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A conversation with Mr. de Larosière: An interview with the Managing Director of the Fund

Author(s):
International Monetary Fund. External Relations Dept.
Published Date:
June 1982
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The Managing Director of the Fund interviewed by Finance & Development

Q. In recent speeches you have emphasized that industrial countries must persevere with their strict financial policies to bring down inflation. In the light of unemployment and reduced economic activity—both particularly harmful to the developing countries as well—isn’t the cost too high? Why doesn’t the Fund promote other policies, for example, complementary incomes policies to reduce inflationary expectations?

A. I think that what we have to stress now is that unemployment and reduced economic activity have been bred by years of inflation and lax financial policies. There is no way of reducing unemployment by rekindling inflation. Countries have tried that in the past and it just doesn’t work. Some immediate but artificial activity could well be created by a relaxation of demand management but sooner or later, probably sooner rather than later, inflation would get worse, savings would abate again, and balance of payments problems would become more acute; countries following those policies would be compelled to return to more restrictive financial policies which would, at that time, be even more costly for them and for the world as a whole. For this reason, we in the Fund strongly encourage all countries to engage in strong anti-inflationary struggles and to carry out these policies to the end.

On the costs to developing countries, I would like to point out that the Fund staff has been working on various scenarios for the World Economic Outlook. One scenario, which we call the central scenario, assumes that the industrial countries are successful in their anti-inflationary policies and by 1984 manage to return to sounder growth. In the second scenario, the same countries are assumed to relax their demand policies now. Clearly this second scenario would have much more serious, in fact dramatic, consequences on the developing countries than the first one in terms of growth and international trade. But the developing countries are not only interested in seeing that the industrial countries remain resolute in their efforts to control inflation, they are also keenly interested in the modalities of this anti-inflationary policy. They are particularly interested in the mix of fiscal and monetary policies adopted by major industrial countries and, of course, interested in its implications for interest rates in the world. They are also keenly interested in the approaches of industrial countries toward the question of open trade and official development assistance. On incomes policy, I would like to say that in our judgment whilst income policies, or I would prefer to say income practices, may be useful in combating inflation, they cannot be in any case the sole, or principal, element of such a policy. They can have a complementary role but they can’t take the place of a sound demand management policy.

In future issuesFinance & Developmentwill present other interviews with senior Bank and Fund officials.

Q. Many observers purport to have detected a sharp change in the degree of Fund conditionality in recent years. Specifically, they claim that there was a substantial loosening until about a year ago, but that the pendulum has swung since then toward much tighter conditionality. First, is this true? If so, what are the reasons for it?

A. To answer that question one has to recall what conditionality is about. Conditionality refers to the economic and financial measures which are needed in a particular country in order to restore a sustainable external position at the end or toward the end of a Fund program—that is, a deficit that can be financed by long-term capital flows without undue burden or strain on the debt service position of the country in question. For instance, if a country runs a balance of payments current deficit amounting to let’s say 8 per cent of its gross domestic product (GDP), and if in that particular case its sustainable deficit is considered to be in the order of 2 per cent of its GDP, an adequate three-year adjustment program would imply an adjustment of some 2 percentage points a year in the deficit of that country. But, suppose now, for the sake of the argument, that this same country has moved into a worse balance of payments position. For instance, a deficit of 12 per cent instead of 8 per cent of GDP because of an irreversible deterioration in its terms of trade or/and because of a slippage in its domestic financial policies. Its long-term sustainable financable position has not by the same token changed and it is still, in my example, at 2 per cent of GDP. The necessary adjustment would imply a reduction of a little more than 3 percentage points a year in the course of the three-year program. Now, in such a situation, which in fact often happens and has occurred in 1980 and 1981 with the worsening of international recession, the perception might have arisen that conditionality has tightened. But what has really happened is not a tightening of conditionality per se, it is a worsening of the external conditions of the country in question and the need for more adjustments.

A number of programs designed in 1979–80 have encountered such problems; putting these programs back on track implies in most cases supplementary adjustment measures. It has become necessary for the Fund, in view of these changing conditions, to obtain from members requesting assistance substantial assurances that the requisite adjustment measures would, in effect, be undertaken. More and more often the assurances are best provided by members willing and able to undertake policy measures right at the beginning of their programs and this is a requirement that the Fund relies upon quite frequently now.

It is important to have a clear understanding and a consensus on the crucial importance of conditionality in the present conditions. In the wake of the first oil shock, such a consensus had not been reached. Unconditional facilities, or facilities with light conditionality, were resorted to or designed in the expectation that the balance of payments problems might be reversible. It became very clear by 1978 that such an unconditional or “recycling-oriented” approach was not warranted by the realities of the situation as we saw it evolve at that time. Balance of payments must be adjusted and the Fund must link its high credit tranche resources to the adoption of meaningful adjustment policies by member countries.

Why did some people perceive or feel a loosening of conditionality a few years ago? Perhaps because conditionality was being again applied after a period of practically no conditional lending in favor of developing countries from 1974 to 1978. In addition, in the wake of the second oil shock and the consecutive explosion of external imbalances in 1979–80 the amounts of financial support provided by the Fund had rightly been increased in order to give the Fund that “critical mass” which is needed to entice member countries to agree on meaningful and realistic programs, and also to catalyze the provision of other external funds needed for the financing of the balance of payments problems in question.

In reality the degree of adjustment measured in terms of, for instance, annual reductions in external deficits relative to GDP has not decreased since 1978 as measured against the Fund’s long-lasting standards or experience. It has, if anything, increased because of the increase in the magnitude of the problems.

To summarize my answer I would say three things: 1) the Fund decided to abandon pure recycling methods after 1978; 2) the Fund decided to equip itself better financially in order to cope with balance of payments problems as they emerged in the wake of the second oil crisis in 1979–80; and 3) with the worsening of world conditions in the recent period the Fund has often insisted on supplementary measures to be taken by member countries in order to restore the initial objectives of Fund programs which had gone off track. Thus, as has been the case for more than 30 years, Fund conditionality has been constantly adapted—in the framework of its guidelines and under the guidance and control of its Executive Board—to the size of the imbalances and the stronger adjustment efforts they called for.

It is, of course, quite obvious that one cannot always resolve everything in one, two, or three years, especially in the case of the poorest countries whose abilities to effect adjustments are quite limited. In such cases, however, I do not believe the solution is to be found solely with the IMF. The Fund is not a development assistance agency. It has extended its terms and may now lend for up to 10 years within the framework of extended arrangements. But the structural difficulties that the least developed countries face in a complicated world cannot be resolved by an uncontrolled expansion of the lending facilities of the Fund. This approach would be fruitless and contrary to the very purpose of our institution, which is to provide medium-term balance of payments assistance on a revolving basis. If we think a country is not in a position to right its balance of payments within a few years, and that the adjustment measures that ought to be taken go beyond socially tolerable limits in the country concerned, the proper solution is to present the problem to the international community in very clear terms. We have done this on several occasions in the recent past. In cooperation with the World Bank, we then ask potential creditor countries directly concerned with the economic future of the country in question to take a close look at the financing problems. In the event, restoring a viable balance of payments position in such a country requires more than an improvement in economic policies; it entails long-term or grant-type international assistance as well. The Fund can play a useful role in implementing a “concerted action” which includes both a recovery program supported by the Fund and balance of payments assistance or development assistance from various other sources.

Q. When it comes to affecting policies of individual countries, some observers claim the Fund’s influence is severely limited, and only to deficit countries that come to the Fund for financing rather than to the market. Is this fair?

A. It is a fact that some countries need Fund financial support and, in order to obtain it, have to engage in negotiations on economic and financial measures incorporated in the programs, while some other countries do not have to resort to the Fund’s financial support either because they have ample access to capital markets or because they are in a surplus position. Now we can’t change that basic situation. But I think it would be wrong to infer from it that the Fund has little or no influence on its other member countries. As you know, the Fund has a surveillance function whereby it conducts with each of its member countries consultations on the policies of those countries, and this surveillance function is a very important one. We must strive in the Fund, and we do strive, to act in such a way that the Fund exercises surveillance over the exchange and related policies of all its members, those with a high degree of financial autonomy and those which have to borrow from the Fund, in a spirit of symmetry.

We must strive in the Fund, and we do strive, to act in such a way that the Fund exercises surveillance… in a spirit of symmetry.

I referred a moment ago to the mix of monetary and budgetary policies in major industrial countries which is so relevant for the world as a whole and for interest rates on the international markets which have such a bearing on developing countries. The International Monetary Fund has laid considerable stress on this matter in its consultations with the industrial countries, in its World Economic Outlook documents, and in my public statements. There are perhaps no immediate operational sanctions attached to our recommendations on surveillance but the Fund is an institution which holds a very high moral authority. A country, or a group of countries, which were openly in violation of the Fund’s major surveillance recommendations would be put under very strong pressure to right its or their situation. The existence of this surveillance function perhaps explains why there has been, in a time of floating rates, no open recourse to manipulation of exchange rates for competitive objectives.

Q. The Fund is now involved in a large number of low-income African countries. Many believe that in these countries, the problems of the balance of payments are inseparable from the problems of development and that, consequently, a true adjustment program would be a development program. Do you agree with this view? Is it not the case that these countries require far more economic aid than balance of payments assistance on Fund terms?

A. It is indeed true that the problems of many poor African countries are large and of difficult solution. Dealing with them on a systematic basis requires a careful analysis of the causes and nature of the balance of payments problems. It is important to ascertain whether they are temporary or permanent in character, and whether they are of internal or external origin. Such an analysis is an obvious first step before a balance of payments adjustment program can be designed for any one country. It is, of course, true that external circumstances, especially changes in terms of trade, do affect heavily the balance of payments position of African countries. It is fully within the competence of the Fund to assist countries to adjust to such developments. Externally originated imbalances, when they are permanent, need to be adjusted.

It is also true that in many instances the persistent balance of payments problems of most African countries have originated or have been compounded by inappropriate domestic adjustment responses to the impact of adverse external factors; we have had many cases where the implementation of domestic policies to keep domestic demand beyond sustainable levels has provoked external imbalances and at the same time has discouraged domestic supply through inefficient resource allocation and use. I hasten to say that these developments are not limited to Africa. Many other regions in the world, developed or developing, are the scene of similar inappropriate policy responses.

Adjustment programs supported by the Fund are directed at correcting the effects of inappropriate policies and of lasting deterioration in terms of trade and to this end they include demand restraint as well as supply-oriented measures. It is well known, of course, that the Fund’s balance of payments assistance is temporary and revolving in character and limited to a specific multiple of the member’s quota. These limitations and characteristics of the Fund’s intervention are an essential feature of the Fund and will not be changed. But it is important when devising a balance of payments adjustment program for a Fund staff mission not to make the wrong choices or the wrong recommendations as far as actual conditions are concerned. A fiscal or a pricing policy obviously has a major impact on the allocation of resources and the fundamental economic structural components of an economy. A monetary policy can discourage savings and encourage imports, or promote exports and encourage savings. So what is important is not that the Fund gets into long-term structural policies, but that the Fund, in designing a medium-term balance of payments stabilization program, should make sure that its adjustment measures are not incompatible with the long-term structural changes which are necessary in a country. That is why it is so important that Fund balance of payments missions rely in this area on the expertise of the World Bank. We have to cooperate actively with the World Bank in reaching the appropriate choices on stabilization measures which can have an impact, and a lasting impact, on the structural future of the country.

Q. Do you think that it is possible—or even sensible—to try to keep the Fund and Bank completely separate? Or would it be better to recognize that there is a degree of overlap and to try to promote coordinated and parallel activities?

A. The difference between the Fund and a development lending institution, such as the World Bank, can be seen most clearly by looking at the nature of the Fund’s lending and the policy focus of its programs.

The Fund’s resources are of a revolving nature. I spoke of this earlier. Countries borrow from the Fund when faced with temporary balance of payments disequilibria. The Fund provides this financing in the context of a policy program which is designed to return the country to a balance of payments position which can be sustained without continued recourse to exceptional financing and which enables the country to repay the Fund within a few years. The time frame of a Fund program, the policies adopted, and the financing provided all depend upon the nature and size of the disequilibrium, but the central feature of the program is always the implementation of a consistent set of macroeconomic policies which will enable the country to reestablish a sustainable balance between aggregate demand and supply in the economy.

The main objective of development lending, on the other hand, is to enable a country to invest more than it is able to save, thereby increasing its stock of capital faster than would otherwise be possible and raising its rate of growth over the long term. The basic assumption is that the country will, on average, have a current account deficit which is financed, inter alia, by development lending and that this net resource transfer will continue until some time in the future when the country reaches a higher stage of development. The primary policy focus of a development institution is, therefore, on the efficient use of productive resources. Is investment being directed toward the sectors and projects with the highest economic return? Does the incentive structure ensure that scarce resources are allocated efficiently?

Having drawn this essential distinction between the basic natures of the two types of institutions, I must emphasize that there are important areas of interdependence between the objectives sought by each. While the Fund and the Bank retain their separate responsibilities and functions, we call upon each other for advice within each institution’s area of expertise and consult and collaborate so as to ensure that the efforts of each institution reinforce the effectiveness of the programs supported by the other. The Fund, for example, looks to the Bank for views on the size and composition of a country’s investment program and for analysis of the microeconomic impact of pricing decisions, while the Fund provides the Bank with guidance on macroeconomic policies. Both institutions have found this type of collaboration to be most fruitful, and we fully intend to continue and expand our efforts in this direction in the future. It is, for example, becoming more common for staff members from one organization to participate in missions of the other.

Q. We read increasingly that Fund financial programs with members have broken down because the country was unable to meet performance criteria. Does this trend disturb you? What are the causes? Were the programs unrealistic to start with, or was the breakdown due to circumstances beyond the control of a particular country?

A. Well, first of all, I would like to answer by facts. Last September the Executive Board of the Fund reviewed the performance of all 23 member countries for which upper credit tranche stand-by arrangements were approved in 1978–79. This review showed that performance toward the major targets under these programs was as follows. First, the targets for the current account of the balance of payments were fully achieved in half of the programs. The current account improved in relation to GDP in almost two thirds of the cases. Second, the original targets for inflation were also achieved in about one half of the programs. Although the rate of price increase actually declined in only about a third of the programs, many of the programs provided for wide-ranging increases in officially set prices for price decontrol. Third, in almost two thirds of the programs credit expansion slowed down. On average for all programs the rate of credit expansion declined by more than 20 per cent. Fourth, on the fiscal front, substantial budgetary adjustments were made by many members. In more than a third of the programs the budget adjustment exceeded 2 per cent of GNP. In about a fifth of the programs the improvement in the budget was as high as 5 per cent of GNP or even more.

Now this performance is very obviously a mixed one and actual performance fell short of the targets in a number of cases. I would say roughly half. But here I would like to make a few remarks. First of all this is hardly surprising when one allows for the fact that conditions in the world economy during this period turned out to be much worse than expected when many of the programs were drawn up. In particular, the second wave of oil price increases took place during the period, adding to the strains on the balance of payments of many of these countries. Second, the record shows that the Fund’s programs have been healthy, albeit with the shortcomings that our review pinpointed, and they have been helping the borrowing countries to adjust and the world at large to achieve better international payments conditions. But there is much scope for achieving further improvement in the implementation of programs and this was recognized amply by the Executive Board during the last review. It was felt that much could be gained by putting more emphasis on early and prior policy action by member countries seeking Fund support. Improvements in our monitoring methods and devices were also called for. More extensive use of technical assistance by the Fund, particularly in the fiscal field, in helping countries to devise and carry out programs was also suggested.

To summarize, my answer to your question is yes, I am disturbed by the mixed performance of a number of our programs. Incomplete programs always should concern the Fund. Whenever such instances arise, we analyse these cases in detail to get at their causes, to find out whether they are the result of faulty programming, faulty implementation, or unanticipated events. Let me stress here that there are hardly ever any instances where causes of departures from the agreed programs can be classified in a very neat fashion. But to the extent feasible we try, and we must try, to ascertain their relative importance, and we are continually trying to find practical ways of eliminating or at least minimizing them.

The importance of performance criteria as signposts cannot be overstressed in a world economic environment that has not contributed to easing the problems of adjustment of members.

You mentioned in your question circumstances beyond the control of the member as one of the possible reasons for departure. There are, of course, numerous examples of this particular kind, most notably in recent times, energy price developments and, as I said a moment ago, recession and interest rate hikes. In many respects, they are the relatively simplest factors to identify, if not to deal with. If the circumstances are transitory, the departure is also bound to be transitory, and the program can be expected, without major changes, to return on track in due course. But, if these circumstances are not reversible, then further measures must be taken and there are well-established methods to reach understandings on the required policy adaptations.

In this context, I would recall that consultation clauses between the members and the Fund are standard features of Fund arrangements. More important, we should not lose sight of one of the most, if not the most, important roles of performance criteria. They are devised to provide signals about the performance of the economy. Thus, lack of observance, while it interrupts the member’s right to continue borrowing from the Fund, also serves to indicate the need for a review of the situation so that suitable understandings can be reached. The importance of performance criteria as signposts cannot be overstressed in a world economic environment that has not contributed to easing the problems of adjustment of members. Such an environment not only increases the hazards associated with the design of performance criteria but makes it difficult for many countries to steer a steady policy course for a sustained period.

Q. The balance of payments deficits of the non-oil developing countries seem to be deeply entrenched and growing. Are they sustainable over the medium to long term? If not, what measures should governments and international financial institutions like the Fund be taking to help correct the situation?

A. There has been an indepth study on this question. In our continuous World Economic Outlook projections we have been looking at 1985 as a horizon in order to assess whether the financial situation in the international payments field could be sustainable at that time and we have come out with very interesting findings. If adjustment measures are taken and sustained during the years 1982–85 in industrial and nonindustrial countries and if we keep an open international trade system alive, then the scenario that we have been developing under these assumptions, what we call our central scenario, shows that the external payments situation, the debt situation, would be manageable in 1985. Now this, of course, is a very global appreciation and there will be a number of countries in the mid-1980s, especially in the categories of low-income countries and producers of raw materials, which will encounter individually strained external situations. The debt service ratios that have been calculated in 1984–85 for those different categories of countries point to a high degree of indebtedness, not an unmanageable global situation but to high indebtedness situations for some.

Thus I would say that this analysis points to three lines of thought. The first is that the Fund should be strongly equipped financially to foster the adoption and implementation of meaningful adjustment programs, without which the sort of scenario described is not likely to happen. Second, substantial development assistance is needed especially for low-income countries if one wants to avoid the conjunction of low growth in those countries and unsustainably high debt situations. And, third, open trade and absence of protectionism is a key to the development of this rather optimistic scenario. If that doesn’t happen, then the whole logic and consistency of what I have explained falls apart.

Q. The number of cases of rescheduling of developing country debt to international banks has risen sharply in recent years. In most of these cases the country has responded to its payments problems by seeking both a restructuring of its debts and Fund support for its adjustment program. To what extent is there a need for coordination between the Fund and the banks in these cases?

A. First, let me say that one of the main lessons which has been learned from this experience is the importance of efforts on the part of all parties concerned to avoid the emergence of debt servicing difficulties. While the ultimate responsibility for debt management policy always rests with the country concerned, the creditors have sometimes taken perhaps too short term a view. We know too well of cases where lenders have been rather eager to step in when developments were favorable to them and finance levels of budget and balance of payments deficits, deficits that were unlikely to be sustainable over time, and then have been tempted to cut back rather sharply on new funding when problems began to emerge. Both borrowers and lenders must keep the medium-term outlook constantly in mind. The Fund can assist in this effort by stressing in its discussions with member countries the need for a well-formulated debt management strategy and by encouraging and facilitating the dissemination of information which lenders need to take such a medium-term view.

…the Fund should be strongly equipped financially to foster the adoption and implementation of meaningful adjustment programs…

The experience with recent rescheduling cases has also taught us the importance of a timely response once a problem does begin to emerge. It is in the interest of both the country and the banks to recognize that a formal, multilateral approach may be required at an early stage. When a rescheduling case is obviously open, I think there is no merit in delaying the discussions and the understandings. Once discussions have begun, the Fund can use its good offices to help the parties come to a joint understanding of what is reasonable and what is possible given the constraints faced by each side. The Fund can assist the country in formulating an adjustment program which will enable it to resume normal servicing of its obligations within a reasonable period of time. It can provide financial resources to the country in support of that program and can help explain the adjustment strategy to the country’s creditors. The banks, for their part, should be prepared to reschedule on terms which are consistent with such reasonable adjustment efforts and to maintain commercial relations with the country while that program is being implemented.

Q. Calls for the reform of the international financial institutions continue to be heard in the United Nations and other forums. Do you think that one day those seeking major reforms in the structure and operations of institutions such as the Fund will reach their objective?

A. Well, I can’t tell because I don’t know the future. But I believe the Fund is a very useful, and I may say, healthy institution in a very difficult world. I am not sure that we are ready now nor that we can at the present time conduct a negotiation on a fundamental reform of the monetary system. What we have to do in the immediate future is to cope with the massive problems of the present, to cope with them in the most skillful way possible and with the sense of practicality which has always been one of the major assets of this institution. But this does not mean that we should not be thinking and reflecting on the future evolution of the system. All systems evolve. There are always, in the world and in history, currents that move systems, and we in the Fund should be very attentive in seeking to understand what is happening in the world and to enable ourselves, when conditions are more suitable, to undertake a reexamination of the fundamentals. We should be able then to bring into that discussion inventive thoughts and practical ideas.

Q. How did you perceive the role of the Managing Director when you came into this office four years ago? Has it changed since?

A. No, I don’t think the role has changed. I have always perceived, and more and more with the passage of time, that this role is essentially twofold: first, serving the member countries by responding impartially to their guidance, and, second, running the institution and animating its staff in the most effective and forward-looking manner.

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