IEO Annual Report 2005-06
Chapter

Appendix 7 Evaluation of Fiscal Adjustment in IMF-Supported Programs: Recommendations, Board Response, and Subsequent Follow-Up

Author(s):
International Monetary Fund. Independent Evaluation Office
Published Date:
January 2007
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IEO RecommendationExecutive Board Response1Follow-Up2
Program design and internal review
Program documentation should provide a more in-depth and coherent justification for the magnitude and pace of programmed fiscal adjustment and how it is linked with assumptions about the recovery of private sector activity and growth. It will also facilitate the review process and discussions at the Board, as well as provide external audiences with a more convincing explanation for the rationale for the program and identify possible risks and subsequent corrective measuresDirectors supported this recommendation, and deemed that this initiative would instill greater discipline in program design, enhance transparency, and provide the public and the private sector with a more convincing rationale for the program, thereby helping to overcome political obstacles to implementation. Nevertheless, they recognized that uncertainties regarding key macro-economic variables, particularly in countries in crisis, and concern about the implementation of policy measures and reforms complicate this task. A few Directors cautioned against spurious precision in such justifications, and others noted that the magnitude and pace of programmed fiscal adjustment may also reflect political constraints. Several Directors stressed the importance of better integrating debt sustainability analyses into program work. Directors looked forward to further staff analysis of growth projections in the context of program design discussions.The Fiscal Affairs Department (FAD) has prepared a guidance note to staff on how reports might best present the appropriate size, pattern, and composition of fiscal adjustment.
The internal review mechanism should place more emphasis on the early stages of the process. A more intensive process of brainstorming is needed at the time of the initial brief, and he brief should also articulate more clearly the basis for the iscal program, and its links with debt sustainability issues.Directors supported this recommendation. They welcomed management’s recent initiative aimed at enhancing the effectiveness of the review process, which, inter alia, encourages early consultation among departments.Following a recent assessment of the internal review process by a staff task force, management endorsed several changes to the process, including more systematic discussions of key issues prior to the preparation of briefing papers. In particular, pre-brief meetings that bring together originating and reviewing departments for a discussion of the main policy issues are required for all Article IV consultations and new program briefs.
Programs should give greater emphasis to the formulation and implementation of key institutional reforms in the fiscal area, even if (as is likely) they cannot be fully implemented during the program period. Programs should make stronger efforts to specify those structural reforms that should be carried out during the program horizon as part of a broader road map of priority reforms. This road map, and its prioritization, should ideally have emerged in the course of surveillance and be updated regularly as outlined below.Directors agreed that key institutional reforms can be more critical for fiscal sustainability than short-term expenditure and revenue measures. However, they recognized that short-term measures are hard to avoid in many cases, especially if the immediate objective is economic stabilization. Medium-term institutional reform may be of particular relevance in countries that have achieved macroeconomic stability and where “second generation” reforms are necessary to foster growth and reduce longer-term vulnerabilities. Some Directors agreed with the report’s suggestion that reforms should be broken down into those that require executive action, legislation, and capacity building.See below.
Directors, however, pointed out that in crisis situations, the pressing need to resolve the crisis may pose serious constraints on a medium-term approach. They reiterated the conclusion of the discussion on the Evaluation of the Role of the IMF in Recent Capital Account Crises (BUFF/03/125) that a crisis should not be used as an opportunity to force long-awaited reforms, however desirable they may be, in areas that are not critical to the resolution of the crisis or to address vulnerability to future crises. Careful judgment will continue to be needed to focus conditionality on those reforms judged critical while at the same time ensuring that adequate progress is made in addressing vulnerabilities and achieving the program’s goals during the period of the arrangement, thus safeguarding the IMF’s resources.
Surveillance
The surveillance process should be used more explicitly to provide a longer-term road map for fiscal reforms and to assess progress achieved.Most Directors agreed that Article IV consultations should play a stronger role in identifying longer-term reform priorities and the causes of past failures in addressing fiscal problems, and that these analyses should inform subsequent program design. In this respect, the various initiatives to distinguish Article IV surveillance from program work are aimed at providing fresh perspectives.A pilot exercise was conducted in 16 countries with a view to strengthening discussion of structural fiscal issues, building on fiscal strategy briefs produced by FAD. Following on from this pilot, FAD now maintains and regularly updates fiscal strategy briefs for about 55 countries. These briefs can be used by area departments to inform discussions with the authorities on critical structural and institutional fiscal issues that can be covered subsequently in Article IV and program reports. In a number of countries, staff reports have included enhanced coverage of structural fiscal issues and prioritized agendas for reform.
  • In collaboration with the authorities, the IMF should clearly identify in surveillance reports the most critical distortions in a country’s public finances from the perspectives of equity and efficiency.

  • Such an analysis would provide a road map for fiscal reform in the future, with a clear sense of priorities. It would help to provide the basis for identifying critical reforms—particularly in areas where these reforms have been lagging—that would need to be addressed should IMF financing be required in the future.

Some Directors considered the current framework of surveillance to be adequate for achieving the objectives of the IEO’s recommendation. Directors also called for staff reports to set out in more detail the progress in implementing the recommendations of Reports on the Observance of Standards and Codes (ROSCs) and technical assistance missions, as well as key reform priorities. Nevertheless, they underscored that the ultimate responsibility to develop a fiscal reform agenda resides with the individual country authorities, while the IMF should stand ready to provide advice.
  • The identification in advance of areas considered critical will allow the authorities flexibility in the timing and packaging of reforms that is often lost if these reforms are flagged at the last minute in the context of a crisis situation. This approach would also help foster greater domestic debate on key reforms and hence would encourage homegrown solutions and greater ownership. Early and clear prioritization of reforms is also consistent with streamlining objectives—it will avoid last minute bunching of reforms under crisis situations.

Directors also stressed that, consistent with the IMF’s mandate, surveillance needs to focus on key issues of macroeconomic relevance, which will be different in each country, and should draw on the expertise of other institutions as appropriate. They encouraged the use of cross-country experiences and comparisons, including inputs from regional and multilateral surveillance, to assist in program design. Most Directors viewed Article IV consultations as the appropriate vehicle for staff to identify countries in need of an in-depth fiscal review, stressing that this identification process should be applied uniformly to all member countries of the IMF. In most cases, these needs could be accommodated through technical assistance and ROSCs.
  • The analysis of fiscal reform priorities should be accompanied by an assessment of why certain important distortions were not addressed in the past and what lessons have been learned from past experience. This should include an effort to identify and unbundle the various constraints to critical reforms, including lack of technical capacity, areas where additional legislative action is necessary, and areas where key decisions from the executive branch are required.

  • Surveillance should include more systematic efforts to estimate the extent of tax evasion and tax exemptions, including the use of cross-country comparisons.

  • Public debt sustainability could help anchor the road map of fiscal reform priorities proposed above and to assess trade offs over time. At the same time, debt analysis provides a check of cumulative progress in improving fiscal systems that could also be reported in successive surveillance reports.

Role of the IMF in social protection
The IMF should clearly delineate the operational framework in which social issues will be addressed within program design in non-PRGF countries. This should include a clear indication of the IMF’s responsibilities and activities in this area.Directors agreed that an important aim of program design should be to protect critical social expenditures. However, they stressed, as recognized in the report, that the IMF should not become involved in the detailed selection and design of social policy; this task is outside both the IMF’s mandate and its expertise. A number of Directors supported the IEO’s call for updating of the 1997 guidelines that direct IMF work in the social area, in order to improve their clarity and effectiveness as an operational tool in protecting the most vulnerable from economic shocks and budgetary retrenchment. Other Directors, however, viewed the existing guidelines as adequate, and a few considered that the annual and medium-term budgets of non-PRGF countries already adequately identify critical social sector programs. These Directors recalled that the new framework for Bank-IMF collaboration on public expenditure issues should enhance countries’ public expenditure reform strategies, including measures to protect critical social spending. Most Directors agreed with the recommendation that staff should inquire, during Article IV consultations, whether the authorities have identified social programs that they would like to protect in the event of a crisis, as they believed this would help dispel the criticism that IMF-supported programs unduly curtail social spending. A few others considered this recommendation impractical, as it would create significant costs and pressures for the authorities with little benefit.During the discussions of the 2004 Biennial Review of IMF Surveillance, the Executive Board concluded that, “In members where shocks could have a sizable impact on social conditions, most Directors were of the view that Article IV consultations and other contacts can offer an opportunity to solicit interested members’ views on protection of social safety nets or of other priority expenditures in times of economic stress.” The Surveillance Guidance Note issued to staff in early 2005 calls for social and related issues—such as poverty, income distribution, social safety nets, and social expenditures—to be addressed, with due regard to principles of focus and selectivity. However, the guidelines do not mention the specific recommendation noted in the first bullet under “Role of the IMF in socialprotection.”3
The objective should be to assist middle-income countries to prepare and improve their institutional framework to allocate resources to critical social programs and to establish mechanisms to protect the most vulnerable groups in the face of external shocks and budgetary retrenchment.
  • The IMF could invite the authorities regularly during Article IV consultations to identify the existing critical social programs and social services that they would like to see protected in the event of adverse shocks. Participation on the part of the authorities would clearly be voluntary.

  • Successful implementation will depend heavily on having better and more transparent expenditure monitoring systems. On the basis of the priorities identified by the authorities, the IMF and the World Bank could join their accelerated efforts to reform public expenditure management (PEM) systems, specifically geared toward the social area, with a view to protecting the specified programs and spending categories.

  • This concrete application of the PEM initiative is particularly important because in many cases where there is an IMF- supported program the World Bank is also active with adjustment lending supporting the budget.

  • Surveillance would routinely report on these initiatives and their progress over time.

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