The experience with Fund-supported programs, 1980–81
Justin B. Zulu and Saleh M. Nsouli
Faced with mounting domestic and external financial imbalances, numerous African countries adopted adjustment programs supported by the use of Fund resources during 1980–81. The experience of these countries in carrying out their adjustment efforts establishes that the achievement of the objectives of programs has been closely linked to the effective implementation and adaptation of the requisite policy measures to reflect changing domestic and external conditions.
Prior to 1980, the economic and financial problems facing the African countries were manifested in sluggish economic growth, rising inflation rates, and widening deficits on the aggregate current account of the balance of payments. Real per capita income declined during the 1970s, while the rate of inflation approximately doubled, reaching an average annual rate of over 20 percent during 1977–79. The combined current account deficit of the balance of payments rose from about $4 billion in 1974 to close to $10 billion annually in 1978–79. The financing of these deficits partly by foreign borrowing led to a dramatic increase in external debt, from $15 billion at end-1974 to $46 billion at end-1979, contributing to a near doubling in the debt-service ratio. Further, international reserves declined sharply.
These deteriorating economic conditions reflected a number of adverse external factors and some domestic factors. Following the increase in oil prices in 1973–74, the industrial countries experienced a sharp decline in economic activity accompanied by a substantial acceleration in inflation. For developing countries these events tended to have an adverse effect on demand for their exports and to worsen their terms of trade. The increases in oil prices further directly aggravated their already widening current account deficits.
Domestic financial policies, which were not promptly adapted to the emerging situation, also played a role. In particular, many African countries had embarked on ambitious public investment programs and had rapidly expanded government current expenditures. In some countries the improving prices of primary and mineral products of the late 1960s and early 1970s had contributed to an increase in government revenues and export proceeds that allowed such expansion. As demand for exports tapered off and their terms of trade deteriorated, budgetary receipts started to lag behind the growth in expenditures and budgetary deficits widened. Increasingly, these deficits were financed by domestic bank and external borrowing. The expansion in credit to the government sector, accompanied in some instances by an accommodating stance on credit to the private sector, increased the pressures on domestic prices and the balance of payments.
This study covers countries that had programs in effect during 1980–81. These were the Central African Republic, Equatorial Guinea, Ethiopia, Gabon, The Gambia, Ivory Coast, Kenya, Liberia, Madagascar, Malawi, Mauritania, Mauritius, Morocco, Senegal, Sierra Leone, Somalia, Tanzania, Togo, Uganda, Zaire, and Zimbabwe.
Countries generally resorted to price controls, consumer subsidies, maintenance of low producer prices, administrative controls on imported goods, and, in many cases, exchange rates were maintained at levels incompatible with financial stability. In particular, the import restrictions resulted in shortages of consumer as well as intermediate and capital goods. The imbalances were reflected in a widening of parallel markets for goods and foreign exchange. The growing distortions contributed significantly to the slowdown in economic activity.
Accordingly, as the African countries entered the decade of the 1980s, they faced major financial and structural problems that urgently needed to be addressed. A number of these countries worked closely with the Fund to design and implement appropriate adjustment programs during 1980–81. The total amount committed under programs supported by use of Fund resources rose sharply from SDR 455.2 million at the end of 1979 to SDR 1.8 billion at the end of 1980 and further to SDR 4.3 billion at the end of 1981. Purchases nearly doubled in 1980 and more than doubled in 1981, reaching a record SDR 1.7 billion.
In providing financial support for adjustment programs, the Fund follows its guidelines on conditionality, which were reformulated in 1979. These guidelines emphasize the need to encourage members to adopt corrective measures at an early stage of their balance of payments difficulties. They also provide that, while the normal period of a stand-by arrangement will be one year, in some cases they may extend up to three years; that a flexible approach to the treatment of external borrowing in adjustment programs needs to be adopted; and that due regard has to be given to the domestic social and political objectives, the economic priorities, and the circumstances of members—including the causes of their balance of payments problems. Within this general framework, considerable flexibility has been maintained in the application of conditionality. Particularly in countries with severe structural problems, greater emphasis has been placed on supply-oriented policies and increased financing over a sufficiently long period to allow fruition of the effects of the measures taken.
While the Fund provided resources to support appropriate adjustment programs, a primary concern of the African countries that adopted such programs was the achievement of a sustainable level of economic growth. However, the key to such sustainability was the establishment of domestic and external financial stability. If a country had high levels of domestic inflation, often reflecting excess demand pressures, savings and investment would be discouraged, leading to a drop in economic growth. Similarly, if a country faced protracted external imbalances, the shortage of foreign exchange could result in a curtailment of important imported inputs and capital goods. In addition, the distortions arising from an inappropriate exchange rate could undermine both the export-oriented and import-competing industries. Again, therefore, the sustainability of economic growth would be impaired. Accordingly, in the general design of these programs, the three basic and interdependent objectives were to promote economic growth, to reduce inflation, and to improve the current account position of the balance of payments over the medium term.
Considerable emphasis was given to economic growth in the programs under consideration; most aimed for an increase in economic growth during the program year. Nearly all programs attempted to contain inflation to about 15 percent per annum, implying for most a reduction in inflation from the previous year. In a number of cases, however, an increase was projected. This reflected a certain degree of pragmatism as to how much, if at all, inflationary pressures could be controlled in the span of one year, and in some cases reflected necessary adjustment of controlled prices within the country. Although programs generally emphasized an improvement in the external sector position, medium-term considerations did not always allow for an improvement in the current account position or in the overall balance of payments in the span of one year. This was particularly so in the case of supply-oriented programs, where an expanded level of investment financed by external financial assistance could involve an increase in associated imports contributing to a short-term widening of the current account deficit. However, such investment was viewed as contributing to the productive capacity of the economy and as being conducive to increased exports or reduced imports over the medium term.
In attempting to attain these objectives, each program was designed differently. Each addressed the specific problems of the country concerned, took into account the macroeconomic relationship imposed by the institutional framework, and set the quantitative targets for the instruments selected. Since most of the African countries under consideration faced, and continue to face, deep-rooted structural problems, the programs generally emphasized supply-oriented policies, designed to bring about structural change, and financial policies aimed at reinforcing the structural adjustment process and limiting the growth in demand. These entailed measures to (1) affect growth, (2) enhance financial management, and (3) improve the external position.
First, since economic growth is heavily dependent on the level of domestic capital formation, provided that the investment undertaken is allocated efficiently, the programs incorporated measures to strengthen the development planning process. In recommending these measures, the Fund relied heavily on the expertise of the World Bank. In addition, to improve resource allocation and mobilize domestic savings, as well as to encourage private sector investment, the programs paid close attention to pricing policies. In particular, the programs aimed at reductions in the scope of price controls and subsidies and, where applicable, the adoption of realistic producer prices. Where public sector enterprises played an important role in production, the operations of public enterprises were also carefully reviewed, and these were, in a number of cases, streamlined. In other cases, where these enterprises were considered not viable on efficiency grounds, they were phased out. Clearly, public enterprises cannot be judged solely on a profit basis when they provide vital social services. However, social services should be specifically financed in the budget; profit-oriented public enterprises should not be called upon to provide them.
Second, given the size of the financial imbalances in most countries, financial stability could not be reestablished without significant measures to improve the fiscal position. On the revenue side, a number of programs included tax measures designed to expand the revenue base and to increase the elasticity of the tax system. In many cases, improvements in tax collection procedures also contributed considerably to revenue performance. On the expenditure side, there was usually an emphasis on limiting the growth in current expenditures, largely through more efficient expenditure controls, closer scrutiny of new government hiring, restraint in granting salary adjustments, and economies in administration and other expenditures. Capital expenditures were generally assessed against the availability of resources and carried out within the context of the macroeconomic framework of the development plan. Because of the attempt to improve revenues and contain expenditure increases, nearly all programs aimed for a reduction in the ratio of the government deficit (excluding grants) to GDP.
As monetary policy was heavily dependent on fiscal developments in many of the countries under consideration, the more restrained fiscal policies generally allowed the monetary authorities to follow a more flexible credit policy toward the private sector, contributing thereby to the promotion of private economic activity. For countries where the growth of credit to the private sector had been relatively modest in the previous year—and these constituted the majority of the program countries—the programs aimed to increase the growth of private sector credit. Within the context of monetary policy, most programs involved adjustment in interest rates with a view to improving domestic resource allocation, enhancing the process of financial intermediation, and promoting domestic savings and investment.
Third, the programs generally addressed three main issues affecting the external sector: restrictions on current international transactions, exchange rate policy, and external debt. Restrictions had usually been imposed in response to rising imbalances; without such controls, there would have been, at the prevailing exchange rate, a shortage of foreign exchange in the country and pressures on the exchange rate. Such restrictions were thus symptomatic of the need for adjustment. All programs, therefore, attempted to deal with the underlying imbalances in order to enable the country to reduce the restrictions.
The exchange rate, with appropriate supporting policies, is a major instrument in the adjustment process. An inappropriate exchange rate generates cost-price distortions that have a negative effect on consumption and investment as well as on the trade balance, as it tends to reduce the profitability of export-oriented and import-competing activities in the country. These effects all have a detrimental impact on economic growth. The appropriateness of the exchange rate level, therefore, was carefully reviewed in the context of the programs under consideration. In several cases, exchange rate action was taken. A notable example is Somalia, which devalued its currency by 150 percent in domestic currency terms during 1981–82 (see box). Uganda also devalued its currency by about 100 percent over May 1981-June 1982. In both instances, dual exchange rate systems were introduced on a temporary basis. Another example is Zaire, which devalued its currency in mid-1981 by about 67 percent. Finally, given the importance of achieving a sustainable external debt position, Fund-supported programs aimed at containing the external debt burden to levels consonant with the debt-servicing capacity of the country.
It is difficult to assess the performance of a country on the basis of a few quantitative indicators, insofar as progress made in certain areas in the adjustment process may be unquantifiable and the effects of measures taken may start to be felt only after a considerable gestation period. For instance, the effects of measures contributing to a reduction in economic distortions may take time to materialize fully and cannot be readily quantified. Nonetheless an impression of the progress made can be gathered from examining two basic yardsticks: the targets of the program and the previous year’s performance. Economic growth targets were achieved in about one fifth of the cases; the inflation targets were met in nearly half the cases; and the external sector targets in about two fifths of the cases. The ratios of savings and investment to GDP were generally close to targets. While the ratios of government revenues (excluding grants) to GDP were in most cases close to targets, government expenditure ratios generally exceeded targeted amounts. Because of this, the budgetary deficit (excluding grants) as a proportion of GDP was considerably exceeded in two thirds of the countries. The rate of growth of net credit to the government, accordingly, generally did not conform to targets. Further, credit to the private sector was exceeded in numerous cases. Reflecting these developments, net domestic credit growth exceeded the targets in about half the cases.
Given these deviations, how did the countries perform relative to the preprogram year? In terms of economic growth, there was a considerable improvement in 40 percent of the cases. Inflation was reduced in over half the countries and the current account position of the overall balance of payments improved in about half the countries. Turning to the indicators of policy, there were no major changes in savings and investment. Government revenue (excluding grants) as a ratio to GDP increased sufficiently to offset the rise in the ratio of government expenditures to GDP, bringing about an improvement in the government budget (excluding grants) as a proportion of GDP in about 60 percent of the cases. On the monetary front, in most cases net credit growth to the government sector remained about equal or declined, while credit growth to the private sector was nearly equal to or exceeded the previous year’s rates. Overall net domestic credit expansion was in most cases nearly equal to or less than the previous year’s.
There is a striking correlation between the attainment of the objectives and the observance of policy measures. In 14 programs in which all or a major part of the policy measures were observed, most of the targets were attained. In 9 cases, where the policy measures were generally not observed, the objectives were not attained. Accordingly, in 23 of the programs there was a close correlation; only in 7 was the relationship not established.
When slippages in implementation occurred, they were primarily due to the emergence of unforeseen developments, an inability to mobilize sufficient political support for the requisite adjustment measures, limitations in the administrative infrastructure, overoptimistic targets, and delays or shortfalls in net inflows of development assistance. However, unforeseen events were encountered both by countries that succeeded in implementing the programs and by countries that did not. This suggests that adjustment can be kept on track if unforeseen factors are handled by readapting and reinforcing policies to limit the deviations from the adjustment path. This would imply the intensification of the adjustment efforts, for which a strong political commitment would be necessary.
Review and prospects
During the last four years, the economic conditions generally in Africa have not shown signs of improvement. Economic growth has remained below the population growth rate. Inflation continued to rise in 1980–81 to an average annual rate of about 25 percent, but tapered off somewhat in 1982–83. The terms of trade declined sharply, reflecting in part the recession in the industrial countries. The current account deficit climbed from about $10 billion in 1979 to an annual average of about $14 billion in 1980–83. These deficits continued to be financed primarily by foreign borrowing, with the result that total outstanding external debt rose by about 50 percent and reached over 50 percent of GDP. The rising international interest rates contributed to an even steeper rise in the debt-service ratio, which nearly doubled.
Somalia’s adjustment experience, 1981–83
Against a background of virtual stagnation in economic activity and increasing financial imbalances, the Somali authorities launched in mid-1981 a major adjustment effort, supported by two consecutive stand-by arrangements with the Fund ending in January 1984. The programs included major measures on both the supply and demand sides, which together with favorable weather conditions have contributed to promoting economic growth, reducing inflationary pressures, and strengthening considerably the external sector position.
Somalia is basically a pastoral economy, with over 80 percent of its population (estimated at 5 million) engaged in livestock raising and agriculture for their livelihood. With an extremely small industrial sector, Somalia is highly dependent on imports for consumer and investment goods.
During the 1970s, a series of internal and external developments, including a severe drought in 1974–75, the outbreak of regional hostilities in 1977–78, and an ensuing inflow of refugees, adversely affected economic performance. By the end of the decade, widening budgetary deficits, financed primarily through the banking system, were exerting considerable pressure on the price level and the balance of payments. In 1980, economic activity stagnated, and the rate of inflation reached 59 percent. Furthermore, the balance of payments deficit led to a sharp drop in international reserves, while external debt arrears accumulated.
In mid-1981, the Somali authorities adopted a major adjustment program, supported by a one-year stand-by arrangement from the Fund, designed to promote economic growth while curtailing the expansion in domestic aggregate demand. On the supply side, the key measures included a devaluation of the Somali shilling by 50 percent in foreign currency terms for most foreign exchange transactions (the main exception being imports of specified essential goods), the liberalization of private sector imports through official channels, increases in the producer prices of most agricultural products, closures and reassessments of public enterprises, and the strengthening of development planning. On the demand side, fiscal and monetary policies were significantly tightened, with the interest rate structure revised upward. The overall government deficit was narrowed in 1981 to 30 percent of expenditure from 39 percent in 1980. Growth of net credit to the Government from the banking system was sharply reduced, while credit to the nongovernment sector was allowed to expand faster than in the previous year in order to promote private sector economic activity. Consequently, in 1981, the rate of overall domestic credit expansion was only about half the 1980 rate.
These measures, together with favorable weather conditions that led to increased agricultural production, resulted in the marked improvement in the performance of the Somali economy. Although Somalia has no official national income accounts data, Fund staff estimates show that the growth of economic activity accelerated sharply in 1981, reaching about 5 percent. During the second half of 1981, prices started to decline, with the result that, notwithstanding a high rate of inflation in the first half of the year, the annual rate of inflation for 1981 fell to 44 percent. Simultaneously, the external sector position improved significantly—the overall balance of payments deficit of $13 million was nearly half that recorded in 1980 and almost one tenth of that projected in the program. The Central Bank’s international reserves increased, and the country’s external payments arrears were reduced to about one third of their end-1980 level.
To consolidate the progress made in 1981, the authorities adopted a new stabilization program in mid-1982, supported by an 18-month stand-by arrangement with the Fund with policies aimed at effecting structural changes to lay the foundation for accelerated adjustment. The objectives included maintenance of the growth momentum of the economy, further reduction in inflation, and attainment of a sustainable external sector position over the medium term.
A variety of measures were taken to stimulate supply: the Somali shilling was further devalued, for instance, and a managed floating exchange rate system was introduced; controls on private sector imports were further eased; and marketing and pricing policies were liberalized.
Supply-oriented policies were reinforced with tight fiscal and monetary policies, including a further increase in interest rates. Budgetary operations were generally kept under strict control, despite the recurrence of a border conflict. The Government reduced its net indebtedness to the banking system, effectively releasing resources to the nongovernment sector. Meanwhile, credit to the private sector grew markedly in both 1982 and 1983, to meet resurgent demand. The expansion in domestic liquidity was reduced in 1982 to almost half the 1981 rate, while in 1983, domestic liquidity is projected to have declined significantly.
Reflecting the policies implemented and continued favorable weather conditions, economic growth is estimated to have almost doubled in 1982. Agricultural production, in particular, benefited from the effects of the devaluation and the liberalization of pricing and marketing policies. The rate of inflation was nearly halved. Moreover, despite an unexpected capital outflow, the overall balance of payments outcome was relatively close to the program target. By the end of 1982, Somalia had eliminated all its outstanding external payments arrears. In 1983, adverse weather conditions and a ban imposed by Saudi Arabia on cattle imports from Africa had a serious impact on the Somali economy. The effects, however, were mitigated by the policies pursued, with the result that the rise in the rate of inflation is estimated to have been limited and the current account deficit of the balance of payments to have been narrowed.
By undertaking a major adjustment effort, Somalia has been able to achieve, within a short span of time, substantial improvement in its economic conditions. The contribution of the measures undertaken since 1981 can be expected to be fully realized over the medium term. In this context, the continued pursuit of appropriate economic and financial measures, the formulation and implementation of an appropriate public investment program, and the availability of external financial assistance at concessional terms will affect critically the medium-term prospects of the Somali economy, in particular with regard to the achievement of a sustainable rate of economic growth under conditions of financial stability. Cognizant of these facts, the Somali authorities have prepared for 1984–86 a program for the rehabilitation and consolidation of the economy, including a public investment program, which was favorably received at a Consultative Group Meeting for Somalia organized by the World Bank and held in Paris in October 1983.
Nur Calika, Economist, East African Division, IMF
The immediate prospects for 1984 indicate that African countries will continue to face sluggish rates of economic growth, a high rate of inflation, and a difficult external sector position. The international economic and financial environment is expected to improve; if it does not, it may compound the difficulties that the African countries will face in carrying out their adjustment efforts. In the African region, foreign grants have essentially remained constant in nominal terms since 1979. Therefore, the trend has been for a significant decline in the real value of foreign grants. There are no indications that this trend is likely to be reversed in the foreseeable future. Further, net foreign capital inflows in the African region have remained virtually constant in nominal terms since 1978, implying also a severe real reduction. The recent developments in international capital markets have increased the sensitivity of commercial bankers to the possible risks involved in lending to the non-oil developing countries. As a result, commercial bank lending to developing countries in general is expected to be considerably tighter during the coming years. Furthermore, concessional foreign loans are likely to be constrained by the recent developments in the external position of major oil exporting countries. Thus, both in terms of commercial borrowing and foreign aid, the African countries are likely to face greater constraints in the coming years.
Against this background, the need for adopting appropriate adjustment measures becomes even more urgent and underscores the fact that the adjustment process cannot be viewed as a temporary facet that moves a country from a disequilibrium to an equilibrium position. As both domestic and external economic conditions change, domestic policies have to be readapted continuously to maintain the economy as close as possible to a position of financial stability. The Fund can play an important role in assisting the African countries in two main ways. First, it can provide considerable assistance in the area of policy formulation to contribute to improved financial management. Fund programs generally contain an integrated set of policies that, by reestablishing domestic stability and external financial viability, can contribute to the attainment of a sustainable growth path. Second, the Fund can contribute directly and indirectly to the provision of the necessary external financing to ease the burden of adjustment. Under stand-by or extended arrangements, countries have access to Fund resources. More important, the Fund can play a catalytic role, by working closely with the commercial financial community, as well as with donor governments, to foster an integrated and coordinated effort to secure necessary additional financing. The integrity of Fund conditionality provides the necessary assurance to the international financial community to participate in such financing.
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