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Collaboration between aid agencies and the IMF

Author(s):
International Monetary Fund. External Relations Dept.
Published Date:
March 1986
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Richard D. Erb

I have been asked to discuss some of the practical aspects of coordination of financial flows to developing countries in the context of Fund-supported economic programs … . Over the past five years the Fund’s involvement with these countries has been particularly diverse and intense. The three main overlapping areas of activity include Fund financing of economic programs, Article IV consultations, and technical assistance … .

The increase in Fund activity in low-income countries, especially Fund lending, reflected the serious economic imbalances in these countries arising from adverse external developments and domestic policy weaknesses. Associated with the increase in Fund activity has been greater collaboration with aid agencies and development finance institutions and, in particular, the World Bank… .

I also need not elaborate on the important, and I would add healthy, differences in the mandates, expertise, financial structures, and relationships with countries that characterize each of our respective institutions, but from the perspective of the International Monetary Fund I would like to make some general observations on why collaboration between the Fund, the World Bank, and aid agencies is important and growing. First, our respective institutions share common objectives in seeking to help countries promote economic growth in the most efficient way and in the context of a balance of payments that can be financed over the short and medium term. Economic growth and a sustainable balance of payments are not conflicting objectives but go hand in hand. The experience of many countries indicates that economic growth is not durable if domestic and external financial imbalances emerge.

This latter point leads to a second justification for close collaboration: aid agencies, development banks, and the Fund work with individual economies whose components are integrated… As recent experience in many countries has demonstrated, a well-prepared and executed project or investment program may be undermined by a deteriorating economic environment caused by rising inflation and a growing fiscal imbalance, or by price and exchange rate rigidities. At the same time, the achievement Of broad fiscal, monetary and balance of payments targets may be jeopardized and growth prospects weakened if resources flow to unproductive investments. Through collaboration, a sharing of analyses enhances our mutual understanding of the complexities and interrelationships in an economy and improves the prospects that policy advice and financial support provided by our respective agencies will enhance economic growth and external stabilization.

A third factor that has indicated closer collaboration stems from the need to better coordinate and indeed reinforce the financing that is provided by each institution. The macroeconomic assessments of the IMF and the sectoral and investment program assessments of the World Bank provide a firmer base on which aid programs may be formulated and financing requirements evaluated. At the same time, the total magnitude of financing available from all sources has a significant impact on the policy choices and the short- and medium-term growth prospects of a country. This is particularly true for countries which have been hit by internal or external shocks, such as a drought or sudden decline in the terms of trade, and are being supported by IMF balance of payments assistance.

It is sometimes suggested that greater collaboration between the IMF and development finance institutions is needed in order to provide a better meshing of the perceived short-run perspective of the IMF and the perceived long-run perspective of development agencies. While I believe that different time horizons shape our respective activities and that this is another reason for closer collaboration if our institutions are to better serve low-income countries, the notion that the Fund is only short-run oriented and development agencies long-term oriented is misleading… .

Issues for future cooperation

… I would like to identify some concrete issues that I think would be useful to address as we look to the future and strengthen collaboration.

(1) Medium-term analysis. In recent years, the Fund has been devoting more effort to providing analysis and policy advice within a medium-term context. Normally the staff attempts to put its analysis in a three- to five-year framework. This is done not only in the context of extended Fund facility programs but also one-year stand-bys and Article IV consultations… .

Among the unknowns that often make it difficult to develop a firm medium-term outlook … are … first, Fund missions often find that it is difficult to evaluate a country’s public investment prospects because aid agencies and development institutions are not firm with respect to the projects or sectors they intend to support over a two- or three-year period. Even when projects or sectoral programs may be identified, often the timing of disbursements is uncertain.

A second factor … is the uncertainties surrounding the form, magnitude, and timing of external financing flows. Low-income countries depend primarily on official sources of finance, but most official sources of finance, including those providing debt rescheduling, do not normally provide financing plans for a period beyond one year. Indeed, the Fund is subject to criticism if it goes too far in making assumptions about official financing and debt rescheduling beyond the immediate short run. In short, if the Fund is to make further progress in helping countries to develop their policies in a medium-term framework, aid agencies and development institutions will also need to be more forward looking and less short term in their orientation. The Fund could assist aid agencies in this regard by providing more detail in medium-term projections on the growth and balance of payments implications of different assumptions about the volume and timing of foreign assistance.

(2) Adjustment program design … the Fund has supported a number of economic adjustment programs implemented by low-income developing countries over the past five years. In many countries faced with a deteriorating current account position—and sometimes accompanied by deteriorating external financial flows—major policy adjustments were necessary to reduce public sector demand, to constrain money and credit growth, and to establish appropriate price incentives through changes in exchange rates, domestic prices, and interest rates. The magnitude of those adjustments depended importantly on the magnitude of additional official assistance … . But whatever the magnitude of adjustment required to live within external resources, an effort was made by Fund missions to encourage governments to cut budget deficits to help reduce imbalances between aggregate demand and supply. Where possible, missions encouraged governments to cut consumption expenditures or raise revenues rather than cut investment expenditures … .

I realize that in the course of such adjustment some bilateral and multilateral development assistance programs were curtailed. In some cases, investments were cut because a government’s total resources were not adequate and the government had alternative priorities. In other cases the development assistance was cut because the investment projects no longer were productive in light of the changed economic conditions. From this experience I draw a conclusion …: while it is important for the Fund to encourage a country faced with the need to adjust to changed economic circumstances to protect investment projects conducive to long-term development and growth, it is also important for aid agencies to reassess periodically whether a project or a development program makes sense in light of changed economic circumstances … .

Most countries faced with the need to adjust to domestic imbalances or changed economic circumstances must consider structural changes, including not only changes in exchange rates and prices but also, for example, the elimination or restructuring of state enterprises. Although such adjustments lead to more efficient use of resources and have a positive impact on economic growth, the experience of the Fund suggests that such structural adjustments are often more difficult for governments to implement than overall cuts in government expenditures or monetary restraint. This occurs because sometimes the negative impact of such adjustments is felt by some sectors before the positive effects are experienced in other sectors … . However, to the extent that aid flows can be quickly redirected toward activities or sectors of an economy that have become more efficient because of a structural adjustment in exchange rates and prices, the quicker and more dramatic the growth impact. The availability of raw materials and spare parts and infrastructure repair in a sector favorably affected by an exchange rate change will accelerate the productive response in that sector. This leads me to another conclusion …: while it is important for development assistance agencies to frame their assistance within a medium-term framework, it is also important to be flexible and responsive to new development opportunities which may arise because of changing economic conditions. In this context aid agencies might consider linking a certain proportion of their aid to support improved policies rather than projects in low-income countries.

(3) Financing adjustment programs. Fund-supported adjustment programs are sometimes criticized for being too harsh and for forcing governments to sacrifice economic growth and subject their citizens to austerity. Unfortunately, the adjustments faced by many countries are difficult and a cause of political and social tensions. But it is the build-up of economic imbalances and the inability of a country to live within available foreign resources that ultimately forces an adjustment … . In providing support, the Fund itself is able to help alleviate the external financing constraint by providing quick-disbursing, untied balance of payments assistance. Relative to aid agencies and development assistance institutions, the monetary role and character of the IMF enables the Fund to play a major financing role in the early years of an adjustment period and thus ease the adjustment process for countries.

When expected aid flows, World Bank assistance, and Fund assistance are not adequate to meet a country’s immediate financing needs in the early years of adjustment, the Fund and the World Bank usually make an effort to help a country seek additional assistance in special donor meetings … If the additional foreign assistance is disbursed irregularly and over a longer period of time, the detrimental impact on an economy’s short-run and long-run development and growth prospects is severe. Thus, I would draw yet another conclusion that I believe is relevant to our discussion of collaboration: in order to promote economic growth and development, development assistance agencies need also to consider ways of providing some quick-disbursing, untied aid in a short-run framework.

Over the coming years it will be important to ensure that external financing is available to sustain the adjustment efforts low-income countries have been undertaking in recent years. The Fund is willing to continue supporting these efforts, but Fund financing on a growing and sustained basis would not be consistent with the monetary character of the Fund, the already high debt-service burdens of many of the low-income countries, or with the protracted nature of their problems… .

Low-income countries have little access to additional commercial bank lending and, in any case, substantial bank lending would not be compatible with their debt-carrying capacity. Thus, the bulk of external financing for low-income countries will need to be provided on concessional terms either directly from bilateral aid agencies or through multilateral development institutions. Of course, there is some trade-off between an increase in the volume of aid and an increase in aid efficiency. However, I believe it will be necessary for donor countries to try and find ways of increasing the volume of aid to low-income countries to facilitate the difficult adjustment measures that are needed and to ensure that such adjustment does not come at the cost of a further decline in living standards in the short run and more quickly restores the basis for economic growth and a sustainable balance of payments.

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