The conditionality practices developed during the 1950s and 1960s underwent a comprehensive review in the Fund’s Executive Board in late 1968, when a slump in growth and a surge in inflationary pressures were in prospect for the industrial countries. The decision taken at that time summarized the major elements of the prevailing policies on the use of Fund resources. Two considerations dominated the decision: first, that these policies should provide adequate safeguards to preserve the revolving character of the Fund’s resources; and, second, that they should allow for a flexible but uniform treatment of all members. Subsequently, periodic Executive Board reviews were undertaken to gather the experience with particular performance criteria—with, for example, credit ceilings, foreign borrowing limitations, and balance of payments (BOP) tests; these reviews and the subsequent Board decisions helped to define further the Fund’s policies on conditionality. In this manner, the policies that the Fund had developed on the use of its resources over more than two decades were broadly formalized in Executive Board decisions, which then served as a guide to the actual implementation of conditionality.
As these policies were being consolidated, strong pressures had begun to mount on the international monetary system. A succession of crises in foreign exchange markets had cast growing doubts on the continued viability of the par value system. By 1971, the fixed exchange rate regimes—a major feature of the Bretton Woods agreement in 1944—had ceased to be operative despite an attempt made to preserve them at the end of that year; and they were altogether abandoned early in 1973. As a result, an international monetary system based initially de facto and later de jure—after the Second Amendment to the Articles of Agreement—on flexible exchange rate arrangements for many of the industrial countries came into effect. While these developments were taking place in the international monetary sphere, the international economy experienced a series of disturbances related to unprecedented sharp rises in world prices for energy and other primary commodities. These increases exacerbated already existing inflationary pressures and eventually led to a severe recession in the industrial world, with particularly adverse consequences for the economies of the developing countries.
The first article on this subject by Manuel Guitian—”Fund conditionality and the international adjustment process: the early period, 1950-70” published in Finance & Development, December 1980—examined the rationale for the conditionality attached to the use of the Fund’s resources, and described the implementation of Fund conditionality practices that were developed during the 1950s and 1960s. This is the second of three articles on Fund conditionality
This article will examine the steps taken by the Fund in the 1970s to adapt its conditionality practices to the needs of members in a world economy characterized by such serious and widespread disturbances. A new round of disturbances arose as the decade ended; the last article in the series will analyze the initiatives currently underway at the Fund to take into account in determining its conditionality practices the economic environment that now seems in prospect for the 1980s.
It was evident early in the 1970s that the prevailing changes in the international economic environment called for a number of adaptations in the Fund conditionality practices. The new setting of relatively large increases and sharp shifts in external payments imbalances called for a different emphasis in the blend between adjustment and financing that was typical of existing stand-by arrangements. Early financing of imbalances became important to deal with the magnitude, suddenness, and intractability of the deficits. The rationale behind the priority given to financing was that if funds were available to a member at an early stage of a payments difficulty, it would not have to introduce abrupt measures and run the risk of reinforcing the recessionary trends associated with the upsurge in inflation in general and the energy price rise in particular. To meet this need for quickly disbursed resources, the Fund established financing arrangements subject to a limited degree of conditionality.
These initiatives for rapid initial financing were accompanied by other departures in the Fund’s conditionality practices that stressed the need for members to adjust to disturbances that appeared to have acquired a permanent character, but that also allowed for a longer adjustment period than had been typical until that time.
Relatively low conditionality
It was considered that a first priority was to make available resources subject to relatively low conditionality, in order to avoid the introduction by members of policies which would accelerate the momentum of the recession in the international economy. Consequently, the Fund established in 1974 a temporary oil facility, to assist members in financing payments deficits related to the increases in the cost of petroleum and petroleum products. The resources made available under this facility were borrowed by the Fund, and were additional to any other assistance that members might obtain from the Fund under the regular and special facilities that had been established earlier. The conditionality attached to the use of the 1974 oil facility was minimal, consisting of only two qualitative requirements: members were to consult with the Fund on their BOP policies and prospects, including policies aimed at coping with the energy problem, and, in dealing with their difficulties, were to refrain from relying on restrictions on international transactions.
The additional financing under the 1974 oil facility provided a respite during which the persistence and the intractability of the imbalances could be assessed and the extent of the adjustment needs gauged. In April 1975 the Executive Board decided to extend the oil facility for another year—making it the so-called 1975 oil facility—and the respite was prolonged. By then, it was already evident that the sharp changes in the terms of trade that had taken place after the 1973-74 energy price rise would not be altogether reversible. The decision on the 1975 facility, therefore, recognized that financing would now need to be accompanied by specific adjustment measures, and the limited conditionality that had been attached to the use of resources under the 1974 oil facility was moderately tightened.
Under the 1975 facility, in addition to the qualitative commitments they had undertaken under the previous oil facility, members were required to provide a quantitative description of the policies they intended to pursue in order to achieve a medium-term solution to their BOP problems, and the adequacy of those policies was made subject to an assessment by the Fund. The policy statement was also required to contain a specific aim to conserve energy; members were expected to describe the particular measures they had taken or proposed to take in order to conserve petroleum or to develop alternative sources of energy.
Generally speaking, while the policy measures were expressed in quantitative terms, they were not made subject to performance criteria, and the drawings from the facility were neither linked to performance under the policy program nor were they phased in installments. Thus, although the conditionality attached to the 1975 oil facility was more extensive and detailed than that of its predecessor, it still fell short of the standards applied to the use of the Fund’s general resources under stand-by arrangements in the upper credit tranches.
The oil facilities were terminated in March 1976. During their two-year duration, they were used by 55 members and provided them with approximately 7 billion special drawing rights (SDRs). The oil facilities, in effect, introduced a modification—in favor of financing—in the typical blend between adjustment and financing in the Fund’s stand-by arrangements. As the facilities were funded with resources borrowed by the Fund, drawings under them carried market-related interest rates that were higher than those charged on the use of the Fund’s own resources. The higher cost of the oil facility loans was to some extent offset by the fact that their maturities extended over a longer period than was allowed under stand-by arrangements at that time; resources provided under the latter were repayable within an outside range of three to five years, while oil facility loans were repayable within three to seven years.
These steps taken by the Fund to smooth out and make more gradual the necessary adjustments to prevailing monetary disturbances were supplemented in 1975 by an important liberalization of other special Fund facilities that are subject to a low degree of conditionality, in particular the compensatory financing facility, designed to finance temporary shortfalls in members’ export receipts.
Longer-term conditional resources
At the time the first oil facility was established, another major initiative was undertaken, an initiative that focused on the duration of the adjustment process. The nature and size of the payments imbalances facing many members in the early 1970s were such that they required longer periods of adjustment than were currently provided for under stand-by arrangements and, therefore, larger amounts of assistance than could be made available under those arrangements. Consequently, in 1974 the Fund established an extended facility to provide medium-term financing to members with particularly difficult BOP problems.
The extended facility was an important development in the policies on the use of Fund resources. Financial support under stand-by arrangements did not usually exceed 12 months, although members could enter—and had in fact entered—into successive one-year arrangements over several years. Extended arrangements, in contrast, assured members of Fund assistance for up to three years. Since a longer period of adjustment requires more resources to carry out financing, the Fund also increased the amount of its assistance in relation to quotas.
The traditional policies on the use of Fund resources normally limited the amount of Fund assistance under stand-by arrangements to the equivalent of 100 per cent of a member’s subscription, or quota, in the Fund. Extended arrangements raised that maximum amount to the equivalent of 140 per cent of a member’s quota.
The extended facility was designed to alleviate two main categories of payments problems; (1) severe imbalances due to structural maladjustments in production and trade, where cost and price distortions were widespread and long standing; and (2) imbalances due to a combination of slow growth and an inherently weak BOP position that constrained the country’s pursuit of effective development policies. In its formulation and administration, the extended facility has proved to be particularly beneficial to developing countries.
Financial facilities of the Fund and their conditionality
First credit tranche
Program representing reasonable efforts to overcome BOP difficulties; performance criteria and installments not used.
Higher credit tranches
Require substantial justification of member’s efforts to overcome BOP difficulties; resources normally provided in the form of stand-by arrangements which include performance criteria and drawings in installments, dependent on observance of performance criteria.
Medium-term program for up to three years to overcome structural payments maladjustments; detailed statement of policies and measures for first and subsequent 12-month periods; resources provided in the form of extended arrangements which include performance criteria and drawings in installments, dependent on observance of performance criteria.
Supplementary financing facility
For use in support of programs under stand-by arrangements reaching into the upper credit tranches or beyond, or under extended arrangements, subject to relevant policies on conditionality, phasing, and performance criteria.
Compensatory financing facility
Existence of temporary export shortfall for reasons largely beyond the member’s control; member cooperates with the Fund in an effort to find appropriate solutions for any payments difficulties.
Buffer stock financing facility
Existence of an international buffer stock accepted as suitable by the Fund; member expected to cooperate with the Fund as in the case of compensatory financing.
The standards of conditionality attached to the use of resources under the extended facility were similar to those applicable under stand-by arrangements. The difference in the use of resources available under extended and stand-by arrangements was not so much in the degree of conditionality as in the greater assurance the member gave under the extended arrangements that appropriate adjustment policies would not only be adopted but would also be sustained over the medium term. Assistance from the extended facility was granted to support comprehensive economic programs designed to restore sustainable financial balance to the economy. It included policies of the scope and character required to correct structural imbalances in production, trade, and prices. Particular attention was paid to policy measures intended to mobilize domestic and foreign resources, to improve their utilization, and to reduce reliance on restrictions on international transactions.
Requests from members for extended arrangements were accommodated when it was clear that the solution to their BOP problems would require a relatively lengthy period and that the intended policies were appropriate to cope with the magnitude of the problem. Under extended arrangements, members presented a comprehensive quantitative program setting forth the measures to be taken, the policies to be pursued, and the objectives sought during the period of the arrangement. Within this medium-term framework, there was a more detailed statement of the policies and measures for the first 12-month period. There was also an understanding that for each following 12-month period the member would present to the Fund a concrete assessment of the progress made and a statement of the policy measures to be used to advance the adjustment program during its subsequent stages. The quantitative targets of the program constituted performance criteria that were included as provisions in the extended arrangement and determined—as was the case with stand-by arrangements—the circumstances under which the member could make the drawings that were phased over the program’s period. However, in contrast to stand-by arrangements, resources from the extended facility were made repayable within an outside range of four to eight (recently extended to ten) years. Thus, like oil facility loans, their maturity was longer than that prevailing for stand-by arrangements.
Since the facility’s establishment, the commitments of financial assistance to members under 17 extended arrangements have amounted to about SDR 6 billion.
This has been an important supplement to the assistance of more than SDR 13 billion provided to members under the 166 standby arrangements concluded during the 1970s.
Special problems recognized
Parallel with the establishment of the oil facilities and the extended facility, steps were taken to alleviate the severe difficulties that the disturbances in the international economic scene imposed on certain members, particularly those in the developing world. A first step was the establishment of an interest subsidy account in 1975 to alleviate the burden of the relatively high interest cost of loans from the 1975 oil facility on the most seriously affected developing countries. The subsidy account was financed by voluntary contributions of 25 countries in relatively strong payments positions.
A second step, taken in 1976, was the establishment, on a temporary basis, of a Trust Fund for the benefit of low-income developing countries. Its resources came from profits from the sale of gold owned by the Fund and provided concessional assistance to support eligible members’ efforts in carrying out programs of BOP adjustment. Trust Fund assistance was available to a member when the Fund was satisfied that it had a BOP problem and was making a reasonable effort to improve its payments position.
The conditionality attached to Trust Fund loans was equivalent to that associated with assistance under the 1975 oil facility. Trust Fund loans were also available to eligible members that had entered into a stand-by arrangement or an extended arrangement with the Fund, which of course were subject to higher conditionality standards. The terms of the loans were concessional: they carried an interest rate of 0.5 per cent per year and were to be repaid within a period of five to ten years.
The Trust Fund is in the process of being wound up. During its existence, it has made loans for some SDR 3 billion to low-income developing countries. In addition, the Trust Fund made available to all developing countries some SDR 1 billion in direct distribution of profits from gold sales.
Need for additional resources
All these steps were aimed at adapting the mix of adjustment and financing in national stabilization programs to the circumstances of the 1970s, but they did not seem to be sufficient. It was felt that the external payments imbalances that beset the international economy were so persistent and so large that foreseeable demands for Fund resources would continue to be substantial, particularly after the lapse of the oil facilities in 1976. There were grounds for believing that, given the size and number of prospective imbalances, a further expansion of the Fund’s role as a financial intermediary would foster an orderly adjustment and help maintain confidence in the sound expansion of the world economy in the context of a relatively stable international financial system.
However, the Fund’s main source of assistance was its members’ quota subscriptions. Over time, the size of the Fund’s periodic quota increases had lagged well behind the expansion in international transactions. As a result, in most instances quotas represented a small and even declining proportion of the imbalances of member countries. This was the case even after the one-third increase in quotas that came into effect in April 1978 under the Sixth General Review of Quotas.
To ensure that the amount of financial resources that members could draw from the Fund would be adequate in relation to their needs, a decision was taken by the Executive Board in 1977 to establish a temporary supplementary financing facility to provide additional assistance to countries facing external payments imbalances that were large in relation to their quotas. This would serve as a bridge until the Seventh General Review of Quotas, providing for a 50 per cent increase, was completed.
The facility was funded by resources borrowed by the Fund from members in strong payments positions. Since financing from this facility was supplementary to the general resources that the Fund channeled under stand-by arrangements or extended arrangements, it was subject to the same conditionality standards. The availability of these supplementary resources practically doubled the regular amount of Fund assistance that members could obtain under stand-by arrangements and extended arrangements, from the traditional 100 and 140 per cent of quota to approximately 200 and 280 per cent of quota, respectively.
Supplementary resources were intended to help members cope with large imbalances that were difficult to redress in a short time. It was therefore assumed that stand-by arrangements involving the use of these supplementary funds would cover periods longer than the traditional one year, extending in practice up to three years. In addition, provision was made for possible instances in which even these specified maximum amounts would not be sufficient, and a “special circumstances” clause for further enlarged assistance to countries was included in the decision of the Executive Board.
The supplementary financing facility was to become effective when its borrowed resources had reached some SDR 8 billion, an event that did not take place until early 1979. The ample availability of unconditional funds in world capital markets, however, contributed to financing the deficits incurred in the interim and probably explains the limited recourse to Fund conditional resources by members until recently. Since the facility became effective, all of its resources have been committed in connection with stand-by arrangements or extended arrangements. Its loans bear market-related interest rates and are to be repaid within an outside range of three and one half to seven years.
Review of conditionality
During the 1970s, conditionality was adapted, both to increase the amounts of Fund assistance available to members through a variety of facilities (themselves subject to different degrees of conditionality), and to allow for a more gradual implementation of members’ adjustment policies. Toward the end of the decade, it was felt that another comprehensive review of conditionality was warranted. The review was undertaken by the Executive Board over 1978-79 and was completed with the adoption of a Board decision on March 2, 1979, containing a new set of guidelines for the policies on the use of Fund resources.
The new guidelines include many of the conclusions reached at the review that had been conducted in 1968. However, they also contain a number of other far-reaching considerations. Countries are frequently hesitant to undertake early adjustments and tend to delay the adoption of corrective measures until BOP difficulties have become severe, by which time the measures needed are stringent. The guidelines, therefore, encourage members to come to the Fund at an early stage of their payments problems. The guidelines also recognize the need for longer periods for stand-by arrangements to enable the member to implement its adjustment program successfully in cases where the imbalances are structural and therefore particularly intractable. In connection with stand-by arrangements, the guidelines reaffirm the need for the longer periods of up to three years that had been introduced with the extended facility and that had also been allowed for stand-by arrangements in the supplementary financing facility decision.
Adjustment programs typically include measures in key and sensitive economic areas: fiscal, credit, incomes, foreign borrowing, and exchange rate policies, as well as on trade and payments restrictions that are of direct concern to member countries. Consequently, the guidelines make clear that in helping members to design adjustment programs, the Fund will pay due regard to their social, political, and economic priorities and objectives as well as to their particular circumstances, including the causes of their BOP difficulties. For these purposes, the performance criteria included in arrangements supported by Fund resources will normally be limited to those that are necessary to evaluate the implementation of the program. Generally, performance criteria will be confined to broad macroeconomic variables and only in exceptional cases will they relate to other variables—that is, “when they are essential for the effectiveness of the member’s program because of their macroeconomic impact.”
Approval of a member’s request for Fund assistance will be recommended to the Executive Board when it is consistent with the Fund’s provisions and when there is a reasonable assurance that the program of policy action will be carried out. In certain circumstances, the new guidelines recognize that this may require the rapid adoption of certain initial measures that are critical to the design of the adjustment program. There are also cases when the economic situation of the member makes it particularly difficult to establish performance criteria for an extended period. In these instances, provision is made in the guidelines for the Fund and the member to agree in advance on a review of the progress made in the implementation of the program so as to reach understandings on key policy measures for the periods ahead.
Other important points stressed in the guidelines include the need to ensure broad coordination in the implementation of policies on the use of Fund resources to preserve the nondiscriminatory treatment of members. The need to review and adapt the terms of conditionality to changing circumstances is also confirmed in the guidelines. Individual country programs are to be assessed as they unfold to gauge their appropriateness, and global studies of arrangements with the Fund are to be made to evaluate the effectiveness of the national programs, the adequacy of the policy instruments, and the results achieved. These studies will serve as a basis for periodic and comprehensive reviews of conditionality by the Executive Board.
By the time the new guidelines were adopted in early March 1979, renewed pressures were brought to bear on the the international economy by a second round of sharp increases in world energy prices. This sudden disturbance was superimposed on a world economy that had not yet totally recovered from the troubles of the early 1970s. It contributed to the widely prevalent and historically high rates of inflation, to a slowdown in the growth of trade and economic activity, and to the re-emergence of large BOP surpluses and deficits among major groups of countries. As was the case in the early and mid-1970s, a need had once again arisen to adapt further the policies of the Fund to facilitate countries’ adjustment efforts in an unfavorable and deteriorating international economic environment. These difficulties posed a major challenge for the formulation of appropriate policies on the use of Fund resources to guide the institution’s operations in the 1980s.
MargaretGarritsen de VriesThe International Monetary Fund 1966-1971: The System Under Stress (Washington, D.C.International Monetary Fund1976).
MargaretGarritsen de VriesThe International Monetary Fund 1966-1971: The System Under Stress (Washington, D.C.International Monetary Fund “Economic Shocks of 1970s Viewed as Signs of Profound Change in World Relationships” IMF Survey (January71980).
JosephGoldConditionality (IMF Pamphlet Series No. 31Washington, D.C.1979).
LouisM. GoreuxCompensatory Financing Facility (IMF Pamphlet Series No. 34Washington, D.C.1980).
International Monetary Fund “Guidelines on Conditionality” Annual Report 1979 (Washington, D.C.International Monetary Fund1979) pp. 136–38. International Monetary FundSelected Decisions of the International Monetary Fund and Selected DocumentsEighth Issue (Washington, D.C.International Monetary Fund1976).