The Fund in 1990/91
- International Monetary Fund
- Published Date:
- January 1991
The Fund fulfills its surveillance mandate in two key ways: by examining each member’s policies and performance and through regular discussions of the world economic outlook. In its latest review, the Executive Board recognized that the scope of surveillance had broadened to include structural and other issues relevant to understanding broad macroeconomic developments and the context in which macroeconomic policies are formulated and implemented.
The Fund’s regular consultations with its members have paid increased attention to the need for corrective policies to have a medium-term orientation, the desirability of raising domestic savings, and the role of structural policies in enhancing economic performance.
The Board expects that the recession that began in 1990 in a number of industrial countries will be relatively short-lived. However, concerns persist over the slowing of growth in Europe, continued uncertainties in the Middle East, and the problems associated with reforms in east Germany, Eastern Europe, and the U.S.S.R. The outlook for the developing countries is less favorable than had been expected. While many of these countries have embarked on policy reforms with Fund support, their immediate prospects are uncertain.
The Fund’s mandate to exercise firm surveillance over the exchange rate policies of its members forms the basis of its oversight of the international monetary system. This mandate requires the Fund to oversee the full range of each member’s macro-economic and relevant structural policies—as these collectively determine the setting in which members conduct their exchange rate policy—and to evaluate each member’s economic performance for the benefit of all members. Such surveillance by the Fund rests on the principle that sound and consistent economic policies will lead to stable exchange rates and an expanding world economy, together with low inflation and the avoidance of excessive external imbalances.
The Fund fulfills its surveillance responsibility in two key ways: by examining each member’s economic policies and performance (bilateral surveillance) and through Board discussions of the world economic outlook (multilateral surveillance). Both of these involve the active participation of member countries. In the first instance, a Fund staff team visits each member country regularly (usually at annual intervals) to gather information and consult with the authorities about their policies and economic performance; the result is a staff report that in most cases is discussed by the Board. In addition, the Board meets regularly—generally twice a year—to assess the interaction of economic policies and to discuss economic prospects for the world economy under various policy assumptions. These discussions permit reviews of members’ policies from a multilateral perspective and allow for systematic monitoring of the global economic situation.
Apart from these principal means of surveillance, the Board periodically discusses exchange rate developments in the major industrial countries, as such developments have a large impact on the world economy. In addition, the Fund’s Managing Director takes part in the policy coordination discussions of the Group of Seven industrial countries. He not only addresses economic developments and policies within and among the Group of Seven countries, but he also brings a global perspective to these meetings that calls attention to the interaction of policies internationally. This, in turn, helps support the efforts of the national authorities of the major industrial countries to consider the global consequences of their domestic policies. The Fund also provides technical assistance to member countries in several areas relevant to macro-economic policy implementation. Such assistance is provided through advisory visits, formal training, and advice given during periodic consultations.
At its April 1991 meeting, the Interim Committee underscored the Fund’s key role in assisting the countries seriously hurt by the Middle East crisis. Fund surveillance, policy advice, technical assistance, balance of payments support, and mobilization of other financial and technical assistance are vital in helping several countries in the region formulate the appropriate macroeconomic and structural policies. The Committee also considered essential the roles of national governments and international institutions in providing financial and technical support to those Eastern European countries seeking to introduce market-based systems while addressing internal and external imbalances. Foreign private capital, nevertheless, would be expected to play an increasingly important role in meeting the requirements of these countries. The Interim Committee encouraged the Board to continue evaluating the functioning of the international monetary system, emphasizing the positive contribution of policy coordination to the evolution of the system.
Analytical Framework. Fund surveillance seeks to foster more consistent and disciplined policies on the part of its members. The Fund contributes to policy coordination through its work on key economic indicators and on alternative medium-term scenarios. The Fund staff prepares medium-term projections for a range of indicators that are used to help monitor and review the policies and performance of the large industrial countries. These indicators include, among others, real GNP or GDP, real domestic demand, gross private investment, GDP deflators, general government financial balances, and current account balances. The staff develops, for Board consideration, medium-term scenarios to illustrate the economic consequences of alternative policy paths in member countries and to help identify areas of potential conflict that may require the attention of policymakers. Fund surveillance also extends to the monitoring of structural policies and their consistency with macroeconomic policies and exchange rate developments.
Box 2.The IMF Executive Board, the Interim Committee, and the Development Committee
The Executive Board (the Board) is the Fund’s permanent decisionmaking organ, composed of 22 Directors appointed by member countries or elected by groups of countries. Chaired by the Managing Director, the Board usually meets several days a week to conduct the business of the Fund. Prior to reaching decisions, it discusses papers prepared by Fund management and staff. In 1990, the Board spent about half of its time on country matters (Article IV consultations, the review and approval of arrangements), and most of its remaining time on policy issues (such as quotas, surveillance, the debt strategy, and overdue financial obligations).
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 lat-ter’s functions of supervising the management and adaptation of the international monetary system, considering proposals by the Fund’s Executive Board to increase quotas or 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) has 22 members—Governors of the Fund and the Bank, 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 the Fund on all aspects of the transfer of real resources to developing countries.
The Board conducted its biennial review of surveillance in the second half of 1990 and early 1991. Directors reaffirmed the Board’s role in the implementation of surveillance. They recognized that the scope of surveillance in recent years had broadened in response to changes in the domestic and external environment of members and to a recognition that structural developments may have a material impact on overall economic performance and policy formulation. This tendency should not, Directors believed, come at the cost of the coverage and quality of treatment of the “core” macroeconomic issues of surveillance that have important implications for achieving reasonable price stability, sustainable external positions, and orderly economic growth. Indeed, focusing on those structural issues having a broad impact should improve the quality of the Fund’s analysis and policy advice. It was recognized, however, that the Fund may not have the expertise to address fully some structural issues, and Directors thus encouraged the staff to draw on the expertise of other organizations, as appropriate, when addressing issues outside of core areas.
The world economic outlook exercise, in the Board’s view, would continue to evolve as a multilateral framework for surveillance, as well as a basis for integrating the analysis of individual countries—particularly the seven major industrial countries—into a larger multilateral context. The Board welcomed the added emphasis on the systemic implications of country developments in both bilateral and multilateral surveillance. A number of Directors suggested that bilateral consultations be framed more explicitly against this multilateral setting—especially where alternative scenarios could result in substantially different individual country prospects.
The movement toward increased liberalization and integration of capital and goods markets and toward economic integration of member countries within specific regions also poses greater challenges for Fund surveillance and policy coordination. In general, the Board favored a more regional and cross-country perspective for surveillance, especially when macroeconomic policy is institutionally coordinated or centralized. The circumstances of different countries would have to be taken into account, however, and Directors emphasized the need for consultations with the national authorities of each country within the group. It was suggested that more could be done in the framework of the world economic outlook exercise to integrate analyses of groups of countries in order to address regional or cross-country issues.
Any strengthening of Fund surveillance, in the Board’s view, would not come from modifications to the Fund’s basic principles of surveillance, which remain valid, but rather from members’ willingness to give full consideration to the views expressed by the international community—through the forum of the Fund—in formulating and adopting their own macroeconomic and structural policies.
Article IV Consultations
Fund staff teams meet periodically with the authorities of member countries to collect and analyze a wide range of economic and financial information. The information allows the Fund to appraise the member’s overall economic situation and policies, discuss policy options, and make recommendations. Consultations are mandated in Article IV of the Fund’s Articles of Agreement, or charter. Through them, the Fund fulfills its obligation to exercise surveillance over the exchange rate policies of its members. In principle, consultations are held annually; they may, however, occur less frequently, depending on the member’s circumstances.
Consultations begin with Fund staff reviewing policy, institutional, and statistical information on all aspects of the balance of payments; capital flows; national accounts; government accounts; money and credit; and wages, prices, and interest rates. This is followed by discussions with the authorities to evaluate the effectiveness of economic policies since the last consultation—and whether they contribute to noninflationary growth and sustainable external positions—and advise how these policies might be modified in the coming year. The discussions include an assessment of progress in eliminating any exchange and trade restrictions. The Fund staff team then prepares a detailed report, which in most cases is discussed by the Board. A summary of the discussion, often containing suggestions about how to strengthen areas of policy weakness, is later transmitted to the member’s government.
Consultations help draw attention to the international implications of policies and developments in the economies of individual countries—especially the major industrial countries whose policies have a major impact on the global economy. Consultations also keep the Fund informed of economic developments and policies in member countries, which permit it to respond quickly to member requests for Fund financing and to proposed changes in policies or practices that require Fund approval.
The specific nature of consultations is determined by the characteristics of the member country and the prevailing external economic environment. In recent years, greater attention has been devoted to the following:
The need for corrective policies to have a medium-term orientation.
The need to raise domestic savings—both public and private—in view of the increasing constraints on the supply of global savings, and to stimulate more productive investment.
The role of structural policies in enhancing economic performance. These policies are aimed at improving the functioning of economies by expanding productive capacities through, for example, financial and tax reforms, privatization, and measures to enhance labor market flexibility. They include measures to eliminate the inefficient use of resources and allow more rapid adjustment to technological innovations, changes in relative prices, or trade liberalization; and measures that increase output potential by expanding the supply of productive resources or raising overall productivity.
Most consultations with members are held annually.5 The “bicyclic” procedure—introduced in 1987 to help reduce the frequency of Board discussions while maintaining the quality of Fund surveillance—provides for a consultation with a Board discussion every second year; in intervening years, the staff holds interim consultation discussions with the member and submits a report to the Board on these discussions, but this does not normally constitute a consultation with the Fund. In February 1991, as part of its biennial review of the implementation of surveillance, the Board modified the bicyclic procedure to provide for annual consultations, under which the interim staff reports could either be discussed by the Board following a request by either an Executive Director or the Managing Director, or the consultations completed by decision but without discussion. Some support was expressed for expanding the bicyclic procedure to more countries.
In 1990, the Fund completed 92 full consultations, covering 60 percent of the membership. This compared with 99 consultations, covering 65 percent of members, in 1989. The decline was more than accounted for by a fall in the number of consultations with developing countries, particularly those with arrangements under discussion; it also reflected the preference of the staff and country authorities to submit the consultation report jointly with other requests or program reviews. Consultations were completed for 72 developing countries last year, representing a 10 percentage point drop in coverage from the preceding year. At the same time, the number of full consultations with industrial countries rose substantially, with the proportion covered rising to 83 percent. The increase was attributable to the fact that 9 of the 22 industrial countries are currently on the bicyclic schedule and 7 of these countries were discussed by the Board in 1990, compared with 2 in 1989.
At its October 1990 Article IV review of the U.S. economy, the Board concluded that slow economic growth in the United States appeared unlikely to lead to recession, although the rise in oil prices increased the downside risks. The Board believed that a strategy that would address near-term problems in a longer-term perspective was required. The risks of recession should be minimized, but an excessive focus on near-term problems could jeopardize long-term economic goals. Budgetary issues were of particular interest to the Board since the U.S. review took place prior to the enactment of the 1990 Budget Act. The main task confronting the U.S. authorities, in the Board’s view, was to ensure that their policy actions were consistent with strong growth over the medium term, together with lower inflation and a smaller current account deficit. The key ingredients of such a strategy included a fiscal policy aimed at boosting national saving, a monetary policy committed to fighting inflation, and structural policies geared to enhancing economic efficiency.
The Board took note of the progress achieved in cutting the fiscal deficit as a percent of GNP and supported the thrust of the authorities’ budgetary objectives (including a federal budget surplus roughly equivalent to the social security cash flow surplus by the mid-1990s). Directors were concerned, however, about the worsening in the fiscal outlook since the January 1990 budget and about the outcome of ongoing budget negotiations between the Administration and the Congress. In view of the national savings problem, the Board believed that the authorities should strive for major progress on the fiscal front. Many Directors underlined the importance of setting a path for the fiscal balance consistent with the authorities’ medium-term budgetary goals. These Directors were concerned that budget summit participants might limit the deficit cuts for fiscal 1992 (October 1991 to September 1992) to below the amount needed to meet the Gramm-Rudman-Hollings targets for fear that larger cuts would trigger a recession.
In view of the prospects for sluggish growth, the Board considered the possible short-term effects of a substantial budget reduction in 1990/91. Many Directors favoring a fiscal cut that met the Gramm-Rudman-Hollings target felt that a large, front-loaded reduction would stimulate domestic investment and exports. A few others were dubious of a large fiscal cut in light of the already marked slowing of output growth. These Directors preferred a less front-loaded, multiyear package that nonetheless entailed genuine cuts, one that clearly demonstrated the authorities’ commitment to deficit reduction. Such a package, in their view, while not fully meeting Gramm-Rudman-Hollings targets, could muster sufficient credibility to yield substantial benefits.
Most Directors saw a need to complement spending cuts with revenue measures. In this connection, many Directors recommended introducing energy taxes; these would also promote energy conservation and environmental objectives. Some Directors also advocated introducing taxes on consumption, including possibly a value-added tax, and removing tax preferences that discourage saving. The Board stressed the importance of budget reforms to ensure full implementation of the agreed cuts in the fiscal deficit—including a Gramm-Rudman-Hollings provision for adjustment over the course of a fiscal year.
On the external front, the Board believed that the large current account deficit was a manifestation of a low national saving rate, rather than of strong investment. The solution was to raise saving; in particular, to bolster the fiscal position and to eliminate distortions affecting private saving decisions. Although market-induced exchange rate changes or partners’ policy actions could reduce the current account deficit, such a narrowing without an increase in national saving would take its toll on domestic investment. The Board reaffirmed the importance of policy coordination as an effective means of correcting external imbalances among the major industrial countries in the context of sustained world economic growth and price stability.
On exchange rate policy, the Board noted the decline in the dollar’s exchange value in the preceding 6 to 12 months. A number of Directors felt that exchange rate changes could play a role in external adjustment, provided they were accompanied by appropriate domestic policies. They underscored the importance of U.S. policies that would allow the dollar depreciation to assist external adjustment without thwarting capital formation and price stability.
The Board noted that monetary policy faced a difficult situation of sluggish growth combined with relatively high inflation. Monetary policy had so far succeeded in avoiding a serious rise in inflation without precipitating a recession, albeit with little progress toward the Federal Reserve’s long-term goal of price stability—a goal strongly supported by the Board. In the Board’s view, the United States, as the main reserve currency center, had a responsibility to preserve the value of the dollar as the main anchor in the international monetary system and thus firmly to contain inflation. In particular, in light of the prevailing oil market instability and depreciation of the dollar, many Directors called for continued prudence in monetary management to assure that these developments would not lead to a lasting rise in inflation. The Board emphasized that a significant tightening of fiscal policy would facilitate the task of monetary policy. At the same time, many Directors called for caution in easing monetary and credit conditions even after a fiscal correction was put in place.
The Board was encouraged by the authorities’ commitment to a more open trading system through a successful conclusion of the Uruguay Round. Directors believed that the world trading system was at a critical juncture and urged the U.S. authorities to maintain their traditionally strong stance against protectionism, to continue to play a leadership role in the Uruguay Round, and to take concrete steps toward eliminating longstanding trade barriers—such as those in the textile area.
In other areas of structural policy, Directors welcomed the proposed measures to encourage private saving, although they questioned the likely size of the effects. A few were concerned about the possible fiscal implications of tax incentives for private saving. Several Directors commented on the apparent fragility of the U.S. financial system; they were interested in the forthcoming review of the deposit insurance system and possible proposals for reform. As to infrastructure investment, the Board welcomed the Administration’s proposals for redressing emerging problems in the transport system, but the U.S. authorities still needed to review comprehensively capital requirements of the public sector and the level of government at which they should be funded.
The Board commended the U.S. role in global efforts to deal with the debt problems of developing countries. These initiatives had to be buttressed by efforts to ensure satisfactory and durable economic growth and world trade. In this connection, the Board underscored the need for the major industrial countries to pursue sound economic policies and to keep their markets open. The decline in U.S. official development assistance as a percent of GNP was a cause for concern, and the Board urged the authorities to reverse this trend.
By the spring of 1991, following the Board discussion, two notable events had taken place. The first was that the economy had entered a recession, which appeared likely to be shorter and shallower than the average. The other was the enactment of a budget agreement, intended to reduce the fiscal deficit by a cumulative amount of nearly $500 billion over the next five years relative to what it would have been.
Japan had managed to achieve a fifth year of economic expansion, with rapid output growth in 1990/91 led by domestic demand and the current account surplus narrowing further. Although the high level of resource use had contributed to an acceleration of price pressures, such pressures had eased somewhat more recently. Japan’s sustained growth with price stability owed much to the authorities’ sound financial policies.
At its July 1991 discussion of the Japanese economy, the Board generally considered Japan’s economic prospects to be favorable, with economic activity slowing moderately to a sustainable pace. A few Directors urged the authorities to remain vigilant over cost and price pressures and to gear their policies toward achieving a further reduction in price pressures. They considered that the attainment of price stability in Japan would have both domestic and global economic benefits. At the same time, the Board encouraged the authorities to step up implementation of structural reforms, which would expand the economy’s supply potential while enhancing welfare; action in the structural area was especially important in light of longer-term considerations associated with the prospective aging of the population.
Directors noted that the July 1 cut in the official discount rate had occurred in an environment of moderating price increases. Since aggregate demand was still rising rapidly and the labor market was strained—while the risk of a sharp slowing of output growth appeared low—most Directors believed that monetary policy should remain tight until underlying price pressures had subsided. It was important, in this connection, that the official discount rate cut not be seen as a relaxation of the commitment to stabilize prices. Directors noted that a restrained monetary stance would also help support the exchange rate of the yen, which appeared weak relative to fundamentals. On the other hand, the view was expressed that inflation risks should not be exaggerated; neither should the risks of continued monetary tightness for economic growth be underrated.
The Board commended the authorities’ conduct of fiscal policy in fiscal year 1990/91. The progress achieved in fiscal consolidation was consistent with the need for a cautious policy stance in view of the sustained strength of private domestic demand in the past year. For 1991/92, most Directors supported the broadly neutral fiscal stance envisaged and agreed that fiscal consolidation should be continued over the medium term in light of likely fiscal pressures associated with the aging population. At the same time, Directors generally thought that these concerns should not compromise the need for greater investment in the social infrastructure. Some other Directors questioned the need for further fiscal consolidation. They also urged the consideration of measures to reduce labor market pressures.
Directors observed that, after a sharp narrowing in recent years, the current account surplus was expanding again. The expected range of the surplus was not, in the view of many Directors, a cause for concern, and any such concerns should not compromise the pursuit of price stability. Other Directors, however, believed that the world economy did not need a larger Japanese external surplus. They and others stressed that an expected increase in the surplus underscored the need for stronger market-opening efforts by Japan, in light of rising trade tensions with Japan’s trading partners. Further, on Japan’s external position, the view was expressed that in an environment of free trade and the absence of structural distortions, one should accept the current account position that would result.
The area of trade policy presented Japan with an opportunity for further reform that could yield considerable domestic and international benefits. All Directors urged Japan to take bold steps in opening up its markets further and, in particular, to reduce the protection and domestic support of agriculture. Such actions were especially important at a time when all countries had to help bring the Uruguay Round to a successful conclusion. Directors noted the further progress in financial and tax reform, but saw substantial scope for action remaining in other structural areas.
Japan was commended for having become one of the largest providers of official development assistance and its plans to double such assistance under the current five-year plan were welcomed. The Board also welcomed Japan’s intention to strengthen the link between its development assistance and the policies of recipient countries.
The Board, at its September 1990 discussion of the German economy, commended the German authorities for the historic achievement of economic unification in a climate of stability and confidence. Directors focused their comments on how policy should respond to the domestic pressures unleashed by German economic, monetary, and social union and on the international consequences of this union. The Board was also interested in ensuring a smooth and fast transformation of the command economy of the former German Democratic Republic into a market economy.
Germany was in a favorable position to meet the challenges ahead. Monetary policy was focused on checking inflation and inflation expectations, and money growth had been on target since the beginning of 1989. Fiscal restraint had led to substantial cuts in direct taxation, improved incentives, and a financial surplus for the general government in 1989. Economic growth was strong in 1990 for the third consecutive year, unemployment had fallen sharply, and inflation remained moderate. The large balance of payments surplus, a concern of recent years from an international perspective, was expected to narrow as resources were diverted to supporting development in east Germany.
There was some concern in the Board that, given the high degree of capacity use in Germany and much of the industrial world, demand pressures could reignite inflation; another view was that German capacity limits were not as rigid as previously thought. The Board believed that prospective changes in the balance of savings and investment in Germany and the rest of the world had put upward pressure on inflation-adjusted interest rates. Higher interest rates had had adverse implications for investment in general, but particularly for the indebted developing countries. It was thus important to direct global efforts to raising the supply of savings and to ensure that savings were allocated to productive ends.
The stance of economic policy was particularly important as Germany would be faced with a sharp increase in demand induced by reunification. Macroeconomic policy therefore needed to be sensitive to resource pressures resulting from increased demand, while structural policies had to help ensure that the higher demand elicited a substantial output response with a minimal effect on prices.
In the area of monetary policy, the Board commended the authorities’ management of the monetary union between east and west Germany. The Board endorsed the authorities’ determination to resist inflation. Given the money management problems entailed by monetary union, the Board believed the authorities should pay greater heed to a broad set of economic indicators—including exchange rates and interest rates.
On the exchange rate—and particularly with respect to parities in the exchange rate mechanism (ERM) of the European Monetary System—Directors expressed contrasting views on the impact of German economic and social union and the appropriate policy response. One view held that a revaluation of the deutsche mark within the ERM would help alleviate the negative impact of German union on other ERM participants. Other Directors thought that a realignment was not warranted in light of anticipated developments in current account balances and the markets’ relative inflation expectations; also, a realignment might jeopardize progress toward convergence of inflation and inflation expectations, which was a central goal of the ERM.
The Board was concerned about the prospective sharp rise in the fiscal deficit. Government borrowing in 1990-91 was likely to be much greater than initially projected, owing, in significant part, to measures aimed at sustaining consumption and employment in east Germany. The larger deficits would add to demand pressures and increase the burden on monetary policy. Although Germany would remain a net supplier of savings to the rest of the world, some Board members feared that larger government deficits would strain the already scarce supply of global savings. Most Directors felt that attempts to rein in deficits should focus on cutbacks in certain government subsidy programs.
Although the authorities were reluctant to raise taxes, the worsening fiscal situation argued for such action. A number of Directors felt that, if increases in taxes were necessary, they should apply to indirect taxes, in view of the effort to reduce direct taxation and the possible need to boost value-added tax (VAT) rates as part of the harmonization of indirect taxes within the European Community (EC). Some others were concerned, however, that increases in indirect taxes could have undesirable implications for prices; they thought that a temporary rise in direct taxes might be more appropriate. In early 1991, Germany decided to increase taxes in response to additional unexpected budgetary costs, resulting from financial assistance to Eastern European countries and the U.S.S.R., larger output losses in east Germany associated with the breakdown of CMEA trade, and Germany’s financial contributions in connection with the Middle East crisis.
The Board expressed regret at the pace of structural reform. Labor market rigidities were limiting the potential supply of labor in the Federal Republic. Also, trade liberalization in such areas as agriculture, iron and steel, and textiles would help expand domestic supplies and aid the developing countries, which are important exporters of these products. In this connection, the Board urged the authorities to help assure the success of the Uruguay Round; while most trade issues had to be dealt with multilaterally, a number of Directors noted that Germany could also act alone in such areas as coal, shipbuilding, and aerospace. The agenda for structural policies was particularly pressing for the former German Democratic Republic. In the industrial sector, the challenge was to identify viable firms and ensure that they did not grow dependent on official support. The Board questioned the management of the public Trust Fund, which had assumed management of most of the public assets of the former German Democratic Republic; some of the operations of this Fund, the Board felt, could serve to delay structural adjustment and privatization in east Germany and might have unfavorable fiscal and monetary consequences.
The Board emphasized that private investors would have to play a central role in order to realize the potential of economic and social union. Policymakers should thus establish an economic environment conducive to private initiative and avoid ad hoc policy intervention. Important, in this connection, were the establishment of an economic framework conducive to private initiative—in particular, a quick resolution of issues related to property rights; reconstruction of the public infrastructure and establishment of an efficient public administration; and an evolution of labor costs in line with productivity developments.
In sum, the authorities’ management of economic and social union was commendable, but the rapidly deteriorating fiscal situation and the direction of industrial policy were causes for concern. The Board hoped that Germany’s attention would not be diverted from the needs of other countries undergoing structural change toward a market system or from the plight of many developing countries. In this context, Directors welcomed the increase in Germany’s official development assistance.
France’s economy improved markedly during the three years leading into 1990. Although growth had since slowed, the underlying economic situation was considerably better than in the first half of the 1980s. The improvement owed largely to the stead-fast pursuit of policies aimed at reducing inflation and enhancing the supply of productive resources. These policies, which were anchored by a commitment to a fixed exchange rate and supportive monetary and budget policies, had led to a major reduction in inflation. Moreover, wage restraint and fiscal and structural reforms had bolstered the performance of enterprises, leading to a fundamental improvement in the economy’s productive capacity. As a result, French output and employment had grown strongly, unemployment had receded somewhat, the current account had remained near balance, and inflation had stayed low and improved relative to the average of France’s partners in the EMS. The Board, discussing the French economy in September 1990, commended these achievements, which had enabled France to participate fully in the resurgence of economic activity in Europe.
The Board believed that, in consideration of the still high unemployment rate, it was important for the authorities to continue—and indeed reinforce—their efforts to adjust policies so as to strengthen the responsiveness of the economy further. Continued policy adjustment was especially urgent to enhance external competitiveness in light of prospective European developments; German unification, the single European market, and the market-oriented restructuring of Eastern Europe would present French producers with steadily mounting competition. The Board therefore welcomed the authorities’ continuing commitment to corrective policies and their intention—embodied in the 1991 budget—to reinforce the adjustment strategy and not to accommodate the rise in oil prices stemming from the Middle East crisis.
Fiscal policy, in the Board’s view, should continue to aim at restraint. The growth of public spending should be held below that of GDP, to support a gradual reduction of the fiscal deficit and to provide scope for further tax cuts. These tax cuts should seek to strengthen incentives and the position of enterprises. In this connection, the Board welcomed the authorities’ decision to cut the corporate tax rate on undistributed profits. Although the cuts in VAT rates would help lower inflation and hasten the harmonization of VAT rates within the EC, they were implicitly at the expense of cuts in direct taxes. Consequently, a number of Directors felt that the French authorities, and perhaps those of other EC countries, should reconsider the degree to which they should reduce reliance on indirect, rather than direct, taxes.
The Board agreed that the overall tax burden in France was too high. The Government needed to redouble its efforts to curb nonpriority spending. Particular concern in this respect was expressed about the social security funds; prospects for spending on pensions and health care were especially worrisome. The Board commended the authorities’ plans to broaden the base of social security contributions to include nonwage income, as this would lower the opportunity cost of hiring labor; however, the new funding arrangements should be implemented in a way that did not lead to additional spending.
With respect to monetary policy, the Board noted that the improvements in controlling inflation might provide new room for maneuver on interest rate policy, consistent with France’s EMS commitments. Nonetheless, most Directors believed that the authorities should continue giving priority to completing the process of disinflation; this would enhance the credibility of policies, strengthen long-term external competitiveness, and foster price stability in Europe—which would advance progress toward European economic and monetary union.
Directors emphasized the importance of complementing policies of budget and monetary restraint with market-oriented structural reforms—particularly in the labor markets. In this connection, Directors were concerned about possible actions that would hinder labor market adjustment by raising the relative cost of unskilled labor; they were also concerned that measures to index minimum wages to average wages would undermine efforts to sustain wage moderation and reduce unemployment. They urged the authorities to address labor market imbalances, mainly through manpower training programs, and not to add to rigidities in the labor market.
In the view of a number of Directors, the scope for reductions in protectionism afforded by the Uruguay Round represented the best and most immediate way to improve resource allocation. In this view, the authorities should act more forcefully to maximize the long-run benefits for both France and the world economy of multisectoral reductions in trade barriers, and particular emphasis was placed in this regard on agriculture and textiles. The Board urged the authorities to contribute fully to a successful conclusion of the Uruguay Round and to support a liberal external payments regime as the EC moves toward a single market. Directors commended the authorities for the increase in official development assistance as a share of GDP, for their intention to raise this share gradually, and for their efforts to reduce the debt burden of low-income countries.
Despite a tightening of monetary policy since mid-1988, the U.K. economy performed more strongly than expected during the first half of 1990, with clear signs of a sharp slowing of activity emerging only in the third quarter. The unexpected persistence of demand growth contributed to a further rise in underlying inflation. Indeed, as of February 1991—when the Board considered the U.K. economy—inflation was about 3 percentage points above the average of countries participating in the ERM of the EMS, although this partly reflected special factors, and the gap has since narrowed. While deepening recession was a matter of concern, Directors believed that the key policy challenge facing the authorities was to reduce inflation to the level of the United Kingdom’s low-inflation partners in the ERM; in this connection, they warmly welcomed the Chancellor of the Exchequer’s statement that bearing down on inflation is and will remain the Government’s top priority.
Directors noted the United Kingdom’s October 1990 entry into the ERM, which would strengthen the framework for the anti-inflation strategy and in time might be expected to mitigate the costs of reducing inflation. They emphasized, however, that ERM membership would not automatically confer enhanced credibility on policymakers; rather, any such gains in credibility would have to be earned by adhering to consistent anti-inflation policies. ERM membership had heightened the urgency of a quick alignment of U.K. inflation with that of its low-inflation partners in the ERM, especially because of the importance assigned to a strong currency in the fight against inflation.
The Board believed that interest rate policy had to be managed in a way that established the United Kingdom’s credibility in the ERM; monetary policy should continue to be concerned with achieving a rapid fall in inflation, and not with short-term domestic economic considerations. The majority welcomed the authorities’ intention to conduct interest rate policy with regard to the pound sterling’s standing in the ERM. A number of Directors thought that the changed focus of monetary policy following ERM membership also implied that fiscal and wage policy should contribute more to the goal of price stability.
The Board commended the Government’s prudent medium-term management of its public finances. In the period ahead, fiscal policy needed to remain tight in order to ensure the success of ERM entry. On this basis, the Board counseled that targets in the 1991/92 budget should signal clearly to the markets that fiscal policy would continue to support a fall in inflation. Some Directors were concerned about a further economic weakening and cautioned against an overly tight fiscal stance. In his 1991 budget, announced after the Board’s consideration of the U.K. economy, the Chancellor reasserted the objective of a balanced budget over the medium term.
On the external front, concern was expressed by some Directors that the current account deficit could remain sizable after inflation convergence was achieved. Large deficits could put pressure on interest rates and on the exchange rate, notwithstanding the country’s strong external asset position. These Directors suggested that policies should therefore be consistent with improving external competitiveness. In this connection, they called for renewed efforts to enhance the growth of productivity and wage flexibility through further structural reforms, especially in the labor market. More recent data reveal a substantial reduction in the United Kingdom’s current account deficit and significant progress toward inflation convergence.
ERM membership implied ambitious goals for reducing wage and price inflation in the United Kingdom. Some Directors felt that policy should focus on making wages more responsive to market conditions, while others considered that the authorities could take greater responsibility in determining wages.
Directors welcomed the U.K. commitment to a liberal system of international trade. Some encouraged the authorities to increase the ratio of official development assistance to GDP.
(In 1990, the Fund established a consultation relationship with Hong Kong. It concluded a consultation with Hong Kong in January 1991 as part of its consultation with the United Kingdom, in view of Hong Kong’s status as a U.K. territory.)
Italy’s improved economic performance in recent years permitted the removal of all remaining exchange controls and the entry of the lira (in January 1990) into the narrow band of the ERM of the EMS. Unemployment was still high and progress on reducing inflation to the level of Italy’s core partners in the EMS remained elusive, in the wake of near-full-employment pressures in the center and north of the country, as labor costs were elevated by excessive wage increases and continued labor market imperfections.
The Italian authorities see the commitment to a stable exchange rate as a fundamental component of the substantive actions needed to lower inflation, contain labor costs, and restore fiscal discipline. The Board welcomed the authorities’ determination to participate fully in the process of European integration.
The Board, in reviewing the Italian economy in February 1991, noted that fiscal retrenchment was more modest than targeted, despite continued buoyant economic activity. And significant structural measures had yet to be taken to curb the growth of public spending over the medium term, or to reduce the sizable economic imbalances among regions. There were signs of a weakening in Italy’s competitive position, and the need to sustain the stable exchange rate policy heightened the urgency of fiscal and wage restraint.
In the first half of 1990, the increased credibility that followed the entry of the lira into the narrow band of the ERM led to lower interest rates, which helped contain the budget deficit; at the same time, reserves continued to expand and the lira stayed strong. The renewed rise in interest rates that followed, together with the relative weakening of the lira within the ERM band, suggested that market sentiment remained sensitive to adverse changes in the domestic economy and in the external environment.
Directors reiterated their support for the authorities’ medium-term policies of fiscal adjustment, but saw the policy objectives as minimum requirements. They were concerned about the consequences of a slowing economy for fiscal revenues and cautioned that insufficient fiscal correction in 1991 could derail the adjustment program. The Board thus encouraged the authorities to take additional corrective measures during 1991 to keep the budget on target and to help stabilize the public-debt-to-GDP ratio by 1992. Cuts in spending would be key to fiscal restraint, as tax rates were already at, or above, average EC levels and progress on tax administration was hard to achieve. Prime targets for spending cuts included health, pensions, public sector wages, and public transport. More rapid progress toward privatization would also reduce the fiscal debt burden and the size of the public sector and enhance overall economic efficiency; privatization could not, however, substitute for fiscal adjustment. Several Board members, while endorsing the goal of decentralized responsibility for public revenue and expenditure decisions, doubted that the local authorities could exercise more discipline than the central government. They were also concerned that such a strategy might worsen regional disparities.
The Board welcomed the increase in employment evident in all regions, but was concerned about high unemployment in the south. It repeated its calls for greater differentiation in labor costs to reflect regional productivity differences, and for the removal of obstacles to labor market flexibility and labor mobility. Finally, the Board commended the authorities on the increase in Italy’s official development assistance.
After seven years of expansion, Canada’s economy moved into recession in the spring of 1990. The onset of recession was preceded by the emergence of strong demand pressures, rising inflation, and a tightening of policies to control demand. The Board, meeting in February 1991 to discuss the Canadian economy, concluded that the authorities needed to act to keep the recession from becoming a prolonged downturn while at the same time laying the foundation for a robust and sustained expansion.
Many Directors agreed that the economy may have turned the corner on inflation; others were unconvinced, and Directors generally cautioned that the path to resuming sustained growth might not necessarily be smooth. The economy was characterized by a number of strains. Inflation-adjusted short-term interest rates and the exchange value of the Canadian dollar remained high, profit margins were squeezed, and wage pressures persisted. These strains appeared to be traceable, in large part, to a sizable fiscal deficit, which placed an undue burden on monetary policy and complicated efforts to lower inflation expectations. It was important to address these problems in order to restore healthy and durable growth. The key ingredient in the Board’s view, was a substantial, front-loaded fiscal correction that would assist monetary policy in establishing a noninflationary environment. There were, however, some concerns that a sizable fiscal cut at a time of weak demand might erode business confidence and worsen the economic downturn.
On the monetary front, it was important to avoid any action that might be seen as lessening the commitment to price stability. While acknowledging that some further easing in monetary conditions might be feasible if the recession deepened, the Board believed that any lasting change in monetary conditions would have to await additional corrective steps on the fiscal side, an easing of wage pressures, and a lessening of inflation expectations. In this connection, any meaningful easing of monetary conditions should be related to the size of the fiscal correction.
The persistent upward pressure on wages concerned many Board members, who wondered how institutional and structural aspects of the labor market could be adjusted to yield the required flexibility. The Board encouraged the Canadian authorities to show maximum restraint in public sector wages, both at the federal and provincial level, with some Directors seeing a role for incomes policy.
With respect to the balance of payments, the large current account deficits of recent years concerned some Directors. The Board cited, in this connection, the appreciation of the inflation-adjusted exchange rate in the wake of the authorities’ firm monetary stance. Many Directors stressed that strong fiscal policy action could play an important role in adjusting the real exchange rate and in ensuring an improvement in the current account.
In the event, the budget for 1991/92 presented in February 1991, following the Board discussion, included substantial deficit-cutting measures; it projects that the federal deficit on a public accounts basis would decline to 1 percent of GDP by 1995/96. It also establishes guidelines for wage settlements in the Federal Government and sets a target path for inflation intended to promote achievement of price stability over the medium term.
In the area of structural policy, the Board commended the authorities for the major initiatives they had launched—including the introduction of the goods and services tax—and for their efforts to reform financial markets and the pension system. Directors underscored the need for greater market orientation in the agricultural sector; government assistance to agriculture remained large, which had negative consequences for economic efficiency and the budget.
The Board welcomed the authorities’ efforts to foster a freer trade environment. It commended Canada’s record on development assistance, although it was noted that spending on aid had been reduced in the past two budgets; some Directors hoped that efforts at fiscal correction would not lead to further cuts in development assistance.
Smaller Industrial Countries
Article IV consultations with the smaller industrial countries echoed many of the issues raised in assessments of the larger developed countries. They generally emphasized the need for the sustained pursuit of sound macroeconomic policies, combined with structural reforms to enhance overall efficiency and flexibility.
Most of the smaller industrial countries experienced continued growth in 1989-90, with generally moderate inflation, although several experienced slowdowns and others overheating of their economies and rising price pressures. The Board commended the efforts of many countries that had sustained comprehensive economic and structural reforms over a period of years; these were generally aimed at greater labor market and price flexibility, and at more liberalized trade policies and financial markets.
For most countries, Directors welcomed a strengthened commitment to exchange rate stability, which had helped enhance price stability; for those countries preparing for the single European market in 1992, a “hard currency” policy (that is, pegging to the currency of a country with an established reputation for price stability) was also helpful in promoting progress toward monetary union in Europe. A policy of exchange rate stability, however, required the appropriate macro-economic and structural policies. For some European countries preparing for the single market, the Board cited the need to harmonize monetary instruments and policies (and ensure central bank policy independence), as well as to harmonize tax instruments to improve the competitiveness and efficiency of goods and factor markets and the financial system, and to bolster external competitiveness.
A recurring theme of consultations with the smaller industrial countries was the need for added fiscal restraint—to contain inflation and ease the pressure on monetary policy—and for strengthening fiscal consolidation to increase national savings and stabilize public debt. The recommendation for fiscal restraint was frequently accompanied by a call for structural reform of the fiscal system; such reforms would include, for example, reducing the size of the public sector through selective spending cuts, reforming the tax system and tax administration, and, generally, setting fiscal policy on a medium-term path. In most cases, the Board advised that fiscal consolidation be accomplished through cuts in spending. Another common theme was the need to reduce high levels of unemployment, mainly by easing labor market rigidities (for example, through greater wage differentiation, improved occupational mobility, and elimination of wage indexation). The Board commended many of the smaller industrial countries for their generally liberal trading systems, although it counseled several to reduce trade barriers, particularly with respect to products exported by developing countries. Directors also commended many of these countries for their favorable records on overseas development assistance.
Difficult external financing conditions and the unfavorable global environment constrained the economic performance of many developing countries in 1990 and underlined the importance of the pursuit of sound macroeconomic policies to reinvigorate growth and control inflation. The Board, in its many Article IV consultations with developing countries in 1990-91, reaffirmed the primacy of sound domestic policies to help dampen excess demand pressures, accompanied by structural reforms to increase the supply of productive resources. Directors commended the sustained pursuit of cautious monetary and fiscal policies of many developing countries, frequently combined with far-reaching structural and financial-market reforms. Many countries, however, needed to implement reforms with greater determination and consistency. Fiscal restraint was a common theme—to be achieved mainly through selective spending cuts—and some countries needed firmer monetary control. The developing countries’ own adjustment efforts, however, needed to be supported by a favorable external economic environment, with improved access to industrial country markets. The impact of open markets on the external viability of developing countries is crucial. These countries also required adequate flows of external financing—whether on commercial or concessional terms—and many needed help with their heavy debt burdens.
A recurring theme of discussions with developing countries in 1990-91 was the need to sustain broadly based macroeconomic stabilization and structural reforms over the medium term, avoiding an on-again off-again approach to adjustment. Perseverance was needed in light of the seriousness of these countries’ problems, their limited resources and often rapid population growth rates, and the increasingly competitive global economic and financial environment. At the same time, developing countries were encouraged to protect the poorest and most vulnerable from the impact of corrective policies by targeting assistance to these groups.
Indebted Developing Countries
For the indebted developing countries, the Board reaffirmed the importance of sound domestic policies geared to increasing savings and investment and to using these resources more effectively. These countries had to create an environment conducive to capital formation and foreign direct investment, and one that would attract the repatriation of flight capital. In some cases, a reduction of debt and debt service, in conjunction with strong economic and structural policies, would contribute to higher economic growth and could help restore access to spontaneous credits from international capital markets. The Board welcomed the successful conclusion of financing packages involving debt and debt-service reduction with commercial banks by a number of countries; some of these countries managed to regain limited access to spontaneous lending.
The specific policies needed to bolster economic growth and price stability in the developing countries vary according to the circumstances of each country. In general, however, Article IV discussions stressed the importance of reducing budget deficits by curbing public sector wages and employment, reducing subsidies, and scaling back transfers to public enterprises. On the revenue side, the Board frequently cited a need for greater efforts to broaden tax bases and strengthen tax administration to improve compliance. Reduced fiscal deficits were considered important goals as they help curb inflation and prevent a crowding out of private investment. Consultations also stressed the need for sustained structural reforms in the public sector, reinforced by other reforms. Such reforms would help encourage private investment; strengthen the external position by, for example, promoting export diversification; and support fiscal consolidation by making tax systems and public enterprises more efficient. With respect to public enterprises, the Board called for close monitoring of financial and economic performance; more frequent price adjustment, in certain cases; and accelerated privatization or, where appropriate, restructuring.
Exchange rate policies remained a vital aspect of Article IV consultations with developing countries, although exchange rate practices and systems of members are diverse and Fund policy advice is not uniform. In consultation discussions during 1990-91, the Board emphasized repeatedly that exchange rate adjustments and policies had to be supported by the appropriate economic and structural policies; if, for example, a devaluation is not supported by tight fiscal and monetary policies and wage restraint, it could lead to spiraling wage increases and rising inflation by igniting inflation expectations. The Board stressed the need for realistic and consistent exchange rate policies that promoted external adjustment and growth, while facilitating monetary control and stable prices. Many developing countries had taken positive steps—including unification of exchange markets—and had acted to reduce or eliminate exchange and trade restrictions; some continued to maintain overvalued currencies and multiple exchange rates. A number of countries had managed to reduce their external debts, while others needed more prudent debt management. The Board commended a few countries that had eliminated arrears in 1990; those with outstanding arrears were advised to eliminate these quickly and normalize relations with creditors. For many low-income countries engaged in medium-term economic adjustment programs, the Board stressed that the success of these endeavors required external financing on concessional terms and a determined pursuit of reforms.
Other general themes of consultations with developing countries included the need to adopt flexible and realistic pricing and interest rate policies (the latter entailing positive real interest rates to encourage savings); reduce administrative controls and give greater latitude to private activity; reduce subsidies; diversify economic bases; rebuild international reserves; remove trade restrictions (or substitute tariffs for quantitative restrictions); and make good use of foreign and Fund technical assistance to enhance economic and administrative capacities.
Article IV consultations with Eastern European countries welcomed the comprehensive and ambitious stabilization and structural reform programs and generally counseled their quick implementation. This often required immediate steps to liberalize prices and the external trade and payments system and to unify and adjust the exchange rate. The discussions emphasized tight monetary and fiscal policy to prevent inflation and unsustainable external imbalances in the wake of price and external sector liberalization. They recommended privatization or restructuring of public enterprises to enhance efficiency in the context of creating an environment hospitable to entrepreneurship, economic transformation, and growth. They also cited the need for financial and banking reforms to promote financial intermediation. Given the magnitude of the reforms required, consultations with these countries stressed the need for adequate social safety nets to cushion the effects of, for example, large increases in unemployment. They also underscored the critical need for various forms of external financing and, in some cases, debt-reduction assistance.
The reform programs of Eastern European countries share four goals.
First, the wholesale replacement of central planning and management by a market-oriented system characterized by market-determined prices, flexible capital and labor markets, the legalization of private property, and adoption of open trade and investment policies toward the rest of the world. This last consideration, in turn, virtually mandates creation of convertible currencies.
Second, establishment of a viable financial system founded on market-based interest rates to encourage adequate savings, an efficient allocation of capital, and the development of equity markets. Supervisory institutions for the oversight and regulation of the new financial world will also have to be created. At the same time as they take these steps, the authorities must establish independent financial institutions, including an autonomous central bank; a system of nondiscriminatory VAT-style indirect taxation; a comprehensive personal income and corporate tax system; a network of reliable statistics; and consistent accounting and auditing standards.
Third, measures to liberalize the operation of firms and markets. A necessary task facing Eastern Europe is the transfer of ownership of previous state assets to private hands. Doing so will encourage private investment and improve resource allocation.
Fourth, creation of a viable social safety net. Falling production and rising unemployment are already common throughout Eastern Europe. If the new governments are to be successful in carrying forward systemic reforms, they must have programs in place to cushion the short-term impact, such as funds for unemployment insurance and job retraining.
All Eastern European countries face a difficult economic environment in 1991. The switch of CMEA trade to world prices with settlement in hard currencies, while it will promote long-run efficiency gains, nevertheless imposes large additional costs on Eastern European countries’ balance of payments in the short run. The change in CMEA arrangements has involved major disruptions in regional trade, which are being intensified by economic dislocation in the U.S.S.R.
Several countries in the region were hit by drought in 1990, and this shock continues to have an adverse impact on their balances of payments in 1991. The prevailing unfavorable economic environment provides the background to, and added stimulus for, the major program of reform launched over the past two years.
The Board discussed these developments at a March 1991 seminar. Directors noted that the cost of reform in Eastern Europe, in terms of time, lost income, and lost output—although inevitable given the structural reforms that were necessary—had been much higher than anticipated. Directors were of the view, however, that a more gradual approach would only prolong the difficult transition period. In view of these obstacles, Directors noted the desirability of making progress on all fronts at once, with structural reforms in the areas of trade, price liberalization, banking, and privatization. Far from being discouraged from tackling serious reform programs, Eastern Europe’s new governments have faced up to the costs involved and are moving forward boldly.
At its March 1991 discussion of the Bulgarian economy, the Board strongly commended the authorities for launching an accelerated program of reform within a short period of time after joining the Fund. It was emphasized that, while the program represented a sharp break with the past, there were no viable alternatives to an ambitious and frontal approach. All speakers agreed that Bulgaria’s large inherited disequilibria, combined with the break up of the CMEA system on which Bulgaria had been heavily dependent, left little latitude for phasing in stabilization and structural reforms. The priorities and pace of the program were endorsed, particularly the upfront measures to liberalize prices and the external trade and payments system, eliminate the monetary overhang, and seek an early start to privatization and other structural reforms.
The Board broadly supported the Bulgarian authorities’ reliance on floating exchange rates and the newly created interbank market for foreign exchange. It was generally agreed that the tight financing constraints and the lack of reserves, together with uncertainties surrounding the likely equilibrium exchange rate, were persuasive arguments in favor of the authorities’ policies.
Comprehensive structural reforms, in the Board’s view, were required to support stabilization and attract foreign investment. The Board commended the authorities for the progress already made but noted a long agenda of legislative and institutional changes that demanded further attention. Beside financial institution reform, the most urgent priorities lay in the state enterprise sector. While expecting that small-scale privatization could proceed with relative speed, Board members cautioned that the larger state enterprises posed the biggest threat to the current program. Restructuring and privatization of these enterprises would provide a critical test of Bulgaria’s reform process.
The Board underscored the crucial role external assistance was likely to play in 1991. It was recognized that Bulgaria would make substantial demands on Fund resources, and the Board indicated its readiness to consider such requests in view of the scope of the current adjustment program and Bulgaria’s obvious need for external finance. Directors further noted that the 1991 financing gap relied heavily on funds supplied by the Group of Twenty-Four industrial countries and the World Bank, without which the reform process and its speed would be seriously threatened.
The Board recognized that the budgetary targets were ambitious, but saw no alternative if the large macroeconomic disequilibria were to be eliminated in an orderly manner and commended the far-reaching structural reforms on both the revenue and expenditure sides. Given the difficult reform process ahead, the Board attached importance to the provision of a sizable social safety net.
The authorities’ monetary and credit expansion limits won support. Given the country’s exchange rate objectives, however, the Board underlined the need for flexibility in administering the new interest rate structure, and urged the authorities to resist pressures to reduce interest rates prematurely, before there was sustained evidence that inflationary expectations had been subdued.
The Czech and Slovak Federal Republic
At the Board’s January 1991 review of the Czechoslovak economy, the authorities were complimented for their commitment to a comprehensive, well-balanced, and far-reaching reform program to transform the economy by adopting market mechanisms. It was stressed that the key to success lay in actions to liberalize prices and trade and exchange relations, along with quick implementation of the privatization program.
The Board welcomed recent increases in prices of energy products as a means of passing through higher import costs. Concern was, however, expressed that some of the increases in retail prices of non-oil energy products had been delayed until March, and the Board emphasized the importance of implementing the delayed price increases by that date. More broadly, the Board looked forward to early elimination of the remaining price and export-licensing regulations, while emphasizing that temporary safeguards and transitory arrangements should not become permanent. The Board welcomed the authorities’ resolve to curb inflationary pressures by continuing to adhere to restrictive fiscal and monetary policy and to a tax-based incomes policy that should substantially curb excessive wage increases.
Concern was voiced at the prospect that output would continue to decline in 1991, bringing rapid increases in unemployment. The Board expressed the view that a successful transition to a market economy and prompt return to positive growth would depend on the pace of structural reforms. Many on the Board considered that these structural reforms should not be permitted to lag behind tight macro-economic policies. The Board emphasized, in particular, measures involving privatization, hard budget constraints on enterprises, the introduction of bankruptcy legislation, and the dismantling of monopolies.
The Board recognized that Czechoslovakia’s reform program entails major risks. The scope and rapidity of planned institutional changes envisioned by the program are considerable, and the Government could be expected to come under pressure to relax its stance, particularly if output and inflation turn out worse than expected.
The crucial role expected to be played by external financial assistance was underscored. The Board saw the need for the Fund to provide strong support at the beginning of the program through the stand-by arrangement and access to the newly created oil import element of the compensatory and contingency financing facility (see section on Fund financial support, below). Directors agreed it was necessary to reverse the large decline in international reserves in 1990 and to provide adequate reserves in 1991 to support the exchange rate policy.
At its review in February 1991, the Board welcomed Hungary’s program of economic reforms, viewing it as a comprehensive response to many weaknesses that had hampered production and contributed to the rise in external debt. By narrowing domestic and external imbalances, a stronger foundation had been established for the Government’s medium-term program, and there had been a substantial improvement of the current account in convertible currencies. Continued determination in preventing the re-emergence of an unsustainable external deficit, combined with the authorities’ determination not to seek external debt rescheduling, would, in the Board’s view, be essential to rebuild the confidence of Hungary’s creditors. The Board also welcomed the authorities’ goal of reducing the state’s economic role by privatizing state assets and curtailing state budget expenditures.
Concern was, nevertheless, expressed in the Board about the acceleration of inflation in 1990. While the current high rates of inflation largely reflected price adjustments, Directors stressed the importance of strengthening the financial discipline of enterprises and of stronger competition in goods and factor markets throughout the economy. Accelerating structural reform would increase price responsiveness to tighter monetary and fiscal policies. Another virtue of structural reform, in the Board’s view, would be to increase the availability of goods.
The planned convertibility of the forint for current transactions would play an important role in promoting a market-based reallocation of resources toward efficient and profitable production and investment, in the Board’s view. A number of Directors, however, encouraged the authorities to commit themselves to more rapid progress toward convertibility, including capital account convertibility.
It was recalled that reaching the fiscal target in 1990 required corrective budget adjustments at midyear. Given the large external and internal uncertainties, the Board called for continued close monitoring of fiscal developments and for not delaying necessary corrective measures.
The Board’s April 1991 review of Polish economic performance and its approval of an extended arrangement for that country reflected strong approval of the authorities’ ambitious stabilization and structural reform measures. The Board also expected rapid progress on structural reform to enhance supply responses and to speed the transition to a market economy. Sharply lowering the inflation rate, eliminating shortages, achieving a substantial fiscal surplus, and replenishing foreign exchange reserves were considered by the Board to be major successes. At the same time, while the Polish authorities were credited for the progress they had already made in institution building and in enacting legislation, achieving longer-term systemic changes had proven to be more difficult and time consuming than initially envisaged. The fall in output had likewise been sharper than expected; the subsequent recovery, moreover, was sluggish, and efforts at midyear (1990) to stimulate output had revealed that earlier stabilization gains had been rather fragile—serving to underline the economy’s underlying vulnerability.
The Board therefore endorsed the authorities’ renewed commitment to strong stabilization policies and to accelerated structural reforms. With respect to stabilization policy, the Board endorsed the goal of reducing inflation to a single-digit annual rate by 1993. Directors further urged the Polish Government to make rapid progress on structural reform to enhance supply responses and speed the transition to a market economy. Without extensive and rapid privatization, the Board agreed that the successful shift to a market economy would be a difficult task indeed.
It was agreed that Poland’s bold program of economic reconstruction deserved the exceptional support of the international community. Directors therefore welcomed the Paris Club’s positive response to Poland’s request for debt reduction, and looked forward to a speedy agreement being reached on comparable debt-reduction agreements with commercial banks and CMEA creditors. Noting that the precise modalities and implications of debt reduction had yet to be worked out, some members of the Board were uneasy about the implied uncertainty of external financing needs and underscored the importance of relatively long maturities for restructured debt and a graduated debt-servicing schedule. In supporting Poland’s request for an extended arrangement, however, most Directors expressed confidence that the modalities of debt-restructuring agreements would contribute adequately to financing assurances over the medium term and, of course, appropriately protect the level of reserves.
The unprecedented reform path on which the Polish authorities are embarked inevitably involves uncertainties. The Board, however, concluded that, in general, a gradual approach to reform entailed greater risks than an accelerated one. This was highlighted by economic developments in other CMEA countries, notably the U.S.S.R., which could undermine Poland’s growth objectives and, with it, the social consensus in favor of a sustained adjustment effort.
In its October 1990 review of Romania’s liberalization program, the Board agreed with the authorities’ conclusion that comprehensive structural reform in a setting of tight fiscal and monetary policies provided the only viable path to economic renewal. The Board accordingly endorsed the measures already taken, including abolition of central planning along with steps to liberalize economic activity. Directors stressed the importance of financial sector and fiscal reform and expressed concern over the substantial declines in output over the first eight months of 1990; in view of excess liquidity, the recent growth in money incomes was judged by the Board to be excessive and it warned that if this trend were not reversed, the reform process itself could be jeopardized.
At an April 1991 review of Romania’s reform program, the Board commended the authorities’ commitment to accelerated economic transformation as reflected in the country’s 1991 reform program, notably with respect to steps already taken to dismantle the centrally planned system and to establish the institutional and legal framework of a market economy. Directors welcomed approval of the law transforming most state enterprises into commercial companies and the measures undertaken to significantly liberalize prices and trade.
The Board noted the crucial role of tight fiscal and monetary policy and welcomed the tax reform measures taken in 1990, which were designed to increase the coverage and elasticity of the tax system, and encouraged them to continue their commitment to adjustment measures in this field. Directors recognized that monetary policy would continue to serve as the main nominal anchor preventing price level adjustments from turning into an inflationary spiral. The financial liberalization program, which includes the removal of ceilings on interest rates and the implementation of new laws on banking activities, was welcomed by the Board.
Though the Board recognized the necessity of having a dual exchange rate policy, there was some concern about the possible harmful effects of this policy on employment and prices; all Directors urged early unification of the official and interbank market rates. They also observed that Romania’s balance of payments outlook was uncertain and noted that the strategy of paying off the entire external debt in the late 1980s had exacted high costs in the form of impaired living standards, declines in net investment, and stagnation in real GDP. The Board stressed that the country’s successful adjustment would depend on external support.
Though Yugoslavia is not a member of the former CMEA area, its economic structure and the problems deriving from it make it an integral part of the broader reform process transforming Eastern Europe. In reviewing Yugoslavia’s progress in March 1991, the Board drew attention to the authorities’ remarkable success in reducing inflation from very high levels at the end of 1989 to virtually zero monthly inflation in the second quarter of 1990. The Board also indicated that it was encouraged by the development of a liberalized domestic pricing system for most goods and a unified exchange market, which, at least until recently, was maintained relatively free of restrictions on current account transactions. Directors welcomed the private sector’s response to economic liberalization, and they urged the authorities to speed the transformation of social enterprises into entities with clearly defined ownership rights and to restructure the banking system.
The Board noted, however, that the authorities’ capacity to master inflation had proved short-lived, largely because there had not been the necessary wage restraint at the local and federal level. Political pressures, along with delays in clarifying ownership of social resources and tightening financial discipline, were largely responsible for this reversal.
The Board endorsed the authorities’ intention to pursue a tight monetary policy, stressing that such action would require removal of the remaining institutional obstacles to central monetary control and an expansion of the monetary instruments available to the National Bank. Directors placed special emphasis on eliminating the ability of regional national banks and accounting offices to undermine monetary policy. To strengthen monetary control in the short term, temporary limits on bank credit had proved useful, but these should not become a substitute for reserve money management. Directors cautioned against a return to administrative controls on interest rates, emphasizing the importance of keeping interest rates at internationally competitive levels.
Much concern was expressed about the ability of the federal authorities to reestablish effective control over economic policies and to carry out structural and institutional reforms. Several Directors observed that the sharp loss in competitiveness in 1990 was only partially compensated for by the recent steep devaluation.
Box 3.Study of the Economy of the U.S.S.R.
The joint study on the Soviet economy, requested by the Heads of State and Government of the seven principal industrial countries and the President of the Commission of the European Communities at the July 1990 Houston Economic Summit, was completed by the Fund, the World Bank, the Organization for Economic Cooperation and Development (OECD), and the European Bank for Reconstruction and Development (EBRD) in December 1990. Three volumes of background papers were published in March 1991.
Convened by the Fund, the study was to undertake a detailed examination of the Soviet economy, make recommendations for its reform, and establish criteria under which the international community could most effectively support such actions. The joint study’s recommendations were submitted to summit participants in December 1990 and published shortly thereafter. It concludes that, notwithstanding present Soviet reform efforts, a total transformation of the U.S.S.R.’s economy promises to be an extraordinarily complex undertaking that will take many years to complete.
The Board discussed the study at a seminar in January 1991. Directors supported the views put forward in the study that restoration of financial stability, a large-scale up-front liberalization of prices, and ownership reform were the three prongs of a successful reform. The need for a substantial tightening of fiscal and monetary policies was emphasized both in view of the already sizable monetary overhang, as well as the growing risk of fiscal and financial imbalances and inflationary pressures.
Directors emphasized the complications resulting from the unsettled financial and legal relations between the union and the republics, which might hamper the pursuit of all-union fiscal and monetary policies. In this connection, it was suggested that the Soviet economy might benefit from the experience of the members of the European Community in strengthening cooperation in economic and fiscal and monetary policies. However, it was also suggested that the sheer size and diversity of the U.S.S.R. argued in favor of a certain degree of decentralization of economic policymaking. Several speakers saw merit in giving greater consideration to the sequencing of reforms, but in general the view prevailed that it was preferable at this stage to emphasize the need for comprehensiveness—in other words, that there should be substantial progress in a number of areas simultaneously.
The Board expressed concern that the constitutional division of powers between the federation and republics would frustrate efforts to obtain binding commitments on spending, and that outlays associated with stabilization and reform would accordingly be sacrificed. In this regard, the Board was also seriously concerned about a shortfall of revenues due the federation from the republics and about increased federal budget arrears.
World Economic Outlook
The World Economic Outlook report analyzes current economic conditions and describes short-term and medium-term prospects for the world economy, the major industrial countries, and other industrial and developing country groups. The report serves as the basis for regular reviews by the Board and the Interim Committee of the interaction of the economic policies of member countries and their effect on the international monetary system. By integrating analyses of the economic policies of individual countries in a multilateral context, the world economic outlook exercise provides a global framework for surveillance conducted through Article IV consultations with individual countries. In doing so, it draws attention to potential conflicts and tensions that may arise between countries if prevailing economic policies continue unchanged. It also constitutes a framework for analyzing key global issues, such as the adequacy of global savings, the debt problem, economic policy coordination, the international monetary system, and regional and cross-country issues.
In its discussion of the world economic outlook in April 1991, the Board expected that the recession that began in 1990 in North America, the United Kingdom, and a few other industrial countries would, on the whole, be relatively shallow and short-lived. The Japanese and German economies were likely to continue to expand, albeit at a slower pace than in 1990. This “cyclical desynchronization” and consequent absence of synchronized policy responses among the major economies was, in the Board’s view, a welcome development because it reduced the risk of a generalized slowdown in the world economy. The fall in oil prices and interest rates was expected to boost economic activity in the oil importing industrial countries, and consumer and business confidence were showing some signs of recovery.
Many Directors cautioned that a quick recovery was by no means assured, owing to the risks of continued fragility in some financial systems—particularly in the United States—the slowing of growth in Europe, continued uncertainty over the situation in the Middle East, and the problems encountered with reform in east Germany, Eastern Europe, and the U.S.S.R. Prospects for the developing countries were also uncertain and less favorable than previously expected, particularly in Africa.
In discussing developments relating to the crisis in the Middle East, the Board noted the effects of the sharp, albeit temporary, rise in oil prices in 1990. Although the direct external and budgetary impact of higher oil prices on the industrial countries was relatively small, the estimated costs to the oil importing developing countries were considerably larger and more prolonged, especially for those countries directly affected by losses of worker remittances, the need to resettle expatriates, and other disruptions stemming from the crisis in the Middle East. In responding to the crisis, the industrial countries—and many of the developing countries—had ensured that changes in oil prices were passed through to consumers. This pass-through was generally endorsed, since it was seen as preferable to subsidies or price controls; it was agreed that the pass-through should be symmetrical. One view was that domestic prices should in some cases be kept high, despite a drop in world prices, for budgetary or environmental reasons. It was also acknowledged that, while taking account of environmental and budgetary concerns, taxation of energy products should avoid interfering with the efficient use of resources.
The Board stressed the importance of maintaining a cautious and steady monetary policy, focused mainly on reducing inflation, rather than on external developments; in this connection, the recent exchange rate changes (notably, the substantial strengthening of the U.S. dollar) were not seen as a major cause for concern. Although Directors were alert to the difficulties facing certain financial institutions, the solution was not to ease fiscal and monetary policies. A number thought that lower interest rates could be helpful, but this could only occur in many countries in the context of continued efforts toward fiscal consolidation.
During the discussion of the world economic outlook, Board members cited the many developing countries engaged in Fund-supported policy reforms, although they noted that these countries’ short-term prospects were uncertain, as they depended upon the degree to which reforms would be implemented. Moreover, the external environment for the developing countries had deteriorated: growth in the industrial countries had weakened, non-oil commodity prices had fallen further, and, for the oil importers, fuel import costs had risen in 1990, although this increase was reversed in the early part of 1991. In addition, the conflict in the Middle East had severely disrupted the economies of some countries in the region and others in Africa and Asia. The worsened external environment had complicated the task of economic policy in several countries that had implemented or strengthened corrective policies. The Board welcomed the increased flow of external finance to the developing countries in 1990, and noted that some countries with recent debt-servicing problems—which had sustained appropriate policies and restructured their external indebtedness—succeeded in regaining access to international capital markets in 1990.
Most Directors expressed concern about prospects for Eastern Europe, and especially for the U.S.S.R. Strong and comprehensive reform in these countries was desirable, they agreed, despite the adverse global environment and the short-term costs (in terms of output and employment) of adjusting their economies. The transition to a market system with new relative prices would require a far-reaching restructuring of enterprises and industries. The Board had increasingly come to the view that the transition in Eastern Europe was likely to be more prolonged than initially thought and involve substantial losses in output and employment. As a result, many Directors stressed the need, on the one hand, for a social safety net, and, on the other, for access to the markets of industrial countries to ensure a successful transition. Some concern was expressed about the potential need for large external financing for the Eastern European countries over the medium term. Indeed, several Directors feared that financing constraints would slow the transition. The Board agreed that the best way to secure a steady flow of external capital was to sustain or accelerate the pace of reform, particularly structural reform and privatization. Directors noted that the Fund, which had already committed substantial financing for Eastern Europe, asked the staff to monitor closely economic developments and the progress of reform in the region. The Fund would, however, continue to ensure that its assistance for Eastern European countries would not impinge on that provided for other developing countries engaged in macroeconomic and structural reform.
The Interim Committee, meeting on April 29-30, 1991, just two weeks after the Board review, largely concurred with the Board’s expectations about the weakening of economic activity in the industrial countries and the subsequent recovery. The Committee agreed that monetary and fiscal policies should be directed at laying a basis for lower real interest rates and sustained global economic recovery with price stability. It stressed the importance of increasing global savings. To help achieve these objectives, Committee members welcomed budgetary actions in several countries and urged others to step up efforts to strengthen their fiscal positions. They considered that coordinated macroeconomic policies had to be complemented by structural reforms aimed at increasing economic efficiency, particularly those designed to foster greater market competition, and at removing distortions affecting private saving, investment, and the allocation of capital. Such a medium-term strategy was crucial to raising investment and growth in the industrial and developing countries and to addressing the challenges of reform and reconstruction.
Committee members commended the Fund’s prompt assistance to those countries seriously affected by the crisis in the Middle East. In some countries in that region, the effects of the crisis had compounded existing imbalances and structural maladjustments. The Committee encouraged the Fund to continue helping the affected countries adopt appropriate macroeconomic and structural adjustment policies.
With respect to Eastern Europe, the Interim Committee welcomed the comprehensive efforts to introduce market-based systems. Despite the initial output and employment losses, it saw no alternative to strong and all-encompassing reforms if these countries hoped to achieve sustainable growth and full integration into the world economy. The Committee concluded that while financial and technical support by national governments and international institutions were essential at the current stage, foreign private capital flows would be expected to play an increasingly important—and eventually a decisive—role in meeting Eastern European financing and technical assistance needs; this would require, in turn, tangible progress toward a stable economic environment hospitable to private enterprise.
The Interim Committee was encouraged by the perseverance of a number of developing countries in pursuing comprehensive policy and structural reforms. It emphasized the indispensable role of adequate and timely external finance in support of reform policies in developing countries, including those that had avoided debt-servicing problems. It welcomed the progress achieved by several heavily indebted countries pursuing reforms in putting in place bank financing arrangements. At the same time, the Committee noted that difficult cases remained unresolved, and it urged all parties to expedite negotiations. The Interim Committee also underscored the importance of sustained support by official bilateral creditors. With respect to the poorest countries, the Committee welcomed the ongoing review in the Paris Club of proposed adaptations to debt-restructuring and debt-reduction practices to assure appropriate support for members embarked on broadly based reforms.
Both the Board and the Interim Committee expressed concern over the failure to reach agreement in the Uruguay Round of multilateral trade negotiations. They agreed on the urgency of achieving a successful conclusion to the Round. (See discussion of international trade policy, Section 4, below.)
Industrial Country Policies
In discussing the industrial countries, the Board took note of trends in national saving and investment in the industrial countries and of the global adequacy of saving. Most Directors were concerned about the projected net absorption of world savings by the industrial countries over the medium term. The Board called for efforts to increase national saving and emphasized that, although careful consideration should be given to removing distortions that discourage private saving, the most direct way to boost saving was through more rapid reductions in fiscal deficits. At the same time, Directors stressed that an efficient allocation of savings at the national and global levels was just as important as a higher level of savings.
The Board drew attention to the projected use of savings to fund sizable central and general government fiscal deficits in a number of industrial countries. Although financing requirements remained large in some countries, Directors welcomed the deficit-reduction plans announced in the United States, Germany, and Canada. They commended the November 1990 budget agreement in the United States, although some questioned whether a full implementation of the measures would raise national savings sufficiently to meet domestic and external objectives. In Germany, the Board acknowledged the inevitability of some temporary worsening of the fiscal position, given the historical challenge of unification and the reconstruction of east Germany. The German authorities had announced significant measures to limit the fiscal deficit and to ensure that it would decline over the medium term. However, the deficit still appeared to be far higher than previously thought, and several Directors believed that additional deficit-cutting measures might be needed to avoid upward pressure on interest rates and prevent adverse spillovers onto other EMS countries.
The Board, at its September 1990 world economic outlook discussion, welcomed the continued progress toward economic integration among EC members. Directors agreed that the Fund should continue to monitor closely these developments—including tax coordination—since the evolving institutional arrangements and the timing of subsequent stages in the process of integration would play a central role in the economic evolution of the EC and in the relationship between the EC and other countries.
Developing Country Policies
Although the global environment was difficult, the Board believed the developing countries could succeed in restoring sustained growth with sound corrective policies, consistently implemented. Directors cited the stronger economic performance of countries with relatively high saving rates in the 1980s and pointed out that several countries had recently adopted corrective policies that could improve their economic prospects, if they avoided policy slippages. The Board welcomed the Fund staffs alternative policy scenarios in the World Economic Outlook report; these illustrated the consequences of policy slippages and highlighted the importance of the external environment, and of adopting and sustaining policies that would promote domestic saving and investment and a more efficient use of resources.
External creditors had an important role to play in assisting the policy reform efforts of the indebted developing countries. In addition, the Board emphasized the fundamental importance of creditor countries maintaining and improving access to their markets. Most Directors also felt that debt-restructuring arrangements could help improve debtor countries’ cash flow and reduce disincentives associated with an overhang of debt. The Board concluded that additional flows of external financing would be required, not only for poorer countries caught in a low-saving, low-growth situation, but also for those close to restoring normal relations with creditors. Directors also attached particular importance in this context to the Trinidad proposals of the U.K. Government(see discussion of debt strategy, Section 2, below). It was also noted that the higher domestic saving, investment, and growth were in the developing countries, the greater was the likelihood of attracting private capital inflows.
Box 4.Currency Convertibility in Eastern Europe
Under Articles I and VIII of the Fund’s charter, the attainment of currency convertibility to cover current account transactions by member countries is an objective of the Fund to which all members have subscribed. The Articles distinguish between current account convertibility and capital account convertibility by allowing members to restrict convertibility for capital transactions (Article VI, Section 3). Also, as defined in Article XXX (d), current transactions can include certain transactions of a capital nature—in particular, payments of moderate amount for amortization of loans or for depreciation of direct investments.
For the several member countries in Eastern Europe now transforming from centrally planned to market-based economies, the establishment of current account convertibility is a desirable objective, at least over the medium to long term. To guide member countries undergoing this transformation, the Board met in December 1990 to consider the issue of convertibility and its central position in a market-based economy. The discussion centered on the following issues:
the point in the transformation process at which convertibility should be introduced;
the necessary preconditions for convertibility;
the desirability of introducing current account convertibility before capital account convertibility; and
the pros and cons of introducing transitional arrangements for limited convertibility prior to introducing full convertibility.
The economic benefits to be derived from current account convertibility were not in question: it would expose domestic production to the spur of foreign competition and relative prices, which were essential in providing the production and investment guidance that had been lost with the collapse of central planning systems. Directors also agreed that if the benefits of convertibility were not to be short lived, certain preconditions should already be in place: an appropriate exchange rate; adequate international liquidity (that is, reserves and foreign financing); the absorption of any liquidity overhang; and sound macroeconomic policies. The importance of tight budget constraints was also underscored, as well as the need for incentives that would induce enterprises to respond appropriately to market prices.
Directors’ views differed over the speed with which countries should move to current account convertibility. Should convertibility be introduced early in the transformation process, even in the absence of some of the preconditions; or, should the preconditions be sufficiently well established to ensure the durability of the effects of convertibility? Adherents of early convertibility argued that many countries no longer had the luxury of choice; central planning had ceased to function, leaving in its wake confusing and uncertain price signals, plummeting production, and inefficient production processes. Since relative prices were essential in defining trade, the early introduction of current account convertibility was crucial.
Those Directors favoring a slower approach, however, stated that countries with little experience of free markets (and none of the necessary machinery in place to conduct market-based trade) might be swamped by the short-term effects of early convertibility. Emphasis would need to be placed on monitoring external equilibrium; and the necessary depreciation of the currency to keep the production sector competitive could lead to a dramatic decline in real income. For many of the affected economies, convertibility without an appropriate exchange rate regime or sound macroeconomic policy package might not serve the intended purpose.
Those countries that were unable to respond appropriately to external price shocks or changes in the terms of trade might want to adopt transitional arrangements. For example, temporary import tariffs could be introduced to protect domestic production, provided they were packaged with measures to unify the exchange rate, remove quantitative import restrictions, and introduce current account convertibility, and provided there was a preannounced and credible system for phasing out the tariffs over time.
At whatever speed an individual country’s circumstances dictated the introduction of convertibility, Directors generally agreed on the importance of moving early to unify the exchange rate for current account transactions, remove quantitative restrictions on trade, rationalize tariffs, and introduce a competitive system for allocating foreign exchange.
Although individual country circumstances would have to dictate the speed of transition, most Directors felt that current account convertibility should be established as early as possible, along with a comprehensive set of reforms sufficient to establish the preconditions. Countries concerned about capital outflows and runs out of the domestic currency could postpone introducing full capital account convertibility, although several Directors pointed to the benefits that inflows of foreign capital and managerial skills could provide for the transforming economies and doubted whether in any case capital controls could any longer be truly effective. These Directors emphasized that capital movements could contribute to macroeconomic stability and discipline and could encourage the development of the domestic financial system.
International Monetary and Capital Market Issues
In fulfilling its responsibility to monitor the operation of the world monetary system and identify possible improvements, the Board periodically discusses developments in this area. At an informal session in June 1990, Directors stressed the importance of Fund oversight of the international monetary system in light of its rapid evolution. They noted the range of emerging economic and monetary unions in different regions of the world, including German economic, monetary, and social union, and the broader European economic and monetary union; the issue of currency convertibility and potential payments systems in Eastern Europe (see box on currency convertibility in Eastern Europe); and changes in the provision, measurement, and management of international liquidity.
A major issue addressed at the Board discussion was whether an exchange rate system could help “anchor” monetary policy against inflation. The Board concluded that exchange rates alone could not anchor the monetary system; rather, responsibility for achieving price stability lay mainly with the fiscal and monetary authorities of each country. Directors noted that the growing importance of Japan and Europe made unrealistic any return to a Bretton Woods-type system in which world price stability depended almost entirely on control of inflation in one country. Board members agreed that rigid rules to guide monetary policy could prevent adequate responses to unforeseen circumstances. They also agreed that monetary policy had too often in the past been overburdened and that well-disciplined fiscal policy had to assist monetary policy in promoting sustained, noninflationary economic growth.
Choice of Exchange Arrangement
In discussing the wide diversity of exchange rate arrangements prevailing in the world economy, the Board focused on three explanatory factors:
the structural characteristics of an economy;
the need to reinforce monetary policy credibility; and
commitments to regional integration.
At an informal session on exchange rate policy issues in November 1990—during which Directors examined the experience with member countries pursuing Fund-supported policy reforms and assessed the Fund’s exchange rate advice in the context of Article IV consultations—the Board agreed that no prescription for the choice of exchange rate regime or exchange rate management could be applied uniformly; rather, the particular circumstances of each country and the economic objectives of the authorities must be the main determinants. In particular, reservations were expressed about establishing rules for guiding the nominal exchange rate with reference to a real effective exchange rate target. Rigid adherence to such a target could prove destabilizing, not only because of the problems associated with indexation, but also because of the difficulty of identifying the equilibrium real exchange rate—which changes in response to domestic and external shocks. It was argued by some Board members that the Fund, while avoiding dogmatism, should seek to give more consistent advice on exchange rate policy. They also believed that more stable exchange rates among the major industrial countries—achieved through better coordination of macroeconomic policy—would be conducive to a more stable international monetary system.
Regardless of the chosen exchange rate regime, the Board firmly believed that domestic financial and structural policies had to be geared to achieving price stability and maintaining or improving external competitiveness. For countries that had earned a reputation for financial discipline, the choice of exchange rate regime is not critical. For those countries with long histories of inflation and financial imbalances, the Board noted that exchange rate policy was secondary to appropriate fiscal and monetary policies in determining the success of economic stabilization efforts. In such cases, the view was expressed by some that a fixed nominal exchange rate could serve as an anchor for price stability, both by providing a benchmark for price level expectations and by clearly signaling the authorities’ commitment to financial discipline. Such a strategy would require the authorities’ firm resolve to maintain sound policies, and a commitment to significant prior policy actions, supplemented by access to adequate foreign exchange reserves (including foreign lines of credit) to defend the exchange rate. It was also noted that policymakers had historically been unwilling to subordinate fully domestic policies to an external discipline.
Where a country needs to adjust its real exchange rate, the Board agreed that an appropriate balance needs to be struck between restrictive policies and exchange rate adjustment, as the former would be likely to reduce output and the latter to increase inflation in the short run. Where external imbalances are large, for example, purposeful and properly focused exchange rate action may correct underlying cost and price disparities and limit the cost of adjustment in terms of forgone output; such action must, however, be supported by restrictive monetary and fiscal policies and appropriate structural policies. In assessing the mix of exchange rate and other adjustment policies, the Fund needs to take into account the specific economic and institutional environment of the member country—including the exchange regime preferred by the authorities—while safeguarding its wider responsibility to oversee the stability of the global monetary system. Where countries are members of currency unions, which preclude exchange rate action and limit the scope of monetary policy (see box on CFA franc zone), the burden of adjustment in Fund-supported policy reforms must be borne by fiscal policy in conjunction with appropriate structural policies and wage restraint.
Evolution of the Monetary System
Some Directors saw the monetary system evolving in a “tri-polar” direction, based on the U. S. dollar, the yen, and the EMS. If the system were to evolve in such a tri-polar direction, the question would arise of how to limit more effectively serious misalignments or excess volatility among the major currencies. Should the exchange rates of the largest industrial countries—or across the three poles of the system—be subject to “loose and quiet” guidelines, or should they be guided by publicly announced targets or narrow ranges? Although the issue remains open, the Board reaffirmed that policy coordination among the industrial countries plays an important role in promoting greater exchange market stability and sustaining noninflationary expansion in the industrial world.
Box 5.CFA Fraric Zone
The CFA zone is a currency union comprising 13 countries divided into two regional groupings—the West African Monetary Union (WAMU) and the Central African Monetary Area (CAMA).1 Each region has its own central bank—the Banque Cen-trale des Etats de l’Afrique de 1’Ouest, which serves the WAMU, and the Banque des Etats de l’Afrique Centrale, which serves the CAMA.
The CFA monetary arrangement consists of a common currency area with a fixed exchange rate. The two regions share an external monetary standard, the CFA franc, which is pegged to and freely convertible with the French franc at a rate that has remained unchanged since 1948: CFAF 50 = F 1. The French Government stands ready to support the convertibility of the CFA franc with overdraft facilities made available through the two operations accounts maintained with the French Treasury by each of the CFA zone’s two central banks.
The fixed exchange rate requires that official reserves be maintained at a level sufficient to finance balance of payments deficits and that the domestic inflation rate be aligned with the external monetary standard—that is, the French franc. Maintaining a fixed peg to a common external anchor, which requires adhering to a consistent set of macroeconomic policies, enhances the credibility of the zone’s policymakers; remaining linked to a currency center, such as France, that has achieved financial stability assures the importation of that center’s low inflation rates.
In the WAMU, the central bank is charged with the overall management of monetary and credit policy, within guidelines formulated by the Union’s Council of Ministers. In the CAMA, monetary policy is determined by the central bank, while a Ministerial Council deals with monetary cooperation among the member countries. Monetary policy in the individual countries of the two zones is conducted by the national agencies, within the framework established by the two central banks. These countries, most of which are small developing economies, view the cost of giving up this autonomy as outweighed by the benefits of credibility, discipline, and price stability afforded by the attachment to a common external anchor. Monetary policy is conducted according to a set of rules that include specific objectives for the net foreign asset position of the central banks. In particular, the access of governments to monetary financing of their budget deficits is limited. The rules, which have generally been respected, have been successful in safeguarding the external position of the central banks, but less so in regulating internal imbalances, particularly since the limits on bank borrowing do not extend to foreign borrowing.
At an informal Board discussion reviewing the CFA franc arrangement, held in November 1990, Directors noted that despite the different economic structures of the countries in the CFA zone and their unequal ability to weather external shocks, the CFA monetary arrangement had worked well over a long period in maintaining low rates of inflation, owing partly to political solidarity among the members. The common priority for maintaining low rates of inflation and the discipline displayed in the conduct of common monetary and exchange rate policy had not been emulated, however, in the conduct of other macroeconomic policies. As a result, zone members were experiencing problems, including large fiscal imbalances, a large volume of domestic and external arrears, a weakening of their financial systems, erosion of revenue bases, and structural constraints. These disruptions had coincided with a substantial downturn in the terms of trade and a loss of price competitiveness.
Although some Directors questioned whether it was practical to secure the necessary extent of adjustment using domestic policies alone, the Board recognized the commitment of the zone members to the CFA arrangement. Directors therefore concluded that there was an urgent need for strong fiscal policies, structural reforms, and containment of costs; this need was underscored by the fixity of the exchange rates.1 The seven member countries of the WAMU are Benin, Burkina Faso, Côte d’lvoire, Mali, Niger, Senegal, and Togo; the six member countries of the CAMA are Cameroon, the Central African Republic, Chad, the Congo, Equatorial Guinea, and Gabon.
Current Account Imbalances
Directors, at their June 1990 seminar on the international monetary system, discussed the current account imbalances among the major industrial countries and how to distinguish “good” from “bad” imbalances to guide Fund advice in this area. The view was expressed that such a judgment depended on the appropriateness of the fiscal position; whether the increased investment associated with the imbalance could provide a rate of return that exceeded the cost of borrowing; and whether any increased consumption associated with the imbalance could be seen as temporary or desirable. The Board concluded that in prescribing policy action to correct an undesirable external imbalance, one had to look at the source of the imbalance. Several on the Board thought it irrelevant to distinguish between good and bad imbalances, as the multilateral nature of the external adjustment process would inevitably involve adjustment of both types. A number of Directors stressed that current account imbalances could not be assessed without looking at global saving and investment needs. They pointed to a global shortage of savings and said that policies aimed at reducing external imbalances should take into account the need for higher savings. Others, while not challenging the need for increased global savings, argued that there was no less compelling a need to ensure that the process of adjusting external imbalances did not have a global contractionary bias.
Global Liquidity Management
Several Directors believed that an improved functioning of the monetary system required a better mechanism for creating and distributing international liquidity. Although some saw no need to enhance the role of the SDR in managing global liquidity, a few felt that the SDR could and should play a larger role in the system. Several thought that this could best be achieved by increasing the attractiveness of the existing stock of SDRs.
At its February 1991 discussion of international capital markets, the Board reaffirmed the overriding importance of sound macroeconomic policies in promoting financial market stability and confidence. This was especially noteworthy in light of recent shifts in the pattern of international capital flows, political and economic shocks to the markets, and longer-term changes in the structure of major financial systems. Capital market conditions had changed markedly over the course of 1990, the Board noted, from a situation of buoyant activity in a relatively stable macroeconomic setting to unsettled market conditions. Despite these difficult circumstances, the financial markets had once again demonstrated their resilience. Indeed, despite a heightening of risks for the major economies and a sharp rise in uncertainty wrought by the outbreak of the Middle East crisis, the markets experienced no significant disruption.
The economic slowdown in a number of countries raised concerns about the deteriorating quality of some bank loan portfolios and the potential fragility of financial institutions and markets in some important financial systems. A deep and prolonged slowdown would accentuate such concerns and limit maneuvering room for policymakers. In discussing the strains on the U.S. financial system, the Board welcomed the U.S. Treasury’s proposals to provide for a safer and sounder banking system. There were concerns about financial fragility in other countries; qualifying these concerns, however, was the fact that many major banks were better capitalized, were engaging in more careful risk-based pricing, and had often restructured in order to improve management of costs.
The major industrial countries responded appropriately to the market strains, in the Board’s view, by enhancing their supervision and regulation; movement toward financial liberalization and deregulation, Directors felt, had to be accompanied by stronger supervision. In this connection, the Board cited the increased integration of capital markets and commended efforts—by the Basle Committee and other forums—to foster international harmonization and cooperation in the supervisory area. A number expressed the view that financial conglomerates should be supervised more effectively. Still, the Board recognized the limitations of regulation and the need to limit the moral hazard risks associated with comprehensive financial safety nets.
The Board discussed the prospect of a global scarcity of capital created by the low level of world savings. Some Board members believed that such concerns were exaggerated, particularly in view of the slowdown in some major economies, but others cited the potential demand for savings by developing countries and the need to finance postwar reconstruction in the Middle East. Directors agreed, however, on the urgent need to raise world savings, both by steps to encourage—or, in some cases, remove disincentives to—greater private saving and through fiscal restraint. A relaxation of capital adequacy standards in response to concerns about a so-called credit crunch would be inappropriate, in the Board’s view. At the same time, banks’ efforts to curtail the growth of their assets should not be pushed to the point of underfinancing otherwise creditworthy undertakings. A careful balance had to be struck in pursuing sound lending standards.
Developing countries continued to face limited access to spontaneous bank credit in 1989-90, with few exceptions. At the same time, some countries with debt-servicing problems managed to restore gradually access to spontaneous capital flows, although the amounts were modest and the number of countries limited. Recent developments, Directors noted, confirmed that if developing countries wished to regain access to capital markets, they would have to implement and sustain appropriate macroeconomic and structural policies—including capital market liberalization. The tougher global competition for investment capital together with the “flight to quality” by investors underscored the central importance of sound economic policies in maintaining or restoring creditworthiness. Such policies, the Board emphasized, help reverse negative investor sentiment and foster capital inflows, including the repatriation of flight capital.
Box 6.Tax Policy Issues
The closer integration of the global economy and of capital markets has increased the potential for the domestic tax systems of individual countries to have global effects, particularly with respect to capital flows. In light of this, the Board discussed, in July 1990, ways of containing potentially harmful cross-border effects of national tax systems.
Directors concluded that some coordination of national tax systems was desirable to promote widely accepted tax principles, so as not to hamper, or unduly influence, international commodity and factor flows. Although many member countries had negotiated bilateral or regional treaties to reduce barriers to commodity and factor flows, these could not be seen as steps toward an eventual multilateral treaty. Tax harmonization or market integration within the European Community did not appear to pose significant risks for non-EC economies. Indeed, several Directors were confident that the trade-creating effects of the EC initiatives would outweigh their trade-diverting effects. With respect to Fund surveillance over tax policies, Directors favored no new institutional arrangements. Rather, they recommended that the Fund strengthen fiscal surveillance through its operations, and especially in Article IV consultations.
Directors noted that new borrowings by developing countries could be promoted by certain financing techniques, although some of these had limitations of their own. Several Directors cautioned, for example, against widespread use of collateralization beyond a transitional phase during which it could help re-establish access to markets. While clearly less important than the quality of policies in debtor countries themselves, banking regulations in creditor countries might help debtors regain market access. At the same time, Directors stressed the importance of increasing direct investment and other non-debt-creating flows to the developing countries.
Causes and Consequences of Capital Flows
The Board, in July 1990, discussed the causes and consequences of international capital flows. Two broad themes emerged during the meeting: that the globalization, innovation, and integration of major financial markets was an important structural feature of the evolving world economy, which had to be reflected in Fund surveillance; and that countries should pursue sound and stable macroeconomic policies to maximize the benefits of greater capital market integration. In view of the enhanced role of capital flows in the global economy, Directors agreed, improved data were needed on the scale, direction, and composition of these flows; the Fund would also continue to monitor closely capital market institutional developments, including those of a regulatory nature.
During the 1970s and 1980s, capital flows among the industrial countries expanded sharply, with foreign investors and foreign financial institutions increasing their participation in the major domestic financial markets. This growing integration of major domestic and offshore financial markets has produced significant efficiency gains. Integration of financial markets appeared to be proceeding far more rapidly than that of the goods markets, and, several Directors noted, trade liberalization was also lagging.
With respect to potential global demands on capital, several Directors cited the large increases in financial needs associated with major economic restructuring efforts in a number of countries, including those in Eastern Europe. Others highlighted the importance of private capital flows in financing the large current account and fiscal imbalances of the industrial countries. The predominance of official capital flows in financing the current account deficits of many indebted developing countries during the 1980s was noted by some on the Board. While those developing countries that had consistently pursued prudent macroeconomic and debt management policies had maintained access to international financial markets, other indebted countries continued to encounter problems in accessing private capital flows. Although the restoration of creditworthiness would take time, in the view of some Board members, the sustained implementation of sound macroeconomic policies and structural reforms in borrowing countries was clearly a prerequisite.
Many Directors saw the process of deregulation, globalization, and innovation in major financial markets as a two-edged sword. While these developments had yielded important efficiency gains, they may also have complicated the conduct of monetary and fiscal policy and created new systemic risks associated with volatile asset prices. Most Directors felt that financial innovation and liberalization had generally weakened the predictability of the relationship among the authorities’ operating instruments, monetary aggregates, and nominal income. Monetary policy was seen as operating more through changes in interest rates and exchange rates than through liquidity or quantitative credit constraints. At the same time, the industrial countries’ experience in the 1980s suggested that monetary policy’s ability to promote stability had endured.
The Board discussed whether fiscal discipline had been weakened by the growing integration of financial markets. It agreed that growing financial market integration had increased the transmission of the effects of fiscal policy developments between countries. Consequently, the growing integration of capital markets had raised the incentives and pressures for greater coordination of macroeconomic policies. Indeed, given the speed with which major financial shocks could now spread across global markets, the Board believed that the case for coordinated responses to crises had been strengthened, particularly among central banks. Directors also supported the steps already taken to strengthen the ability of major financial institutions—and of payments, clearance, and settlement systems—to cope with the increased volatility of asset prices and to improve their crisis management. At the same time, many were concerned that such coordinated responses and efforts at crisis management might be used as a substitute for greater policy coordination. They also expressed concern that officially provided financial safety nets might encourage excessive risk taking by the private sector, thereby creating large public sector liabilities. Directors recognized that any strengthening of regulatory standards needed to be adopted broadly; that if any single country attempted to impose stiffer regulatory standards on its own, it risked losing business to countries with more lax standards. Appropriate regulatory standards, the Board concluded, did not constitute a reversal of financial liberalization, but rather a mechanism to ensure the smooth functioning of the markets through minimal regulation.
Box 7.Working Party on the Measurement of International Capital Flows
In December 1989, the Fund established a senior-level Working Party, under the chairmanship of Baron Jean Godeaux, to study the measurement of international capital flows and the phenomenon of an excess of measured capital inflows over outflows that results in a positive statistical discrepancy for the world as a whole. (An earlier working party, in 1987, studied the discrepancy in global current account statistics.) The Working Party was established in recognition of the growing need—for country, regional, and global analysis—of more accurate and timely data on capital flows and on holdings of foreign assets and liabilities. Its task is to formulate recommendations to reduce asymmetries in the components of the global capital accounts; it is therefore focusing on evaluating the main features of national statistical practices that contribute to these asymmetries. In cooperation with national balance of payments compilers, the Working Party is examining major types of capital flows: direct investment, portfolio investment, banking and other short-term capital movements, holdings of international reserves, and such other topics as illegal capital flows associated with the drug trade.
In January 1991, the Managing Director informed the Board of the work of the Working Party at its halfway point. He noted that:
considerable progress had already been made in identifying specific discrepancies for direct investment flows;
gaps in data on portfolio investment were more problematic, especially since market participants could operate globally using electronic facilities that may not be captured by the usual statistical reporting systems;
to improve data on international bank capital flows, efforts were being made to reconcile balance of payments data with other sources—including the Fund’s international banking statistics;
work had begun to reconcile data on international debtor and creditor positions with balance of payments figures;
the Working Party—together with the Fund’s Statistics Department—was seeking to improve data on capital transactions of international organizations; and
it appeared unlikely that capital flows associated with illegal activities could be identified separately from other flows, using the types of data available to compilers of banking and other international financial statistics; nonetheless, better geographic breakdowns could be attained in certain balance of payments figures, which might have limited use.
Three main objectives remain for the study team: to complete work on the main types of capital flows; to organize a comprehensive set of adjusted data for world capital accounts, incorporating as many adjustments as possible; and to recommend measures to be taken by national compilers, and by the Fund, to reduce world data discrepancies and promote greater uniformity in the procedures for producing statistics on world capital flows. The Working Party’s final report is expected at the end of 1991.
Private capital flows to developing countries in the 1970s were dominated by commercial bank lending, Directors noted, but securities flows—including the use of market-based hedging instruments and foreign direct investment—would be likely to play a relatively larger role in the 1990s. Foreign direct investment and portfolio investment in equities were regarded as equally, if not more, important potential sources of external financing. The sharp rise in external assets held by residents of many developing countries in the 1970s and 1980s, in the Board’s view, reflected a desire to hold internationally diversified portfolios but was also a response to the perceived risks of holding domestic financial instruments. To repatriate flight capital, Directors reiterated the fundamental importance of sound macroeconomic policies, financial liberalization, and other structural reforms to create incentives for residents of developing countries to hold their savings in domestic financial markets. It was noted, however, that some capital controls might be needed in the early stages of developing domestic financial markets.
2. External Debt Situation and Strategy
In its reviews of the debt strategy during 1990/91, the Board reaffirmed the main elements of the strategy, in particular the value of the case-by-case approach and the importance of debtor countries adopting sound economic policies to promote normal creditor-debtor relations. The Board also stressed the important role official bilateral creditors have played by supporting debtors’ policy adjustment efforts through new financing, debt rescheduling, and debt forgiveness.
By the end of the financial year, the Fund had approved support for commercial bank debt-and debt-service-reduction operations in seven countries, four of which had successfully completed such operations with the aid of Fund financing, supplementing other official sources. Another five countries had reduced their stock of debt or had negotiated agreements with commercial banks.
When supported by sustained macroeconomic and structural reform policies, comprehensive bank financing packages have helped to improve economic performance and to ease the restoration of normal access to capital markets. However, important challenges remain. Many developing countries are still heavily burdened with debt. Solving these cases is likely to be difficult; much will depend on debtor countries adopting and carrying out strong economic policies. The Board urged that both debtors and banks intensify their efforts to lay the groundwork for the cooperative solution of debt-servicing problems.
The debt crisis, which broke out in the early 1980s, impaired many developing countries’ economic prospects and threatened the financial integrity of the international banking system. Recognizing these problems, the debt strategy sought to strike an appropriate balance between financing and adjustment. It involved a case-by-case approach and emphasized cooperative and voluntary market-based efforts on the part of creditors and debtors.
The strategy produced some positive results. Debtor countries received significant financial support through reschedulings and concerted new money packages, which helped them to implement adjustment programs. But by 1985, the adjustment process had become strained, with stagnant or declining per capita incomes in many heavily indebted countries, and increased difficulties in assembling concerted commercial bank financing packages.
In October 1985, the then U.S. Treasury Secretary, James A. Baker III, responded to these difficulties with a plan that emphasized three mutually supporting elements: the adoption by debtor countries of growth-oriented macroeconomic and structural reforms, increased structural adjustment lending by multilateral institutions, and additional net lending by commercial banks.
It became increasingly apparent, however, that many countries’ debt problems were deep-rooted and that their heavy debt-servicing obligations and growing stock of debt could discourage private sector investment and growth. Moreover, the mobilization of concerted new money packages from commercial bank creditors became more difficult, with a growing number of banks preferring to “exit” by selling their claims at a discount.
In March 1989, Mr. Baker’s successor as the U.S. Treasury Secretary, Nicholas Brady, launched an initiative that strengthened the debt strategy by increasing the possibility for voluntary, market-based debt-and debt-service-reduction operations. By reconciling banks’ diverse preferences with the need to support strong adjustment policies in debtor countries, such operations were seen as a way to help strengthen debtors’ external positions, ease constraints on investment and growth in their economies, and restore their access to private credit markets. The case-by-case approach was again a key element of this initiative. It was the only way to tailor options to individual countries’ circumstances, giving due consideration to differences between countries. Moreover, debt and debt-service reduction alone would not be enough. It would need to be supported by sound policies, especially policies to increase domestic savings, attract private capital flows and direct investment, reverse capital flight, and reduce domestic debt.
Role of the Fund
The Fund has played a pivotal role in the debt strategy all along, by providing both policy advice and financial support for policy adjustments. Such policy adjustments help mobilize financial support from other creditors. In May 1989, the Board took two decisive steps to implement the strengthened debt strategy: it approved Fund support for debt-reduction and debt-service-reduction, subject to certain criteria; and it modified the Fund’s policy on financing assurances from other creditors to enable the Fund to provide more timely support for strong programs. (The guidelines on Fund support for debt reduction and its policy on financing assurances are detailed in the 1989 Annual Report.)
By the end of April 1991, Fund financial support for debt-and debt-service-reduction operations had been approved for seven countries: Argentina, Costa Rica, Ecuador, Mexico, the Philippines, Uruguay, and Venezuela. The last four of these have successfully completed debt reduction operations aided by Fund resources. All these operations were cost effective in that the features of the debt exchanges were consistent with conditions in the secondary market at the time preliminary agreement was reached with banks. A number of other countries—including Chile, Jamaica, Morocco, Niger, and Nigeria—have either reduced their stock of debt or have negotiated agreements with commercial banks that provide scope for such reduction. Several others are at various stages of negotiations on bank debt restructuring packages.
The Board reviewed the debt situation and strategy in August 1990 and again in April 1991. Both times, it reaffirmed the main elements of the strategy—in particular, the case-by-case approach and the fundamental importance of sound economic policies in promoting normal creditor-debtor relations.
Directors noted that many heavily indebted countries have made progress in negotiating or implementing bank financing packages—although the negotiations have often been drawn out. When supported by sustained macroeconomic and structural reforms, these packages have helped to improve economic performance and prospects. They have also facilitated some debtors’ gradual restoration of access to spontaneous foreign financing, despite tight capital market conditions.
Important and tough challenges remain, however. Many countries’ unresolved bank debts pose serious difficulties. Some of these countries have large and growing arrears to banks. Even if they adopt and sustain strong adjustment policies—a critical requirement—they will need substantial financing to normalize their financial relations through comprehensive debt operations. Phased debt operations—depending on policy track records and the extent of financing available—might help in such cases.
The Board noted that sound economic and fiscal and monetary policies had helped countries that had not restructured their debts to retain spontaneous access to international capital markets.
Directors saw no need to modify substantially the guidelines on Fund support for debt operations, which, implemented in close collaboration with the World Bank, continue to be versatile enough. A number stressed, however, the need for flexible application of the guidelines so as to avoid unnecessary obstacles to future agreements.
During their April 1991 meetings, the Interim and Development Committees welcomed the progress under the strengthened debt strategy. At the same time, they noted that difficult cases remained, and urged all parties to speed up negotiations.
Official Bilateral Creditors
In contrast to commercial banks, official bilateral creditors have maintained their financial support in recent years for countries with debt-servicing difficulties. They have rescheduled such countries’ official bilateral debts, provided temporary cash-flow relief to reinforce adjustment efforts for certain categories of debtors, and extended assistance in other—often concessional—forms, including official development assistance (ODA) and support for export credits.
Especially since 1987, Paris Club creditors have taken a series of innovative steps in response to the chronic debt-servicing difficulties of rescheduling countries.
In mid-1987 they agreed to lengthen maturities of reschedulings for low-income countries’ debts from 10 years to 15-20 years.
In 1988, they introduced a menu of options for reschedulings for the poorest countries that included the cancellation of one third of consolidated debt-service payments, further extensions of maturities, and interest rate concessions. This menu—known as “Toronto Terms” because it was endorsed by creditor governments at the Toronto Summit of June 1988—has been applied in 27 rescheduling agreements for 20 countries for total debt-service payments of some $6 billion. About $0.6 billion in debt-service payments have been canceled.
In September 1990, they introduced new terms for certain lower-middle-income countries. These terms include the lengthening of maturities (from 10 years to 15-20 years) and provisions for voluntary, bilateral debt conversions (swaps), such as debt-for-equity, debt-for-nature, and debt-for-aid. Eligibility for these terms is determined case by case, taking into account countries’ per capita income levels, the share of official bilateral debt in their total external debt, and the severity of their indebtedness.
Box 8.Toronto Terms and After
In June 1988, the leaders of the Group of Seven major industrial countries participating in the fourteenth economic summit in Toronto endorsed a debt relief plan for the official bilateral debts of those low-income countries undertaking macro-economic and structural adjustment programs. The “Toronto menu,” which has become the accepted standard in the Paris Club for dealing with low-income countries’ debts, comprises three options: reducing debt service by one third, rescheduling at concessional interest rates, or rescheduling at longer maturities.
The options cover debt service falling due during a specified consolidation period.
In 1990, a number of creditor governments made proposals for debt relief measures involving deeper concessions than the Toronto Terms.
The United Kingdom proposed three major modifications in what have come to be known as the “Trinidad Terms.” First, the restructuring would apply to the total stock of debt (contracted before the Paris Club “cutoff” date) rather than to debt service falling due during the specified consolidation period. Second, two thirds of the debt would be forgiven and the remainder repaid over 25 years, including 5 years’ grace. Third, for countries with severe cash-flow problems, moratorium interest (interest on the debt rescheduled) could be capitalized for 5 years, and later payments could be graduated and linked to the country’s export capacity.
Belgium proposed creating a Trust Fund to hold all or part of industrial countries’ claims on countries eligible for the Toronto Terms. The Trust Fund could reduce these claims or convert them to local currency. Foreign exchange payments received would be made available for development.
The Netherlands proposed canceling all bilateral official debts of the poorest countries facing severe debt problems, conditional on their implementing sound macroeconomic policies.
Box 9.External Debt and Domestic Debt
Since the outbreak of the external debt crisis in 1982, domestic public debt has risen sharply in many developing countries. In the 15 developing countries with high levels of external debt (Argentina, Bolivia, Brazil, Chile, Colombia, Cote d’lvoire, Ecuador, Mexico, Morocco, Nigeria, Peru, Philippines, Uruguay, Venezuela, and Yugoslavia), the average proportion of domestic public debt to GDP rose from 10 percent in 1981-82 to 16 percent by 1987-88. External debt also grew rapidly, relative to GDP, over the same period (from 23 percent to 38 percent). Consequently, there was a sharp increase in total public debt, from 36 percent of GDP in 1981-82 to 52 percent of GDP in 1987-88.
The growth of domestic public debt has been of concern for two main reasons. First, it has led to a sharp increase in debt-service payments, which have, in turn, constrained public sector investment. Second, the growth of the domestic debt burden has been accompanied by a sharp rise in inflation and increasingly negative and volatile real interest rates, which also have impaired investment and growth.
Is there a relationship between the size of domestic debt and an external debt problem? One way of finding out is to look at the relationship between a government’s net worth (the difference between the present value of its assets and liabilities, or between its revenues and its obligations) and the secondary market discount on external debt. The government’s net worth, which is difficult to calculate precisely, provides some indication of a government’s ability to service its total debt, while the secondary market discount is a measure of a country’s ability—as perceived by the market—to service its external debt. If there is a relationship between domestic and external debt, one would expect that the higher the government’s net worth, the higher would be its perceived ability to service external debt, hence the lower would be the secondary market discount. To what extent does this hold in reality?
A staff study on domestic and external debt, which was the basis for a Board discussion on the issue in July 1990,1 showed that for 9 of the 15 countries for which the required data were available (Argentina, Brazil, Chile, Colombia, Ecuador, Mexico, Peru, the Philippines, and Venezuela), there was indeed a highly significant correlation between government net worth and the secondary market discount during 1987-88. Intuitively, this is what one might expect. After all, both domestic and external debt have an equal claim on government resources. Therefore, if an external debt problem exists, it is likely that, side by side, a domestic debt problem also exists.
It is notable, however, that the current ratio of total public debt to GDP of the 15 highly indebted countries is comparable to that of a number of industrial countries, some of whom have public-debt-to-GDP ratios of close to, or more than, 100 percent. Why are these countries not perceived by international financial markets to be facing the sort of debt crisis that besets the 15 large debtors?
There may be several explanations for this, including differences in the credibility of macroeconomic policies between developing countries and industrial countries and their differential access to capital markets. Another explanation may be that expected fiscal developments are more favorable in industrial countries with large domestic debts than in the 15 highly indebted countries. Many studies suggest that the industrial countries may have a substantially greater ability to raise revenues than developing countries, because of more efficient tax collection and certain structural factors. If this is so, it implies the need for developing countries—especially those with heavy external debts—to implement fiscal and structural reforms in the public sector. Such reforms, coupled with policies that make the market more optimistic about future fiscal performance, could significantly improve the creditworthiness of these countries’ public sectors and, with it, their external debt-servicing ability.1 The study was later published as Occasional Paper No. 80, entitled Domestic Public Debt of Externally Indebted Countries, by Pablo E. Guidotti and Manmohan S. Kumar.
Debt reschedulings—often on concessional terms—have also been provided by non-Paris Club creditors.
In the light of proposals for deeper concessions for low-income countries by a number of creditor governments, Paris Club creditors are considering other debt relief initiatives. Moreover, the Paris Club adopted agreements with respect to Poland and Egypt in April and May 1991, respectively, in which the stock of debt was restructured on concessional terms.
During the past two years, there has been a significant expansion in the forgiveness of ODA debt by official bilateral creditors. In 1989, Belgium, France, Germany, and the United States forgave about $6 billion in claims held on some low-income countries of sub-Saharan Africa. In 1990, France reduced interest rates for a number of middle-income African countries; Canada forgave ODA-related claims on many Caribbean countries; and the United States extended partial debt relief to countries in the Western Hemisphere. In addition, the United States canceled $6.6 billion of Egypt’s military debt, and a number of Gulf Cooperation Council members forgave $6.3 billion in claims on Egypt.
In its April 1991 review of the debt situation, the Board stressed the important role official bilateral creditors have played in the debt strategy by supporting debtors’ adjustment efforts through new financing, debt reschedulings, and ODA debt forgiveness. Still, despite the wide diversity in individual situations and financing needs, many countries with heavy official bilateral debts continued to face highly uncertain prospects for medium-term external viability and economic growth (see Chart 9).
Chart 9.Total Public Debt and External Public Debt2
1 The Group of Fifteen countries comprises Argentina, Bolivia, Brazil, Chile, Colombia, Cote d’lvoire, Ecuador, Mexico, Morocco, Nigeria, Peru, Philippines, Uruguay, Venezuela, and Yugoslavia.
The September 1990 adaptations of debt-restructuring terms for lower-middle-income countries were expected to improve the prospects for these countries. In this connection, Directors also noted the agreement on far-reaching debt relief for Poland, and several remarked on the innovative link to the Government’s adjustment program.
Directors welcomed further consideration of the recent proposals by a number of creditors for low-income countries (involving restructuring and debt forgiveness based on the stock of debt) and the continuing review of these issues in the Paris Club.
During its April 1991 meeting, the Interim Committee also welcomed the Paris Club’s review of proposals to adapt debt-restructuring and debt-reduction practices for the poorest countries to ensure appropriate support for Fund members adopting comprehensive economic reforms. The Development Committee encouraged Paris Club creditors to complete their review by mid-1991.
3. Fund Financial Support of Member Countries
The Fund moved swiftly to help its members cope with the impact of events in the Middle East. Soon after the crisis developed, the Fund acted to provide greater access to its resources under stand-by and extended arrangements, to augment and extend financing under enhanced structural adjustment facility (ESAF) arrangements, and to introduce a temporary oil import element into the compensatory and contingency financing facility (CCFF).
During 1990/91, the Fund committed SDR 5.6 billion under 20 new arrangements with member countries (stand-by and extended arrangements, and SAF and ESAF arrangements) and approved SDR 2.1 billion for 11 countries in CCFF financing. The level of this support increased sharply toward the end of the financial year. Although total commitments in 1990/91 were less than the SDR 11 billion committed in the previous year, they were still higher than in any other year since 1984/85. In all cases, the Fund’s financial support is a part of its broader assistance to its members, which includes both policy support and technical assistance. This financing helps member countries regain a viable balance of payments position combined with economic growth and exchange rate stability.
The Fund collaborates closely with the World Bank. Staff members of the two organizations work closely together in their relations with member countries, in their responses to the debt problems of developing countries, and in helping countries to meet overdue financial obligations. The Fund also cooperates with the World Bank in improving its assessment of the effects of economic reform on the poor.
In 1990/91, the Fund committed a total of SDR 5.6 billion in support of macroeconomic and structural policies in its member countries—a level below the SDR 11.3 billion committed in 1989/90, but well above that of any of the six earlier years. The Board approved 20 new arrangements during 1990/91, including 13 stand-by arrangements, totaling SDR 2.8 billion; 2 extended arrangements, totaling SDR 2.3 billion; and 2 arrangements under the structural adjustment facility (SAF) and 3 arrangements under the ESAF, totaling SDR 478.5 million. In addition, 11 countries made drawings under the compensatory and contingency financing facility (9 under the oil component), totaling SDR 2.1 billion.
Box 10.Fund 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 consist of the following:
Stand-by arrangements, which typically cover periods of one to two years, focus on appropriate macro-economic policies—such as exchange rate and interest rate policies—aimed at overcoming balance of payments difficulties. Performance criteria to assess policy implementation—such as budgetary and credit ceilings, appropriate exchange and interest rate policies, and avoidance of restrictions on current payments and transfers—are applied and purchases (or drawings) are made in installments. Repurchases (or repayments) are made in 3 years to 5 years, except for purchases made with resources borrowed by the Fund under the enlarged access policy.
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 program states the general objectives and policies for the three-year period and the policies and measures for the first year; policies for subsequent years are spelled out in annual reviews. Performance criteria are applied and repurchases are made in 4 years to 10 years, except for purchases made with resources borrowed under the enlarged access policy.
Enlarged access policy, which is used to increase the resources available under stand-by and extended arrangements for programs that need substantial Fund support. Access to the Fund’s general resources under the enlarged access policy have been 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, depending on the seriousness of a member’s balance of payments need and the strength of its adjustment effort. However, the Fund has temporarily (until the end of 1991) suspended the lower annual, three-year, and cumulative limits. The Fund borrowed to help finance purchases under this policy, and repurchases of purchases financed with borrowed resources are made in 3½ years to 7 years. In September 1990, the Board decided that once borrowed resources had been fully used, ordinary resources would be substituted to meet commitments of borrowed resources in financing purchases made under the enlarged access policy (see page 61).
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 (PFP). Within this framework, detailed yearly policy programs are formulated and are supported by SAF arrangements, under which annual loan disbursements are made. The programs include quarterly benchmarks to assess performance. The rate of interest on SAF loans is 0.5 percent, and repayments are made in 5½ years to 10 years.
Enhanced structural adjustment facility (ESAF) arrangements, whose objective, 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. In November 1990, the Board endorsed the possibility of a fourth annual ESAF arrangement, provided it is approved before the end of November 1992, and so long as resources are available.
The compensatory and contingency financing facility (CCFF), which serves two purposes. The compensatory element provides resources to members to cover export shortfalls and excesses in cereal import costs and in oil import costs that are temporary and arise from events beyond their control; the contingency element helps members with Fund arrangements to maintain the momentum of adjustment when faced with a broad range of unforeseen, adverse external shocks, such as declines in export prices or increases in import prices and fluctuations in interest rates. Repurchases are made in 3¼ years to 5 years. In November 1990, the Board agreed to introduce an oil import element in the CCFF temporarily (up to the end of 1991) to compensate members for sharp increases in import costs for crude petroleum, petroleum products, and natural gas (see page 52.)
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 3¼ years to 5 years or earlier. Currently, the BSFF may be used to finance eligible members’ contributions to the 1987 International Natural Rubber Agreement.
By the end of April 1991, 45 arrangements were in effect with 43 countries. Of these, 14 were stand-by arrangements, 5 extended arrangements, 12 SAF arrangements, and 14 ESAF arrangements. Among the countries that entered into arrangements with the Fund in 1990/91, 6 were in Africa (Burkina Faso, the Congo, Morocco, Mozambique, Nigeria, and Rwanda), 5 were in the Western Hemisphere (Costa Rica, El Salvador, Guyana, Honduras, and Uruguay), 5 were in Europe (Bulgaria, Czechoslovakia, Hungary, Poland, and Romania), and 3 were in Asia (Bangladesh, India, and the Philippines). For one country, Guyana, the Fund committed resources under both a standby arrangement and an ESAF arrangement.
A striking feature of Fund financial support during 1990/91 was its sharp increase toward the end of the period. There were two main reasons for this.
Commitments to five Eastern European countries (Bulgaria, Czechoslovakia, Hungary, Poland, and Romania) were made during the final four months of the financial year, accounting for SDR 3.6 billion—or almost two thirds—of the Fund’s total commitments during the year.
Drawings under the CCFF more than doubled, to SDR 2.1 billion, compared with SDR 0.8 billion in 1989/90. This surge largely reflected the addition of the oil element to the CCFF (see page 52). SDR 1.9 billion of the total purchased under the facility was drawn in the last four months of the financial year under the oil element—by Bulgaria, Costa Rica, Czechoslovakia, Hungary, India, Jamaica, the Philippines, Poland, and Romania. Commitments under the CCFF, which often overlapped with requests for Fund arrangements, significantly increased the effective rate of access to Fund resources.
A major challenge faced by the Fund in 1990/91 was to help its members cope with the financial impact of the Middle East crisis, which broke out in August 1990. The crisis heightened uncertainty in the world economy and intensified the problems of a number of developing countries that were already experiencing difficulties. Notably, many countries were hit by increases in oil prices, declines in earnings from merchandise exports, tourism, and workers’ remittances, and higher expenditures associated with resettling returning workers and integrating them into the domestic economy.
At its September 1990 meeting in Washington, the Interim Committee agreed that the Fund should respond rapidly to such difficulties by using and, as appropriate, adapting, its existing instruments, including access to stand-by and extended arrangements, the CCFF, and the ESAF. The Committee invited the Executive Board to work out these adaptations urgently, and to take account of current circumstances in tailoring members’ access to Fund resources, including ways to help members service new debt.
In early November 1990, the Board met to discuss the Fund’s response to the developments in the Middle East. It saw no need to create new Fund facilities, stressing that the adaptation of existing instruments would suffice to meet members’ adjustment and financing needs. In support of this view, Directors noted that the Fund’s liquidity position was projected to remain broadly satisfactory through the end of 1991—although there remained the need to bring into effect, as early as possible, the quota increase under the Ninth General Review. Moreover, the fact that there were many members with current Fund arrangements—contrary to the situation during previous oil price increases—meant that there already existed a framework into which stronger policies and other changes could be introduced.
The Board focused on adaptations with respect to three types of facilities—stand-by and extended arrangements, structural adjustment and enhanced structural adjustment facilities, and the CCFF.
With regard to stand-by and extended arrangements, the Board noted that in most cases in which a member’s economy had been hurt by developments in the Middle East, there was a wide margin under present access limits that would enable the Fund to provide additional resources quickly to support suitably strengthened macroeconomic policies; the average annual access under stand-by and extended arrangements then in effect was equivalent to 51 percent of quota, ranging from 15 percent to 101 percent. It would remain essential to address members’ changed circumstances case by case, and additional access would depend on the need for Fund resources and the adoption of stronger macroeconomic measures that enhanced the member’s capacity to repay the Fund.
Recognizing the importance of signaling to members the Fund’s readiness to be flexible and supportive, the Board agreed to suspend, through the end of 1991, the lower annual, triennial, and cumulative access limits under the enlarged access policy.6 Under the enlarged access policy, a member may now have annual access of up to 110 percent of quota under a stand-by or an extended arrangement, and cumulative access of 440 percent of quota, depending, among other things, on the strength of its adjustment program and its balance of payments need. These limits are not entitlements and can be exceeded under exceptional circumstances. Moreover, the rephasing of drawings under stand-by and extended arrangements was seen as a useful way to speed up the provision of Fund resources. Changed external conditions meant that existing arrangements might need to be augmented and perhaps extended in some cases, with any augmentation being accompanied by stronger macroeconomic policies under Fund-supported programs.
The Board also supported the re-phasing and augmentation of resources under ESAF arrangements, although here too decisions on individual access would depend on strengthened policies, the prospects for financing from other sources, and the member’s capacity to repay the Fund. The Board agreed that the total amount of an ESAF arrangement could, unlike in the past, be augmented on the occasion of a midyear review, depending on individual country circumstances. Through these provisions, early users of the ESAF—those who have been granted or are about to be granted the third year of arrangements—would have the same contingency protection as other users.
The Board also decided to allow the Fund to add a fourth year of ESAF support for eligible members, provided such support is approved before November 30, 1992 and so long as resources are available. The Board stressed that a fourth year ESAF arrangement—which should not be seen as an entitlement—would be appropriate for providing assistance to members whose past policy performance had been satisfactory and that had adopted strong measures in response to external developments.
Projections of potential demand for ESAF resources suggest that overall access could be prudently augmented and fourth-year ESAF arrangements accommodated within available ESAF Trust resources. Additional contributions to the ESAF Subsidy Account would be needed to ensure that the interest rate on all lending from the ESAF Trust remains at 0.5 percent a year for the entire period of the loans.
The Board also decided to make the compensatory and contingency financing facility more flexible. Given the importance of oil imports in developing countries’ balance of payments, the Board agreed to introduce an oil import element in the CCFF temporarily, up to the end of 1991. Oil imports, like cereal imports, would be an integral part of the compensatory component of the CCFF. (For a description of how the oil import element works, see the discussion of the CCFF, page 52.)
To safeguard Fund resources, the Board agreed that all drawings under the oil import element would require members to follow appropriate domestic energy policies in addition to the measures that typically accompany drawings under the CCFF.
The Board agreed that members should be encouraged to attach contingency mechanisms (mechanisms under the CCFF that guard against unexpected, adverse external shocks) to arrangements approved by the Fund. This could be done not only at the time of approval of the associated arrangement, but also at the time of the mid-term review of the arrangement, provided there were at least six months left before the arrangement expired.
In a further discussion on the Middle East crisis in April 1991, the Board called for an immediate, major reconstruction and recovery effort in the region, noting that the crisis had exacerbated the deep-seated problems that predated it. Directors favored the adoption of an outward-oriented reform strategy led by the private sector.
The Board agreed that the Fund could best serve Middle Eastern countries by continuing its traditional role—that is, by helping these countries formulate and implement comprehensive programs, especially in the macroeconomic area, and by endorsing programs that deserve broad international support. In addition, the Fund should strengthen its regional surveillance and provide technical assistance. As in other regions, its financial role would be largely catalytic.
Directors saw financial coordination as being important for the effective and efficient use of external resources in the reconstruction and development of the Middle East. At the beginning, country consortia could help organize assistance efforts quickly and flexibly, the workings of which could evolve and improve with time. For its part, the Fund could, as experience has shown, work with a variety of arrangements and mechanisms while preserving its independence and its evenhanded treatment of members.
Policies in Member Countries
An important part of the Fund’s mandate is to encourage and support comprehensive macroeconomic and structural adjustment programs in its member countries through a combination of policy advice, and technical and financial assistance. In each case, Fund support is tailored to the country’s unique circumstances. In FY 1990/91, the Fund provided financial assistance under new arrangements to 19 countries.
Box 11.The Fund’s Response to the Middle East Crisis
In responding to the crisis in the Middle East, the Board decided to adapt the Fund’s existing instruments, as follows:
Modify or rephase the amount of financing available to members, as appropriate, to take into account the effects of developments in the Middle East;
Suspend, until the end of 1991, the present lower annual, three-year, and cumulative borrowing limits under the enlarged access policy;
Allow the Fund to increase total ESAF (enhanced structural adjustment facility) financing for members at the time of mid-term reviews of such arrangements;
Permit the Fund to add a fourth year of ESAF support for countries that would complete their current ESAF arrangements before November 1992;
Introduce, until the end of 1991, an oil import element into the compensatory and contingency financing facility (CCFF) that compensates for the sharp, unexpected increase in oil and natural gas import costs;
Expand the coverage of compensatory financing under the CCFF to include losses resulting from shortfalls in receipts from pipelines, canals, shipping, transportation, construction, and insurance;
Attach an external contingency mechanism to Fund arrangements at the time of a review provided at least six months remain before the arrangement expires.
Bangladesh adopted a series of policies under a three-year ESAF arrangement (for SDR 258.8 million, approved on August 10, 1990), which built on a Fund-supported SAF arrangement that covered the period 1986/87-88/89. These policies aim to achieve an annual average growth rate of 4.7 percent, reduce inflation, strengthen the country’s external payments position, and fight poverty. The Government plans to cut the budget deficit, expand and rationalize the Annual Development Program, to ensure adequate funding for important projects, and make public enterprises more efficient. Financial and trade reforms and a carefully targeted strategy to alleviate poverty are also envisaged.
To stem the sharp deterioration of the economy that occurred in 1990 and to move toward a market-oriented system, the Government of Bulgaria has adopted a front-loaded, radical, and comprehensive economic program. The program, which is supported by the Fund through a stand-by arrangement (for SDR 279.0 million, approved on March 15, 1991) aims to correct the external imbalance; absorb the monetary overhang and cut the budget deficit; reform exchange rate, interest rate, and pricing policies; establish private ownership; and make the foreign trade system more competitive. Measures to protect vulnerable groups during the transition will also be introduced. In February 1991, Bulgaria purchased SDR 60.6 million under the oil element of the CCFF. A second purchase may be made when six months of data become available. Should Bulgaria’s balance of payments position worsen because of higher-than-anticipated oil and gas prices, an additional SDR 77.5 million will be made available under a contingency financing mechanism associated with the stand-by arrangement.
In Burkina Faso, the Government has adopted an economic strategy for 1991-93 (supported by the Fund under the SAF for SDR 22.1 million, approved on March 13, 1991) that aims to reduce financial imbalances and promote growth by increasing the role of the private sector while reducing and refocusing that of the state. This strategy relies on policies designed to enhance agricultural production and exports, boost private investment through more liberal trade, price, and labor-market policies, rehabilitate the banking system, strengthen public sector management, and improve the quality of human resources.
The Congo has faced economic and financial difficulties since the mid-1980s, owing mainly to a sharp decline in oil revenues, onerous external debt-service payments, and a limited diversification of the economy away from the oil sector. The country has implemented a number of measures supported by the Fund designed to correct domestic and external imbalances. The latest stand-by arrangement for the Congo (for SDR 28.0 million, approved on August 27, 1990) was in support of a program that focused on reducing the still large fiscal imbalance by increasing non-oil revenue and curbing noninterest current expenditure. In addition, development expenditure will be increased to diversify and strengthen the productive base of the economy and the banking system will be restructured.
The Government of Costa Rica has adopted a range of policies for 1991-92, supported by the Fund (under a stand-by arrangement for SDR 33.6 million, approved on April 8, 1991) geared to reducing inflation, strengthening the balance of payments, and setting the stage for sustained growth. The policies include financial tightening, an exchange rate policy designed to maintain international competitiveness, and structural reforms to improve economic efficiency. To help Costa Rica meet higher oil import costs and to cover a shortfall in export receipts in 1990, the Fund also approved a drawing of SDR 33.6 million under the CCFF. A further SDR 21 million may be made available under the contingency window of the same facility in the event of unanticipated negative external developments.
On January 1, 1991, the Government of the Czech and Slovak Federal Republic launched the crucial phase of its economic reform program aimed at a rapid transformation to a market economy. The main elements of the program, which the Fund is supporting with a stand-by arrangement (for SDR 619.5 million, approved on January 7, 1991), are the liberalization of the price, trade, and exchange systems; the maintenance of a fixed exchange rate to help anchor domestic prices; tight fiscal and monetary policies; an incomes policy; and rapid and extensive privatization. An additional SDR 147.5 million is available owing to an external contingency mechanism under the CCFF associated with the stand-by arrangement, and a further SDR 483.8 million will be available under the oil import element of the same facility, of which SDR 314.5 million has been purchased.
Economic performance in El Salvador during 1985-89 was set back by armed conflict, adverse external developments, and natural catastrophes. The Government’s economic strategy for 1990-91, supported by the Fund under a stand-by arrangement (for SDR 35.6 million, approved on August 27, 1990) aims at lowering inflation and strengthening the balance of payments, thus setting the stage for higher production and employment. The key to this strategy is the narrowing of the overall public sector deficit in line with available external financing, while allowing a reduction in the public sector’s net debt to domestic banks and the repayment of internal and external arrears.
The Government of Guyana has developed a set of economic policies for 1990-92 that the Fund is supporting through a stand-by arrangement (for SDR 49.5 million) and an ESAF arrangement (for SDR 81.5 million), both approved on July 13, 1990. The policies aim to lay the basis for sustained growth, higher employment, and lower inflation; to strengthen the external position; and to complete the normalization of financial relations with external creditors. The strategy envisions moving toward a more open, market-oriented economy and promoting export-led growth by raising output in the traditional sectors, while developing new lines of activity.
In Honduras, the Government is aiming to create the conditions to raise output growth to about 4 percent a year and reduce inflation to about 7-8 percent a year during 1991-95, while substantially strengthening the country’s external position. The policies envisaged for 1991 (supported by the Fund through a stand-by arrangement for SDR 30.5 million, approved on July 27, 1990) include a modification of the exchange system, measures to reduce the overall public sector deficit and to increase interest rate flexibility, and a tariff reform geared to reducing the anti-export bias of existing import protection measures. There is also provision for a social safety net.
The Government of Hungary’s medium-term economic strategy, which the Fund is supporting through a three-year extended arrangement (for SDR 1,114.0 million, approved on February 20, 1991) is designed to boost the country’s productive potential by accelerating the move to a market-based economy. Great emphasis is being placed on privatization, reducing the state’s role in the economy, and strengthening the workings of the free market through price, import, and exchange rate liberalization. Other measures include tight budgetary and monetary policies, a comprehensive banking reform, and an overhaul of the social security system. The extended arrangement is associated with a provision for a further SDR 299.5 million under a contingency financing mechanism. The Fund has also approved Hungary’s request for the use of resources totaling SDR 226.2 million under the CCFF to cover excessive oil import costs during the period November 1990-October 1991. A second tranche of SDR 121.8 million may become available upon review of six months of data.
The crisis in the Middle East has had severe and widespread effects on India’s economy. Revenue losses and expenditures related to the crisis have weakened the budgetary position, international reserves have fallen, and higher energy prices have slowed growth. On January 18, 1991, the Fund approved the use of resources totaling SDR 1,268.8 million for India, of which SDR 551.9 million is available under a first credit tranche stand-by arrangement for three months and SDR 716.9 million under the oil import element of the CCFF. The Government has announced it intends to reduce sharply the fiscal deficit and implement a wide range of policies to improve the Indian economy’s efficiency and competitiveness, including policies to strengthen the financial position and performance of public enterprises.
Although the economy of Morocco strengthened markedly from 1986 to 1988, higher public investment and adverse external developments led to higher-than-expected budget and current account deficits. The Government’s economic strategy for 1990, which was supported by the Fund through an eight-month stand-by arrangement (for SDR 100.0 million, approved on July 20, 1990), aims at substantially reducing macroeconomic imbalances, especially in the fiscal area. Other objectives include a new phase of public enterprise reform involving extensive privatization and financial reforms, and a further opening up of Morocco’s economy to the rest of the world.
The economic progress achieved during the last three years under a comprehensive economic rehabilitation program (supported by the Fund under a SAF arrangement) has encouraged the Government of Mozambique to formulate another program covering the period through 1992, which the Fund is supporting through an ESAF arrangement (for SDR 85.4 million, approved on June 1, 1990). This program aims at accelerating production and export growth through appropriate price incentives, adequate supplies of inputs and consumer goods to rural areas, easier access to imports, and a more flexible business environment. There will be an increased role for the private sector—including foreign investors—as well as greater autonomy for public enterprises.
Nigeria has made substantial economic progress since beginning its SAF arrangement approved by the Fund in 1986. Notably, it has lifted most price controls, abolished marketing boards, liberalized the trade and exchange system, strengthened the public sector, and tightened financial discipline. The Government plans to continue policies aimed at enhancing Nigeria’s medium-and long-term development prospects, and at dealing with its heavy debt-service burden. During 1990-91, the Fund is supporting these policies through a stand-by arrangement for SDR 319.0 million, approved on January 9, 1991.
Despite a strong recovery from the severe economic and financial crises of the mid-1980s, the Philippines economic performance faltered in late 1989 because of a series of adverse economic shocks and policy slippages. In response, the Government launched a new stabilization plan supported by the Fund under a stand-by arrangement (for SDR 264.2 million, approved on February 20, 1991), which aims to restore growth by reducing inflation, cutting back the balance of payments deficit, and increasing the level of international reserves. The Fund also agreed that 25 percent of each drawing under the stand-by arrangement be set aside to support debt-reduction operations. To help the country meet higher oil import costs and to cover an anticipated shortfall in export receipts, the Fund has provided an additional SDR 277.1 million under the CCFF, of which SDR 171.2 million was under the oil component. A further SDR 88.1 million may also be made available under the contingency window of the CCFF if there are unforeseen, adverse movements in certain export and import prices or in interest rates on foreign debt.
Poland’s economy has made important progress under the stabilization and reform program launched in 1990. The Government’s economic framework for 1991-93, which the Fund is supporting through an extended arrangement (for SDR 1,224.0 million, approved on April 18, 1991) has three aims: to bring down inflation to a single digit annual rate by 1993 (compared with about 250 percent during 1990), to accelerate the transformation to a market economy, and to eliminate the overhang of external debt. The Fund has accepted Poland’s request to set aside 25 percent of each disbursement under the arrangement for debt-reduction operations. The Fund has also approved a drawing of SDR 162.6 million under the CCFF to help Poland meet an expected increase in oil and gas import costs in the year to September 1991. An additional SDR 87.6 million would be made available later provided the relevant conditions have been met. A further SDR 442.0 million may be made available under the contingency window of the same facility should Poland’s external position come under pressure because of higher-than-expected oil and gas prices during 1991-93. The arrangement also provides for possible augmentation by up to 40 percent of Poland’s quota for interest support.
Romania’s Government, which is committed to a rapid shift toward a market-based economy, has drawn up an economic program for 1991 that aims to eliminate the substantial monetary overhang in the economy and correct relative price distortions while reducing inflation; to move to a viable balance of payments position and build up international reserves; and to arrest the fall in economic activity after the substantial declines experienced in 1989 and 1990. The Fund is supporting the program through a stand-by arrangement (for SDR 380.5 million, approved on April 11, 1991). Under a contingency financing mechanism associated with the arrangement, SDR 131.0 million may be made available if Romania’s balance of payments is affected by higher-than-projected oil and gas import costs. The Fund has also approved drawings under the CCFF totaling SDR 247.7 million to help Romania meet expected increases in the cost of oil and gas imports in the year ending June 1991.
Rwanda’s economy experienced a spate of economic difficulties in the 1980s, and its GDP growth rate declined in both 1989 and 1990. The Government has adopted a three-year economic and financial reform package, which the Fund is supporting through a SAF arrangement (for SDR 30.7 million, approved on April 24, 1991). The Government’s objectives are to restore growth, reduce inflation, and accelerate the return to a viable balance of payments position, through a wide range of macro-economic and structural policies.
The Government of Uruguay is seeking to strengthen the balance of payments, lower inflation, and implement structural changes designed to raise investment and growth. Its policies, which are supported by the Fund under a stand-by arrangement (for SDR 94.8 million, approved on December 12, 1990) are focused on improving public finances, tightening credit, linking public sector wage policy to the projected decline in inflation, and achieving market-determined interest rates. A flexible exchange rate policy will help maintain competitiveness. Also envisaged are banking and financial reforms, the reorganization of the social security system, and the deregulation and privatization of some public enterprises, including the elimination of several state monopolies. Provision is made for one quarter of access under the arrangement to be set aside to finance debt reduction.
Review of SAF and ESAF
Since the second half of the 1980s, the Fund has become increasingly active in its support of growth-oriented macroeconomic and structural reforms in low-income countries. It has provided this support mainly through two highly concessional facilities—the structural adjustment facility (SAF), established in 1986, and the enhanced structural adjustment facility (ESAF), established in 1987.
The Board reviewed the operations of the SAF and the ESAF—as well as the policy orientation and balance of payments assistance of aid agencies—in July 1990, in the light of the experience of 33 countries that had, by that time, used these facilities.
The Board agreed that while encouraging results had been achieved in promoting growth, progress toward balance of payments viability had been rather mixed. The design of structural policies had been particularly challenging; in many cases, the time needed for fundamental reforms was longer than expected because of weak administrative capacity.
The Board focused on four main areas: program design and monitoring; the design and use of policy framework papers, or PFPs (a PFP outlines the design of a structural adjustment program and is prepared in close collaboration with a member’s authorities and the staffs of the Fund and the World Bank); aid flows; and operational issues.
With regard to program design and monitoring, the Board found that ESAF-supported programs were generally more effective in strengthening countries’ external positions than SAF-supported programs. (Under the ESAF, countries can receive more assistance than under the SAF. Moreover, structural policies are typically stronger, reviews are conducted, and disbursements are semi-annual rather than annual.) Countries should therefore be further encouraged to adopt programs warranting ESAF support as early as possible. Directors agreed that program monitoring would best be provided through ESAF arrangements and with a careful tailoring of access to take account of the track record of policy implementation and the prospects for external viability.
Box 12.Access Under the SAF and the ESAF
Under SAF arrangements, qualified members may borrow up to the equivalent of 70 percent of quota in three annual installments, each disbursed at the beginning of the program year in support of a structural adjustment program for that year. SAF resources are lent at an annual interest rate of 0.5 percent; repayments begin five and a half years, and end ten years, after the loan disbursement date.
Under ESAF arrangements, the equivalent of up to 250 percent of quota over a three-year period can be made available, depending mainly 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 so far has ranged from 90 to 190 percent of quota, and has averaged 145 percent of quota. ESAF loan disbursements are made over a period of three years in six installments, two for each program year, with the first disbursement at the beginning of the program year and the second on approval of a program review. The maturity of ESAF loans is identical to that of SAF loans; the interest rate is also currently the same as that under the SAF (0.5 percent a year) although the rate is subject to review by the Board—in light of the availability of subsidy resources.
To improve the ability of the SAF and the ESAF to strengthen countries’ external positions, there should be more emphasis on macroeconomic policies that raise domestic savings. Especially important are measures to strengthen the fiscal position by tackling structural problems in the public sector at an early stage, positive real interest rates, and financial sector reforms to encourage private savings. Emphasis should also be placed—although with caution—on more rapid progress toward a realistic exchange rate, supported by appropriate domestic fiscal and monetary policies and by trade liberalization.
Structural measures should be concentrated in a few key areas that are critical for the effective functioning of macroeconomic policy instruments. Moreover, key indicators—such as the financial position of major public enterprises—should be used more systematically to track the progress of structural reforms.
Turning to program monitoring, the Board agreed that structural benchmarks (policy targets) and performance criteria should be kept to a minimum, with policy actions and timing being defined as concretely as possible. Prior policy actions would remain appropriate when they are essential to meet program goals or if there are policy slippages or unsatisfactory track records.
The Board affirmed that PFPs should continue to focus on major policy objectives, the measures needed to attain them, and financing requirements. PFPs’ coverage of poverty issues could be strengthened; they should identify measures that can help cushion the possible adverse impact of certain policies on vulnerable groups among the poor in ways consistent with the program’s macroeconomic framework.
Governments should be encouraged to be fully involved in preparing PFPs and to use them in their internal decision making. More should also be done to use PFPs in coordinating technical assistance from aid donors, the World Bank, and the Fund in their respective areas of expertise.
In the area of aid flows, although Directors were generally encouraged by the responsiveness of major aid agencies in providing balance of payments assistance tied to programs supported by the Fund and the World Bank, they were concerned about shortfalls in official balance of payments assistance in a number of cases. They called for efforts to make aid flows more predictable, including more systematic exchanges of information, better policy implementation, and standardized procurement and disbursement procedures.
To promote more exchange of information on country operations with multilateral agencies that are providing financial support for economic reforms, the Board agreed to allow access to a wider range of Fund country documents and for the number of organizations receiving these documents to be enlarged, provided the confidentiality of the documents would be properly safeguarded.
Directors agreed on the following operational modifications:
To extend the cutoff date for the approval of requests for new ESAF arrangements from November 30, 1990 to November 30, 1992, so that more eligible members with protracted balance of payments problems can qualify for the facility. The interest rate on ESAF Trust loans would remain at 0.5 percent, although it might be necessary to seek additional subsidy contributions.
To consider, during a midyear review, additional financing under the ESAF in case a member faces unexpected adverse external shocks. Any such financing would be within the total access committed for the three-year period of the arrangement—that is, the financing would involve a re-phasing of access over the three-year period, not its increase. Moreover, account would be taken of unexpected favorable external developments.
In November 1990, the Board agreed that the total amount of an ESAF arrangement could be augmented (see page 44).
The Board agreed that it would be prudent to maintain unchanged the list of members eligible for SAF/ESAF assistance, but to keep under review the question of the possible expansion of eligibility. As noted above (page 45), in November 1990, as part of its response to the Middle East crisis, the Board endorsed the possibility of a fourth annual ESAF arrangement, provided this was approved before the end of November 1992 and that sufficient resources were available.
Compensatory and Contingency Financing Facility
The compensatory and contingency financing facility (CCFF) continued to evolve during financial year 1991. In response to the Middle East crisis, in December 1990 the Fund adapted many of its policies. The adaptations included technical modifications to enhance the flexibility of the CCFF, as well as the introduction of a temporary oil import element into the CCFF. Thus, the purposes of this facility now are:
to compensate countries for shortfalls in export earnings and for sharp increases in the costs of cereal imports or (temporarily) oil imports; and
to protect members pursuing
Fund-supported economic policies from the effects of unexpected external disruptions.
Compensatory financing, first introduced in 1963, helps members experiencing—for reasons largely beyond their control—balance of payments problems owing to temporary declines in commodity export earnings below their medium-term trends. Compensatory financing is subject to members’ adequate cooperation with the Fund to find solutions to their payments difficulties. Initially, only merchandise exports were covered by compensatory financing, but the range of exports covered has expanded over the years. In 1979, the facility was broadened to include shortfalls in receipts from two categories of services: tourism and “worker remittances” (earnings of workers stationed overseas that are repatriated to the home country). In 1981, a new window was added to the facility to allow compensation for countries faced with an excessive rise in the cost of imports of cereal products.
On December 5, 1990, as part of its policy adaptations in light of the Middle East crisis, the Fund widened further the range of services eligible for compensatory financing to cover most services, including earnings from pipelines, canal transit fees, shipping, transportation, construction, and insurance. Here too, shortfalls in receipts must be temporary and largely beyond the control of the member country. The December 1990 adaptation also permits quicker access to compensatory credit—by permitting the member to use estimated, rather than actual, data to calculate the earnings’ shortfall for the full shortfall year (as opposed to a maximum of six months previously).
The CCFF’s new oil element compensates members for sharp rises in the cost of their imports of crude petroleum, petroleum products, and natural gas. The rise in oil import costs must also be temporary and beyond the member country’s control. And the member country would need to be pursuing, in addition to macroeconomic policies to deal with its balance of payments difficulties, appropriate domestic energy policies—including, when needed, prior energy policy actions (in particular, passing through to consumers the higher cost of oil imports). Access to drawings under the oil element would fall under the current overall access limits under the CCFF: 122 percent of a member’s quota. These include maximum access equivalent to 40 percent of quota under the contingency element; 57 percent of quota under the oil element; 40 percent under the export shortfalls element; 17 percent under the cereal element; plus an “optional” 25 percent of quota, which may be used to supplement any of the four elements of the CCFF. (Thus, access to oil element drawings can be up to 82 percent of quota, including the optional tranche.)
The oil element will remain in force until the end of the 1991 calendar year.
In August 1988, the Fund added a contingency financing element to the compensatory financing facility, creating in the process the CCFF. Contingency financing is provided to members pursuing economic policies supported by the Fund under stand-by or other arrangements; the Fund provides an advance assurance to the member of financial protection in the event of an unexpected, and potentially destabilizing, external economic shock. The contingency funds may be provided if certain key elements of the country’s balance of payments—such as export prices, import prices, interest rates, tourism receipts, or worker remittances—fall short of a predetermined benchmark level. The contingency money gives members greater confidence to adopt corrective policies, knowing that their reform efforts will be partly protected from external shocks that they cannot predict or control.
In response to the Middle East crisis, the Fund increased further the flexibility for obtaining contingency financing protection. A member with an arrangement from the Fund may apply for contingency protection at the time of a review under the existing arrangement if the arrangement has at least six months remaining; originally, contingency mechanisms could only be attached to an arrangement for a member at the time of its initial approval by the Fund.
Protecting the Poor During Reform
The Fund continued to improve its assessment of the effects of economic reform measures on poor groups. It expanded its advice on program design, including such elements as the mix and sequencing of reform policies, so as to develop ways to strengthen the beneficial effects of policy reforms for the poor, while mitigating any adverse effects.
In September 1990, the Development Committee considered a paper on strategies for effective poverty reduction in the 1990s, which was prepared jointly by the staffs of the Fund and the World Bank. The study stressed the importance of sustained economic growth for poverty reduction and of sound macroeconomic and structural policies to secure such growth. It underscored the twin importance of investment in human capital to enhance the contribution of the poor to economic growth and of social safety nets to protect the poor during reform. In considering these issues prior to the Development Committee meeting, the Board supported the Fund’s efforts to strengthen its information on and analysis of poverty issues, so as to incorporate poverty concerns into the design of policy adjustment programs. The Board also endorsed the staffs effort to disseminate the knowledge of relevant country experiences among member countries, in particular by using technical assistance to provide advice on the design and implementation of cost-effective social safety nets, as well as to catalyze external financial assistance.
The Fund has taken the following steps toward meeting these objectives:
In cooperation with the staff of the World Bank, the Fund staff discusses with member authorities during missions the implications of economic policies for poor groups, as well as the appropriate policy mix, which could include the use of social safety nets to protect the poor during policy reforms. The staff has also continued to cooperate with the donor community. The PFP process for SAF and ESAF arrangements, involving member governments, the Fund, and the World Bank, was a major instrument for this cooperation.
An informal seminar was held in October 1990 at the Fund for the representatives of a number of UN agencies on ways to expand cooperation on the social aspects of adjustment. The participants agreed that strengthened informal exchanges of views would enable the Fund staff to improve their understanding of social and other sectoral policy issues in member countries, while its UN counterparts would benefit from the Fund staff’s knowledge of the macroeconomic situation in these countries.
The staff also discussed poverty issues with the representatives of many nongovernmental organizations, including aid agencies, religious groups, and national and international federations of labor. These discussions enabled the staff to improve its understanding of the social situation in member countries and to explain the Fund’s role in the economic reform process.
In December 1990, an in-house seminar discussed staff experiences in assessing the effects of reform measures on poor groups and the design of social safety nets. The staff focused on the effects of changes in product and factor prices resulting from reform programs and ways to protect the poor.
In advising governments on program design, the staff explored ways to strengthen the beneficial effects of reform measures on poor groups. For example, increases in domestic producer prices of agricultural exports have helped small farmers. Many programs have included measures to protect or expand existing social services or to target them more effectively.
In many countries—including Algeria, Bangladesh, the Islamic Republic of Iran, Jordan, Sierra Leone, South Africa, Sri Lanka, Trinidad and Tobago, and most Eastern European countries—the staff had extensive discussions with the authorities on the issue of protecting the poor during economic reform.
A common issue in policy measures designed to help the poor has been the reform of price distortions. Distorted prices, such as an overvalued exchange rate and too low domestic prices, can lead to an inefficient use of resources and to macroeconomic problems, such as fiscal imbalances. A realignment of administered prices or, more fundamentally, the introduction of an efficient pricing system, while they benefit many among the poor, can adversely affect the real income of some poor groups in the short run by, for example, raising the prices of food and other essential items consumed by the poor. To mitigate such effects, Fund-supported programs often maintain some subsidies on basic necessities. For example, Jamaica, Jordan, and Trinidad and Tobago kept some food subsidies, while El Salvador and Honduras retained subsidies on transportation and basic utilities.
Tax reform programs often incorporate specific measures to reduce their impact on poor groups. For example, Bangladesh increased excise rates on goods and services consumed mainly by more affluent groups, whereas Jordan implemented tariff reform, but exempted several essential commodities from import duties.
Special measures aimed at protecting poor groups have been set up in many countries. For example, Jordan introduced a temporary rationing scheme for sugar, rice, and powdered milk to ensure a subsistence level supply to the poor at subsidized prices, with any extra supply being at market prices. Mozambique introduced an income supplement and food provision scheme for low-income families in a large urban area and food aid to displaced families in rural areas.
Many countries have strengthened nutrition, health, and education programs, and some have established a special fund to this end. For example, Bangladesh, Burkina Faso, El Salvador, Honduras, Pakistan, and Uganda provided the poor with easier access to public health and education services. Bangladesh’s reform program included measures to increase food security, generate rural employment, and enhance farm incomes. El Salvador and Honduras set up a social investment fund to create employment opportunities for the poor and to reduce mortality, malnutrition, and illiteracy among women and children. Burkina Faso and Guyana also introduced targeted public works programs. Uruguay established a school-feeding program in poor areas and is proceeding with social security reform to protect the poor.
Box 13.The Fund and the Environment
Economic activities and the natural environment influence each other in diverse and complex ways, many of which have only recently begun to be systematically analyzed. Meanwhile, public concern about the environment and how it is affected by economic policies has mounted.
In early 1991, the Board informally considered the extent to which the Fund should address environmental issues. It concluded that the staff should be mindful of the interplay between economic policies, economic activity, and environmental change. This would help the Fund to avoid policies that could have undesirable environmental consequences, while ensuring that the thrust of its actions promote balance of payments viability and sustainable growth. The Board further agreed that this should be done in ways that are consistent with the Fund’s mandate, size, and structure.
To these ends, the Fund will devote modest additional resources to tapping the expertise of institutions with environmental competence and responsibilities, including the World Bank, the Organization for Economic Cooperation and Development, and the United Nations Environment Program, rather than undertake fundamental research in this area. Such expertise would help Fund missions to member countries to conduct more informed discussions with governments faced with macroeconomic policy choices that have major environmental implications—although there would be no environmental conditionality.
The Board stressed that the Fund’s work on environmental issues should be evenhanded and universal in scope, spanning countries in all regions and stages of development.
All of the reform programs in Eastern European countries have unavoidably resulted in changes in relative prices and higher unemployment. Unlike many other reforming countries, they already had an extensive social security system. An important change was, however, the introduction of unemployment benefits, which did not exist before. To mitigate the effect of price increases on the poor, the Eastern European countries also redesigned the existing direct income transfers, such as family allowances and child benefits, sickness benefits, maternity allowances, and pension systems.
Technical Assistance and Training
With the rise in the volume and extent of Fund operations in recent years, demand for the institution’s technical assistance services has increased steadily. Requests for assistance come from a wide spectrum of members, including many from countries in the process of moving toward a market-based economy. These include members in Eastern Europe, as well as other countries transforming previously nonmarket economies, specifically Algeria, Angola, Benin, Cape Verde, Lao People’s Democratic Republic, Mozambique, and Viet Nam. Such countries require help in setting up a network of banks (including a central bank) and a regulatory framework. In addition, substantial assistance has been provided in the fiscal area—in areas such as the introduction of appropriate tax policies, improvement in tax administration and budgetary practices, and development of cost-efficient social security schemes—and in developing statistical data bases.
Countries call on technical assistance from the Fund to help them reform thoroughly the structure of their economic and financial institutions as the necessary prelude for restoring economic growth. Generally, structural adjustment policies entail more complex adjustments than the more traditional balance of payments financing, and may demand a level of expertise and experience that is often lacking in developing countries. For this reason, the Fund is providing a greater amount of short-term technical assistance to help members carry out such structural and institutional reforms, with fewer experts than in the past being stationed in countries for long periods. The coordination of technical assistance efforts has also increased, both between various departments within the Fund and between the Fund and other agencies, such as the World Bank and the United Nations Development Program (UNDP).
The Fund’s technical assistance is given at the request of countries through advisory visits, formal training, and advice extended in the course of other staff contacts with member authorities. In addition, program negotiations, Article IV consultations, and various Board discussions often have an important technical advisory component. Assistance focuses largely on ways to improve macroeconomic management, in particular through training economic policy officials, improving economic statistical information, helping to reform the tax system and tax administration, and helping to improve the functioning of the central bank and the financial system.
While the Fund’s own resources devoted to technical assistance have expanded in recent years, two other developments have permitted the Fund to extend its efforts further by increasing available resources devoted to assistance.
In 1989 an agreement was reached under which the Fund serves as an executing agency for UNDP assistance. As of April 30, 1991, UNDP-funded projects in 24 countries and 1 region totaling $14 million had been approved; projects in 5 of these countries and the single regional project had been completed as of the end of the financial year. Projects in a further 7 countries were under negotiation. This agreement enables the Fund to take a more systematic and longer-term approach toward meeting countries’ technical assistance needs and to develop skills in member countries through training programs.
In March 1990 a special administered technical assistance account funded by Japan was established to finance technical assistance designed to help members tackle debt-related issues. Resources of the account are used to help Fund members strengthen their administrative capacity and their capacity to formulate, implement, and maintain macroeconomic and structural programs to resolve or to avoid debt problems. Disbursements can also be made from the account to the Fund’s General Resources Account to reimburse the Fund for expenses incurred in technical assistance projects.
Training of officials from Fund member countries is provided by the IMF Institute, both at headquarters and overseas, and by other departments, including the Central Banking, Fiscal Affairs, Legal, and Statistics Departments, and the Bureau of Computing Services.
In its courses, the IMF Institute emphasizes the techniques and policy issues that arise in the formulation and implementation of policy adjustments in member countries. Participants in the courses are the government officials most involved in macroeconomic policy and analysis in a country—generally from central banks or ministries of the economy, finance, and planning. Such officials are usually those who have frequent contacts with Fund missions. During 1990/91, the IMF Institute gave 13 courses and 3 seminars at Fund headquarters; the latter included a seminar on centrally planned economies in transition. In order to address the needs of a growing number of government officials, 18 seminars were conducted overseas by the IMF Institute during 1990/91. For these seminars, the Institute’s training material is adapted to make it relevant to the country or region in which the seminar is held. While most of these seminars were held in developing countries outside Europe, 5 took place in Eastern European countries and emphasized techniques of macro-economic management in market economies.
During the financial year, the Central Banking Department expanded its technical assistance to Poland and initiated similar programs with the State Bank of Czechoslovakia, the National Bank of Romania, and the National Bank of Bulgaria. In each of these programs the department, in cooperation with from five to seven central banks, has formed a team of consultants to provide a broad program of technical assistance to modernize central banking. The areas of focus include banking supervision, economic and monetary research, foreign exchange market developments, domestic money market development, monetary policy operations, central bank accounting and internal audit, the role of the central bank in payments and settlement operations, and the organizational structure of a central bank. Altogether, 14 central banks have collaborated in these programs, making available 38 of their staff who have worked in the modernization efforts in Eastern Europe. The cooperating central banks have contributed through extending bilateral training and providing extensive support for these programs. In addition, a senior policy advisor, generally a recently retired Governor or Deputy Governor from a European central bank, was provided to each country under arrangements enabling monthly visits for consultations with senior central bank authorities. These programs are being continued in 1991/92.
The Fiscal Affairs Department has steadily increased its technical assistance work in recent years. An important element in this expansion has been the increased involvement in the structural adjustment area; all the low-income members with SAF and ESAF arrangements with the Fund have received technical assistance in the fiscal area. The department also enlarged its activity in Eastern Europe; at least two missions, dealing with particular issues of tax policy and administration, were extended to each of the member countries in the region. In Poland, for example, the Fund is providing extensive technical assistance to the authorities in introducing a VAT system and a broad-based personal income tax, as well as advice on budgetary controls and tax administration.
The Statistics Department (formerly Bureau of Statistics) has also revised its program of technical assistance, which is designed to help countries develop a current data base of economic statistics to enhance economic analysis, improve policy formulation, and enable a country to conduct international comparisons of data. As the economic problems facing countries have expanded in scale and complexity and new mechanisms have been developed to address these, such as SAF and ESAF arrangements, there has been a greater demand for full and accurate data. The Statistics Department is ideally placed to address this need. It has expanded its response by sending teams to member countries to review a number of problems simultaneously and by offering longer-term statistical assistance, often through stationing a resident statistical advisor in a country. (Further information on the Fund’s technical assistance activities during 1990/91 is included in Appendix III.)
The Fund and the World Bank have complementary roles in promoting sustained economic growth, stability, and development in their member countries. The staffs of the two institutions collaborate closely to help members move most effectively toward these objectives. Guidelines for cooperation between the Fund and the Bank, first formalized in 1986, have been periodically reviewed. In March 1989, the two managements clarified the primary responsibility of each institution and agreed to avoid duplication of work by putting in place additional administrative procedures for collaboration and more efficient use of staff resources. In August 1990, the Executive Boards of the Fund and the Bank each reviewed progress in this collaboration.
At its August review, the Fund Board agreed that the Fund’s primary responsibility is in the area of macro-economic policies and the related policy instruments and institutions, whereas the Bank’s primary responsibility lies in structural reforms and policies for effectively allocating resources to both the public and private sectors. The two Boards urged the staff of each institution to focus its efforts on the areas of its primary responsibility and expertise. The procedures formalized in the 1989 agreement had helped to ensure a close working relationship between the two staffs through systematic and frequent meetings of senior staffs and managements. At the operational level, there had been close contact in the field as well as at headquarters through increased use of joint or parallel missions, cross-participation in missions, timely exchange of documents, and cooperation in technical assistance. Collaboration had become more transparent and systematic for the staff, the Board, and member countries. The Board recognized that, despite differences in approach, conflicting policy advice to country authorities had generally been avoided, as had delays in providing financial assistance. Financial support extended to member countries by the Fund and the Bank had been further coordinated and the two institutions had increasingly cooperated in their relations with individual countries.
Recently, the Fund and the Bank have collaborated in providing financial and technical support to Eastern European countries that are making the transition to market economies. They also coordinated their responses to the Middle East crisis and their support to the region in the aftermath of the war. Through their collaboration the Fund and the Bank have helped countries to meet overdue financial obligations. The two staffs have worked together to assist countries to remain current in their obligations and to eliminate existing arrears. Since the strengthened cooperative strategy was introduced in early 1990, clearance of arrears to the Fund and the Bank has been achieved in two cases, and progress is being made in rights accumulation and Fund-monitored programs (see page 67).
The two staffs have continued to consult on the debt strategy and have coordinated their support of debt-and debt-service-reduction packages implemented under members’ policy adjustment efforts. Furthermore, the two institutions are careful to be consistent in introducing procedures to support debt-and debt-service-reduction operations, designing, for example, steps to govern the disposition of augmentation resources released early to member countries (see section on the external debt situation above).
The PFP process for SAF-eligible and ESAF-eligible countries is continuously enhanced by promoting a more central role for the recipient countries and a greater, though informal, involvement of donors, as well as through closer collaboration between the two staffs. This process has become an increasingly effective instrument for designing medium-term policy measures to address the social aspects of SAF-and ESAF-supported programs, in which the Fund staff relies heavily on the advice of its Bank counterpart. At the August 1990 review of progress in Fund-Bank collaboration, a few members of each of the two Boards evidenced some support for developing PFP-like documents for middle-income countries, in particular centrally planned economies in transition or countries undergoing major macroeconomic and structural transformation. Subsequently, PFP-like documents have been prepared for Hungary and Poland.
4. Trade Policy Issues
In 1990/91, discussions in the Uruguay Round of multilateral trade negotiations continued but failed to conclude on schedule in December 1990. There was encouraging progress, however, toward greater trade liberalization in Eastern Europe and in other developed and developing countries and in the decision of a growing number of countries to participate in the multilateral trading system. These developments were a welcome reflection of the increasingly widespread view that a competitive external and internal environment stimulates growth. Such growth must be accompanied by a stable and predictable global trading environment; for this reason, a successful, broad-based conclusion of the Uruguay Round is essential. The Fund cooperates with the General Agreement on Tariffs and Trade (GATT) to promote a strengthened, open trade environment. Also, in its surveillance work and its support for members’ policies, it stresses that trade liberalization is an important element of economic reform.
The accelerating trend toward market-oriented policies, which is often furthered by Fund support for members’ policy adjustment, needs to be sustained for these policies to succeed. An open and competitive external trading environment under clear and predictable rules is of prime importance in achieving these objectives. The Interim and Development Committees, at their September 1990 meetings, stressed the importance of an open trading system to the success of policy adjustments in developing countries, market-based reforms in Eastern European countries, and balanced growth in the industrial countries. They emphasized the need for a successful conclusion to the Uruguay Round and underscored the importance of a comprehensive agreement for the functioning of the multilateral trading system and the global economy. At its April 1991 meeting, the Interim Committee expressed concern over the delays in reaching agreement in the Uruguay Round, and urged all members to work with determination toward its prompt and successful conclusion.
Successful completion of the Round would provide a solid basis for sustainable higher rates of economic growth worldwide. It involves reaching agreement on a broad range of issues, including greater market access for goods and services, and specifying trading rules that both make such access assured and predictable and provide for effective dispute settlement. With a positive outcome, there would be greater assurance that the recent trend toward regional associations would be complementary to an open and multilateral trading system and that they, consequently, would support balanced growth worldwide. A renewed and strengthened commitment to the principles underlying the GATT and their extension to new areas, including services—which are being negotiated separately—and trade-related measures affecting intellectual property and investment, would support further progress in structural reform, help resolve debt problems in developing countries, and facilitate the transition of the Eastern European and other economies to market-based systems.
Whereas the potential benefits to balanced economic growth of successfully concluding the Round are clear, the costs of failure would be equally significant. Without a strengthened multilateral framework that provides basically uniform rules for trade between countries with diverse interests and production potentials, the trend toward greater reliance on market forces to guide the allocation of resources would be harder to sustain. Failure to reach a comprehensive agreement could result in defensive trade policies, intensify trade disputes, weaken support for trade liberalization, and erode the nondiscrimination principle of GATT through countries adopting bilateral solutions to trade problems or forming inward-looking trading blocks.
In 1990, growth in the volume of world trade slowed for the second year in a row, although it continued to outpace that of output as the global economy weakened. This slowdown risks intensifying defensive trade actions to preserve markets for domestic producers. Furthermore, in Eastern Europe, the drastic fall in intra-CMEA trade and, in particular, trade with the U.S.S.R., has created production and employment problems. Even so, there were notable positive developments in trade policy, particularly unilateral liberalization in Eastern Europe and in some developed and developing countries. In Eastern Europe, a new arrangement provides that, effective January 1991, all transactions are to be conducted at world market prices and in convertible currencies. Also, some members (most recently, Argentina and Peru) lifted import restrictions, taken for balance of payments reasons, as permitted under relevant GATT provisions. Moreover, a growing number of countries have become participants in the multilateral trading system. Between May 1990 and April 1991 membership in the GATT grew from 96 to 101; applications for membership of a further nine countries were pending as of April 1991; and the U.S.S.R. was granted observer status. It would be ironic if this progress toward greater competition and guidance by market signals were not supported by the steps needed to strengthen a market-oriented multilateral trading system.
The difficulties in removing market rigidities globally, particularly in agriculture, are reflected in the obstacles faced by the Round and were the reason why negotiators were unable to conclude it as scheduled in December 1990. Negotiations, then suspended, were resumed in February 1991 after an understanding was reached on agriculture to the effect that participants would negotiate specific commitments on domestic support, market access, and export subsidies. Success in the Round depends on commitments to substantial reforms in agriculture by the major trading countries. Furthermore, difficult issues still remain to be resolved in other areas, such as services, market access, and GATT rules on trade restrictions. Other areas of concern are the continued use of “gray area” selective measures outside GATT rules, particularly by the European Community and the United States; persistent bilateral trade tensions among the EC, Japan, and the United States; and recourse to antidumping and countervailing duty actions with protectionist effects. The trend toward regionalism could be a cause for worry. Regional liberalization can be beneficial if it takes into account the interests of nonmembers and runs in parallel with multilateral commitments; however, commitments to regional integration should be seen as a step toward, and not a substitute for, greater global integration.
The Fund has given trade issues greater weight in surveillance and in its support for members’ policies, stressing that trade liberalization is a key element of economic reform. Both in the world economic outlook exercise and in Article IV consultations, the Fund emphasizes the special responsibility of industrial countries to promote open trading; but all countries need to contribute to this environment as a necessary element of durable growth. Trade liberalization has been a critical element in many Fund-supported programs. Measures have included removing quantitative trade and exchange restrictions supported by an exchange rate adjustment, and rationalizing and reducing tariffs and other trade taxes. Also, the Fund’s periodic review of issues in the trading system complement the recently initiated GATT trade policy reviews of its signatories, thereby enhancing the transparency of the multilateral trading system and members’ policies. The GATT’s trade policy reviews provide valuable input into the Fund’s efforts in this respect.
The Fund cooperates with the GATT to promote a strengthened, open, multilateral trading environment. This cooperation is most evident in GATT consultations with members using trade measures for balance of payments reasons, where the Fund has a statutory role in assessing whether balance of payments conditions warrant temporary trade-restrictive measures. In addition, there are frequent meetings between Fund and GATT officials, including day-to-day contact through the Fund’s Office in Geneva, and a regular exchange of documents. Proposals were made in the Round for increasing cooperation between the GATT and the Fund(and the World Bank) in the context of the interdependence between trade and other elements of the global economic environment. Decisions on the nature of such cooperation have been postponed until the shape of the GATT, in the context of the results of the Round, becomes clearer.
5. The Fund’s Financial Operations and Policies
An increase in total Fund quotas from SDR 90.1 billion to SDR 135.2 billion—which would raise the size of the Fund by 50 percent—was authorized by the Board of Governors in June 1990. The increase will not come into effect before the Third Amendment of the Fund’s Articles, which would provide for the suspension of voting and related rights of members that do not fulfill their obligations. The rise in the number of countries seeking Fund support and in the demand for Fund resources underlines the need to bring into effect the quota increase under the Ninth General Review as soon as possible.
During 1990/91 use of the Fund’s resources increased. Purchases (drawings) from the General Resources Account rose substantially to SDR 6.2 billion, from SDR 4.4 billion in 1989 90; repurchases (repayments) decreased by SDR 0.6 billion to SDR 5.4 billion. Consequently, Fund credit outstanding in the General Resources Account rose for the first time since 1985 and stood at SDR 22.9 billion at the end of the financial year. At the same time, new commitments under stand-by and extended arrangements amounted to SDR 5.1 billion in 1990 91, less than half the exceptionally high level in the previous year. Holdings of adjusted and uncommitted usable resources fell to SDR 23.8 billion, and are projected to decline rapidly in association with increased financing demands, such as for Eastern Europe and because of the effects of the Middle East crisis. The total allocation of SDRs remained at SDR 21.4 billion in 1990 91.
Overdue financial obligations to the Fund rose modestly during 1990/91 to SDR 3.4 billion, the smallest increase since 1984/85. The number of members in arrears on obligations of six months or longer fell from eleven to nine. Two members cleared their overdue obligations in June 1990, while four others acted to stabilize the level of their arrears and have begun to implement comprehensive policy reforms.
Membership in the Fund increased by four countries to 155 during the financial year, and two other countries—Switzerland and Albania—applied for membership.
Ninth General Review of Quotas
An increase in the total of Fund quotas from SDR 90.1 billion to SDR 135.2 billion was authorized by the Board of Governors on June 28, 1990.7 Increases were proposed for all members except Cambodia, which did not participate in the Ninth General Review of Quotas.
The resolution of the Board of Governors specifies that no quota increase shall come into effect before the effective date of the Third Amendment of the Fund’s Articles. The proposed amendment would provide for suspension of voting and other related rights of members that do not fulfill their obligations under the Articles. Furthermore, under the Resolution, members have until December 31, 1991 to consent to their increases in quotas; this period may be extended by the Executive Board. Members with overdue obligations to the General Resources Account may not consent to the proposed increase until they become current in these obligations. Moreover, during the period up to December 30, 1991, no increase in quota may take effect until the Fund determines that members having not less than 85 percent of total quotas on May 30, 1990 have consented to the increases proposed for them in the Resolution. As of July 31, 1991, 62 members accounting for 47.2 percent of total quotas on that date had consented to their increases in quotas. After December 30, 1991, quota increases may take effect when the Fund determines that members having not less than 70 percent of total quotas on May 30, 1990 have consented to their proposed increases.
The Third Amendment becomes effective when three fifths of the Fund’s members, having 85 percent of the total voting power, have accepted the amendment. As of July 31, 1991, 37 members accounting for 30.6 percent of the total voting power had accepted the proposed amendment.
Fund Liquidity and Borrowing
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 the currencies 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, 1991, the Fund’s usable ordinary resources totaled SDR 40.1 billion, compared with SDR 41.2 billion a year earlier. This decline during the financial year was primarily due to an excess of purchases over repurchases (Chart 10), and also to the exclusion of one currency from the operational budget.
Chart 10.General Resources: Purchases and Repurchases, Financial Years Ended April 30,1980-91
1Purchases excluding reserve tranche.
In assessing 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 of currencies in the budget and the possibility that currencies of some members in weak external positions could become unusable. Undrawn balances of commitments of resources are also taken into account in assessing the Fund’s liquidity. As of April 30, 1991, the Fund’s adjusted and uncommitted usable resources totaled SDR 23.8 billion, compared with SDR 26.2 billion a year earlier.
The Fund’s liquid liabilities increased to SDR 26.2 billion at April 30, 1991, from SDR 24.8 billion at April 30, 1990. These liabilities comprised reserve tranche positions, which increased by SDR 0.6 billion to SDR 21.9 billion, and loan claims on the Fund, which rose to SDR 4.3 billion from SDR 3.5 billion a year earlier. The ratio of the Fund’s adjusted and uncommitted resources plus any balances held in the Borrowed Resources Suspense Account to its liquid liabilities—or the liquidity ratio—declined by 11.6 percentage points over the course of 1990/91 to 94 percent. The quota increase will contribute importantly to supporting the Fund’s liquidity in the period ahead, particularly if demands on the Fund’s resources continue at levels comparable with those experienced during the recent past.
The Fund borrows from official sources to supplement its resources and to finance members’ purchases (drawings) under the enlarged access policy established in 1981. As of April 30, 1991, all credit lines available to finance enlarged access had been fully utilized and SDR 0.8 billion of borrowed resources was held in the Borrowed Resources Suspense
Account pending use in purchases. The total of borrowed resources drawn during 1990/91 amounted to SDR 2.0 billion (including the SDR 0.8 billion invested in the Account), compared with SDR 1.0 billion during 1989/90. The Board decided on September 17, 1990 that once borrowed resources had been fully used, ordinary resources would be substituted to meet commitments of borrowed resources in financing purchases made under arrangements under the enlarged access policy. Ordinary resources substituted for borrowed resources will carry the same repayment terms as borrowed resources and the same charges as ordinary resources. The Board’s decision applies only to arrangements that have been approved not later than the date on which the increase in quotas under the Ninth General Review of Quotas becomes effective, or December 31,1991, whichever is earlier. It also provides for a review of this policy at the same time that the Executive Board reviews the decision on the enlarged access policy.
The Fund’s liquidity is affected primarily by the use of its resources through members’ purchases (drawings) and by members’ servicing of previous purchases. Total purchases from the General Resources Account, excluding reserve tranche purchases,8 increased substantially to SDR 6.2 billion in 1990/91 from SDR 4.4 billion the previous financial year. Disbursements under the CCFF accounted for a large portion of this increase.
Repurchases (repayments) in the General Resources Account, including those made ahead of schedule, amounted to SDR 5.4 billion, representing a decline of SDR 0.6 billion from the previous financial year.9
Repurchases, which reached a peak in 1987/88 following a large expansion of Fund credit in the early 1980s, are expected to continue downward in the near future, reflecting a decline in the use of Fund credit during the latter half of the 1980s and the revolving nature and medium-term maturity of the Fund’s balance of payments lending. Depending on the sources of the financing, repurchases tend to peak four to five years after the corresponding purchases.
The increase in purchases, accompanied by the decline in repurchases, resulted in an expansion in outstanding Fund credit in the General Resources Account from SDR 22.1 billion at the end of 1989/90 to SDR 22.9 billion at the end of 1990/91 (Table 2 and Chart 11). Details are provided in Appendix Table II. 9.
|Financial Year Ended April 30|
|Purchases by facility (General Resources Account)1||6,060||3,941||3,168||4,118||2,128||4,440||6,248|
|Stand-by and first credit tranche||2,768||2,841||2,325||2,313||1,702||1,183||1,975|
|Buffer stock financing facility||—||—||—||—||—||—||—|
|Compensatory financing facility||1,248||601||593||1,544||238||808||2,127|
|Extended Fund facility||2,044||498||250||260||188||2,449||2,146|
|Loans under SAF/ESAF Arrangements||—||—||139||445||554||826||575|
|Special Disbursement Account resources||—||—||139||445||380||584||180|
|ESAF Trust resources||—||—||—||—||174||242||395|
|Repurchases and repayments||2,943||4,702||6,749||8,463||6,705||6,399||5,608|
|Trust Fund loan repayments||212||413||579||528||447||357||168|
|End of period|
|Total outstanding credit provided by Fund||37,622||36,877||33,443||29,543||25,520||24,388||25,603|
|General Resources Account||34,973||34,640||31,646||27,829||23,700||22,098||22,906|
|Special Disbursement Account||-—||—||139||584||965||1,549||1,728|
|Percentage change in total outstanding credit||8.7||-2.0||9 3||11.7||-13.6||-4.4||5.0|
|Number of indebted countries||91||87||88||86||83||87||81|
Excluding reserve tranche purchases.
Excluding reserve tranche purchases.
Chart 11.Total Fund Credit Outstanding to Members (Including Trust Fund, SAF, and ESAF), Financial Years Ended April 30,1980-91
Currencies used in purchases, repurchases, and other Fund transactions and operations are selected through the adoption by the Executive Board of a quarterly operational budget. (See the box on the Operational Budget.) The amounts of currencies of members deemed to be in a strong balance of payments position are selected to promote over time balanced positions in the Fund in relation to gross holdings of gold and foreign exchange reserves. The method of allocating currencies in the operational budget was reviewed during the 1991 financial year, introducing the limitation that the Fund’s holdings of a member’s currency in relation to its quota should not be reduced substantially below the average of other members included in the budget. The method of allocating currencies is to be further reviewed before the end of December 1991 or the coming into effect of the Ninth General Quota Review, whichever comes earlier.
Repurchases of purchases made with borrowed resources do not in all cases exactly match the timing of repayments by the Fund of the corresponding borrowings, which in the past have tended to have a shorter maturity than purchases. In 1990/91 such mismatch in maturities resulted in a net inflow of ordinary resources of SDR 0.9 billion (the excess of the inflow to the Fund in repurchases over the outflow from the Fund in repayments to lenders). Nevertheless, at the end of 1990/91, cumulative payments to creditors exceeded cumulative repurchases of purchases made with borrowed resources by SDR 3.2 billion. This accumulated mismatch is expected to continue to decline during 1991/92.
Stand-By and Extended Arrangements
Thirteen new stand-by arrangements, all with developing members, came into effect in 1990/91. Commitments of Fund resources under these arrangements, including a first credit tranche arrangement with India for SDR 0.6 billion, totaled SDR 2.8 billion, as compared with 16 stand-by arrangements for SDR 3.2 billion in the previous year. The largest commitments were to Eastern European countries (Bulgaria for SDR 0.3 billion, Czechoslovakia for SDR 0.6 billion, and Romania for SDR 0.4 billion). All but 2 of the 13 stand-by arrangements were financed exclusively with ordinary resources.10 As of April 30, 1991, 14 stand-by arrangements were in effect, with total commitments of SDR 2.7 billion, and undrawn balances amounting to SDR 2.0 billion.
Two extended arrangements were approved during 1990/91, one for Hungary (SDR 1.1 billion) and another for Poland (SDR 1.2 billion). With these new commitments, total commitments at April 30, 1991 under the five extended arrangements in effect at that time reached SDR 9.6 billion, of which SDR 5.3 billion remained undrawn. Drawings under extended arrangements are financed up to 140 percent of quota with ordinary resources, and the balance with borrowed resources.
In connection with the Fund’s strategy for dealing with the problems of heavily indebted countries, a total of SDR 396 million was earmarked from new commitments of stand-by and extended arrangements in 1990/91 for possible debt-reduction operations. Disbursements of these “set asides,” including amounts “set aside” under arrangements in preceding years, amounted to SDR 463 million during the financial year. In the case of five arrangements in effect during this financial year, the Board also indicated its willingness to consider a possible augmentation to provide collateral to support debt-service reduction; in December 1990 the Board agreed to one such augmentation for Venezuela in the amount of SDR 154 million.
Total new commitments of Fund resources under stand-by and extended arrangements in 1990/91 amounted to SDR 5.1 billion, or less than half the SDR 10.9 billion recorded in the previous year. Annual access, which averaged 60 percent of quota under new stand-by arrangements and 65 percent of quota under new extended arrangements, ranged from 30 percent of quota (Nigeria) to 101 percent of quota (Guyana).
SAF and ESAF
The Fund continued in 1990/91 to provide financial support under three-year arrangements to low-income members through the SAF and the ESAF.
As of April 30, 1991, there were 12 SAF arrangements and 14 ESAF arrangements in effect. Two new SAF arrangements were concluded in 1990/ 91 with Burkina Faso (SDR 22.1 million) and Rwanda (SDR 30.7 million). Three new ESAF arrangements totaling SDR 425.7 million were also concluded with Bangladesh (SDR 258.8 million), Guyana (SDR 81.5 million), and Mozambique (SDR 85.4 million). Cumulative commitments under SAF and ESAF arrangements totaled SDR 3.4 billion as of April 30, 1991 while cumulative disbursements under the two facilities amounted to SDR 2.5 billion, compared with SDR 2.0 billion as of April 30, 1990. Following amendments of the ESAF Instrument in September and November 1990, requests were approved by the Board to augment the three-year ESAF commitment for Ghana and to increase the amount of the midyear disbursement under the second annual arrangements for Kenya and Uganda.
Resources totaling about SDR 8.7 billion are expected to become available to finance SAF and ESAF arrangements. Loans under SAF arrangements are funded with resources projected to total about SDR 2.7 billion, derived from repayments on loans from the Trust Fund (established in 1976). ESAF arrangements are financed with Special Disbursement Account resources not utilized under SAF arrangements and with ESAF Trust resources expected to total SDR 6.0 billion. At the end of April 30, 1991, the resources available for lending in the ESAF Trust amounted to SDR 5.3 billion, unchanged from the preceding year. Of this amount, agreements with lenders amounting to SDR 5.1 billion have been approved by the Executive Board and have entered into effect. Some of the borrowing agreements call for market-related interest rates, while others bear concessional interest rates.
Box 14.The Operational Budget
Because of the cooperative character of the Fund and the revolving nature of its resources, Fund credit is financed through the use of currencies of a wide range of members, large and small, industrial and developing. Members that are in a strong reserve and balance of payments position make resources available to members experiencing balance of payments difficulties. The guidelines that govern the allocation of currencies in which the Fund could make its resources available or receive repayments from members, are laid down by the Board and are implemented through an operational budget that is approved on a quarterly basis. The Board reviews the guidelines underlying the operational budget from time to time.
As already mentioned, on September 24, 1990 the Board approved a two-year extension of the commitment period for ESAF Trust loans, from November 30, 1990 to November 30, 1992. The extension of the commitment period for Trust Loans required a corresponding extension on the disbursement period under the agreements with lenders to the ESAF Trust Loan Account from June 30, 1993 to November 30, 1995. Most lenders to the ESAF Trust Loan Account have agreed to the requested extension of the commitment and disbursement periods and the respective agreements have been amended accordingly.
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 Account take a variety of forms, including direct grants and deposits made at varying concessional interest rates. Resources available for subsidy payments in the Account as of April 30, 1991 amounted to SDR 384.5 million, up from SDR 226.9 million as of April 30, 1990.
The ESAF Trust made interest payments to lenders in 1990/91 amounting to SDR 27.1 million, of which SDR 2.3 million was financed by payments of interest made by borrowers and the balance of SDR 24.8 million was drawn from the resources of the Subsidy Account.
Reflecting in part the addition of the oil import element to the CCFF, purchases under the CCFF more than doubled to SDR 2.1 billion in 1990/91, compared with SDR 0.8 billion during the previous year, and accounted for almost one third of total purchases from the General Resources Account. The total for 1990/91 comprised purchases amounting to SDR 1.9 billion under the oil element of the CCFF, and SDR 0.2 billion under the export shortfall provision (or SDR 0.6 billion less than purchased under the export shortfall element during the previous financial year). Purchases under the oil element of the CCFF were made by Bulgaria, Costa Rica, Czechoslovakia, Hungary, India, Jamaica, the Philippines, Poland, and Romania. No purchases under the contingency element of the CCFF were made in 1990/91. There were no purchases under the buffer stock financing facility and no amounts were outstanding under this facility as of April 30, 1991. (See box on Fund Facilities and Policies.)
SDRs, the international reserve asset created by the Fund, 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. 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 number of institutions prescribed by the Fund to accept, hold, and use SDRs remained unchanged at 16 during 1990/91.11
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 Review of international and regional organizations and a number of international conventions. In addition, the SDR has been used to denominate financial instruments created outside the Fund by the private sector (private SDRs). At the end of the financial year, the currencies of six member countries were pegged to the SDR.
SDR Valuation and Interest Rate Basket
The SDR valuation basket was revised effective January 1, 1991 in accordance with the 1980 decision and the review of the SDR valuation by the Executive Board in 1990.12 The five currencies used in the previous basket were retained, as the issuers of these currencies were those whose exports of goods and services during the period 1985-89 had the largest value. The initial weights for these currencies were revised to reflect changes from 1980-84 to 1985-89 in their relative importance in international trade and finance. The currency weights were translated into currency amounts on the basis of the average daily exchange rates for the three months preceding the introduction of the respective baskets, ensuring that the value of the SDR was the same on December 31, 1990 under both the revised and the previous baskets. The revised basket will be in effect until December 31, 1995. The initial weights and the corresponding amounts of each of the five currencies in the new valuation basket are shown in Table 3.
|Currency||January 1, 1986||January 1, 1991|
|U.S. dollar||42 (0.452)||40 (0.572)|
|Deutsche mark||19 (0.527)||21 (0.453)|
|Japanese yen||15 (33.4)||17 (31.8)|
|French franc||12 (1.020)||11 (0.800)|
|Pound sterling||12 (0.0893)||11 (0.0812)|
The financial instruments included in the SDR interest rate basket were also reviewed. With effect from January 1, 1991 the rate on the two-month private bill used for the Japanese yen component was replaced by the rate on three-month certificates of deposit, and the rate on three-month interbank deposits used for the French franc component was replaced by the interest rate on three-month treasury bills. The instruments for the United States dollar (market yield for three-month U.S. Treasury bills), the pound sterling (market yield for three-month U.K. Treasury bills), and deutsche mark (three-month interbank deposit rate in Germany) remained unchanged. The changes in the instruments reflected changed circumstances in financial markets in light of innovations and deregulations.
Pattern of Holdings
The total allocation of SDRs remained unchanged at SDR 21.4 billion in 1990/91. Holdings of SDRs by participants decreased by less than SDR 0.1 billion during the year to just below SDR 20.8 billion, with a corresponding increase in the Fund’s holdings of SDRs in the General Resources Account to SDR 0.7 billion.13 Those of prescribed holders remained basically unchanged at less than SDR 20 million. During the year, SDR holdings of developing countries, as a proportion of their net cumulative allocations, increased from 44.4 percent to 45.9 percent, while those of industrial countries declined marginally from 122 percent to 121 percent. (See Appendix Tables 11.12 and II.13.)
Total transfers of SDRs during 1990/91 declined substantially to SDR 14.8 billion from SDR 16.8 billion, reflecting the effect of a significant decrease in transfers among participants and prescribed holders and a moderate decline 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 prescribed holders are presented in Table 4.
|Financial Year Ended|
|Annual Averages1||April 30||Total|
|1988||1989||1990||1991||Jan. 1, 1970-|
Apr. 30, 1991
|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||5,266||47,040|
|Net interest on SDRs||42||161||259||283||305||344||480||535||4,132|
|Transfers from participants to|
General Resources Account
|Interest received on General|
|Resources Account holdings||16||135||551||307||81||56||86||79||3,170|
|Transfers from General Resources|
Account to participants and
|Repayments of Fund borrowings||—||88||86||614||1,999||1,782||1,845||1,090||9,608|
|Interest on Fund borrowings||4||27||184||443||585||490||334||195||3,859|
|In exchange for other members’ currencies|
|Acquisitions to pay charges||—||3||95||896||402||244||368||364||5,155|
|Acquisitions to make quota payments||—||114||—||—||—||—||—||—||341|
|General Resources Account holdings at end of period||1,371||5,445||4,335||1,960||770||976||628||694||694|
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 increases came into effect and before the SDR two-way arrangements imported 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 increases came into effect and before the SDR two-way arrangements imported significant increases to the SDR transactions by agreement.
Transfers Among Participants and Prescribed Holders
Transfers of SDRs among participants and prescribed holders declined in 1990/91 to SDR 6.3 billion (see Table 4), mainly because of a significant decrease in transactions by agreement to SDR 5.3 billion (of which SDR 166 million involved prescribed holders). The other SDR 1.0 billion of transfers was accounted for mainly by SDR interest payments, and Fund-related and prescribed operations, the latter consisting of loans, forward operations and settlements of financial obligations. For the third consecutive year, there were no transactions with designation, 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. Charges and repurchases paid in SDRs remained fairly stable at SDR 4 billion, even though total repurchase obligations discharged by members during the year declined by SDR 0.6 billion. As in the past, a large proportion of the SDRs received in purchases and operational payments by participants were sold in transactions by agreement.
As in the previous three years, in 1990/91 buying and selling (two-way) arrangements for voluntary SDR transactions continued to facilitate SDR use in transactions by agreement. While maintaining the SDR holdings of participating members within the desired ranges, these arrangements have contributed to 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 agreement of SDR 5.3 billion in 1990/91, SDR 2.9 billion was effected by directly matching purchasers and sellers (including SDR 1.4 billion from members with standing arrangements to sell) and SDR 2.4 billion represented temporary excess supply or demand and was effected through the sales of SDR 1.1 billion to—and purchases of SDR 1.3 billion from—members with regular two-way arrangements in exchange for U.S. dollars, deutsche mark, French francs, pounds sterling, or Japanese yen. However, members wishing to acquire SDRs (generally for discharging their obligations to the Fund in SDRs) demanded more than other members were prepared to sell (excluding net sales by members with two-way arrangements). The use of the two-way arrangements to meet this excess demand lowered the SDR holdings of the members with these arrangements to the lower end of the permissible range, and the Fund was unable to arrange for all of the acquisitions desired. To help satisfy acquisitions of SDRs by members indebted to the Fund, the Fund staff requested additional sales by a number of members with substantial holdings who sold another SDR 1.5 billion.
Transfers Involving the Fund
SDR transfers between participants and the Fund amounted to about SDR 8.5 billion in 1990/91, compared with SDR 9.1 billion in 1989/90. Receipts of SDRs by the General Resources Account declined marginally from SDR 4.4 billion to SDR 4.3 billion. Receipts consisted mainly of payments of charges on members’ use of Fund resources, which amounted to SDR 2 billion and repurchases of 2 billion made in SDRs (at participants’ option). SDRs accounted for about 37 percent of total repurchases. The remainder of receipts, about SDR 0.3 billion, consisted mainly of quota payments by new members totaling SDR 220 million and interest of SDR 79 million on the SDR holdings of the General Resources Account.
Transfers from the General Resources Account to participants decreased by about 10 percent to SDR 4.2 billion in 1990/91. The total of SDRs used for interest payments and in repayments of Fund borrowings during the year declined by about SDR 0.9 billion to SDR 1.3 billion. SDRs used to finance purchases increased to SDR 1.3 billion, while remuneration payments made in SDRs on members’ creditor positions and SDRs acquired by members against foreign exchange remained about the same at SDR 1.2 billion and SDR 0.4 billion, respectively.
SDRs were used in other operations involving SAF, ESAF, Trust Fund loans, and the SFF Subsidy Account, including disbursements of subsidy or loans to members, repayments by members of principal, and payments by members of interest and special charges. In 1990/91, these Fund-related operations in SDRs totaled SDR 132 million.
Overdue Financial Obligations
The reduction and elimination of overdue financial obligations to the Fund are essential to maintain the cooperative nature of the institution and to preserve its monetary character. Overdue obligations remained a serious problem in 1990/91, although the absolute increase and the rate of growth of overdue obligations over the financial year were the lowest since 1983. The total amount of overdue obligations rose from SDR 3.3 billion at the end of 1989/90 to SDR 3.4 billion at the end of 1990/91, of which almost all were accounted for by members in arrears to the Fund by six months or more. Between the end of 1989/90 and the end of 1990/91, the number of members in arrears on obligations to the Fund by six months or more fell from 11 to 9. All these members were in arrears to the General Resources Account; six had arrears in the SDR Department; six 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 1,081.4 million at the end of 1990/91, compared with SDR 834.4 million at the end of 1989/90.
In 1990/91, no members were declared ineligible to use the general resources of the Fund pursuant to Article XXVI, Section 2(a), and declarations of ineligibility previously in effect with respect to Guyana and Honduras were lifted following full settlement of those members’ arrears on June 20 and June 28, 1990, respectively. As of the end of the financial year, declarations of ineligibility with respect to Viet Nam (January 15, 1985), Liberia (January 24, 1986), Sudan (February 3, 1986), Peru (August 15, 1986), Zambia (September 30, 1987), Sierra Leone (April 25, 1988), Somalia (May 6, 1988), and Panama (June 30, 1989) remained in effect. These eight ineligible members accounted for 97.8 percent of total overdue obligations to the Fund as of April 30, 1991.14
|Financial Year Ended April 30|
|Amount of overdue obligations||1,186.3||1,945.2||2,801.5||3,251.1||3,377.7|
|Number of members||8||9||11||11||9|
|Number of members||8||9||11||11||9|
|Number of members||4||6||6||9||6|
|Number of members||6||7||7||8||6|
|Number of ineligible members||5||7||8||10||8|
|By Type||By Duration|
Somalia’s unpaid charges of SDR 0.3 million in the SDR Department are overdue by less than six months.
Somalia’s unpaid charges of SDR 0.3 million in the SDR Department are overdue by less than six months.
During the year the Fund continued to implement the strengthened cooperative strategy for resolving members’ arrears problems. This strategy has led to some encouraging progress. Two members—Guyana and Honduras—cleared their overdue obligations in June 1990, adopted Fund-supported programs, and have remained current with the Fund despite the difficult international environment, including the adverse impact of the Middle East crisis. Furthermore, four members—Panama, Peru, Viet Nam, and Zambia—have undertaken to stabilize the level of their arrears by, at a minimum, making payments equivalent to newly maturing obligations to the Fund.
These members have also formulated and begun to implement comprehensive adjustment programs, in one case—Zambia—under a rights accumulation program, and in another—Panama—under a Fund-monitored program. In the case of Peru, the authorities are pursuing a macroeconomic and structural adjustment program designed in consultation with the staffs of the Fund, the World Bank, and the Inter-American Development Bank, and an effort is under way to mobilize the requisite financing in support of this program. The Vietnamese authorities elaborated, with the assistance of Fund staff, a broad program of macroeconomic and structural reforms designed to move toward a market-based economic system. In Sierra Leone, there has been progress in key structural areas and the country is making efforts to improve its payments performance to the Fund and to establish a track record that could support a request for endorsement of a rights accumulation program. Thus, by April 30, 1991, more than half of the 11 members with protracted arrears a year earlier had either become current with the Fund or could be considered to be collaborating with the Fund in varying degrees to resolve their arrears problems.
As regards the three other members that have been declared ineligible to use the general resources of the Fund, cooperation with the Fund has been inadequate and remedial measures have been applied in accordance with the established strategy.
The Cooperative Strategy on Overdue Obligations
The cooperative strategy on overdue financial obligations to the Fund was formulated in early 1990 and endorsed by the Interim Committee at its meeting in May 1990. Subsequently, the Board took appropriate action to implement the operational modalities of the strategy, which has three main elements: prevention, deterrence, and intensified collaboration.
Prevention is a key element of the cooperative strategy. In this regard, increased efforts have been undertaken to help ensure that all members using Fund resources will be in a position to meet their obligations to the Fund as they fall due. The process of assessing members’ capacities to repay the Fund has been substantially strengthened, both in discussions with the authorities and in staff papers supporting members’ requests for use of Fund resources. Since mid-1990, all staff papers prepared in support of the use of Fund resources, including use under the SAF, ESAF, and CCFF, have included a section explicitly assessing the member’s capacity to repay. The assessment of capacity to repay is intended in part to highlight potential risks and dangers, arising, for example, from future financing gaps, a bunching of maturities or an excessive debt burden, possible adverse external shocks, or slippages in policy implementation. Every effort is made to ensure that these risks are addressed in program design and implementation and in financing arrangements in order to safeguard the revolving character of Fund resources. Where significant financing gaps or excessive debt burdens are foreseen for the period in which Fund credit would remain outstanding, indications are given of the efforts that will be required of the member and the international community.
The staff has continued to assist members in making specific arrangements with respect to their international reserve management practices to facilitate payments to the Fund. Such arrangements have included targeting a higher level of international reserves and building up budgetary resources in local currency. In addition, a number of countries have arranged for the voluntary advance acquisition of SDRs, in amounts sufficient to settle obligations falling due to the Fund in a subsequent period, combined with a standing authorization for the Fund to debit the member’s SDR account for amounts as they fall due. These latter arrangements are administratively simple and reduce risks of delays in payment, while offering members an international reserve asset that is liquid, provides a market-related rate of return and currency diversification, and is unrestricted in its use.
Remedial and Deterrent Measures
As a complement to preventive measures, the deterrent element of the cooperative strategy was strengthened in 1990/91 through, among other things, a tightening of the timing of procedures for dealing with members with overdue financial obligations. As compared with the procedures endorsed by the Executive Board in August 1989, the revised timetable sets maximum time limits between the date of emergence of arrears to the Fund and a declaration of ineligibility, and makes explicit the timing of a declaration of noncooperation and the initiation of the procedures for compulsory withdrawal. It also includes the possible use of the suspension of voting and related rights as a measure of deterrence, once the Third Amendment of the Articles of Agreement, which would make such a suspension possible, becomes effective. The Third Amendment must become effective in order for the quota increase to come into effect.
The timetable of remedial and deterrent measures has been applied to ineligible members that have been judged not to be cooperating with the Fund. In particular, declarations of noncooperation were issued with respect to Liberia on March 30, 1990 and Sudan on September 14, 1990. In the cases of Liberia and Somalia, internal conflicts have recently brought about changes of government and have led to widespread disruption of economic activity. In these circumstances, the Board has agreed to delay the consideration of the further application of remedial measures until a policy dialogue with the member is once again possible.
The timetable has also been applied in new cases of arrears. After the issuance of complaints under Rule K-l (which involves unfulfilled obligations other than in the SDR Department) in two new cases, communications were dispatched from Fund management to selected Fund Governors regarding the members concerned. These were the first occasions on which such early communications were dispatched since this element of the procedures was introduced in August 1989. The emergence of overdue obligations in these cases—one of which was settled before April 30, 1991 and the complaint under Rule K-l withdrawn—serves as a reminder that, if authorities fail to adopt appropriate policies, arrears problems can emerge quickly, and continued vigilance and prompt corrective measures are required. In this regard, the Board has emphasized that the strong support of the membership will be vital in making deter-rent/remedial measures effective and in eliminating new arrears before they become protracted.
Collaboration and the Rights Approach
Under the collaborative approach, the Fund has developed the techniques of Fund-monitored programs and rights accumulation programs, which permit a member with protracted arrears to the Fund to establish a track record of performance related to policy implementation and payments. With the assistance of support groups, consultative groups, and other arrangements as appropriate, the member is expected to generate the financing needed for its economic program including, at a minimum, amounts to settle financial obligations falling due to the Fund and the World Bank during the program period.
During the past financial year, the Fund staff has been actively engaged in assisting members to mobilize resources under the collaborative approach in the context of their adoption and implementation of programs that would be monitored by the Fund. In the four cases in which most experience has been gained thus far—Guyana, Honduras, Panama, and Zambia—the modalities for mobilizing resources have been adapted to the particular circumstances of the member. In Guyana, a support group (chaired by Canada) and in Honduras a consultative group (chaired by the World Bank) were instrumental in mobilizing finance for the respective programs, including clearance of arrears to the multilateral financial institutions. The Fund-monitored program for Panama is to be financed through a support group chaired by the United States and through contributions from several governments. In Zambia, substantial resources have been committed through the Consultative Group/Special Program of Assistance for Africa to help finance Zambia’s 1990 Fund-monitored program and the rights accumulation program for 1991. In all four cases, official bilateral reschedulings have been arranged within the Paris Club.
The rights approach, which was endorsed by the Interim Committee in May 1990, provides that members can earn rights toward future financing from the Fund through the implementation of a comprehensive economic program with macroeconomic and structural policy standards associated with programs supported by extended and ESAF arrangements. It was envisaged that the rights approach would be available only to those of the 11 members with protracted arrears to the Fund at the end of 1989 that adopted such a program that could be endorsed by the Board by the time of the spring 1991 Interim Committee meeting.
The process of implementing comprehensive economic reforms and mobilizing the requisite external financing so that these reforms could be submitted for endorsement by the Board as rights accumulation programs has, however, required more time than was envisaged a year ago. As of April 30, 1991, only one country—Zambia—had formally submitted a rights accumulation program, which was endorsed by the Board on April 17, 1991. In view of the progress that had been made with respect to policies and payments to the Fund in some countries with protracted arrears, and the difficult circumstances of some others, the Board agreed to extend the deadline for Fund endorsement of rights accumulation programs from the spring 1991 meeting of the Interim Committee to the spring 1992 meeting. This extension will permit programs currently being formulated to be finalized and brought to the Board, and will allow other members in protracted arrears a further opportunity to demonstrate cooperation with the Fund and formulate and implement rights accumulation programs.
Under the rights approach, the encashment of accumulated rights would take place after the clearance of arrears to the Fund as the first disbursement under a successor financial arrangement (for example, under the EFF or ESAF) approved by the Fund, once all requirements for such a successor arrangement have been met. The new arrangement would generally be expected to involve some Fund financing beyond that provided for the encashment of rights. The appropriate mix of resources (SAF, ESAF, and General Resources Account) would be decided at the time of approval of the successor arrangements.
In the context of the collaborative approach, in April 1991 the Executive Board decided to suspend the application of special charges15 in the General Resources Account for members in protracted arrears to the Fund that were judged to be actively cooperating with the Fund toward the resolution of their arrears problems. For those members that had already undertaken to make payments to the Fund equivalent to their obligations falling due, the Executive Board’s decision provided that the suspension would become effective on May 1, 1991 or when the level of their arrears was reduced to or below a specified level, whichever was later. It was also provided that such suspension would be extended to other members in protracted arrears, if the Fund endorsed a Fund-monitored or rights accumulation program for the member or if the Fund determined that the member was actively cooperating toward the clearance of its overdue obligations to the Fund, and the member had undertaken not to increase its arrears to the Fund above a specified ceiling.
Cooperation with the World Bank and Regional Development Banks
Cooperation with the World Bank and regional development banks to resolve overdue financial obligations has intensified during the past few years. As regards cooperation with the World Bank, simultaneous clearance of arrears to the World Bank and Fund is the preferred approach of both institutions in cases in which a member has arrears to both. However, in certain circumstances, sequential clearance may be considered necessary and be the approach most likely to result in an eventual satisfactory resolution of the arrears to both institutions. Simultaneous clearance, including with the relevant regional development banks, was the approach followed in the cases of Guyana and Honduras, and is envisaged in a number of other cases. In Zambia, on the other hand, sequential clearance (with clearance of arrears to the World Bank preceding the Fund) was regarded as a necessary component of the financing strategy in support of the rights accumulation program, because of the magnitude of the financing requirement and the difficulties in mobilizing financing under a parallel clearance approach.
Cooperation has also been close in cases in which members with protracted arrears to the Fund have also been in arrears to regional development banks. Contact and exchange of information at the staff level have been extensive, and in a number of cases parallel missions to formulate structural policies and investment plans have taken place. The concerned regional development bank has also participated in formal or informal meetings of donors and creditors.
Fund Income, Charges, and Burden Sharing
Since 1989/90, the basic rate of charge on the use of ordinary resources has been set as a proportion of the weekly SDR interest rate in order to avoid sharp step-like increases in the rate of charge that in the past had been necessary to achieve the target amount of net income. The Board set the proportion at 91.3 percent at the beginning of 1990/91 and, upon review at midyear, reduced the proportion to 87.8 percent for the remainder of the year in view of the favorable developments in the Fund’s income position. On June 7, 1991, this proportion was further reduced retroactively for the year as a whole to 87.0 percent, resulting in an average rate of charge of 7.65 percent before adjustments under the burden sharing mechanism. The Board decided to continue in 1991/92 the proportional relationship between the basic rate of charge and the SDR interest rate and set the proportion, which will be reviewed at midyear, at 96.6 percent so as to achieve a target amount of net income of 5 percent of reserves.
Net income for 1990/91, after taking into account a retroactive reduction of charges on the use of ordinary resources of SDR 31 million—which was agreed to on June 7, 1991—was equal to the net income target of SDR 70 million and was added to reserves. Reserves increased to SDR 1.5 billion on April 30, 1991 from SDR 1.4 billion on April 30, 1990, and total precautionary balances, which include amounts in the two Special Contingent Accounts, amounted to SDR 1.9 billion at the end of 1990/91.
The Board maintained and extended the various measures taken in recent years to strengthen the Fund’s financial position against the financial consequences of overdue obligations. It also continued its practice of adding a target amount of net income (5 percent of reserves at the beginning of the year) to the Fund’s reserves. The Board agreed that the financial burden stemming from the existence of overdue obligations should continue to be shared in a simultaneous and symmetrical fashion between debtor and creditor members. Under these principles of burden sharing, one half each of the cost of deferred charges and the allocation to the Special Contingent Account (SCA-1) of 5 percent of reserves at the beginning of the year is borne by members paying charges on the use of the Fund’s ordinary resources and by members receiving remuneration, except that adjustments to the rate of remuneration cannot reduce that rate to less than 85 percent of the SDR interest rate. When deferred charges are settled, an equivalent amount is paid to members that paid higher charges or received lower remuneration. Balances in the SCA-1 will be returned to the contributors when there are no more overdue obligations, or at such earlier time as the Fund may decide.
As a part of the cooperative strategy to resolve the problem of large and protracted overdue obligations, and in view of the potentially large disbursements of Fund resources following rights accumulation programs, the Board, effective July 1, 1990, decided to accumulate an additional SDR 1 billion over a period of about five years through a further adjustment to the rate of charge on the use of ordinary resources 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. The resources so generated are collected in a second Special Contingent Account (SCA-2) and are intended to protect the Fund against risks associated with credit extended by the General Resources Account for the encashment of rights earned in the context of a Fund-monitored program and to provide additional liquidity to contribute to the financing of these encashments. Balances held in the SCA-2 will be distributed to members that paid additional charges or received reduced remuneration when all outstanding purchases related to the encashment of rights have been repurchased, or at such earlier time as the Fund may decide.
For 1990/91 the amount to be added to the SCA-1 and the target amount of net income, which is to be added to reserves, were set each at SDR 69.8 million. Unpaid charges due by members in protracted arrears and contributions to the SCA-1 resulted in average adjustments to the basic rate of charge of 98 basis points, and in average adjustments to the rate of remuneration of 94 basis points. Adjustments for extended burden sharing (SCA-2) further increased the basic rate of charge by an average of 29 basis points and further reduced the rate of remuneration, on average, by 67 basis points to 81.7 percent of the average SDR interest rate. For the financial year, the adjusted rate of charge on the use of ordinary resources averaged 8.92 percent and the adjusted rate of remuneration averaged 7.18 percent.
At the end of April 1991, the Fund’s precautionary balances available to protect it against overdue repayments (repurchases) of credit outstanding from the General Resources Account (that is, reserves plus SCA-1) were equivalent to 80 percent of such obligations (which amounted to SDR 2,196 million). Since 1986, the impact of the Fund’s additional exposure to the risk of loss from unpaid charges (which amounted to SDR 808 million) has been compensated through the burden-sharing mechanism described above, with the exposure assumed by the Fund’s creditors and debtors. In addition, precautionary balances in SCA-2, which are expected to be SDR 1 billion within about five years, are available to protect the Fund against risks associated with the encashment of rights by countries currently with protracted arrears to the Fund.
Fund membership increased by four countries during 1990/91, raising the total number of members to 155. Three of the new members joined by the time of the 1990 Annual Meetings: the Czech and Slovak Federal Republic, on September 20, 1990, with a quota of SDR 590 million; the People’s Republic of Bulgaria, on September 25, 1990, with a quota of SDR 310 million; and the Republic of Namibia, on September 25, 1990, with a quota of SDR 70 million. The Mongolian People’s Republic became a member of the Fund on February 14, 1991, with a quota of SDR 25 million. All four members are availing themselves of the transitional arrangements under Article XIV.
Switzerland applied for Fund membership on May 31, 1990. The Board submitted a draft Resolution on its membership to the Board of Governors on March 26, 1991, recommending a quota of SDR 1,700 million. The Resolution was adopted on April 23, 1991; Switzerland’s membership will become effective when it has completed the legislative steps necessary to enable it to sign the original copy of the Articles of Agreement. Albania applied for membership on January 12, 1991, and staff missions visited Albania in March and in May.