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Fund Activities in Developing countries

Author(s):
International Monetary Fund. External Relations Dept.
Published Date:
June 1972
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Ernest Sturc

When the International Monetary Fund was established a quarter of a century ago, its purposes were carefully set out in Article I of the Articles of Agreement. It was to have two main functions. First, it was to be a permanent institution providing a framework of rules for the international monetary system. This framework would be supported by a “machinery for consultation and collaboration on international monetary problems,” and provision was made for a pool of financial resources that could be made available to members temporarily so that balance of payments maladjustments could be overcome without resorting to measures that might impair either national or international prosperity. Second, the Fund was “to facilitate the expansion and balanced growth of international trade, and to contribute thereby to the promotion and maintenance of high levels of employment and real income, and to the development of the productive resources of all members as primary objectives of economic policy.” The Fund carries out this latter function in a variety of ways.

Consultations with Members

There are several instances in which the Articles of Agreement require a member to consult on its policies with the Fund (e.g., Article XIV, Section 4, under which the member has to justify the continuation of its reliance on exchange restrictions). Other actions by a member concerning the exchange rate of its currency, or its exchange regime generally, require the Fund’s prior approval or concurrence. Under the Fund’s policy, a member also discusses with the Fund changes in its financial programs in support of which the use of the Fund’s resources has been pledged. To allow the Fund (Executive Board and staff) to carry out these consultations effectively, the Articles of Agreement require members to furnish the Fund with relevant information. To foster more general international collaboration, the Fund has been empowered to organize itself in such a way that it should “act as a centre for the collection and exchange of information on monetary and financial problems, thus facilitating the preparation of studies designed to assist members in developing policies which further the purposes of the Fund,” (Article VIII, Section 5(c)). In executing these functions over the years, the Fund has developed a close and confidential relationship with its members. This relationship allows the Fund to provide effective assistance to members in the pursuit of their development effort while fully respecting their national sovereignty. This is especially important because the area of the Fund’s competence involves such fundamental issues of national economic life as credit, fiscal, and foreign exchange policies.

Flow of Information

The flow of financial and economic information from the member to the Fund is continuous. Its non-confidential part is tabulated, processed for comparability between members, and reproduced in the Fund’s publications, including International Financial Statistics, Balance of Payments Yearbook, Annual Report on Exchange Restrictions, Direction of Trade, Annual Report of the Executive Directors, and special occasional papers such as “The Problem of Stabilization of Prices of Primary Products” (1969), and “The Role of Exchange Rates in the Adjustment of International Payments” (1970).

In this manner, the Fund generally maintains up-to-date information necessary for meaningful and topical dialogue with each of its members on their economic and financial policies and on the world economic and financial climate in general. The dialogue between the Fund and its members is conducted through periodic visits of the staff to the member country, through visits of officials of the member to the headquarters of the Fund, and through informal meetings during the Annual Meeting of the Board of Governors of the Fund (the Minister of Finance, the Governor of the central bank, and their key advisors are usually then available for discussions). The periodic visits of the staff to the member country usually occur in connection with the Fund’s annual consultation with members, but they also occur in connection with a request by the member to use Fund resources. It is primarily in the course of these annual consultation discussions, and in the discussions leading to financial support by the Fund of a member’s economic and financial program, that much of the Fund’s technical assistance to its developing members is provided. The annual consultation discussions are a prolonged process; from the start of the intensive preparatory work to their completion in the Executive Board of the Fund, the consultation process takes 12 to 14 weeks. Annually, the Fund holds some 75 to 85 consultation discussions and numerous special discussions connected with the use of Fund resources.

Preparation for Consultations

When the date for the consultation is agreed upon with the authorities of the member, the staff prepares a draft paper on recent economic developments in the country. This paper is a detailed description of the economy of the member, its institutional arrangements, its development strategy and goals, and the fiscal, credit, incomes, and balance of payments policies designed to achieve these goals. The paper is based on previous consultation reports and more recent information provided by the member. The paper, of course, reflects also the international environment in which the member’s policies were formulated and implemented, including the impact of international developments on the member’s economy, especially on the marketing of its export products. The draft paper is frequently sent to the authorities of the member in advance of the staff mission’s arrival to enable appropriate officials to check its accuracy, correct errors, and make such additions as they may feel would more fully reflect the current picture of their economy. In drafting the survey paper, the staff takes special note of foreign and domestic impediments to a government’s efforts to achieve its development objectives. In the ensuing discussions the focus is usually on the design of policies that could be helpful in overcoming these impediments.

Benefits of Experience

The staff team, consisting usually of three to four economists, prepares itself for these discussions with a fair knowledge of the difficulties which most concern the officials of the country at any given moment. Thus, when the discussions start, usually in the capital of the member country, the participants can concentrate on the policies, their effectiveness, and on the need for adaptation to changing conditions in the country. Conditions abroad are also considered, insofar as they have an important effect on the economy of the country concerned. The discussions are confidential and frank, as between partners striving to achieve the same objectives. Naturally national officials are more preoccupied with the domestic, social, and political problems that policy adjustments may create; they are also more aware of the institutional and bureaucratic weaknesses that may hinder the execution of certain policies. On the other hand, members of the Fund staff have been exposed to similar problems faced by other members and can often convincingly dispel some apprehensions and help officials to strengthen their determination to start on a new path. The staff members can point to the examples of others. Not only can they draw on their own experience in other countries, but also on that of the rest of the Fund staff, who are consulted before the staff team’s departure from headquarters.

The experience of the past two decades indicates that in the course of these discussions the staff of the Fund has contributed effectively to the development efforts of its members. The contribution consists not only in objectively analyzing existing policies and in identifying new approaches where indicated, but also, in the process, uncovering institutional weaknesses that could and should be corrected in order to introduce new instruments of policy. For instance, in the fiscal sphere, new tax measures may be suggested which have proved effective in other countries in similar economic circumstances. In the monetary sphere, the more timely engagement of existing instruments may be proposed, or the establishment of new credit instruments may be suggested. In other instances, institutional arrangements may be proposed for the gradual introduction of a capital market in the country or for the establishment of savings institutions or specialized banks. In some cases, arrangements are devised for fuller and more frequent reporting of credit data in order to enable monetary officials to detect deficiencies in policies at an early date. Often the identification of institutional weaknesses establishes the need for technical assistance to the member country. In many instances, following such a consultation discussion, the member requests the Fund to send a special mission to help deal with such institutional problems. In the last five years the Central Banking Service and the Fiscal Affairs Department of the Fund have placed 260 experts in some 67 countries.

Technical Assistance on Many Fronts

Technical assistance involves efforts on many fronts. In the fiscal field it may cover such matters as the improvement of budget projections and government accounting (including the operations of public enter-prises) and the strengthening of procedures for expenditure control. Of particular importance in many countries is assistance to the authorities in broadening the tax base by devising new taxes or improving tax administration. In the central banking field, assistance relates to the establishment and reorganization of central banks, revision of monetary and banking legislation, development of monetary policy instruments, and mobilization and transfer of financial savings. The Fund’s technical assistance to developing members extends to other areas as well. For example, the Fund assists members in improving the compilation and reporting of statistics in order to help the authorities to analyze developments in various sectors of their economies. Also, through the IMF Institute, the Fund conducts intensive courses mainly for officials of developing countries in the fields of monetary and fiscal analysis and policy and balance of payments techniques.

Executive Board Discussions

Upon completion of the staff discussions with the authorities of the member, the staff draws up a consultation report including its own appraisal of the economic performance of the member and indicating policies which could best serve it to attain its objectives. This report is discussed by the Executive Directors of the Fund, and, through them, may be distributed to member governments who may also be informed of the discussion in the Executive Board. In this manner, interested governments receive an account of the country’s economic policy based on official statements of the government concerned, together with the evaluation by the Fund’s international staff and the Executive Directors representing the collective membership of the Fund. Governments can then base their policy in regard to their trade, investment, and aid in the member country on the basis of objective information which was fully reviewed by the government of the country concerned.

While the evolution of the extensive economic cooperation among nations that are members of the Bretton Woods institution is attributed to many factors, there is no doubt that the annual consultation of the Fund with its members has made a significant contribution. The reports on recent economic developments in member countries may be made available, if the member concerned agrees, to other international economic institutions such as the World Bank, the regional development banks, the General Agreement on Tariffs and Trade, and the economic section of the UN Secretariat for their confidential use. At present, 120 countries are members of the Fund. Many of them do not have the manpower or the facilities necessary to keep well informed on all countries which are important to them from an economic point of view. The annual consultation reports and discussions of them by the Executive Directors of the Fund are a source of such information. At the same time the developing countries receive reports providing authoritative accounts of economic developments and policies in the industrial countries. These accounts serve as important guideposts for the formulation of their own policies. The developed countries, in turn, receive full information on the objectives and, often, on the obstacles to successful development of the developing countries. This is of considerable help to them in responding to requests for development assistance.

A very important question, which receives a thorough examination in these discussions, is the nature and degree of restrictions that the country may apply to its foreign trade and payments. This subject is, of course, linked with the appropriateness of the exchange rate of the currency, for if the currency is overvalued, the prevailing rate can only be maintained by recourse to restrictions. Almost always, such recourse has tended to distort the allocation of resources and, far from protecting the balance of payments, has, over a period of time, served to weaken it.

It must be recognized that the ability of a developing country to increase its participation in the international economy depends not only on its own policies, but also on the policies pursued by developed countries. The external climate conducive to the development of their economies is greatly influenced by actions of developed countries. Developing countries are particularly vulnerable to restrictions and other barriers to trade which bear heavily on the goods that these countries seek to export. In the Fund’s consultations with developed countries, these issues are regularly reviewed and the Fund’s influence is exercised to foster the removal of impediments. These activities of the Fund will be described in a subsequent article in this series.

Use of Fund Resources

The Fund is even more closely associated with the policies of its members when they request the use of its resources. These resources are not intended to be used to finance development. Their purpose is to enable members to pursue corrective fiscal, monetary, and foreign exchange policies designed to restore balance in their external payments without resorting to measures harmful to national and international prosperity. Nevertheless, the availability of resources in support of a constructive program to overcome the payments imbalance serves the development effort of the member. Nothing is more costly than a sudden and serious interruption of the development process, and the Fund’s resources are often the means whereby a development program is maintained alive. Thus if the payments pressures encountered by the member are relatively minor, the member is usually able, with Fund resources, to overcome them with little or no interruption to its development effort. If the pressures are more serious, emphasis is properly given to changes in policy designed to relieve them. In the meantime, the resources of the Fund help the member to maintain the momentum of development by financing urgent external payments. Considering the hazards to which the economies of developing countries are exposed, particularly when they depend on only a few export products, the assurance that they can confidently rely on the Fund for financial assistance in case of need is a great source of strength.

In the last ten years developing members of the Fund have drawn a total of about $3.6 billion from the Fund under its general policies.1 Some of these drawings have been direct purchases of foreign currencies: the amount purchased has been made available immediately upon approval of the request. But by far the larger amount has been drawn under stand-by arrangements; the Fund commits a given amount of resources in favor of the member and the member makes use of these resources over the period of the arrangement in accordance with certain specified conditions.

In recent years, stand-by arrangements have been the general means of providing assistance to members. The literature on the nature, legal framework, and evolution of this technique of the Fund’s financial dealings with members is considerable.2 Briefly, a stand-by arrangement is based on a decision by the Fund to accept the assurance that the member will implement an economic program designed to achieve certain economic objectives, including, in particular, the strengthening of its balance of payments. In order to maintain the revolving character of the Fund, the member is expected to repay the Fund within three years from the time a drawing is made but it can agree with the Fund on a schedule of repayments extending over an additional two years. The use of the Fund’s resources put at the disposal of the member is phased during the period of the arrangement (generally one year) and the member undertakes that, should circumstances necessitate a departure from certain criteria specified in the arrangement, it should not seek the further drawings that would have been open to it without consulting with the Fund.

In the process of discussing the economic programs, their internal consistency, and the institutional framework within which they would be implemented, the staff has a unique opportunity to assist members in their policy formulation and in making innovations of an institutional or policy character. This is yet another channel used by the Fund to acquaint one member with the successful use of policy instruments by another.

Policies to Restore Stability

The programs the Fund has agreed to support with its resources are varied, both in content and in the emphasis on the policies a member has adopted to ensure their execution. In nearly all instances, however, the policies aim at restoring reasonable price stability in the country and strengthening the external payments position. The origin of excessive demand pressures which underlie price instability or payments disequilibrium may vary from country to country. Frequently, however, the imbalance originates in the fiscal sector as the growth of ordinary expenditures of the government or the public entities tends to outpace the growth of revenues. Financial programs, therefore, are based on a detailed review of the financial operations of the public sector; they try to generate resources for public investment and reduce reliance on inflationary financing. Generally, they contain an overall limitation on the expansion of credit by the central bank or the entire banking system consistent with efforts to align the aggregate demand for resources in the economy with the prospective supply. The thrust of these policies is to create conditions which will free resources for development and strengthen the balance of payments. Restoration of reasonable price stability encourages productive investment; strengthening confidence in the national currency helps domestic savings (at the expense of consumption) and enables the banking system, especially if interest rates are properly adjusted, to help mobilize these savings for development purposes. In this manner, the stabilization programs supported by the Fund create conditions for increased employment and sustained growth in the economy concerned.

Importance of a Realistic Exchange Rate

Usually, another important facet of the program supported by the Fund is the maintenance or the establishment of a realistic unitary rate of exchange for the currency of the member. This is also motivated by the recognition that such a rate strengthens confidence in national currency and thereby stimulates the growth of domestic savings. A realistic unitary rate helps also to reduce capital outflow. Indeed, in connection with many programs one of the developments which has been observed again and again is that, following the establishment of a realistic rate of exchange, there occurs a substantial reflow of funds from abroad. This helps to augment the availability of foreign exchange resources for development at a crucial period of internal stabilization, i.e., when domestic credit and incomes policy need to be restrictive in order to restore price stability. But above all, a realistic unitary rate of exchange helps to bring about a sound allocation of resources within the country, and provides a strong and important link between the growth of its economy and that of the world at large. It enables the country to avoid undue reliance on restrictions on trade and payments and to increase its participation in the international division of labor, thereby creating a basis for furthering its development.

A Gradual Return to Stability

The Fund is not dogmatic in its approach, however. In a number of instances the Fund has decided to support programs in which the government concerned has foreseen only a gradual return to reasonable price stability. Usually these have been situations where economic imbalance has persisted for a number of years in a rather acute form. Therefore, corrective policies both wide-ranging and drastic would be necessary if the aim were to restore economic balance as soon as possible, but such policies would incur the risk that the growth of the economy might be seriously—albeit temporarily—impaired in the process. Many countries have found the application of strong remedial measures politically difficult and have therefore chosen a gradual path to economic recovery. While supporting their efforts, the Fund has stressed the desirability of maintaining exchange rate flexibility in order to reduce the distorting impact of inflation on resource allocation and to help strengthen the balance of payments.

International Assessment of Policies

The corrective programs submitted by member governments to the Fund with the request for its financial support are critically reviewed by the Executive Directors in accordance with the policies on the use of Fund resources. The world economic community is thereby acquainted with the intended changes in the policies of members and the benefits that their implementation is expected to yield. This international assessment of policies of members and their intentions is clearly an element of strength in international cooperation among countries. The endorsement of a member’s economic program by the Fund, which is implied in the Fund’s willingness to enter into a stand-by arrangement with the member, provides it with considerable additional negotiating strength when discussing other aspects of its economic cooperation on a bilateral basis with its trade partners. It also facilitates members’ borrowing from international lending institutions. By fostering confidence in a member’s economic management, it facilitates the flow of funds from foreign banking and industrial sources to the country concerned. In this manner, by shortening the period of readjustment, the Fund helps to speed up recovery and the resumption of growth. With longer-term resources from abroad, the country is able to remove the bottlenecks in important sectors of the economy quickly while stabilization policies take effect. Indeed, evidence shows that in many instances of prolonged imbalance, the stand-by arrangements entered into between the Fund and members were instrumental, both directly and indirectly, in establishing conditions of sustained development within a reasonable period.

Compensatory and Buffer Stock Financing

In some instances, the balance of payments difficulties that a member experiences may arise not so much from weaknesses in its own policies as from disturbances originating abroad or natural calamities over which it has no control. For example, a country may suffer a significant decline in its export earnings when recessions in its markets abroad reduce the demand for its products. Similarly, drought or other natural conditions may cause a decline in production. If the foreign reserves of the country are not sufficient to cushion the impact of a fall in foreign earnings, there may be a serious setback to the pace of its development effort. To tide a country over such emergencies, the Fund established some years ago a facility to compensate the member for shortfalls in export earnings, a facility that was later substantially expanded. A further initiative, again principally designed for primary producing countries, was taken more recently with the establishment of a new facility for the financing of international buffer stocks. Under this facility, a member may use the Fund’s resources to finance its contribution to international buffer stocks under commodity agreements that meet appropriate criteria.

Together, these two complementary facilities permit a member to draw on the Fund up to 75 per cent of its quota, in addition to the regular facilities for the use of Fund resources described above. By the end of 1971 developing countries have used about $440 million under these two facilities. These facilities have made, and will continue to make, an important contribution toward easing problems arising from undue short-term fluctuations in markets for primary products. But, of course, they are not the answer to longer-run structural changes in commodity markets. This broader problem, including the repercussions on developing countries of commodity policies pursued by industrial countries, is being given increasing emphasis in the Fund’s consultations with all members.

The problems facing developing countries are manifold. To ensure steady economic advance and prosperity, the approach to their economic problems must be flexible and involves the use of varied instruments. The cooperation between the Fund and its members, developed and developing alike, facilitates such an approach. The Fund looks at the problems of developing countries from the point of view of their enlightened self-interest. This is the underlying philosophy of the Articles of Agreement and it is reflected in the instruments of cooperation outlined in this article.

The special facilities for the use of Fund resources are described toward the end of this article.

The reader is especially referred to a comprehensive book on this subject by the General Counsel of the Fund, Joseph Gold, The Stand-By Arrangements of the International Monetary Fund (Washington, 1970).

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