investment. At the same time, the Committee recognized the need for the developing countries to pay due attention to shielding the poorest in their populations from the adverse—albeit transitory—effects of economic reforms.
The Board, at its April 1990 discussion, expressed the fear that the staff’s expectation of strengthened economic performance over the medium term was subject to considerable downside risk. This was because the projected improvement depended critically on the effective implementation of corrective policies. The Board commended the improved domestic policies in a number of developing countries in recent years but noted that several highly indebted countries are now saddled with the costs of earlier policy weaknesses. In this context, the Board emphasized the need for more restrictive budget and monetary policies to reverse the trend toward chronic inflation and to restore the confidence and stability needed to foster investment and growth.
The achievement of higher growth rates in the indebted developing countries also requires, in the Board’s view, that markets in the industrial countries remain open, that the supply of world savings be sufficient to ensure a lasting decline in world interest rates, and that official financial assistance to Eastern Europe not occur at the expense of other developing countries. Some Directors have emphasized that policy reforms in the developing countries would be more effective—and more likely to be implemented on a sufficient scale—if they are carried out in conjunction with increased flows of long-term external financing, as well as debt and debt-service reduction. Nonetheless, in an environment of scarce global savings and debt-servicing problems, policy measures in developing countries must focus on raising savings and freeing international trade.
To underscore the importance of free trade, the Board called for urgent action to sustain the expansion of world trade and improve the access of developing countries to export markets. In this connection, a successful conclusion of the Uruguay Round of multilateral trade negotiations by the end of 1990 is essential since it would bring about substantial gains in global economic efficiency and reduce trade frictions, which recently have had negative effects on international trade and financial markets (see Section 4). The Interim Committee, at its May 1990 meeting, stressed that a successful conclusion of the Uruguay Round by the end of 1990 is particularly important for countries seeking to adjust their economies through adopting market-oriented systems. To achieve a successful conclusion, renewed efforts at trade liberalization are needed, especially in such areas as agriculture and textiles. The crucial importance of the principle of multilateralism to guide trade negotiations was emphasized.
Saving in the World Economy
The fall in saving rates in many industrial and developing countries has serious implications for economic welfare and prompted a Board discussion of a staff report in late 1989, as well as consideration at the April 1990 Board session on the World Economic Outlook and by the Interim Committee at its May 1990 meeting. Lower saving results in lower capital investment and poses risks for strong and sustained global economic growth, for external adjustment in the deficit countries, and for ameliorating the debt problem. Moreover, sharp differences in saving patterns among countries have contributed to the emergence of large external imbalances, especially among the major industrial countries. The magnitude of these imbalances, and their persistence, underscores the need for their correction.
Some Board members expressed concern about the impact on developing countries of lower industrial country saving. With saving falling below investment in the industrial countries in the 1980s, the combined current account balance of these countries shifted into deficit. As a result, the net flow of savings—traditionally from industrial to developing countries—moved in the other direction (Chart 8).
Chart 8Gross National Saving Rates: Industrial and Developing Countries, 1965-88
Source: Organization for Economic Cooperation and Development, National Accounts
The Board agreed that reversing the trend toward declining saving rates would require actions to strengthen both public and private saving. Among the most important variables is government policy, which affects public saving directly and private saving indirectly; in addition, government saving has declined substantially while private saving has fallen to a lesser extent. The most effective way to reverse recent trends in saving would be for countries with fiscal deficits to improve the financial position of the public sector and for all countries to adopt structural policies that minimize distortions that work against saving or investment.
The fall in private saving rates in the industrial countries is associated with a number of other variables, including the revaluation of the stock of wealth, increases in the relative income shares of the elderly, shifts in relative prices, tax distortions, and demographic changes. Lower saving rates, however, have been associated partly with developments that have improved economic welfare, as when financial liberalization has allowed households to smooth their consumption over time through easier access to credit. But, in some cases, the structure of taxes and government transfers has discouraged private saving.
Several views were expressed in the Board about how to stimulate private saving in industrial countries. One view noted the importance of maintaining appropriate tax policies—notably to avoid disincentives to saving and high marginal income tax rates. Another supported a shift from income-based to consumption-based taxes; it was argued, however, that consumption taxes tend to be more regressive than income taxes and could aggravate inflation—at least temporarily—through a one-time increase in the price level.
During the 1980s the effects of the reversal in the net flow of foreign savings, which had been toward the developing countries, were exacerbated by sharp declines in national saving rates in most of these countries. The reasons for the fall in national saving rates in developing countries include government dissaving, public enterprise losses, financial repression (i.e., the absence of realistic interest rate policies in the context of liberalized financial markets), macroeconomic instability, and adverse external shocks or changes in terms of trade. The drop in saving rates is especially evident in countries with debt-servicing problems, high inflation, and low percapita incomes. Concern was expressed in the Board over the suggestion that inflation and interest rates had a relatively small effect on saving. Directors noted that sustained positive real interest rates in developing countries had been associated with low inflation and that both are linked to high saving rates. Stable prices and positive real interest rates are prerequisites for development of the financial sector and for an efficient allocation of resources.
The reduced flow of foreign resources since the onset of the debt crisis in 1982 means that the developing countries have to rely mainly on domestic saving to increase investment. Macroeconomic stability, in both the industrial and developing countries, is crucial to stimulating saving and improving the efficient use of savings in developing countries. Addressing excessive levels of debt in certain countries was seen as a way to re-establish conditions more conducive to higher domestic saving. In this connection, the Board noted the importance of fiscal restraint in order to increase national saving by raising public saving. This, in turn, would reduce dependence on foreign borrowing. Monetary restraint is equally important in securing financial stability, thereby improving the environment for both saving and investment. Furthermore, appropriate exchange rate policies promote an efficient allocation of savings by channeling resources into the domestic financial system that would otherwise flow abroad or into unproductive assets.
International Liquidity and the SDR
Issues of international liquidity, the systemic role of the SDR, and the question of an SDR allocation continued to be an important concern of the Board in 1989/90.
In addressing the first of these topics, the Board noted three specific issues. The first is that data limitations and conceptual ambiguities make it difficult to construct a meaningful quantitative measure of international liquidity. Second, the difficulties of measuring international liquidity directly imply that the adequacy of international liquidity should in the first place be addressed indirectly. Third, indirect assessments of the adequacy of international liquidity can—among other things—focus on how well the functions of international liquidity are being performed.
Since the functions of international liquidity are to promote monetary conditions conducive to a healthy world economy, the Board examined whether and how the functioning of the international liquidity system could be improved—and whether and how the systemic role of the SDR could be strengthened. The international liquidity system could be strengthened first by enhancing surveillance and the policy coordination process for the largest industrial countries, where problems can have major spillover effects on the performance of the world economy, and second, by assisting developing countries to cope with balance of payments problems—including, in particular, those that stem from their debt burdens—which are also of major consequence for the world economy.
The Board’s consideration of ways to strengthen the surveillance and policy coordination process focused on the extent to which the use of national currencies as reserve assets may have weakened policy discipline in the major industrial countries, and on whether a larger role for the SDR would be desirable from that perspective. It was argued that certain “rigid mechanisms” for limiting the role of national currencies could only be effective if large industrial countries are willing to accept greater discipline. Such mechanisms include proposals for “substitution accounts,” under which currencies used as reserve assets would be replaced by liquid claims on the international community, such as SDRs, or for “asset settlement mechanisms, “through which a reserve currency country would periodically convert any increase in other countries’ holdings of its currency into an acceptable international reserve asset.
In discussing the use of SDRs in exchange market intervention, some Directors emphasized that, while the official SDR cannot at this time serve as a vehicle for intervention because it is not held outside official circles, it could play a larger role in financing intervention. In this context, there was some interest in a proposal to establish a pool of SDR resources to finance exchange market intervention on a revolving basis.
There was some support for measures to promote gradually the use of SDR-denominated instruments by the private sector including, for example, studying the establishment of a clearing house for the settlement of private SDR transactions. At the same time, however, the current lack of demand for private SDRs was noted, which raised the question of whether and how such demand should effectively be promoted.
In considering the potential role of the SDR, it was agreed that there had been large disparities in the terms and conditions under which different countries could obtain reserves. There was some support for the view that this disparity had resulted in an uneven distribution of international liquidity, which could undermine efforts to achieve global growth and adjustment. According to this view, the SDR system provides a direct means of alleviating the uneven distribution of reserves and liquidity. However, it was also argued that the terms and conditions under which a country can obtain reserves depend in the final analysis on its own policies. The establishment and maintenance of sound and prudent macroeconomic policies was seen as key to restoring creditworthiness, at least over the medium term, and to reducing disparities in the cost of obtaining reserves.
There was some support in the Board for the use of SDR allocations in support of debt- and debt-service-reduction operations as an effective means of providing additional resources that could enhance the current strengthened debt strategy. However, there were also a number of objections to these proposals. The rationale for creating conditional liquidity outside the Fund’s general resources was questioned, and it was argued that the use of the SDR system to support debt- or debt-service-reduction would undermine the monetary character of the SDR.
Although a majority of Directors favored a resumption of SDR allocations, there was not the degree of support required under the Articles for a proposal to be presented to the Board of Governors.
2. External Debt Situation and Strategy
The debt strategy has been strengthened by measures to help the heavily indebted countries through debt- and debt-service-reduction operations vis-à-vis commercial banks. Another major development has been the progressive adaptation of policies by official creditors to the deep-rooted problems of the poorest countries that are indebted mainly to official institutions. These developments encourage indebted countries to persevere with policy adjustments and reforms that lay the basis for price stability, external creditworthiness, and sustained growth. The strategy also places emphasis on measures to promote investment and repatriation of flight capital. Throughout the debt crisis the Fund has played an important role by providing policy advice and financial assistance. This assistance usually stimulates (“catalyzes”) lending and debt reduction from other sources. The experience of early cases involving debt reduction is encouraging. It suggests the Fund’s existing guidelines are versatile enough to deal with diverse financing needs and strategies. Progress to date in implementing the strengthened debt strategy has been good; a number of countries reached agreement on financing packages with their creditors and others are negotiating such packages. The Fund welcomes these positive steps and underlines the need for a flexible, case-by-case approach, especially where further progress is needed to deal with individual countries’ problems.
The Board has continued to devote considerable attention to the external debt problems of Fund members. Ever since the debt crisis broke out in 1982, the Fund’s cooperative, case-by-case strategy for dealing with the problems of heavily indebted countries has evolved in response to changing world economic developments and country circumstances. However, the three main elements of the strategy have remained intact. They are to ensure that (1) debtor countries pursue growth-oriented structural reforms; (2) multilateral, official, and private sources provide adequate finance; and (3) all countries collaborate in maintaining a favorable global economic environment. This strategy has helped improve the economic health of many debtor countries. But in a number of others, debt-service burdens have remained onerous, external financial support has not always been prompt or adequate, and, most important, adjustment has been weak.
In response to these continuing problems, the debt strategy has, in recent years, been strengthened by measures to reduce debt burdens through the incorporation in this strategy of debt- and debt-service-reduction operations. Such operations are necessary to encourage heavily indebted countries to persevere with effective adjustment and reforms, which are critical for the restoration of their economic health. Voluntary debt reduction is also expected to ease adjustment, by complementing new lending, cutting back financing needs to more manageable levels, reducing the stock of debt over time, and generally improving the investment climate. As such, debt reduction is consistent with the main objectives of the debt strategy—to promote satisfactory economic growth in debtor countries and to restore their access to credit markets.
The Fund has played an important role throughout the debt crisis by providing both policy advice and financial assistance. Such assistance, in turn, mobilizes funds from other sources, because it assures the international financial community that appropriate policies are being implemented. In May 1989, the Board considered the Fund’s involvement in debt-reduction operations. A set of guidelines was agreed to determine countries’ eligibility to receive Fund support for such operations, the sort of operations the Fund would support, the extent of access to Fund resources, and the Fund’s policy on financing assurances (these guidelines are detailed in the 1989 Annual Report). The Board agreed that the Fund’s policy toward debt-reduction operations and the way in which the policy will be applied will be kept under review. The guidelines were applied in four initial cases: Costa Rica, Mexico, the Philippines, and Venezuela. In the course of 1989/ 90, the first three of these countries concluded agreements on financing packages with their commercial bank creditors (see Box 4). The Fund also approved stand-by and extended arrangements with six countries (Argentina, Côte d’Ivoire, Ecuador, Jordan, Poland, and Venezuela) that had yet to conclude negotiations on financing packages. In each of these cases, the Fund supported the members’ policies on the grounds that its prompt assistance was important to strengthen the country’s efforts and that agreements with banks could be expected within a reasonable time.
Experience with Debt Reduction
In an early review of the experience in implementing the strengthened debt strategy in August 1989, the Board put this strategy into perspective and agreed that while debt-reduction operations may be important for some countries, they alone are not sufficient to lay the basis for a sustained revival of investment and growth. Such operations can help break the cycle of rising debt and dwindling prospects for regaining market access only when they are supported by sound policies, particularly policies that attract direct investment and other financial inflows, and reverse capital flight.
Nevertheless, the early cases in which the strengthened debt strategy has been applied are encouraging. Experience to date suggests that the Fund’s guidelines are versatile enough to deal with diverse financing needs and strategies. Indeed, their diversity attests to the soundness of the guidelines.
Basis for Support
The Board, in its August 1989 review, noted that a country should base its decision to seek debt reduction and official support for such operations on a coherent financing strategy. This strategy should be designed to support an appropriate medium-term economic reform program and to maintain or regain access to funds from various sources.
While cautioning that countries should not be rigidly categorized, the Board pointed out that:
● For countries that have succeeded in maintaining access to credit markets, debt reduction through buying back or exchanging commercial bank credits is usually not appropriate. But it is crucial that official and multilateral support, including support from the Fund, continue to be made available to these countries.
● Some countries have resumed growth through strong policies, while avoiding both new borrowing and the rescheduling of interest on official debt, but their debt still trades at a heavy discount. Such countries would need to assess carefully whether pursuing officially supported debt reduction would speed up or slow down the restoration of access to credit markets.
● For countries that still depend on concerted commercial bank resources to support adjustment programs, market-based debt reduction can complement appropriate economic policies. Substantial officially supported commercial bank debt reduction is perhaps most clearly needed for such countries.
● For countries facing more severe external difficulties, debt reduction operations may not represent a priority use of funds in the near term. These countries may first need to normalize relations with official creditors and ensure payments for essential imports as well as access to short-term trade credits.
Scope for Debt Reduction
In the August 1989 discussion of the potential scope for debt reduction, there was much concern about the reluctance of commercial banks to lend to developing countries, including to some that have avoided recent debt-servicing difficulties. It was stressed that developing countries—including those pursuing debt reduction—will often continue to need new money as part of a financing package.
The Board agreed that the modifications decided in May 1989 to the Fund’s policy on financing assurances (see Box 5) continue to be appropriate, but the Fund will need to assess both the efficiency of debt-reduction operations and the adequacy of financing agreed with banks, from a short-term and a medium-term perspective. If an overall package were to fall short of the assumptions of a member’s adjustment program or be delayed unreasonably, the Fund will need to reassess the package at an early stage to consider, especially, the implications for the program and for official creditors, including the Fund.
Regulatory, accounting, and tax issues in industrial countries can influence banks’ attitudes to lending, as well as to various debt and debt-reduction instruments, but national policies in these areas are determined mainly by prudential and fiscal considerations. Nevertheless, the governments of major industrial countries agreed in early 1989 to review their tax, regulatory, and accounting regimes with a view, as appropriate, to removing unnecessary obstacles to debt and debt-service reduction.
Box 4Recent Financing Packages
By May 1990, Mexico, the Philippines, and Costa Rica had concluded negotiations on financing packages with commercial banks, which include arrangements for debt- and debt-service-reduction operations.
The package for Mexico, which covers medium- and long-term claims totaling about $48.5 billion, contains three main elements:
● New money commitments for 1989-92, amounting to 25 percent of banks’ exposure at the time the agreement was signed. These loans have a maturity of 15 years (including 7 years’ grace) and carry an interest rate spread of 13/16 over the London interbank offered rate (LIBOR).
● The conversion of bank claims into discount bonds at 65 percent of face value carrying market interest rates (at a spread of 13/16 over LIBOR). The repayment of principal in one lump sum after 30 years is fully assured by collateral and there is an 18-month rolling interest guarantee; that is, interest payments are guaranteed for successive 18-month periods.
● The conversion of claims into par bonds with a reduced fixed interest rate (6.25 percent) with the same maturity and backing as for the discount bonds.
In addition, the agreement provides for the resumption of debt-equity swaps and the recovery by banks of some additional claims if, beginning in 1996, real oil prices exceed the 1990 benchmark level of $14 a barrel.
The agreement implies a total reduction of about $14.5 billion in the present value of Mexico’s debt to commercial banks. When all the features of the agreement are taken into account, the debt and debt-service reduction achieved represents an efficient use of Fund resources.
Mexico will fund its principal and interest guarantees to banks, using resources from the World Bank ($2 billion), the Fund (SDR 1.3 billion), and its own reserves ($1.3 billion). In addition, the Export-Import Bank of Japan will provide import financing of $2 billion in the form of cofinancing with the World Bank and parallel lending with the Fund. As some of these resources were not available at the time the agreement was signed, commercial banks provided bridge financing of $1.2 billion.
Under the Philippines’ agreement with its commercial bank creditors, creditor banks have two options: to provide new money or to tender claims for cash buy-backs at a market-related price. Banks offered new money of $714 million, which is to be disbursed in 1990. And in January 1990, the Philippines completed a buy-back of just over $1.3 billion of bank claims at a price of 50 cents on the dollar—close to the prevailing secondary market price. The buy-backs will provide a net interest saving of about $80 million a year during the program period, which extends from May 1989 through May 1992.
The Philippines financed the buy-back partly with Fund resources totaling SDR 94 million. In addition, the World Bank provided a loan of $150 million (of which $100 million has been disbursed), while the Export-Import Bank of Japan agreed to lend $300 million (which will be disbursed in parallel with Fund purchases) to Replenish the Philippines’ reserves.
Costa Rica agreed with its commercial bank creditors on a package to restructure $1.8 billion of eligible commercial bank debt and past-due interest. The package, which includes debt and debt-service reduction, but not a new money component, comprises three options:
● To buy back both principal and past due interest at a price of 16 cents per U.S. dollar face value of the claim.
● To exchange remaining debt for one of two types of bearer bonds: Type A bonds, which are available to banks tendering at least 60 percent of their claims for buy-backs, and which carry a fixed interest rate of 6.25 percent a year and are repayable in 20 years with a 10-year grace period; and Type B bonds, which are available to banks tendering less than 60 percent of their claims for buy-backs, and pay the same rate of interest as Type A bonds, but are repayable in 25 years with a 15-year grace period. Type A bonds will be backed by a one-year interest guarantee, but Type B bonds will not.
● The treatment of unrepurchased past-due interest as a separate debt requiring a 20 percent cash downpayment, and repayment of the balance over 15 years at a spread of 13/16 of a percentage point over LIBOR. Holders of these claims who have tendered at least 60 percent of their debt for the cash buy-back option will receive a three-year interest guarantee on these claims.
The agreement also allows for additional payments to banks if Costa Rica’s real GDP exceeds its 1989 level by 20 percent, as well as a debt-equity conversion program.
The financing package would eliminate $1.1 billion of claims through the buy-back option. The reduction in interest rates on the bearer bonds is equivalent to an additional debt reduction of $0.2 billion. Assuming that the financing terms apply to the full $1.8 billion of eligible bank debt and past-due interest and that all banks opt for Type A bonds, the agreement will require funding of about $265 million. On this basis, the net debt reduction achieved through the package would be close to that which would result from a buy-back carried out at the secondary market price.
At its September 1989 meeting, the Interim Committee welcomed the setting up of operational guidelines for Fund support for significant debt and debt-service reduction as part of financing packages supporting strong, growth-oriented adjustment programs. It noted the progress that the Fund, in collaboration with the World Bank, has already made in several cases in implementing the strengthened debt strategy. The approach adopted has been able to accommodate the diverse circumstances of individual members.
While recognizing that time is needed to put together complex financial packages involving both new money and debt reduction, the Interim Committee urged that commercial banks should move quickly in this regard. The Fund should carefully evaluate each financing package for its adequacy to the circumstances of the member, the efficiency of debt reduction, and in light of the need to safeguard Fund resources. The Committee reaffirmed that official creditors should not substitute for private lenders. It also stressed that officially supported debt-reduction operations must not divert financial support from those countries that have succeeded in preserving access to capital markets through sound economic policies, despite heavy debt burdens.
The Committee welcomed the concrete steps some creditor governments had taken to review tax, regulatory, and accounting practices to remove unnecessary constraints to debt reduction and encouraged others to do likewise.
The Fund’s Executive Board again considered the issue of the management of the debt situation in April 1990. By that time, more experience had been gained: The negotiations between Costa Rica, Mexico, and the Philippines and their creditors on financing packages involving debt-reduction operations, as mentioned above, had been concluded. The Fund had approved arrangements with six additional countries that had yet to conclude such negotiations (Argentina, Côte d’Ivoire, Ecuador, Jordan, Poland, and Venezuela). Two of these—Ecuador and Venezuela—had made substantial progress in negotiations with their creditors. (Venezuela reached an agreement with its bank advisory committee in March 1990.)
Box 5Financing Assurances
The key objectives of the Fund’s policy on financing assurances are to ensure that adjustment programs are adequately financed, that financing is consistent with a return to a viable balance of payments position and with the member’s ability to repay the Fund, and that the program, if appropriately implemented and supported, would contribute to the maintenance or re-establishment of orderly relations between the member and its creditors.
In May 1989, the Fund modified its policy on financing assurances in light of changes in the financial environment and the possibility that debtors and creditors may need more time to agree on financing packages with their creditors. The modifications were as follows:
● The Fund may, on a case-by-case basis, approve an arrangement outright before agreement on a financing package is concluded between a member and commercial bank creditors, (1) if it is thought that prompt Fund support is essential for the implementation of the adjustment program and (2) provided that negotiations between a country and its creditors have begun and that it can be expected that a financing package consistent with external viability will be agreed within a reasonable period. Progress in the negotiations with bank creditors would be closely monitored.
● In promoting orderly financial relations, every effort will be made to avoid arrears. Nevertheless, an accumulation of arrears to banks—though not to official creditors—may have to be tolerated where negotiations continue and the country’s financing situation makes such arrears unavoidable.
The Board considered that the progress in implementing the strengthened debt strategy has been good. This reinforces two central elements of the strategy—the case-by-case approach and the importance of sound economic policies in normalizing debtor-creditor relations.
The agreements on financing packages reached by Costa Rica, Mexico, and the Philippines provide for a substantial restructuring of commercial debt. If supported by sustained adjustment, they will contribute importantly to restoring growth and a satisfactory medium-term balance of payments position in these countries. The Board concluded that, consistent with the guidelines on Fund support, the agreements represent an efficient use of Fund resources.
The adoption by countries of policies that foster private capital inflows has been an important element reinforcing the beneficial impact of the financing packages agreed with banks. The rise in private sector confidence has been encouraging and has already been reflected in higher domestic investment, financed in part by capital repatriation. In this connection, the Board underscored the importance of strong policies to increase domestic saving, direct investment, and capital inflows, including reversal of capital flight. This is, indeed, an important part of the effort to restore viability with growth, which should continue to receive close attention in the formulation and implementation of members’ programs. Some of the packages agreed with banks have, however, resulted in lower financing than had been anticipated. While the debt-reduction elements themselves were efficient, the overall shortfall has resulted in tighter-than-expected external cashflow positions. Rapid policy responses may be needed to counter the effects of any adverse developments and keep the programs on course.
In many cases, progress in negotiating financing packages containing debt-reduction operations, as well as new money or interest refinancing, has been slow. The causes for the delays include debtors’ uneven adjustment records, banks’ reluctance to make additional loans, and, in a number of cases, substantial payments arrears.
The Board reaffirmed the key objectives of the Fund’s policy on financing assurances (see Box 5). It stressed the need for the Fund to monitor closely the negotiations between members and banks where Fund support is provided at an early stage, in order to assure that the financing provided is consistent with the requirements of the program and the safeguarding of Fund financing. The Board considered that the guidelines on Fund involvement remained appropriate and approved the Fund’s attitude of continuing to avoid any direct role in negotiations; the responsibility of the members themselves is to ensure that the packages agreed with commercial banks are consistent with the requirements of the program supported by the Fund. In this framework, however, it is important that these requirements be well understood between the members and the Fund, and that it be clearly established that a package that falls substantially short of needed financing could call for compensating changes in a member’s policies.
An important aim of Fund support is to help members normalize their relations with their creditors. All parties must be aware of the adverse consequences of arrears and the need for reasonable measures to avoid them. Some countries, especially those with large arrears at the start of a negotiation, have not been able to repay banks in full during the negotiating process. However, the Fund’s early support for arrangements in the presence of arrears, has helped promote normal debtor-creditor relations in a number of cases.
Experience has shown the 1989 guidelines governing Fund support for debt reduction to be reasonable and versatile, although, in the view of many Directors, cases may arise in the future in which various considerations may warrant more flexibility in the use of Fund resources between principal reduction and interest support. Others felt the demarcation continued to be appropriate and were concerned that modifications of an important feature of fche guidelines not be reconsidered without a compelling reason.
The setting aside, for up to one year in advance, of resources to support principal reduction—as approved for Costa Rica, Ecuador, Mexico, and the Philippines—provides a reasonable standard where there is a sound track record of performance and where such up-front financing contributes to more effective debt and debt-service reduction. In other cases, especially where a track record remains to be established, more evenly phased Fund support, in line with satisfactory program performance, may be appropriate. In such cases, debt operations with Fund support could take place in the context of a framework spanning several years, and which might involve, on a case-by-case basis, understandings with banks regarding partial interest payments while the debt reduction is being implemented.
At their May 1990 meetings, the Interim Committee and the Development Committee welcomed the progress under the strengthened debt strategy and reaffirmed the guidelines on the involvement of the Fund and the World Bank, adding that these guidelines should continue to be implemented flexibly. Both Committees stressed the need for measures to encourage domestic savings and capital flows—including the return of flight capital and new investment—in debtors’ growth-oriented reform programs under the strengthened debt strategy.
A major development over the past three years has been the progressive adaptation of policies by official creditors (“Paris Club”) to the chronic and deep-rooted problems of the heavily indebted low-income countries. In mid-1987, official creditors eased repayment terms by lengthening maturities and grace periods for some countries. They followed this up with a more far-reaching step in late 1988, when they introduced a “menu” of options for the poorest countries that included the partial cancellation of debts, further extensions of maturities, and interest rate concessions. This menu was endorsed by the creditor governments participating in the Toronto summit in June 1988. It has been implemented in 19 reschedulings for 16 low-income countries with total debt-service payments of more than $3 billion. About $350 million in debt-service payments have been cancelled and interest on these reschedulings has been reduced by some $45 million a year.
Chart 9Secondary Market Prices for Developing Country Loans, 1986–April 19901
Source: Salomon Brothers.
1 Weighted average for 15 heavily indebted countries.
During 1989, reschedulings of debts to official creditors became more frequent, reaching a peak of 24, compared with an average of 16 a year during 1986-88. Seven countries approached the Paris Club for the first time, while repeat reschedulings continued unabated. In late 1989, official creditors agreed to lengthen maturities beyond ten years for Côte d’Ivoire and Poland—two middle-income countries facing very serious difficulties. And in 1990—also for the first time—they applied the concessional menu to a country outside sub-Saharan Africa (Bolivia).
Box 6Secondary Market For Developing Country Debt
The debt of the developing countries experiencing debt-servicing difficulties tends to be traded at a discount to its face value on what is known as the secondary market; secondary market discounts have typically not been observed for countries that have scrupulously serviced their debt and avoided reschedulings. All agreements on financing packages for debt-and debt-service-reduction operations concluded so far indicate that bank debt reduction is being achieved broadly in line with prices on this market. The market has provided opportunities for banks to manage their portfolio of loans to the developing countries and has facilitated the use of debt-conversion techniques, including debt-equity swaps and debt-reduction operations.
The exact size of the secondary market for developing country debt is uncertain. Its annual turnover is estimated to have grown from less than $5 billion in 1985 to about $30-40 billion in 1988. The cutting back of debt-equity conversion programs in a number of debtor countries contributed to a decline in turnover in the first two months of 1989 to about one half the level of 1988, on a yearly basis. But the announcement in March 1989 by U.S. Treasury Secretary Nicholas Brady of official support for debt-reduction operations caused turnover to recover strongly, as market participants anticipated more debt-restructuring agreements and the resumption of debt-equity programs.
Two types of transactions dominate activity on the secondary market:
● Debt swaps, in which, for example, a bank having claims on one country exchanges some or all of them for claims on another country. Such transactions can help banks reshuffle their developing country loan portfolios to their advantage; banks can, for example, increase their holdings of claims on countries where they have strategic interests and reduce their holdings in other countries.
● Cash transactions, which include purchases by countries of their own debt at a discount and conversions of debt into equity. Such transactions have grown in importance with the increase in debt-conversion schemes and with the emergence of specialized market makers in developing country debt.
Several influences help determine demand and supply—and thus prices—on the secondary market. On the demand side, the demand for debt swaps among banks depends mainly on banks’ longer-term objectives, their levels of loan-loss reserves, their varying views on country risk, and tax considerations. The demand for cash transactions also derives from many sources, including, for example, the extent to which companies finance direct investment through debt-equity swaps, the use of debt-conversion schemes by debtor country residents to repatriate flight capital, and purchases by retail and institutional investors. Elements influencing the supply of claims on the secondary market include the discounts on such claims, banks’ provisioning levels, tax and accounting practices in creditor countries, and capital adequacy considerations. The importance of these elements varies over time and with banks’ nationalities, exposures, and profitabilities.
The structure of the secondary market—especially its relatively low (but growing) liquidity and lack of standardized products—has tended to result in volatile price behavior. Moreover, movements in the average market price have tended to conceal large variations in prices for individual countries.
The Board welcomed the positive steps taken by official creditors, including the lengthening of maturities and rescheduling of interest for certain hard-pressed middle-income countries and the application of the Paris Club’s concessional menu to low-income countries outside sub-Saharan Africa. It also noted the contribution of creditor governments in providing trade finance and other bilateral assistance to help heavily indebted countries. The Board underlined the need for a flexible, case-by-case, approach in dealing with individual countries’ problems.
In May 1990, the Interim Committee and the Development Committee also welcomed the efforts of official bilateral creditors. The Interim Committee noted especially the actions under the Toronto Agreement of June 1988 and the financial contribution of the Export-Import Bank of Japan to support debtors’ adjustment efforts. It emphasized the special needs of the lower middle-income countries.
3. Fund Financial Support of Member Countries
The Fund supports in a number of ways countries that adopt policies and reforms aimed at promoting a better environment for price and exchange rate stability, economic growth, more open markets, and external creditworthiness. In extending its assistance, the Fund recognizes the distinct circumstances and needs of different countries or groups of countries. During 1989/90, the Board approved 26 new arrangements with member countries, amounting to more than SDR 11 billion—the largest amount in six years. The Fund’s financial support is part of its much broader assistance to member countries; its policy support and technical assistance are described elsewhere in this Report. Collaboration with the World Bank has been intensified, and there are regular contacts between the two staffs, both at headquarters and on staff missions. Particular attention is being paid to the implications of economic developments for the poor, and an effort is made, often in conjunction with other organizations, to identify and encourage measures to lessen the impact of negative developments on vulnerable groups among the poor.
A principal activity of the Fund is its support of macroeconomic and structural policy adjustments in its member countries. Such support is provided through various policies and facilities, two of which are specially designed to assist low-income countries.
The Fund committed SDR 11.3 billion to member countries in 1989/90—the highest amount since 1983/84 and more than double that in any of the intervening years. The Board took decisions to support 26 new arrangements in 1989/90, two more than in the year before. These included 16 stand-by arrangements, totaling SDR 3.2 billion; 3 extended arrangements, totaling SDR 7.6 billion; and 3 arrangements under the structural adjustment facility (SAF) and 4 under the enhanced structural adjustment facility (ESAF), totaling SDR 460.5 million. Two arrangements incorporated contingency mechanisms under the compensatory and contingency financing facility (CCFF), while three were accompanied by drawings for compensatory financing of export fluctuations. Among the countries that entered into arrangements with the Fund in 1989/ 90, 9 were from the Western Hemisphere, (Argentina, Chile, Costa Rica, Ecuador, Haiti, Jamaica, Mexico, Trinidad and Tobago, and Venezuela); 10 were from Africa (Algeria, Benin, Côte d’Ivoire, Gabon, Kenya, Madagascar, Mauritania, Sao Tome and Principe, Togo, and Zaïre); 1 was from the Middle East (Jordan); 3 were from Asia (the Lao People’s Democratic Republic, Papua New Guinea, and the Philippines); and 3 were from Europe (Hungary, Poland, and Yugoslavia).
As of April 30, 1990, the Fund had 51 arrangements with 49 countries. Of these, 19 were stand-by arrangements, 4 extended arrangements, 17 SAF arrangements, and 11 ESAF arrangements. The number of countries using Fund resources totaled 87—well over half the Fund’s membership.
In May 1990, the Interim Committee urged the Fund to encourage and support market-oriented economic reforms in all countries. In particular, it stated, the Eastern European countries’ moves toward a market system warrant Fund support as part of a broad international cooperative effort; such support should not however be at the expense of the developing countries.
Stand-By and Extended Arrangements
The SDR 10.9 billion committed by the Fund under stand-by and extended arrangements in 1989/90 represents a more than threefold increase over the average of the preceding six years. This rise partly reflects what the Managing Director described during the 1989 Annual Meetings as “the silent revolution in attitudes in many developing countries,” which has prompted many such countries to request Fund assistance in support of policies that seek to bring down inflation, improve resource allocation, and reduce barriers to trade and foreign investment. Commitments under extended arrangements, in particular, rose dramatically (to SDR 7.6 billion, compared with SDR 1.4 billion in the previous six years combined). The rise in total Fund commitments in 1989/90 derived also from the fact that, for the first time, resources (totaling SDR 2.4 billion) were earmarked to support debt- and debt-service-reduction operations.
Following a review of the Fund’s policy on enlarged access and access limits in August 1989, the Board decided to extend the policy and maintain the existing limits on access to Fund resources until June 30, 1990. During the discussion, Directors thought that maintaining the existing access limits for 1990 would be needed to enable the Fund to provide adequate financial support for members making strong adjustment efforts, including efforts to address their debt problems. It was stressed that access limits should not be viewed as targets or entitlements, and that the guidelines on access in individual cases should continue to be applied prudently but flexibly. Existing limits should generally be sufficient to allow for additional resources that might be made available by the Fund for interest support relating to a member’s debt- and debt-service-reduction operations. The Fund could, however, decide to provide access to its resources over and above these limits in exceptional circumstances.
The Board agreed that the policy on enlarged access and related issues—including access limits—would need to be reviewed before the new quotas resulting from the completion of the Ninth Review of Quotas become effective. At the same time, the Board decided to maintain, for 1990, the current access limits under the buffer stock financing facility. At its May 1990 meetings, the Interim Committee agreed that the enlarged access policy and the present access limits should remain unchanged until the increase in quotas under the Ninth Review becomes effective.
Policies in Member Countries
In assisting its members, the Fund analyzes their economies in detail, helps formulate policies, and provides financial and technical support. Although different policies focus on different problem areas, they are interrelated and are part of a broader effort to promote price stability, economic openness, and sustained growth. The 19 stand-by and extended arrangements supported by the Fund in 1989/90 have diverse features and aims and reflect the unique problems and circumstances of members.
Algeria was prompted to adopt new economic policies (supported by a stand-by arrangement for SDR 155.7 million) by a series of external shocks—notably, lower oil prices—and a decline in agricultural production, which contributed to slower growth and a weaker external position. The policies, Fund support for which was approved on May 31, 1989, aim at laying the foundation for higher growth and employment through structural reforms that improve efficiency. They are designed to decentralize rapidly the public enterprise and financial sectors; ease controls on prices, salaries, and interest rates; enhance the role of the private sector and encourage foreign investment; and rely more on macroeconomic instruments, as opposed to administrative targets, in overall economic management.
On taking office in July 1989, the new Government of Argentina was faced with inflation at record levels, depleted international reserves, and weakening growth. The policies and measures put into place for 1990 (supported by a stand-by arrangement for SDR 1.1 billion, approved on November 10, 1989) aim to reduce inflation, raise real economic growth to about 5 percent, and strengthen the country’s external position. They also seek to eliminate the nonfinancial public sector deficit. Argentina is expected to regularize its relations with its external creditors in the course of the arrangement. The measures adopted by the Government include a number of structural reforms, notably tax, banking, and external sector reforms, and privatization. Modifications of the arrangement were approved in May 1990, following policy slippages that had occurred in late 1989 and the introduction of a new policy package in March 1990.
Chile underwent a major economic transformation in the 1980s, which involved trade liberalization, a rationalization of the public sector, a streamlining of government expenditure, and a reform of the pension system. The one-year stand-by arrangement in the first credit tranche (for SDR 64 million, approved on November 8, 1989) maintains the medium-term framework, policies, and objectives developed under a four-year extended arrangement that ran from 1985 to 1989. The goals are to expand Chile’s exports, continue to strengthen domestic saving and investment, and improve the balance of payments position with a view to maintaining output growth of 4-5 percent a year.
The economic policies of the Government of Costa Rica (supported by a stand-by arrangement for SDR 42 million, approved on May 23, 1989) focus on consolidating the gains achieved in the external sector in recent years to lay the basis for sustained growth. The policies are designed to lower inflation, raise domestic savings, promote private investment, reverse capital flight, and improve the efficiency of resource use. They aim to achieve these goals by reducing the public sector deficit and maintaining an appropriate credit policy and flexible interest and exchange rate policies. The measures also include continued structural reforms focused on the import tariff schedule, the financial sector, agricultural pricing, and the operations of public enterprises.
In its first application of the strengthened debt strategy, the Fund accepted Costa Rica’s request to set aside 25 percent of each purchase under the stand-by arrangement for debt reduction. In addition, the Fund will consider providing additional resources in conjunction with the stand-by arrangement, of up to 40 percent of Costa Rica’s quota, in the event of financing arrangements being concluded with commercial bank creditors for debt-service reduction and if the Fund determines these arrangements are consistent with its guidelines.
The Government of Côte d’Ivoire adopted economic policies in response to declining terms of trade, a loss of export competitiveness, and large foreign exchange outflows. The policies (supported by a stand by arrangement for SDR 146.5 million, as modified on June 22, 1990) seek to stabilize the economy by reducing major imbalances, boosting investment, and limiting further declines in GDP. They also initiated four key structural reforms: restructuring pricing, marketing, and subsidy policies in the agricultural sector; rationalizing and privatizing public enterprises; strengthening domestic tax administration and budgetary procedures; and reforming the financial sector.
During 1986-87, declines in world oil prices, earthquakes, and a weakening of financial policies contributed to serious budgetary and external imbalances in Ecuador. The Government that took office in August 1988 adopted a series of measures, including stronger fiscal and monetary policies and a more flexible exchange rate policy. The Government’s economic measures (supported by a stand-by arrangement for SDR 109.9 million, approved on September 15, 1989) seek to consolidate these gains and, notably, to reduce inflation, further narrow the external current account deficit, strengthen the foreign reserve position, and make resource use more efficient through structural reforms. During the mid-term review of the arrangement, the Fund accepted Ecuador’s request to set aside 25 percent of purchases for debt reduction.
Gabon has suffered a sharp deterioration in its terms of trade since 1986, triggered by falling oil prices—which lowered both export receipts and government revenue—and widened macroeconomic imbalances. The main aims of the Government’s economic policies (backed by a stand-by arrangement for SDR 43 million, approved on September 15, 1989) are to strengthen the current account position, revive growth in the non-oil sector, and contain inflation. The policies include fiscal, monetary, and structural measures. Fiscal measures and a restrictive credit policy were implemented to restrain demand, while the structural measures include continued liberalization and the rehabilitation of public enterprises.
Economic performance in Haiti deteriorated during 1987 and 1988: GDP and investment declined, inflation rose, and the external position remained strained. The Government’s policies aim at reversing these developments by, among other means, increasing savings, reducing the public sector deficit, implementing a cautious monetary policy, and encouraging foreign investment. These measures are supported by a stand-by arrangement for SDR 21 million, approved on September 18, 1989.
Hungary was beset by a number of economic problems in 1989, including a deteriorating fiscal position, a widening of the current account deficit in convertible currencies, and an unexpectedly large balance of payments surplus in nonconvertible currencies. Although the Government took some corrective action at midyear, the problems persisted. The Fund supports policies (through a stand-by arrangement for SDR 159.2 million, approved on March 14, 1990) that aim to reduce Hungary’s economic imbalances while continuing the process of restructuring, reforming, and liberalizing the economy. The policies include fiscal measures designed to reduce the absorption of resources by the public sector, appropriate monetary and credit policies, and a range of structural reforms.
Box 7Fund Facilities and Policies
The facilities and policies through which the Fund provides financial support to its member countries differ, depending on the nature of the macroeconomic and structural problems they seek to address and the terms and degree of conditionality attached to them. They comprise the following:
● Stand-by arrangements, which typically cover periods of one to three years, focus on appropriate exchange rate and interest rate policies aimed at overcoming short-term balance of payments difficulties. Members make purchases (or drawings) in tranches (or segments) of 25 percent of quota each. For drawings within the first credit tranche, the member is required to show reasonable efforts to overcome its balance of payments difficulties. Performance criteria—such as budgetary and credit ceilings, appropriate exchange and interest rate policies, and avoidance of restrictions on current payments and transfers—are not applied. Purchases in the upper credit tranches require substantial justification; the member must have a strong and viable program. Performance criteria are applied and purchases are made in installments. Repurchases (or repayments) on all drawings are made in 3¼ years to 5 years.
● Extended arrangements, under which the Fund supports medium-term programs that generally run for three years (or up to four years in exceptional circumstances) and are aimed at overcoming balance of payments difficulties attributable to structural, as well as macroeconomic, problems. The initial annual program states the general objectives and policies for the three-year period, and policies for subsequent years are spelled out in annual reviews. Performance criteria are applied and repurchases are made in 4½ years to 10 years.
● Enlarged access policy, which is used to increase the resources available under stand-by and extended arrangements for programs that need substantial Fund support. Members’ access to the Fund’s general resources are subject to annual limits of 90 percent or 110 percent of quota, three-year limits of 270 percent or 330 percent of quota, and cumulative limits, net of repurchases, of 400 percent or 440 percent of quota. Access within these limits depends on the seriousness of a member’s balance of payments need and the strength of its adjustment effort.
● Structural adjustment facility (SAF) arrangements, where resources are provided on concessional terms to support medium-term macroeconomic and structural adjustments in low-income countries facing protracted balance of payments problems. The member develops and updates, with the assistance of the staffs 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 annual SAF loan disbursements. The programs include quarterly benchmarks to assess performance. The rate of interest on SAF loans is 0.5 percent, and repayments are made in 5½ years to 10 years.
● Enhanced structural adjustment facility (ESAF) arrangements, whose objectives, conditions for eligibility, and program features are similar to those of SAF arrangements, but which differ in the scope and strength of structural policies, and in terms of access levels, monitoring procedures, and sources of funding.
● The compensatory and contingency financing facility (CCFF), which serves two purposes. The compensatory element provides resources to members to cover export shortfalls or excessive cereal import costs arising from events beyond their control; and the contingency element helps members with Fund-supported arrangements to maintain the momentum of adjustment when faced with a broad range of unforeseen, adverse external shocks, such as declines in export prices or increases in import prices. Repurchases are made in 3¼ years to 5 years.
● The buffer stock financing facility (BSFF), under which the Fund provides resources to help finance members’ contributions to approved buffer stocks. Repayments are made within three to five years or earlier if contributions to a buffer stock are refunded or the borrowing country’s balance of payments situation improves. Since the facility’s establishment in 1969, the Fund has assisted members under the Fourth, Fifth, and Sixth International Tin Agreements, the 1979 International Sugar Agreement, and the 1979 International Natural Rubber Agreement. In April 1990, the Fund decided that its BSFF may be used for financing eligible members’ contributions to the 1987 International Natural Rubber Agreement.
Hurricane Gilbert, which hit Jamaica in September 1988, hampered the country’s adjustment efforts, which it had pursued with much success since the early 1980s. As a result of the reconstruction effort, the public sector deficit increased and international reserves declined. The Government’s economic policies (supported by a stand-by arrangement for SDR 82 million, approved on March 23, 1990) are designed to foster strong fiscal adjustment and exchange rate stability and thus restore growth. They emphasize measures to liberalize the economy, promote exports, and increase domestic savings, particularly in the public sector.
Since the mid-1980s, economic and financial performance in Jordan has been weakened by the prolonged recession in the Middle East, which, together with other external developments, has reduced the flows of official grants and worker remittances and has limited export expansion. Consequently, growth declined and the underlying weaknesses in the balance of payments and the budget—which had relied strongly on external receipts—surfaced. The Government’s policies aim to remedy these problems over the medium term. They comprise major policy adjustments—notably tight fiscal and monetary policies—and structural reforms, including modified investment incentives, trade liberalization, and tariff reforms. The policies are supported by a stand-by arrangement for SDR 60 million, approved on July 14, 1989.
Jordan also made two compensatory drawings (totaling SDR 39.4 million) under the compensatory contingency and financing facility (CCFF) during 1989/90. These were in respect of a shortfall in 1988 in its earnings from merchandise exports, travel receipts, and workers’ remittances.
In recent years, Mexico has contended with major external shocks and domestic imbalances. In response the Government has, since early 1983, implemented policy measures and reforms. During this period, the Fund has provided analytical and financial support on an almost continuous basis. The Fund is currently supporting Mexico through an extended arrangement for SDR 2,797.2 million approved on May 26, 1989 that will help Mexico continue its growth-oriented strategy, curb inflation, and produce a viable balance of payments position. It relies on budget and monetary policies to achieve macroeconomic balance and an array of structural policies to improve efficiency and mobilize resources for investment, increase saving, and promote foreign direct investment and capital reflows.
Mexico’s policies are predicated on a significant reduction in net resource transfers to its creditors. The Fund has therefore accepted the Government’s request that 30 percent of each purchase under the extended arrangement be set aside for debt reduction. In addition, the Fund indicated it would be prepared to consider increasing the amount of the arrangement by up to 40 percent of Mexico’s quota, if financing arrangements were concluded with commercial bank creditors for debt-service reduction and if these arrangements conform with the Fund’s guidelines. This augmentation was approved in January 1990, and the amounts set aside for 1989 and 1990 were released at the same time.
During 1989/90, Mexico drew SDR 453.5 million under the CCFF to compensate for an export shortfall and excessive cereal imports in 1988.
Papua New Guinea was badly hit by the closure, in May 1989, of its largest copper mine, which accounted for 10 percent of GDP, 35 percent of exports, and 15 percent of government revenue. The adverse impact of the closure was compounded by sharp declines in the prices of almost all of Papua New Guinea’s major export commodities. As a result, both export earnings and GDP growth fell, and unemployment rose. The Government’s measures (supported by a stand-by arrangement for SDR 26.36 million, approved on April 26, 1990) have two interrelated aims: to strengthen budget and monetary policies so as to preclude a sharp deterioration in the external position as well as to contain price pressures; and to promote growth-oriented structural change.
Papua New Guinea also drew SDR 42.84 million under the compensatory element of the CCFF in respect of an export shortfall in the year ended June 1990.
The Government of the Philippines is implementing a medium-term program (backed by an extended arrangement for SDR 660 million approved on May 23, 1989) that aims to reduce inflation, strengthen the external payments position, and ease the external debt burden. The strategy to achieve these aims has five elements: a significant increase in productive investments; higher savings; prudent financial policies; structural reforms—mainly public enterprise, financial sector, trade policy, and land reforms; and substantial external support. Of each purchase under the extended arrangement, 25 percent will be set aside for debt reduction. In addition, the Fund would consider an augmentation of the arrangement by up to 40 percent of the Philippines’ quota.
The Fund has also approved an arrangement under the CCFF (totaling SDR 286.3 million) for the Philippines. This is aimed at providing additional financing should adverse external contingencies occur during the period of the extended arrangement. It will cover unanticipated deviations from projections for a number of export and import prices; for trading partners’ import demand; and for interest payments on net external debt with variable interest rates.
The Government that took office in Poland in September 1989 inherited an economy that verged on hyperinflation and was weakened by acute scarcities, badly distorted incentives, and falling output. The authorities responded swiftly to the crisis with a set of emergency measures. They subsequently adopted an ambitious economic program (supported by a standby arrangement for SDR 545 million) designed to consolidate these measures. The program, which was approved on February 5, 1990, aims first to stabilize the economy quickly and decisively with particular emphasis on reducing inflation; and second, to enhance the role of market forces. The stabilization efforts involve three main initiatives: using the exchange rate and wage policy to slow down inflation; reducing demand pressures and strengthening financial discipline; and implementing a tight money and credit policy. The shift to market mechanisms involves measures to liberalize prices and the foreign exchange and trade systems; and the introduction of a wide range of market economy institutions.
During 1982-86, the economy of Trinidad and Tobago deteriorated markedly, but since 1987, the Government has made much progress in reducing economic imbalances. Its economic policies for 1990 are designed to achieve positive growth for the first time in a number of years, reduce inflation, and increase international reserves. In addition to cautious budget and monetary policies, measures to strengthen structural reforms are already under way. Among these measures are further exchange and trade liberalization, the second phase of a tax reform, and public enterprise reforms. The Government’s objectives are supported by a stand-by arrangement for SDR 85 million, approved on April 20, 1990.
Trinidad and Tobago’s stand-by arrangement is accompanied by possible external contingency financing under the CCFF up to a maximum of SDR 42.5 million. This covers unexpected negative deviations from projections of key external variables including export prices of crude petroleum and petroleum products as well as interest rates on external debt carrying variable interest rates.
The medium-term objectives of the Fund-supported program in Venezuela are to strengthen the country’s current account position consistent with real economic growth of 4½-6 percent a year; reduce its external debt burden while improving the external reserve position; and boost domestic investment through an increase in domestic savings, mainly via an improvement in public sector finances. The program, which was approved on June 23, 1989, is backed by an extended arrangement for SDR 3,703.1 million. The Fund has accepted Venezuela’s request that between 25 percent and 31.25 percent of purchases under the arrangement be set aside for debt reduction. In addition, the Fund will be prepared to consider augmenting the amount of the arrangement by up to 40 percent of Venezuela’s quota if financing arrangements are concluded with commercial banks for debt-service reduction and if the Fund finds these arrangements to be consistent with its guidelines. Venezuela’s economic program emphasizes fiscal and monetary restraint and wage policies consistent with lowering inflation.
Faced with spiraling inflation, at the beginning of 1990 the Government of Yugoslavia adopted a bold and comprehensive program of rapid disinflation as part of a broader plan to transform Yugoslavia into a market-guided economy over the medium term. This program is supported by an 18-month stand-by arrangement for SDR 460 million, approved on March 16, 1990. It relies, initially, on the anchors of a fixed nominal exchange rate, a strict cap on nominal wages, and a partial price freeze. These are backed by strict monetary restraint and a major fiscal effort.
Since late 1986, the economy of Zaire has deteriorated as expansionary fiscal and monetary policies reinforced its underlying weaknesses, especially in the areas of basic infrastructure, public finance, and the public enterprise sector. The Government’s economic and financial policies (supported by a stand-by arrangement for SDR 116.4 million, approved on June 9, 1989) are aimed at boosting growth, reversing the deterioration in public finances, reducing inflation, consolidating the external accounts, and increasing international reserves. The stand-by arrangement runs parallel with another arrangement under the SAF, approved in May 1987, which addresses deep-rooted structural problems and various policy-induced distortions.
Arrangements Under SAF and ESAF
Of the seven low-income countries for which the Fund approved new three-year arrangements under the SAF and the ESAF, six (Benin, Kenya, Madagascar, Mauritania, Sao Tome and Principe, and Togo) are in sub-Saharan Africa and one (the Lao People’s Democratic Republic) in Asia.
The economy of Benin went into crisis following the sharp deterioration of the external environment after 1985—particularly the declines in world market prices for oil and cotton. In response to the ensuing negative growth and growing external and fiscal imbalances, the Government took a number of remedial measures in 1987-88. Although it made some progress in strengthening budget and monetary policies, the situation remained critical. The Government has therefore adopted comprehensive medium-term policies, supported by the Fund under a SAF arrangement for SDR 21.91 million, approved on June 16, 1989. These measures aim to reduce the role of the Government in the economy while strengthening the private sector by relying more on market forces to boost growth, to contain domestic cost and price increases, and to bolster the external position. Toward these ends, they seek to reform the government sector (including public enterprises), strengthen incentives, restructure the banking system, and reduce the fiscal deficit.
The policies adopted by the Government of Kenya under the ESAF (for SDR 241.4 million, approved on May 15, 1989) build on earlier measures supported by the Fund under the SAF and under a stand-by arrangement, which covered the period 1988-90. The policies backed by the ESAF—which runs from 1989 to 1991—are designed to further reduce inflation; achieve average real GDP growth of about 5 percent a year; reduce the current account deficit; and increase employment. They emphasize structural fiscal reforms, financial sector restructuring, key trade and industrial reforms, and export promotion.
The medium-term objectives of the Government of the Lao People’s Democratic Republic under a SAF arrangement (for SDR 20.51 million, approved on September 18, 1989) are to achieve real GDP growth of 5-6 percent a year, to reduce inflation to the level of the country’s trading partners by 1992, and to strengthen the balance of payments. In the first year of the arrangement (to June 1990), monetary and fiscal policies were tightened; reforms were put in place to mobilize savings; steps were taken to increase the efficiency of investment in the public sector; and a number of external sector reforms were implemented to encourage both export growth and import substitution. In addition, the Government provided food aid to those adversely affected by a drought that hit the country in 1988.
In the case of Madagascar, the ESAF arrangement (for SDR 76.9 million, approved on May 15, 1989) replaces two earlier arrangements (a stand-by arrangement and a SAF arrangement), which included a number of structural reforms. The ESAF-supported policies aim at achieving positive real per capita growth and more stable finances. They include policy reforms that further strengthen the role of the private sector and reinforce the use of price signals for both internal and external transactions. The arrangement also contains explicit measures to alleviate poverty.
For Mauritania, the ESAF arrangement (for SDR 50.85 million, approved on May 24, 1989) replaces an earlier arrangement under the SAF. The ESAF arrangement aims at achieving real economic growth of about 3.5 percent a year during 1989-91, reducing inflation to about 4.5 percent by 1991, and strengthening the country’s external position. They include measures to contain aggregate demand—particularly its public sector component—and to restore efficiency in manufacturing by rehabilitating public enterprises. The Government also seeks to further the role of the private sector in the economy, for which purpose it has already implemented a number of structural reforms.
Sao Tome and Principe adopted policies supported by the SAF (for SDR 2.8 million) on June 2, 1989, following a severe contraction in the production of cocoa and food crops after 1975, which led to intensified balance of payments pressures. The country also experienced an increase in foreign debt and significant monetary and fiscal strains. The Government’s policies seek to achieve real GDP growth of about 4 percent, on average, during 1989-91; to contain inflation; and eventually to reduce the external current account deficit to a level that can be financed by grants and concessional loans. The policies envisaged include a well-conceived investment program, stronger budgetary management, and improved domestic resource mobilization and budgetary control. To improve incentives, particular importance will be given to flexible exchange rate management, public enterprise and civil service reforms, and distribution of public lands.
The three-year ESAF arrangement for Togo (for SDR 46.08 million, approved on May 31, 1989) replaces an arrangement under the SAF. The earlier arrangement was put in place following a weakening of Togo’s economy and finances, largely because of sharp declines in the world prices of its major exports during 1986-87, aggravated by the appreciation of its currency, the CFA franc, against the U.S. dollar. The ESAF arrangement aims to sustain Togo’s real GDP growth at more than 4 percent a year, contain inflation to about 3 percent, and reduce the current account deficit (excluding grants) to 7.7 percent of GDP by 1991. It includes measures to improve the allocation of public expenditure, make public enterprises more efficient, and give the private sector more scope.
The Fund and the World Bank share the objective of promoting sustained growth and development of their member countries. While their charters provide them with differing but complementary mandates in pursuing this objective, they cooperate to help their members by pooling their specialized expertise and coordinating policy advice and financial assistance. The scope for such cooperation has increased substantially in the past decade, as the efforts of both institutions to address the severe economic and financial imbalances of their members have led to an increasing complementarity in their activities. Because of this, and in order to avoid duplication, the two managements agreed in March 1989 to define better each institution’s responsibilities under its Articles and to develop previously agreed procedures by adopting additional administrative and procedural steps.1
Fund-Bank collaboration is based on regular contacts between the two staffs, both at headquarters and in the field; these are intended to better integrate each institution’s analysis and policy advice, and ensure timely assistance to member countries. Communication between staffs at headquarters includes systematic contacts at the operational level—including a continuous exchange of information on each institution’s work program, proposed lending operations, diagnoses of members’ economic problems, and prospective positions in dealing with members or other international institutions. Staff in one institution also may attend the other’s Executive Board meetings whenever matters of common interest are discussed.
Detailed procedures enable staff jointly to assist member countries in the preparation of policy framework papers for SAF-eligible and ESAF-eligible countries, which set out medium-term economic objectives and planned policy measures. During the 15-month period ended March 31, 1990, discussions on policy framework papers took place in 44 joint or parallel missions, as well as in missions with a cross participation of staff of the other institution. During 1989, the process for policy framework papers was strengthened to ensure a central role for country authorities as well as closer collaboration between the staffs. There is also cooperation in the field either through joint staff missions or through staff participating in each other’s missions. Between January 1, 1989 and March 31, 1990, Bank staff participated in 21 Fund missions that did not directly involve discussions on policy framework papers; Fund staff participated in 13 Bank missions. Collaboration is also close on a range of administrative matters, including preparations for Annual Meetings and meetings of the Development Committee, statistics, and some publications.
Following the 1989 agreement, additional procedures for collaboration have included systematic and frequent meetings of the senior staffs and managements of the two institutions. These meetings help to plan ways to resolve particularly complex country issues and to exchange views on general policy aspects. Also, collaboration has been close in the context of the debt strategy. A joint task force was established to promote cooperation, analyze debt strategy issues, and exchange information on financing techniques. As part of this effort, in May 1989, the Fund and the Bank adopted broadly similar guidelines to support debt- and debt-service-reduction operations. Such contacts have been continuous on those countries for which set-asides for debt- and debt-service-reduction have been approved by both Boards. This had led to unified positions regarding financial packages under discussion with commercial banks, thereby facilitating relations between indebted countries and their bank creditors.
Likewise, there has been considerable collaboration where members have overdue obligations to either the Fund or the Bank, in line with the principles laid out in the 1989 agreement. Both institutions urge members with overdue obligations to become current. Their staffs work together closely to develop general policies and procedures to address the problem of arrears, as well as to assist individual countries to eliminate their arrears. Close working relations are also maintained through consultative and support groups formed to assist members to resolve financing difficulties.
Compensatory and Contingency Financing Facility
The compensatory and contingency financing facility (CCFF) was established on August 23, 1988. This facility has two purposes:
● to help stabilize the earnings of countries exporting primary commodities; and
● to protect the Fund-supported economic policies of members from the disruptive effects of unanticipated external shocks.
The CCFF combines a contingency financing element with the previously existing compensatory financing facility. Compensatory financing, first introduced in 1963, assists members experiencing, for reasons largely beyond their control, balance of payments problems owing to temporary shortfalls in export earnings. Members obtaining financing agree to cooperate with the Fund to find solutions to their balance of payments difficulties. In 1979, compensatory financing was broadened to include tourist receipts and worker remittances in calculating the export shortfall, and in 1981 a further extension allowed compensation for countries faced with an excessive rise in the cost of specific cereal imports. An export shortfall is defined as the amount by which export earnings or cereal import costs deviate from their medium-term trends.
Contingency financing helps members that are engaged in economic policy adjustments supported by the Fund, by providing advance assurances of financial protection in the event of a disruptive external shock. Contingency financing covers deviations in certain key economic variables from “baseline” forecasts. These variables could include export earnings, import prices, international interest rates, worker remittances, tourism receipts, and other variables affected by external conditions beyond members’ control. The contingency element is symmetrical: if the member experiences an external shock that has a positive net balance of payments impact, it is expected to add to its international reserves, where these are low; if reserves are adequate, the member is expected to forgo further borrowings from the Fund under the associated arrangement or make early repayments on previous contingency financing loans (see Box 8).
A member using the CCFF may draw, under the compensatory mechanism, up to 40 percent of its quota for export shortfalls and 17 percent for the excess costs of cereal imports. Under the contingency mechanism, a member may also draw up to 40 percent of quota to cover applicable external contingencies. (Contingency financing associated with any particular arrangement is generally limited to 70 percent of the amount of the arrangement.) In addition, the Fund allows an optional drawing of up to 25 percent of quota to supplement either the compensatory or contingency element, at the member’s choice. Cumulative purchases under the compensatory, contingency, and cereal elements at any one time are limited to 122 percent of quota.
The CCFF was reviewed by the Board in April 1990. Although the essential features of contingency financing were maintained, the Board agreed on a number of changes to make it possible to adapt the facility to the particular needs of members. In particular, in determining coverage of contingency financing, it was agreed to focus on those key external components of the member’s current account that are highly volatile, are easily identified, and whose movements are clearly beyond the authorities’ control. Due consideration will be given to the effects on the current account of changes in excluded external variables that are widely recognized to have been influenced substantially by developments in world markets. The Board acknowledged greater flexibility in determining the threshold. Directors also examined conditions of access to compensatory financing under the facility, with a view to tailoring the availability of financing to the particular circumstances of each member.
Box 8Calculating Contingency Financing
To calculate the amount of financing for eligible members under the contingency mechanism, the Fund “nets out” the effects on the country’s balance of payments of both positive and negative external disturbances. Financing is provided where the net negative effect on the member’s balance of payments exceeds a minimum threshold—that is, for major balance of payments disturbances that are unlikely to be reversed quickly. The threshold is set flexibly around a target of 10 percent of the member’s quota in the Fund. Once the threshold is reached, the Fund extends financing equivalent to a specified percentage of the net sum of deviations that exceeds the threshold. This percentage is determined flexibly on a case-by-case basis.
The Fund and Poverty Alleviation
The Fund has paid increasing attention to the social issues confronting members seeking support. Discussions of poverty-related issues have become more frequent and detailed, and have involved not only the Executive Board, management, and staff, but also member governments and international institutions. Moreover, the staff has increasingly sought to take account of such issues in its analysis and policy advice.
The Board first discussed poverty issues in operational terms in February 1988. It revisited the subject in September 1988 when, meeting as a Committee of the Whole for the Development Committee, it discussed a joint Fund-World Bank report on poverty issues in economic adjustment. During these discussions, it was understood that the Fund’s central mandate is to help members maintain or restore policies conducive to growth, balance of payments and price stability, and a more open economy. However, it is a country’s prerogative to make social choices in implementing its policies; questions of income distribution should not be part of Fund conditionality.
The Board noted that policy adjustments do not necessarily lower the living standards of the poor; sound economic policies are necessary to control inflation and achieve sustainable growth, and growth is necessary for the lasting alleviation of poverty. Timely and appropriate policies are important; the experience of many members has shown that the alternative is often bad economic performance, which affects the poor especially severely.
The Board recognized, however, that some policy changes can adversely affect some of the poor in the short run. It therefore welcomed the greater attention being paid to the impact on poverty and income distribution of policy changes supported by Fund financial assistance.
To better understand the effects of economic measures on the poor, the Fund staff is:
● improving its data base on the poor in individual member countries, in close collaboration with the Bank staff and drawing on authorities’ views during consultations and on information provided by international institutions and nongovernmental organizations;
● discussing with country authorities, during consultations and missions, the effects of policy adjustments on the poor; and
● examining whether programs can be designed to lessen their adverse effects on the poor, without weakening adjustment.
The staff has taken a number of concrete steps. First, it has discussed poverty-related issues as a matter of course with governments in all discussions on policy framework papers with countries with arrangements under the SAF and the ESAF. The discussions have been wide ranging and have included both the general implications of adjustment for the poor and the specific implications of particular adjustment measures for identified groups among the poor.
The Fund has also stepped up its contacts with other institutions, both at headquarters and in the field. It has worked especially closely with the World Bank, which has the mandate and considerable experience in dealing with poverty-related issues. In addition to collaborating with the Fund in preparing policy framework papers, which routinely cover the social aspects of adjustment in SAF-supported and ESAF-supported programs, World Bank staff have provided information and expertise on poverty issues, and have contributed substantially to the Fund’s in-house seminars on these issues. In addition, the Fund staff is strengthening its collaboration with a number of UN agencies and nongovernmental organizations.
The Fund’s increasing focus on poverty issues has influenced its approach to policy analysis and recommendations. A number of arrangements have contained measures to lessen or compensate for the adverse impact of certain economic developments and policies on specific groups among the poor. However, it has not been feasible, so far, to quantify precisely the impact on the poor of either program policies or compensating measures.
Issues relating to the impact on the poor of economic developments and policy measures receive especially close attention in policy framework papers, which provide the framework for SAF-supported and ESAF-supported arrangements. Policy framework papers identify the types of policies that are likely to affect the poor. Among those that are likely to benefit some of the poor are policies aimed at stabilization and external adjustment—for example, demand management policies to stabilize prices, devaluation, and policies that improve economic efficiency, such as price reforms and trade liberalization. These measures help the poor in the tradables sector—for example, small farmers who grow exportable crops. Other beneficial measures are those aimed directly at alleviating poverty or improving social services, such as increases in public health and education expenditures, the establishment of employment schemes, and food subsidies targeted at the poor.
Policy framework papers also identify measures that are likely to affect some of the poor adversely. These include fiscal retrenchment and public sector reform—particularly when accompanied by a freezing of public sector employment or wages. In addition, measures that help certain groups among the poor—for example, those that aim at changing relative prices—can hurt other such groups.
Of course, the possible adverse impact of economic policies on the poor needs to be seen in perspective. Judgments cannot be made on the basis of isolated measures; the collective influence of all policies adopted by a country needs to be considered. Besides, an appraisal of the costs for the poor of policy adjustments should take into account what the outcome might have been in the absence of such policy changes. Studies that have done this have proved revealing. They have found, for example, that although devaluation has, in some cases, hurt some of the poor in the short run (but has benefited other poor), alternative policy responses to an overvalued exchange rate—such as trade restrictions or increases in foreign borrowing—have proved even more damaging to the poor.
Nevertheless, in connection with Fund-supported programs, governments can, and do, implement targeted measures to mitigate or compensate for some of the negative effects on the poor of certain policy adjustments. The following three cases illustrate some of these mitigating measures:
● While implementing policy adjustments under the SAF in 1988 and 1989, the Government of Mozambique built into the policy framework a comprehensive set of compensatory measures aimed at cushioning the impact of adjustment on specific social groups. The policy adjustments had included devaluation, cuts in civil service employment, and reduced food subsidies. The measures introduced by the authorities to mitigate some of the adverse effects of the program included the establishment of food rationing for casual and informal sector workers as well as for the rural population, the provision of free food for displaced public workers, and wage supplements for large families.
● To deal with the adverse social effects of the hyperinflation of 1984-85 and the subsequent stabilization program, the Government of Bolivia, under a SAF-supported program begun in 1987, sought to improve low-income groups’ access to education, health care, clean water, and housing. In addition, the Government established the Emergency Social Fund—a three-year program to channel concessional foreign resources to carefully selected public works programs to improve basic infrastructure and to support other labor-intensive production through the provision of seed capital and credit.
● In connection with the sharp devaluation that was part of the adjustment program supported by a standby arrangement with the Fund in 1989, the Government of Jordan did not allow prices of certain essential items to increase. The consequent budgetary subsidies were offset by revenue measures that had a relatively larger effect on upper income groups.
Although the Fund’s operational experience in addressing poverty concerns is increasing, it is still limited. The need to identify more closely the poor, assess the impact on them of policy reforms, and improve the policy mix in programs remains urgent. The Fund seeks to meet these needs. Notably, it is further expanding its research in poverty-related issues, strengthening its collaboration with governments and other institutions, and improving its design of policies to minimize the adverse effects on the poor.
Technical Assistance and Training
The Fund has provided its member countries with technical assistance and training in economic and financial matters almost since its inception. Such assistance and training continued to be an important element of the Fund’s relations with its member countries during 1989/90, and members sought assistance on a wide range of issues. These ranged from broad policy issues connected with stabilization and adjustment policies and external debt management, to more specialized technical, legal, and data processing matters.
Training is provided by the IMF Institute—both at headquarters and overseas—and by many other departments, including the Central Banking, Fiscal Affairs, and Legal Departments, the Bureau of Computing Services, and the Bureau of Statistics. There were several important developments in the Fund’s technical assistance in 1989/90. Agreement was reached between the United Nations Development Program (UNDP) and the Fund, which allows the Fund to act as executing agency for UNDP-financed technical assistance. The IMF Institute introduced new courses on programming and policies for medium-term adjustment and on techniques of financial analysis and programming and sharply increased the number of external seminars and workshops. There was a sharp rise in the Fiscal Affairs Department’s technical assistance, owing to the continued increase in the number of Fund-supported structural adjustment programs and the changes in Eastern Europe. The Bureau of Statistics initiated an expanded program of assistance that generally requires the services of a resident statistical adviser in a member country.
The Central Banking Department’s assistance to Poland and Angola—both in the process of transforming a centrally planned economy—shows the diversity of forms of assistance to member countries. In Poland, the rapid pace of market-oriented reforms has necessitated new approaches to assistance in the central banking area. In addition to providing a resident technical expert, the Central Banking Department sought the cooperation of six Western central banks, each to contribute in a specific area of functional modernization of the National Bank of Poland. The Fund staff and consultants from the cooperating central banks developed a coordinated program of reforms in each area based on advisory missions and diagnostic studies. The department made available a high-level advisor on money management issues for periodic consultations, at the request of the senior management of the Polish central bank. Also, over the past two years, experts from the Fiscal Affairs Department have advised the Polish authorities on matters of tax policy. For Angola, the Central Banking Department developed a long-term reform and assistance program to restructure the existing monobank and build up a modern banking system. Two missions were organized and an expert was assigned as Advisor to the Governor; two more will be assigned in 1990 as part of a UNDP-IMF project to carry through the reforms.
Much of the policy assistance is provided through the Fund’s Article IV consultation with members or in connection with Fund-supported arrangements. A further type of assistance is to be found in the policy framework programs that are prepared in conjunction with the World Bank for lending under the SAF and the ESAF. In supporting members efforts to adapt their economic policies, the Fund will often use both the expert services of staff members from headquarters and of those assigned to countries as resident representatives. (Further information on the Fund’s technical assistance activities during 1989/90 is to be found in Appendix III.)
4. Trade Policy Issues
Stronger efforts are urgently needed to counter protectionism and to foster a more open trading system with transparent, predictable, and nondiscriminatory rules in order to sustain world trade expansion, to provide markets for exports from indebted developing countries, and to promote market-oriented reforms. For this reason, the Fund considers it essential to reach a successful conclusion of the Uruguay Round of multilateral trade negotiations by December 1990. The Fund continues to promote the adoption of more liberal trade policies by its members.
The Fund is required by its charter to facilitate a balanced growth of international trade. To this end, trade policy issues are an integral part of surveillance, and are regularly addressed in Article IV consultations with member countries, the World Economic Outlook exercise, and periodic trade review papers. Trade liberalization is also often an important element of Fund-supported adjustment programs.
The Board has repeatedly reaffirmed its commitment to trade liberalization as a means to promote steady and balanced economic growth that promotes economic adjustment. In the April 1990 discussion of the World Economic Outlook, it was stressed that the successful conclusion of the Uruguay Round of multilateral trade negotiations by the deadline of December 1990 is essential, as it will bring about substantial gains in efficiency for the world economy and reduce frictions among trading partners that have had visible adverse effects on international trade and on financial markets. Renewed efforts are called for in key areas such as agriculture and textiles, where there are significant differences among participants in the Round. Multilateral resolution of trade issues is important if potentially harmful unilateral and bilateral approaches are to be discouraged.
At their September 1989 and May 1990 meetings, both the Interim Committee and the Development Committee underscored the urgency of resisting trade restrictions, in keeping with political commitments made under the Uruguay Round, and of bringing the Round itself to a successful conclusion by December 1990.
The rapid changes taking place in Eastern European countries in liberalizing trade and payments systems are a positive development for the expansion of world trade and lend further urgency to the need to take full advantage of the opportunity provided by the Uruguay Round to liberalize trade and strengthen the multilateral trading system. The plans for removing trade barriers within the internal European Community (EC) market by 1992 and for moving toward an EC-EFTA European Economic Space and the 1988 Free Trade Agreement between the United States and Canada also have implications for global trade. The Fund considers it essential that regional and bilateral trade arrangements contribute to a more liberal multilateral trading system and take into account the interests of third countries.
Box 9Obligations of Article VIII
During 1989/90, two members notified the Fund that they had accepted the obligations of Article VIII of the Articles of Agreement—Swaziland, on December 11, 1989, and Turkey, on March 22, 1990. Also, Thailand accepted Article VIII status on May 4, 1990. They are, respectively, the sixty-sixth, sixty-seventh, and sixty-eighth members to assume this status (Appendix Table II.16).
Members accepting the obligations of Article VIII undertake to refrain from imposing restrictions on the making of payments and transfers for current international transactions or engaging in discriminatory currency arrangements or multiple currency practices without Fund approval. They also undertake to assure that their currencies are fully convertible. Some of the main purposes of the Fund are to facilitate the expansion and balanced growth of international trade, and thereby contribute to high levels of employment and real income and to assist in establishing a multilateral system of payments in respect of current transactions between Fund members. Among the ways the Fund seeks to achieve these objectives is by helping to eliminate restrictive practices in the exchange and payments areas.
Countries that accept Article VIII status give confidence to the international community that they will pursue sound economic policies that will obviate the need to use exchange and payments restrictions on current transactions and thereby enhance their contribution to a multilateral payments system free of restrictions.
Developments in 1989/90
Despite the continued growth in world trade in 1989 and some positive developments in international trade policy, there are constant pressures to maintain and expand protectionist trade measures. The positive developments during the year include liberalization measures in some industrial countries, such as Australia and the EC member countries; some reduction in barriers to trade in tropical products following the mid-term review of the Uruguay Round; and liberalization in a number of developing countries, including measures implemented as part of Fund-supported adjustment programs. Eastern European countries have initiated market-oriented trade policy reforms, in some cases with Fund support. There has been an increased participation in the General Agreement on Tariffs and Trade (GATT); 14 countries have applied for membership or observer status. Also, effective January 1, 1990, Korea disinvoked the GATT provision that had permitted it to maintain import provisions for balance of payments reasons.
On the negative side, there were concerns over contraventions of the Uruguay Round agreement on abstaining from new restrictions, and a number of GATT panel findings have not been implemented. Trade tensions persist among major industrial countries, as well as between industrial and developing countries. Specific areas of concern include the following:
● Certain aspects of the U.S. Trade and Competitiveness Act of 1988, which permit remedies to trade disputes outside the GATT system.
● Persistent reliance on selective measures taken outside GATT rules to restrain imports, particularly those used by the EC.
● The continued heavy recourse to the use of anti-dumping and countervailing duty investigations, notably by the EC and the United States.
● Problems in bilateral trade issues between the United States and Japan, with each country considering that the other had taken inadequate action on structural reform. Recent discussions have eased trade tensions somewhat.
● An escalation of trade tensions between the United States and the EC, with disagreements on agriculture and on other issues.
● Complaints voiced by the developing countries that the Uruguay Round does not adequately address their specific concerns in the trade area.
Some moves toward regional integration (including the EC internal market and the U.S.-Canada Free Trade Agreement), while leading to liberalization among the countries in a region, have been of concern to third countries, which fear the possible trade-diverting effects of such regional liberalization.
Role of the Fund
Given the increased importance of trade policy issues in the world economy, the Fund has accorded greater weight to such issues, both in its surveillance activities and when it provides financial support. The Fund and the GATT cooperate to promote an open and nondiscriminatory multilateral trading system. Ways of further increasing such cooperation are under consideration in the Uruguay Round.
The Fund continues to emphasize the need for further trade liberalization among its member countries. Trade liberalization and macroeconomic adjustment complement each other, since protectionist pressures can best be reduced by addressing underlying domestic macroeconomic imbalances. In the case of the industrial countries, in particular the major ones, the Fund stresses their special responsibility to provide an external environment that is supportive of adjustment efforts in developing countries. The Fund also underpins the trade liberalization efforts of developing countries by strengthening their economies through financial and technical assistance in the context of Fund-supported programs. The Fund’s periodic trade policy reviews enhance the transparency of trade policies of member countries and simplify the assessment of countries’ trade policies in a global trade and financial environment.
Box 10The Fund and the GATT
Close links already exist between the Fund and the GATT. In GATT consultations with members using trade measures for balance of payments reasons, the Fund provides members of the relevant GATT committee with the latest report on recent economic developments for the consulting country. When full consultations are held the Fund representative makes a statement on a country’s economic adjustment strategy and financial policies.
The GATT’s balance of payments provisions are under discussion in the Round. Industrial countries generally support tighter disciplines on the use of trade measures for balance of payments reasons, which could entail more active Fund involvement. However, most developing countries maintain that the present disciplines are adequate, and that no tightening is acceptable until better market access and an improved international economic environment can ameliorate their external financial difficulties.
Besides the Fund’s role in GATT balance of payments consultations, cooperation between the Fund and the GATT includes frequent meetings between Fund and GATT officials, day-to-day contacts through the Fund’s Office in Geneva, and exchanges of documents. Further cooperation may result from negotiations on a framework of multilateral rules and disciplines for trade in services. The need to respect Fund jurisdiction and responsibilities is recognized, and the Fund staff is being consulted on how to ensure this.
A strengthening of links between the GATT and the Fund and the World Bank are being discussed in the context of the relationship between trade policies and other aspects of the global economic environment. Participants are considering two different approaches: The first would allow collaboration to develop pragmatically in response to issues that need to be addressed jointly. The second would be based on a formalization of institutional links. Both approaches, but especially the formal one, are resisted by some countries that fear that closer GATT links with the Fund (and the Bank) may give rise to “cross-conditionality”—that is, that the GATT might seek to encourage the Fund to support programs only if they include additional specific trade measures.
The Uruguay Round of multilateral trade negotiations has now entered its final phase. Notwithstanding the progress that has been made, many substantive issues remain to be resolved before the conclusion of the Round. These include:
● Enhancing and broadening market access under strengthened and more predictable trade rules, both in areas (such as agriculture and textiles and clothing) that in the past have largely escaped GATT discipline, and in new areas (such as services, trade-related intellectual property rights, and trade-related investment measures).
● Resolving differences among participants with regard to the nature and extent of reforms in agriculture, in textiles and clothing, and in tropical products and natural resource-based products.
● Strengthening multilateral trade rules to improve market access, both to give countries confidence that market access will not be arbitrarily denied and to provide for temporary limitations on access under agreed conditions.
● Resolving disagreements over safeguards, or temporary import restrictions designed to protect domestic producers, where discriminatory trade-distorting measures, such as voluntary export restraints, have increasingly been used in place of measures taken under GATT rules. Differences center on whether these restraints could apply selectively, or whether nondiscrimination should continue to be the guiding principle.
● Resolving differences over the rules related to the use of trade restrictions for balance of payments reasons.
● Seeking to resolve difficulties in the areas of antidumping and subsidies.
● Improving the dispute-settlement mechanism within the GATT to increase predictability of treatment and to reduce the need for unilateral or bilateral measures to resolve trade differences. Although some streamlining of GATT’s dispute-settlement mechanism was implemented following the mid-term review of the Round, basic problems remain.
● Developing a consensus on trade-related property rights and investment measures and services. For many countries, mainly developing countries, agreement means overcoming fundamental problems in the way they view development needs and sovereignty requirements. In addition, agreement would, for some, be contingent on what the Round can offer in other areas, particularly agriculture and textiles.
● Reaching a full agreement on services, although the short time remaining before the end of the Round makes it uncertain how much liberalization will be achieved.
In addition to market access and rule-making, the Round is addressing systemic issues related to the functioning of the GATT. Among much broader issues, these negotiations aim at strengthening GATT surveillance over trade policies of the Contracting Parties to the GATT and increasing the contribution of the GATT to international policy coordination. Following the mid-term review of the Uruguay Round, a new trade policy review mechanism was introduced on a provisional basis, and in December 1989, the trade policies of three countries (Australia, Morocco, and the United States) were reviewed. In addition, increased collaboration between the GATT, the Fund, and the World Bank is being discussed (see Box 10).
5. The Fund’s Financial Operations and Policies
Commitments of Fund resources increased substantially for the second year in a row to SDR 11.3 billion in 1989/90, compared with SDR 4.6 billion and SDR 3.0 billion, respectively, in the previous two years. Purchases from the General Resources Account also increased markedly, to SDR 4.4 billion. Repurchases decreased only slightly to SDR 6.0 billion during 1989/90, and thus Fund credit outstanding in the General Resources Account fell SDR 1.6 billion to SDR 22.1 billion as of April 30, 1990. Nonetheless, the Fund’s holdings of uncommitted and usable ordinary resources at the end of the financial year fell to SDR 41.2 billion, while available borrowed resources were SDR 2.0 billion. Although the Fund’s liquidity remained satisfactory, use of Fund resources is expected to increase further over the next few years. The Fund’s Board of Governors has proposed that the present total of Fund quotas be increased by 50 percent to SDR 135.2 billion as a result of the Ninth General Review of Quotas. The increase will not become effective until a proposed amendment of the Articles of Agreement goes into effect. This amendment would provide for the suspension of voting and related rights of members that do not fulfill their obligations under the Articles.
Overdue financial obligations to the Fund increased during 1989/90 to SDR 3.3 billion. Progress has been made in implementing the Fund’s cooperative strategy for resolving members’ arrears problems. The first two successful cases under the strategy were concluded with the restoration of the eligibility of Guyana and Honduras to use the Fund’s general resources, effective June 20 and June 28, 1990, respectively. The Fund also took steps to strengthen its financial position through additions to precautionary balances and reserves. The Fund’s net income was SDR 85.5 million.
The allocation of SDRs remained unchanged at SDR 21.4 billion and their use continued at the relatively high level of recent years.
Ninth General Review of Quotas
The Executive Directors held 33 meetings on the Ninth General Review of Quotas in the financial year 1989/90. The Board of Governors adopted the resolution proposing increases in quotas under the Ninth Review on June 28, 1990.
The agreed increase in quotas of SDR 45,082.15 million will increase the size of the Fund to SDR 135,214.7 million. Under the Articles, the next review of quotas will be conducted by March 31, 1993. Japan and the Federal Republic of Germany will share the second place in terms of quotas after the United States, followed by the United Kingdom and France, which will also have equal quotas.
The agreed increase in the size of the Fund reflects the Interim Committee’s restatement at its September 1989 meeting of the central role of the Fund in the international monetary system, the need for the Fund to be adequately endowed so as to maintain an effective presence at the center of the system, and its basic monetary character. There was agreement by the Executive Board that this character must be preserved by ensuring that the Fund would continue to provide balance of payments assistance on a temporary basis, that Fund resources revolve, and that the Fund would continue to hold a level of usable assets sufficient to protect the liquidity and immediate usability of members’ claims on the Fund, thereby maintaining members’ confidence in and support of the institution.
Box 11Fund Quotas
Each Fund member is assigned a quota, which determines its financial and organizational relations with the institution. Quotas determine members’ subscriptions to the Fund, their relative voting power, their maximum access to financing from the Fund, and their shares in SDR allocations.
● Subscriptions. The amount of a member’s quota is expressed in terms of SDRs, and is equal to the subscription the member must pay, in full, to the Fund. Up to 25 percent of the subscription has to be paid in reserve assets specified by the Fund (SDRs or usable currencies) and the remainder in the member’s own currency.
● Voting power. Each Fund member has 250 basic votes plus one additional vote for each SDR 100,000 of quota. A member’s voting power is important for two reasons. First, many of the principal policy and operational decisions of the Fund require a certain majority of votes. For example, an adjustment of quota needs an 85 percent majority of the Board of Governors, as does an allocation of SDRs and sales of the Fund’s gold; a 70 percent majority is required for the determination of charges. Second, the voting power of a member has a bearing on the member’s representation on the Board. The five members with the largest quotas each appoint their Executive Director, as can the two members with the largest net creditor positions in the Fund over the past two years. The remaining Directors are elected by groups or constituencies of members, and since a member’s voting power depends on the size of its quota, quotas have a bearing on the formation of these groups as well.
● Access to financing. The maximum access of a member to Fund resources—that is, the maximum amount of financing the member can obtain from the Fund—is determined in proportion to its quota.
● Allocation of SDRs. The SDR facility was created in 1969 to enable the Fund to meet the long-term global need to supplement existing reserves. Members receive shares in an allocation of SDRs in proportion to their quotas on the date immediately preceding the allocation. There have been allocations of SDRs in 1970-72 and 1979-81 for a cumulative total of SDR 21.4 billion.
● Determination and adjustment of quotas. The Articles of Agreement do not indicate how a member’s quota should be determined, though from the very start, quotas have been related to, but not strictly determined by, economic factors, such as national incomes and the values of external trade and payments. In connection with the Ninth General Review, the set of five quota formulas that were agreed in connection with the Eighth General Review were used to derive “calculated quotas,” which serve as broad measures of members’ relative positions in the world economy.2 These formulas employ economic data relating to members’ gross domestic product, current account transactions, the variability of current receipts, and official reserves.
Under the Articles, the Board of Governors is required to conduct a general review of quotas at intervals not longer than five years and to propose any adjustments that it deems appropriate. Such reviews provide an opportunity to consider the adequacy of the Fund’s resources to fulfill its systemic responsibilities and to respond to the temporary balance of payments needs of its members, while maintaining the revolving character of its resources. Reviews and adjustments of quotas of individual members are also designed to reflect such factors as the growth of the world economy and changes in the relative economic size and circumstances of member countries.
When a country applies for membership, its quota can be expected to be determined within the same range as the quotas of members of the Fund considered to be in a comparable situation. The other terms for membership, such as the proportion of subscription to be paid in reserve assets, are set so as not to discriminate in other respects between applicants and existing members in similar circumstances.
The distribution of the overall increase in quotas was guided by the principles agreed by the Interim Committee in its meetings in April and September 1989. In the latter meeting, the Committee reiterated that the size and distribution of any quota increase should take into account changes in the world economy since the last review of quotas, as well as members’ relative positions in the world economy and the need to maintain a balance between different groups of countries, and the Fund’s effectiveness in fulfilling its systemic responsibilities, including its role in the strengthened debt strategy. In order to provide all members with a meaningful increase in quotas and to help maintain a balance between different groups of countries, 60 percent of the overall increase in quotas will be distributed to all members in proportion to their present individual quotas; the remainder will be devoted to bringing members’ quotas more in line with their relative economic positions, and will be distributed in proportion to members’ shares in the total of the calculated quotas.
The quota of Japan, after being raised as described above, will be further increased to be equal o that of Germany, and the rises in the quotas of the other Group of Seven countries will be adjusted in a manner that would maintain unchanged the increases in quotas for all other Fund members. Agreement was also reached between the United Kingdom and France on an equal distribution of quotas between themselves under the Ninth Quota Review and subsequent reviews of quotas. The quotas of four countries (Antigua and Barbuda, Bhutan, Maldives, and Seychelles), with very small quotas of less than SDR 10 million at present, will be increased by additional amounts that would increase their shares in the total of new quotas to their individual shares in the total of calculated quotas.
The quotas determined as indicated above have been rounded to the next higher multiple of SDR 0.5 million for members with present quotas amounting to SDR 10 million or less, and to the next higher multiple of SDR 0.1 million for all other quotas.
A member can consent to the amount of quota increase proposed for it at any time before December 31, 1991. The period may be extended by the Executive Board. However, a member cannot consent as long as it has overdue obligations with respect to repurchases, charges, or assessments to the General Resources Account. The participation requirement will be reached (1) during the period ending December 30, 1991, when the Fund has determined that members having not less than 85 percent of the total quotas on May 30, 1990 have consented to increases in their respective quotas; (2) thereafter, on the date of the Fund’s determination that members having not less than 70 percent of the total of quotas on May 30, 1990 have consented to increases in their respective quotas. A communication of consent from a member with overdue financial obligations to the General Resources Account may not be taken into account in the determination. A further condition before such quota increases can become effective is that the proposed amendment of the Articles of Agreement, which would provide for suspension of voting and other related rights of members that do not fulfill their obligations under the Articles, has come into effect. A member must pay the increase in its quota within 30 days after the later of (a) the date on which the member notifies the Fund of its consent; (b) the date of the determination that the participation requirement is met; or (c) the date of the determination that the proposed amendment of the Articles of Agreement has become effective. The period for payment may be extended by the Executive Board. A member may not make such a payment unless it is current in its obligations with respect to repurchases, charges, and assessments to the General Resources Account.
At its meeting in May 1990, the Interim Committee agreed that every effort should be made by members to ensure that both the quota increase and the amendment of the Articles shall be effective before the end of 1991, and that the Committee would consider what steps might need to be taken if it appeared that these resolutions might not be effective by that date.
Twenty-five percent of the increase in quotas shall be paid in SDRs or in the currencies of other members specified by the Fund, subject to their concurrence, or in any combination of SDRs and such currencies. The balance of the increase shall be paid in a member’s own currency. In addition, the Fund stands ready to assist members that do not hold sufficient reserves to make their reserve asset payments to the Fund, by arranging for them to borrow SDRs from other members that are willing to cooperate, provided that such members would on the same day repay the loans from the SDR proceeds of drawings of reserve tranche positions in the Fund that had been established by the payment of SDRs.
Fund Liquidity, Borrowing, and Member Access
The quota increase will help preserve the Fund’s liquidity in the event of an increase in the use of Fund credit. The liquid resources of the Fund consist of usable currencies and SDRs held in the General Resources Account, supplemented, as necessary, by borrowed resources. Usable currencies, the largest component of these resources, are those of members whose balance of payments and gross reserve positions are considered sufficiently strong to warrant their inclusion in the operational budget for use in financing Fund operations and transactions. As of April 30, 1990, the Fund’s uncommitted and usable ordinary resources totaled SDR 41.2 billion, compared with SDR 42.9 billion a year earlier. Although repurchases were in excess of purchases during the financial year, this was more than offset by the removal of two currencies from the operational budget, which largely contributed to the SDR 1.7 billion decline in the Fund’s usable ordinary resources (Chart 10).
Chart10General Resources: Purchases and Repurchases, Financial Years Ended April 30, 1979–90
1 Purchases excluding reserve tranche.
The Fund borrows from official sources to supplement its resources and to finance members’ purchases under the enlarged access policy established in 1984. Under the enlarged access policy, at present a member may have annual access of up to 90 or 110 percent of quota under a stand-by or an extended arrangement and cumulative access of 400 or 440 percent of quota, depending upon the strength of a member’s adjustment program and balance of payments need. These levels of access represent limits and not entitlements, but these limits can be exceeded under exceptional circumstances. At its September 1989 meeting, the Interim Committee recommended the continuation of the policy of enlarged access and the maintenance of the existing limits on the use of Fund resources through 1989/90. At its May 1990 meeting, the Interim Committee agreed that the enlarged access policy and the present access limits should remain unchanged until the increase in quotas under the Ninth General Review of Quotas becomes effective. On June 25, 1990, the Executive Board approved this agreement, with a provision for review not later than December 31, 1991, and annually thereafter, so long as the decision remains in effect.
On April 30, 1990, available borrowed resources amounted to SDR 2.0 billion, all under the 1986 short-term borrowing agreement with the Government of Japan.3 This represented a use of borrowed resources during 1989/90 of SDR 1.0 billion, compared with the use of SDR 0.2 billion during 1988/89 (Appendix Table II.10).
Against these assets, the Fund’s liquid liabilities declined to SDR 24.8 billion at April 30, 1990 from SDR 27.3 billion at April 30, 1989. These liabilities comprised reserve tranche positions, which declined by SDR 0.4 billion to SDR 21.3 billion, and loan claims on the Fund, which fell to SDR 3.5 billion from SDR 5.6 billion a year earlier.
In order to assess the adequacy of the Fund’s liquidity, the stock of usable currencies is adjusted downward to take into account the staffs assessment of the need to maintain working balances in all currencies and the possibility that currencies of weakening members may become unusable. Undrawn balances of commitments of ordinary and borrowed resources are also taken into account in assessing the Fund’s liquidity. The resulting ratio of the Fund’s adjusted and uncommitted resources to its liquid liabilities—the so-called liquidity ratio—declined by about 10 percentage points by the end of 1989/90 to 105.6 percent (see Box 12).
Box 12Liquidity Ratio
The “liquidity ratio” shows the relationship between the Fund’s highly liquid assets (i.e., adjusted and uncommitted resources and investments in connection with enlarged access) and the Fund’s liquid liabilities in the form of reserve tranche positions and loan claims. The liquidity ratio has ranged between 71.0 and 108.5 at the end of each year from 1983 to 1989.
The Fund’s liquidity is affected by its financing of members’ balance of payments shortfalls and members’ servicing of previous purchases. The total of purchases (drawings) from the General Resources Account increased substantially to SDR 4.4 billion in 1989/90 from SDR 2.1 billion in 1988/89 (Table 1).4 The increase primarily reflected a rise of SDR 2.2 billion in disbursements under extended arrangements. In addition, ordinary resources were used to repay SDR 0.4 billion of Fund borrowing that was to be repaid before the corresponding repurchases became due.5
|Financial Year Ended April 30|
|Purchases by facility (General Resources||10,164||6,060||3,941||3,168||4,118||2,128||4,440|
|Stand-by and first credit tranche||4,164||2,768||2,841||2,325||2,313||1,702||1,183|
|Buffer stock financing facility||102||—||—||—||—||—||—|
|Compensatory financing facility||1,180||1,248||601||593||1,544||238||808|
|Extended Fund facility||4,718||2,044||498||250||260||188||2,449|
|Loans under SAF/ESAF arrangements||—||—||—||139||445||554||826|
|Special Disbursement Account resources||—||—||—||139||445||380||584|
|ESAF Trust resources||—||—||—||—||—||174||242|
|Repurchases and repayments||2,129||2,943||4,702||6,749||8,463||6,705||6,398|
|Trust Fund loan repayments||111||212||413||579||528||447||356|
|End of period|
|Total outstanding credit provided by Fund||34,603||37,622||36,877||33,443||29,543||25,520||24,389|
|General Resources Account||31,742||34,973||34,640||31,646||27,829||23,700||22,098|
|Special Disbursement Account||—||—||—||139||584||965||1,549|
|Percentage change in total outstanding credit||30.3||8.7||−2.0||−9.3||−11.7||−13.6||−4.4|
|Number of indebted countries||90||91||87||88||86||83||88|
Excluding reserve tranche purchases.
Including sales of currencies, which have the effect of repurchases.
Excluding reserve tranche purchases.
Including sales of currencies, which have the effect of repurchases.
Repurchases in the General Resources Account in 1989/90 amounted to SDR 6.0 billion, representing a decrease of SDR 0.3 billion from the previous fiscal year. Of this total, about SDR 0.4 billion consisted of early repurchases made by Mauritius and Thailand whose balance of payments and reserve positions improved during the period.6
The relatively high levels of repurchases in the late 1980s reflect the record use of Fund credit in the period up to the mid-1980s, and the revolving nature and medium-term maturity of the Fund’s balance of payments lending.7 Repurchases are projected to continue to decrease in the short term, reflecting relatively lower levels of purchases in the recent past.
These flows resulted in a fall in Fund credit outstanding in the General Resources Account from SDR 23.7 billion in 1988/89 to SDR 22.1 billion in 1989/90 (Chart 11). Details are provided in Appendix Table II-9.
Chart 11Total Fund Credit Outstanding to Members (Including Trust Fund, SAF, and ESAF), Financial Years Ended April 30, 1979-90
1 Includes the compensatory financing facility prior to September 1988 and the buffer stock financing facility.
Stand-By and Extended Arrangements
In 1989/90, 16 new stand-by arrangements came into effect, all with developing member countries, involving total commitments of SDR 3.2 billion of Fund resources. These compared with 12 new stand-by arrangements and commitments of SDR 3.0 billion in 1988/89. The largest commitments were made to Argentina (SDR 1.1 billion); Poland and Yugoslavia (SDR 0.5 billion each); and Algeria, Hungary, and Côte d’Ivoire (SDR 0.2 billion each). About half of these arrangements involved the use of borrowed resources. As of April 30, 1990, 19 stand-by arrangements were in effect, with total commitments of SDR 3.6 billion in Fund resources, and undrawn balances of SDR 2.5 billion.
Three extended arrangements were approved during the financial year 1989/90: Mexico (SDR 3.3 billion), the Philippines (SDR 0.7 billion), and Venezuela (SDR 3.7 billion). These commitments of SDR 7.6 billion, which included commitments of borrowed resources for all three arrangements, represented the highest level of new commitments under extended arrangements since 1984. In connection with the strengthened debt strategy to reduce debt and debt service for qualifying, heavily indebted countries (see Section 2), a total of SDR 1.9 billion has been set aside under the three arrangements for possible debt-reduction operations, and all these included provision for augmentation of arrangements to provide collateral to support debt-service reduction.8 An extended arrangement of SDR 0.2 billion, approved for Tunisia in July 1988, remained in effect, but no purchase has yet been made. Of the total of SDR 7.8 billion committed under extended arrangements at the end of financial year 1989/90, SDR 5.4 billion was undrawn.
The new commitments made in 1989/90 under extended arrangements followed the Executive Board’s June 1988 decision to enhance the facility and the advent of the debt-reduction initiative. This reflected the Fund’s commitment to structural adjustment programs by making Fund resources available under more flexible terms to members with strong programs of macroeconomic adjustment and structural reforms. Drawings under an extended arrangement are financed up to 140 percent of quota with ordinary resources and the balance with borrowed resources.
Total new commitments of Fund resources under stand-by and extended arrangements in 1989/90 amounted to SDR 10.9 billion, more than three times the amount of SDR 3.2 billion in the previous year. Average annual access under new stand-by arrangements was 47 percent of quota and average annual access under new extended arrangements was 78 percent of quota. Annual access for members, as a percent of quota, ranged from 15 percent in the case of Chile to 93 percent for Mexico, after augmentation to support debt-service reduction.
SAF and ESAF
The Fund continued its financial support to low-income members through the structural adjustment facility (SAF) and the enhanced structural adjustment facility (ESAF) in 1989/90.
New commitments in 1989/90 comprised three SAF arrangements totaling SDR 45 million and four ESAF arrangements, totaling SDR 415 million. The largest of these arrangements was with Kenya, for which a SAF arrangement (SDR 99.4 million) was replaced by an ESAF arrangement (SDR 241 million). All SAF arrangements approved during 1989/90, with the exception of a SAF arrangement with the Lao People’s Democratic Republic (SDR 20.5 million), were with African countries. Cumulative commitments under SAF and ESAF arrangements totaled SDR 3.0 billion as of April 30, 1990. Cumulative disbursements under the two facilities amounted to SDR 2.0 billion as of April 30, 1990, compared with SDR 1.1 billion as of April 30, 1989.
Under SAF arrangements, qualified members may borrow up to the equivalent of 70 percent of quota in three annual installments. Under ESAF arrangements, the equivalent of up to 250 percent of quota can be available, depending upon the member’s adjustment program and its financing needs; under exceptional circumstances, this upper limit can be increased to 350 percent of quota. Access under ESAF arrangements approved thus far has ranged from 116 to 180 percent of quota, and has averaged 161 percent of quota.
Resources totaling about SDR 8.8 billion are expected to become available to finance SAF and ESAF arrangements. Loans under SAF arrangements are funded with resources projected to total SDR 2.8 billion, derived from repayments on loans from the Trust Fund (established in 1976). ESAF arrangements are funded with Special Disbursement Account resources not utilized under SAF arrangements and with ESAF Trust resources expected to total about SDR 6.0 billion. At the end of April 1990, the resources available for lending in the ESAF Trust amounted to SDR 5.3 billion, unchanged from the preceding year. Total borrowing agreements in effect were also unchanged at SDR 4.8 billion, including an associated agreement with the Saudi Fund for Development. Some borrowing agreements call for market-related interest rates, while others bear concessional interest rates.
To enable all ESAF financing to be available at low concessional interest rates (currently 0.5 percent a year), subsidy contributions are received by the ESAF Trust Subsidy Account. Contributions to the ESAF Trust Subsidy Account take a variety of forms, including direct grants and deposits made at varying concessional interest rates. Available resources in the ESAF Trust Subsidy Account as of April 30, 1990 amounted to SDR 227 million, up from SDR 79 million as of April 30, 1989.
The Fund’s special facilities consist of the compensatory and contingency financing facility (CCFF) and the buffer stock financing facility (BSFF). The compensatory element of the CCFF provides financial assistance to countries whose export earnings have fallen substantially below medium-term trends or whose costs of cereal imports have risen significantly owing to exogenous factors. The CCFF’s contingency element provides additional financing to members with Fund-supported adjustment programs to meet external contingencies, including those arising from higher interest rates on external debt.
Purchases under the CCFF rose to SDR 0.8 billion in 1989/90 from SDR 0.2 billion in 1988/89, and accounted for almost one fifth of total purchases from the General Resources Account (Appendix Table II.7). This increase reflected purchases totaling SDR 769 million by Mexico and Algeria under the compensatory financing element of the decision, comprising assistance of SDR 532 million for shortfalls in export earnings and SDR 237 million for increased cereal import costs. In addition, Jordan made purchases of SDR 39 million under the compensatory element of the facility for shortfalls in export earnings. There were no purchases under the contingency element of the CCFF.
Through the BSFF the Fund may finance members’ payments to approved international organizations whose aim is to stabilize commodity prices by building up buffer stocks. For the sixth consecutive year there were no purchases under the BSFF and no amounts were outstanding under this facility at the end of 1989/90.
SDRs, the international reserve asset allocated by the Fund to its participating members, may be held by Fund members (all of which are currently participants in the SDR Department), by the Fund’s General Resources Account, and by official entities prescribed by the Fund to hold SDRs. The number of institutions prescribed by the Fund as eligible to accept, hold, and use SDRs remained unchanged at 16 during 1989/90.9 Prescribed holders do not receive allocations, but 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.
The SDR, which is the unit of account for Fund transactions and operations and for its administered accounts, is also used as a unit of account (or as the basis for a unit of account) by a number of international and regional organizations. A number of international conventions also use the SDR as a unit of account. In addition, the SDR has been used to denominate financial instruments created outside the Fund (private SDRs). At the end of the financial year, the currencies of seven member countries were pegged to the SDR.
Pattern of Holdings
The total allocation of SDRs remained at SDR 21.4 billion in 1989/90. Holdings of SDRs by participants increased during the year to SDR 20.8 billion from SDR 19.9 billion. The Fund’s holdings of SDRs declined to SDR 0.6 billion from SDR 1.0 billion, and prescribed holders reduced their holdings to SDR 20 million from about SDR 0.5 billion. In 1989/90, SDR holdings of developing countries as a group increased by about 2 percent, while those of industrial countries increased by about 5 percent. (See Appendix Table II.12 and Table II.13).
Total transfers of SDRs during 1989/90 of SDR 16.8 billion remained at the high levels of recent years, although they were slightly lower than last year’s transfers. This marginal decline reflected the effect of a substantial decrease in transfers among participants and prescribed holders and a moderate increase in transfers between the General Resources Account and participants and prescribed holders. Summary data on transfers of SDRs by participants, the General Resources Account, and other prescribed holders are presented in Table 2.
|Financial Year Ended|
|Annual Averages1||April 30||Total|
|01/01/70-||05/01/78-||05/01/81-||05/01/83-||Jan. 1, 1970-|
|04/30/78||04/30/81||04/30/83||04/30/87||1988||1989||1990||April 30, 1990|
|Transfers among participants|
|and prescribed holders|
|Transactions with designation|
|From own holdings||222||271||743||166||—||—||—||5,016|
|From purchase of SDRs from Fund||41||1,174||1,553||1,744||986||—||—||14,727|
|Transactions by agreement||439||771||1,262||3,121||7,335||6,686||6,777||41,773|
|Net interest on SDRs||42||161||259||283||361||344||480||3,604|
|Transfers from participants to|
|General Resources Account|
|Interest received on General|
|Resources Account holdings||16||135||551||307||81||56||86||3,092|
|Transfers from General Resources|
|Account to participants and|
|Repayments of Fund borrowings||—||88||86||614||1,999||1,782||1,845||8,519|
|Interest on Fund borrowings||4||27||184||443||585||490||334||3,664|
|In exchange for other members’|
|Acquisitions to pay charges||—||3||95||896||402||244||368||4,796|
|Acquistions to make quota|
|General Resources Account holdings|
|at end of period||1,371||5,445||4,335||1,960||770||976||628||628|
The first column covers the period from the creation of the SDR until the Second Amendment to the Articles of Agreement; the second column shows the period covering the SDR allocations in the third basic period, as well as the Seventh General Quota increases; and the fourth column covers the period during which the Eighth General Quota increase came into effect and before the SDR two-way arrangements imparted significant increases to the SDR transactions by agreement.
The first column covers the period from the creation of the SDR until the Second Amendment to the Articles of Agreement; the second column shows the period covering the SDR allocations in the third basic period, as well as the Seventh General Quota increases; and the fourth column covers the period during which the Eighth General Quota increase came into effect and before the SDR two-way arrangements imparted significant increases to the SDR transactions by agreement.
Transfers Among Participants and Prescribed Holders
Transfers of SDRs among participants and prescribed holders declined somewhat in 1989/90 to SDR 7.8 billion, mainly because of a significant decrease in prescribed operations (Table 2). Transactions by agreement were at about the level of last year, totaling SDR 6.8 billion (of which SDR 1.2 billion involved prescribed holders). The other SDR 1.0 billion was accounted for mainly by transfers for SDR interest payments and prescribed operations.10 There were no transactions with designation during the year, as all prospective uses of SDRs through the designation process were arranged through transactions by agreement with other participants.
Participants acquired SDRs in transactions by agreement mainly to discharge obligations to the Fund, such as charges, which must be paid in SDRs, and repurchases, which may be made in SDRs. Participants also sold in transactions by agreement most of the SDRs they received in purchases and operational payments.
The high volume of SDR use in transactions by agreement during the last three years was facilitated by buying and selling (two-way) arrangements for voluntary SDR transactions. While maintaining the SDR holdings of participating members within the desired ranges, these arrangements have greatly facilitated the smooth functioning of the SDR system by accommodating temporary mismatches between the desired purchases and sales of SDRs by other participants. Of the total transactions by agreemer of SDR 6.8 billion in 1989/90, only SDR 1.8 billion was effected by direct matching of purchasers and sellers. The remainder, that is, SDR 5.0 billion, represented temporary excess supply or demand and was effected through the sales of SDR 2.6 billion to, and purchases of SDR 2.4 billion from, members with two-way arrangements in exchange for U.S. dollars, deutsche mark, French francs, pounds sterling, or Japanese yen.
Transfers Involving the Fund
The remaining amount of SDR transfers of about SDR 9 billion in 1989/90 took place between participants and the Fund. Receipts of SDRs by the General Resources Account increased marginally in 1989/90 to SDR 4.4 billion. Receipts consisted mainly of payments of charges on members’ use of Fund resources, which amounted to SDR 1.9 billion, and repurchases of 2.3 billion made in SDRs (at participant’s option). The proportion of total repurchases that was discharged in SDRs in 1989/90 was about 40 percent.
Transfers from the General Resources Account to participants rose by about 17 percent, to SDR 4.7 billion, in 1989/90. The total of SDRs used for interest payments and in repayments of Fund borrowings in 1989/ 90 declined slightly from the previous year to SDR 2.2 billion. SDRs used to finance purchases increased to SDR 0.9 billion, while remuneration payments made in SDRs on members’ creditor positions in the Fund increased to SDR 1.2 billion and SDRs acquired by members against foreign exchange was SDR 0.4 billion.
SDRs are used in other operations involving SAF, ESAF, and Trust Fund loans, including their repayment, interest payments and payment of special charges on these obligations; and subsidy payments to members. In 1989/ 90, these Fund-related operations in SDRs totaled SDR 211 million.
Overdue Financial Obligations
Overdue financial obligations to the Fund remained a serious problem in 1989/90. The total amount of overdue obligations at the end of the financial year was SDR 3.27 billion, and overdue obligations of members in arrears to the Fund by six months or more increased to SDR 3.25 billion as of April 30, 1990 from SDR 2.80 billion as of April 30, 1989. The number of members in arrears on obligations to the Fund by six months or more remained the same at 11.11 All these members were in arrears to the General Resources Account; nine had arrears in the SDR Department; eight had arrears to the Trust Fund; and two were in arrears on interest payments on SAF loans. Unpaid charges due from these members (deferred charges), which are excluded from the Fund’s current income, amounted to SDR 834.4 million at the end of 1989/90, compared with SDR 642.2 million at the end of 1988/89.
In 1989/90 two members were declared ineligible to use the general resources of the Fund, pursuant to Article XXVI, Section 2(a), in the light of their overdue obligations in the General Department—Panama on June 30, 1989 and Honduras on November 30, 1989. At the date of ineligibility, Panama had overdue obligations of SDR 126.6 million to the General Resources Account (with the longest overdue obligation having been outstanding for 18 months) and SDR 2.7 million in the SDR Department (16 months),12 and Honduras had overdue obligations of SDR 17.3 million to the General Resources Account (with the longest overdue obligation having been outstanding for 12 months), SDR 0.4 million in the SDR Department (less than a month), and SDR 2.8 million to the Trust Fund (12 months). As of the end of the financial year, earlier declarations of ineligibility with respect to Viet Nam (January 15, 1985), Guyana (May 15, 1985), Liberia Qanuary 24, 1986), Sudan (February 3, 1986), Peru (August 15, 1986), Zambia (September 30, 1987), Sierra Leone (April 25, 1988), and Somalia (May 6, 1988) remained in effect. These ten ineligible members accounted for 98.4 percent of total overdue obligations to the Fund as of April 30, 1990.13 The eligibility of Guyana and Honduras was subsequently restored effective June 20 and June 28, 1990, respectively, following full settlement of their overdue obligations on those dates. Selected data on arrears to the Fund for 1984/85-1989/90 are shown in Table 3; additional data on members’ overdue obligations by type and duration are shown in Table 4.
|Financial Year Ended April 30|
|Amount of overdue|
|Number of members||8||8||9||11||11|
|Number of members||8||8||9||11||11|
|Number of members||5||4||6||6||9|
|Number of members||6||6||7||7||8|
|Number of ineligible|
|By Type||Less than||One-||Two-||Three|
Guyana settled its arrears to the Fund on June 20, 1990.
Honduras settled its arrears to the Fund on June 28, 1990.
Guyana settled its arrears to the Fund on June 20, 1990.
Honduras settled its arrears to the Fund on June 28, 1990.
The reduction and elimination of overdue financial obligations to the Fund are essential for ensuring the cooperative nature of the institution and preserving its monetary character. During 1989/90 the Executive Board continued to implement the cooperative strategy for resolving members’ arrears problems. This strategy has led to some encouraging progress. In particular, with the assistance of the Support Group for Guyana, chaired by Canada, Guyana’s arrears to the Fund were eliminated. Honduras was also able to settle its arrears with the help of donor and creditor countries. Furthermore, the emergence of any new protracted arrears cases has been avoided. Despite the payments by Guyana, Honduras, and others, overdue obligations to the Fund were SDR 3.20 billion at the end of June 1990. A number of countries with overdue obligations continued, or began, during 1989/90 to pursue economic policies aimed at restoring growth and external viability as part of their efforts to cooperate with the Fund in addressing the problem of their arrears. There were, however, slippages in policy implementation in some of these cases, in part due to shortfalls in external assistance. Two members (Somalia and Zambia) formulated policy framework papers outlining medium-term economic objectives and policies as well as financing requirements, which were discussed by the Executive Boards of the Fund and the World Bank, and the two institutions are cooperating closely to secure the necessary financing for these countries. Two other members (Sierra Leone and Viet Nam) were also implementing policy measures with the objective of redressing their underlying domestic and external imbalances and normalizing their relations with the Fund. Other members have begun to cooperate with the Fund by entering into discussions on the formulation and implementation of sound adjustment policies. Except for Democratic Kampuchea, all members with protracted arrears to the Fund made some payments to the Fund during the year. In 1989/90 a support group of creditor and donor countries was established for Somalia under the chairmanship of Italy, for the purpose of mobilizing external financing to assist in clearing Somalia’s arrears to the international financial institutions.
In the few cases in which members have not shown a willingness to cooperate with the Fund in resolving the problem of their overdue obligations, the Executive Board has applied remedial measures in accordance with the guidelines established under the cooperative strategy. During 1989/90, the Board further defined the procedures for the application of remedial measures and added two new instruments—communications with Fund Governors and heads of selected international financial institutions and a declaration of noncooperation. Communications have been sent by the Managing Director regarding a member’s failure to fulfill its financial obligations to the Fund in four instances, of which three involved ineligible members and one related to a member that had not yet reached the stage of ineligibility. The Board issued a declaration of noncooperation in the case of one member (Liberia), which noted, inter alia, that if the member did not resume active cooperation with the Fund, the Fund would consider initiating procedures under Section 22 of its by-laws leading to the compulsory withdrawal of the member from the Fund.
The Interim Committee, in its communique of May 8, 1990, endorsed the concept of a “rights” approach, under which a member having at present protracted arrears could earn rights, based on sustained performance during the period of an adjustment program monitored by the Fund, toward future financing from the Fund once its arrears to the Fund had been cleared.
Following the Interim Committee’s endorsement of the approach, the Executive Board agreed on certain key elements of the rights accumulation programs to be pursued under this approach and of the financing of accumulated rights. It was envisaged that the rights approach would be limited to those of the 11 members with protracted arrears to the Fund at the end of 1989 that adopt a comprehensive economic program that can be endorsed by the Executive Board by the time of the Spring 1991 Interim Committee meeting. Rights accumulation programs should adhere to macroeconomic and structural policy standards associated with programs supported by extended and ESAF arrangements. In particular, the programs would involve policies that would help create the conditions for sustained growth and substantial progress toward external viability. The member would also be expected to make maximum efforts to reduce its outstanding overdue obligations to the Fund during the period of the rights accumulation program. However, it has been envisaged that, where necessary, rights could be accumulated up to the equivalent of the overdue obligations outstanding to the Fund at the beginning of the program.
Rights accumulation programs would generally span a period of about three years, and the member would be expected with the assistance of donors and creditors to generate the financing needed to meet the requirements of its economic program and, at a minimum, to remain current on obligations falling due to the Fund and the World Bank. Rights accumulation would generally be phased evenly throughout the period of the program, with a possibility of some front-loading of rights within the first annual Fund-monitored program, if warranted by special circumstances. Monitoring of performance, and hence the accumulation of rights, would be on a quarterly basis. If the program were to go off track, a member could retain accumulated rights for a period of six months, while efforts were made to bring the program back on track or to formulate a new program. After six months, the previously accumulated rights would begin to lapse at a rate of 25 percent of accumulated rights per quarter, although the Executive Board could decide to accelerate or slow this pace as warranted.
Upon the successful completion of a rights accumulation program, prior clearance of the member’s arrears to the Fund, and approval by the Fund of a successor arrangement, the member would be able to encash its accumulated rights as the first disbursement under the successor financial arrangement. The successor arrangement under which rights would be encashed would be financed by the Fund’s general resources or, for the SAF-eligible countries currently in protracted arrears, by the general resources or SAF and ESAF resources, or an appropriate blend of these resources.
The Interim Committee concurred with the proposal that the Fund pledge use of up to 3 million ounces of gold, if needed, as additional security for use of the resources of the ESAF Trust in connection with the financing of accumulated rights. The Executive Board will establish such a pledge after certain members have completed the legislative action necessary to vote for the decision.
Proposed Third Amendment
The Interim Committee emphasized that, even as cooperative efforts were being intensified to eliminate arrears, it was necessary to strengthen and enhance the instruments available to the Fund to prevent and deter overdue obligations. Prevention is a key element in the Fund’s cooperative strategy. In this connection, in staff papers supporting the use of Fund resources assessments of a member’s capacity to repay the Fund will be expanded and made more comprehensive. A particularly important factor is the readiness of the authorities in member countries using Fund resources to adapt their policies in response to unexpected developments, which could include the possibility of some additional Fund financing. The Interim Committee invited the Executive Board to propose to the Board of Governors by the end of May 1990 the text of an amendment of the Articles of Agreement providing for the suspension of voting and related rights of members that do not fulfill their obligations under the Articles. The Executive Board transmitted such a proposal to the Board of Governors, which adopted it effective June 28, 1990. Activation of the provision for suspension in an individual case would require a 70 percent majority of the total voting power in the Executive Board.
Fund Income, Charges, and Burden Sharing
In view of the further increases in overdue obligations, the Board maintained and reinforced the various measures taken in recent years to strengthen the Fund’s financial position. For financial year 1989/90, the amount to be added to the Special Contingent Account was set at SDR 65 million and the target amount of net income, which is to be added to the Fund’s reserves, at SDR 85 million (5 percent of reserves plus the shortfall in 1988/89). Unpaid charges due by members with protracted arrears continued to be offset through adjustments applied to the basic rates of charge and remuneration, which also produced the amounts added to the Special Contingent Account. For 1989/90 the adjustments to the rate of charge amounted to 100 basis points (resulting in an adjusted rate of charge that averaged 9.34 percent), and the adjustments to the rate of remuneration to 94 basis points (resulting in an adjusted rate of remuneration that averaged 7.72 percent).
For the financial year 1989/90, the Board decided that the basic rate of charge would be set as a proportion of the weekly SDR interest rate in order to avoid sharp steplike increases or decreases in the rate of charge that in the past had been necessary to achieve the target amount of net income. The proportion was set at 96.3 percent and continued after the review at midyear. The Board decided to continue in the financial year 1990/91 the proportional relationship between the basic rate of charge and the SDR interest rate. The proportion was reduced to 91.3 percent, so as to achieve a target amount of net income of 5 percent of reserves, and is to be reviewed at midyear. The Board decided also to continue existing arrangements to share the cost of deferred charges, and allocations to the Special Contingent Account of 5 percent of the Fund’s reserves at the beginning of the year. Net income for financial year 1989/90, taking into account a retroactive reduction of charges on the use of ordinary resources of SDR 30 million, was equal to the net income target of SDR 85.5 million. Net income was added to the Fund’s reserves, which rose to about SDR 1.4 billion on April 30, 1990 from SDR 1.31 billion on April 30, 1989, an increase of 6.5 percent. Total precautionary balances, which include amounts in the Special Contingent Account, reached SDR 1.61 billion at the end of 1989/90, an increase of 10.3 percent over a year earlier.
In the context of the arrears strategy, the Interim Committee endorsed, at its meeting in May 1990, an extension of the Fund’s mechanisms for the sharing of burdens associated with overdue obligations among creditor and debtor members. This extension, adopted by the Fund and effective July 1, 1990, will be reviewed annually and will accumulate SDR 1 billion over approximately five years, financed by a further adjustment of 0.35 percent to the rate of charge and, subject to the floor to the rate of remuneration of 80 percent of the SDR interest rate, a further adjustment to the rate of remuneration to yield three times the amount generated by the further adjustment to the rate of charge. The amounts thus accumulated are to assist in the financing and to safeguard purchases that are made as a result of the encashment of rights accumulated under Fund-monitored programs by members with protracted arrears at the end of 1989. This scheme provides for refunds of contributions upon full repayment to the Fund of the use of such credit or at such earlier date as the Fund may determine.
At the same meeting, the Interim Committee welcomed the proposal for voluntary contributions by members whose contributions under the extended burden-sharing mechanism was not commensurate with those of member countries participating in burden sharing. Such voluntary contributions would contribute to the financing requirements of adjustment policies in countries with protracted arrears. It was also noted that the Executive Board was considering a proposal under which individual contributors under the existing mechanism for coverage of deferred charges would agree that their contributions be retained temporarily in the Fund following settlement of those deferred charges.
Angola became a member of the Fund, effective September 19, 1989.
The Czech and Slovak Federal Republic and the People’s Republic of Bulgaria applied for Fund membership on January 22 and February 23, 1990, respectively. Staff missions visited both countries between March and June 1990 to gather the information necessary for the preparation, in each case, of a membership paper for consideration by a membership committee of Executive Directors to the Board, which then submits a draft resolution on membership, including an initial quota increase for the new member, for adoption by the Board of Governors. On July 23, a draft resolution proposing an initial quota of SDR 590 million under the Eighth Review of Quotas for the Czech and Slovak Federal Republic was submitted to the Board of Governors for a vote by August 20, 1990.
In addition, Switzerland applied for membership in a letter dated May 31, 1990—with a staff mission visiting Switzerland in June—while the Republic of Namibia and Mongolia applied for membership in letters dated June 8 and June 26, 1990, respectively.
In June 1990, the Board concluded that, following the merger of the Yemen Arab Republic and the People’s Democratic Republic of Yemen, the Republic of Yemen is a single member of the Fund with a single quota and subject to the provisions of the Articles of Agreement. The Republic of Yemen’s quota is SDR 120.5 million, with a total voting power of 1,455 votes.
Annual Report, 1989, page 38.
See Annual Report, 1983, page 86.
For a summary of the Fund’s borrowings from 1981 onward, see Annual Report, 1988, page 75. Under the agreement with the Government of Japan, the Fund may make drawings until March 31, 1991, although the period may be extended for up to two years if warranted in light of the Fund’s liquidity and borrowing requirements. In addition, the Fund may borrow up to SDR 17 billion under the General Arrangements to Borrow (GAB) and a further SDR 1.5 billion under a borrowing arrangement with the Saudi Arabian Monetary Agency (SAMA) in association with the GAB, when supplementary resources are needed to forestall or to cope with an impairment of the international monetary system.
The figures exclude reserve tranche purchases by three members in 1989/90 (SDR 62 million) and by five members in 1988/89 (SDR 413 million). Reserve tranche purchases represent members’ use of their own Fund-related assets and do not constitute use of Fund credit.
Such use of ordinary resources to repay borrowing will be reversed beginning in 1990/91 when repurchases of purchases financed with borrowed resources will exceed repayments of credit lines.
In accordance with the guidelines for early repurchases, Executive Board Decision No. 6172 (79/101), adopted June 28, 1979.
Depending on the sources of the financing, repurchases tend to peak about four to five years after the corresponding purchases.
The Executive Board agreed to such augmented support for debt-service reduction in January 1990 under the extended arrangement with Mexico for SDR 0.5 billion, or 40 percent of quota. Mexico purchased this amount on February 2, 1990.
Prescribed holders of SDRs are the African Development Bank, African Development Fund, Andean Reserve Fund, Arab Monetary Fund, Asian Development Bank, Bank of Central African States, Bank for International Settlements, Central Bank of West African States, East African Development Bank, Eastern Caribbean Central Bank, International Bank for Reconstruction and Development, International Development Association, International Fund for Agricultural Development, Islamic Development Bank, Nordic Investment Bank, and Swiss National Bank.
These consisted of forward operations, settlement of financial obligations, and transfers o interest under swaps. These “prescribed oper; tions” in SDRs totaled SDR 291 million during 1989/90.
Guyana and Honduras settled their overdue obligations to the Fund on June 20 and June 28, 1990, respectively, reducing this number to nine.
Panama’s overdue obligations to the SDR Department were cleared on May 23, 1990 and its right to use SDRs was therefore restored.
One other member—Democratic Kampuchea—has had overdue obligations to the Fund since 1975, but has not been declared ineligible.