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World Bank Lending for Structural Adjustment:A review of the Bank’s approach and experience

Author(s):
International Monetary Fund. External Relations Dept.
Published Date:
June 1987
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ThenatureoftheBank’ssupportofreformeffortsinmembercountriesandareviewoftheexperience

Constantine Michalopoulos

The World Bank has always stressed the need to use limited investable resources efficiently. In this quest it has attempted to identify investment priorities in recipient countries and lent for projects that promised a high rate of return. Over the years, the Bank has also recognized that it is virtually impossible to have a good project in a bad policy environment. It has, therefore, consistently tried, for instance, to promote appropriate pricing policies for public utilities and agriculture, two sectors for which the Bank has lent considerably. Until recently however, less emphasis was placed on lending that directly supported changes in the macroeconomic environment or in the national economic policies of developing countries.

As the turbulent economic events of the last decade unfolded, Bank programs changed to meet the challenge of adjustment in the economies of member countries. While project and sector investment activities continued to absorb the largest portion of Bank loans and credits, new instruments were introduced, such as structural adjustment and sector adjustment loans and credits. These instruments were designed to support developing countries’ programs and policies of structural reform.

This article looks at structural and sector adjustment lending by the Bank up to the end of 1985. It is based in part on the findings of a major review of 15 structural adjustment loans to ten countries over 1980-82.

Types of lending

There are currently five categories of Bank lending operations: (1) specific investment loans; (2) sector operations, which include sector investment and maintenance loans, financial intermediary loans, and sector adjustment loans (SELs); (3) structural adjustment loans (SALs); (4) technical assistance loans; and (5) emergency reconstruction loans (see table). In practice, the conceptual distinctions between these categories are sometimes blurred, and individual operations can combine different categories. Before structural adjustment lending was introduced in early 1980 (and in some instances thereafter), the Bank also provided a few program loans and credits that were quite similar to the SALs.

Developing country policy issues arise in different contexts in almost all categories of loans. But the loans focus attention on different objectives in each case. In specific project and sector investment loans (and also in financial intermediary loans), for example, the focus is on specific policies that affect the viability of the project or the entity being assisted, such as input and output prices, lending rates to sub-borrowers, and so on. Similarly, technical assistance loans are primarily designed to strengthen and support institutions. Sector adjustment loans help promote the introduction and effective implementation of sectoral policies necessary for sustained economic growth. Finally, structural adjustment loans concentrate attention on macroeconomic policies and associated institutional changes at the national level—although they frequently emphasize reforms of special relevance to particular sectors in which adjustment is most urgently needed. The Bank’s Operational Manual defines structural adjustment lending as “non-project lending to support programs of policy and institutional change necessary to modify the structure of an economy so that it can maintain both its growth rate and the viability of its balance of payments in the medium term.” Thus there is a continuum in the aims of various forms of Bank lending, beginning with policies and institutions to ensure the viability of a narrowly defined project, and ending with the adjustment and operations of macroeconomic policies and institutions of a country.

This does not mean that macroeconomic policies cannot be affected by specific project lending. Indeed, heightened concern about the policy framework can and does substantially affect the context and focus of project operations, which are likely to continue to absorb the bulk of the Bank’s future lending. But structural adjustment lending enables the Bank to address basic issues of economic management more directly and more urgently than before.

Distribution of World Bank loans and credits, by lending instrument, fiscal years 1975-86 1(In percent)
Type of loan19751979-801961-821983198419851986
Specific Investments58.558.544.739.441.149.645.2
Sector operations32.636.145.449.648.246.945.4
Sector investment15.922.526.324.626.427.019.0
Financial intermediary16.713.118.620.613.39.612.4
Sector adjustment0.00.50.54.48.510.314.0
Structural adjustment 28.83.38.09.68.41.15.0
Technical assistance0.20.41.71.22.11.41.4
Emergency reconstruction0.01.20.20.20.31.03.1
Source: Planning and Budgeting Department, The World Bank.Note: Details may not add to 100 due to rounding.

Bank fiscal year ends June 30.

Includes both program and structural adjustment loans and credits.

Source: Planning and Budgeting Department, The World Bank.Note: Details may not add to 100 due to rounding.

Bank fiscal year ends June 30.

Includes both program and structural adjustment loans and credits.

The policy focus

The main purpose of Bank sector and structural adjustment loans is to facilitate the adjustment required to achieve sustainable growth and the mobilization of external financing needed to support a country’s adjustment efforts. This goal is seen by the Bank as a medium-term target. Adjustment loans help delineate the annual steps to be taken in support of the policy reforms needed to promote sustainable growth in the medium term. Subsequent steps are supported by additional loans of various kinds, so that the implementation of a reform package is covered by a series of Bank lending operations over a period of several years. In all cases reform programs have required a firm commitment on the part of governments to maintain the course of the reform effort over time.

Most aspects of macroeconomic and sector policy have been covered by Bank nonproject lending. Such lending has been coordinated with the Fund to supplement the Fund-supported programs in specific countries. While the Bank has deferred to the Fund on matters of monetary and exchange rate policy, it has sometimes been involved in the institutional reform of exchange rate management (as in the case of setting up foreign exchange auction systems in Nigeria and Somalia). It has also worked closely with the Fund on matters pertaining to the reform of interest rate policies (e.g., in Jamaica).

While individual programs have dealt with different policy issues according to the priorities and objectives of individual countries, the Bank has emphasized the following broad and interrelated areas:

• Mobilization of domestic resources through fiscal, monetary, and credit policies. This includes support for both measures to increase revenues and measures to control or reduce expenditures; for efforts to restrict public sector or external borrowing; and to decontrol or restructure interest rates.

• Improving the efficiency of resource allocation and use by the public sector. This includes support for rationalizing public sector investment; strengthening the efficiency of public sector and parastatal enterprises, and rationalization of public sector programs (including divestiture of public holdings in enterprises).

• Reform of the structure of economic incentives in order to reduce distortions, promote more efficient resource allocation, and thus create a more productive economic structure. Within this area, two sets of policy issues are receiving the greatest attention: first, reforms of trade regimes to reduce the bias against exports, and to lower the level and rationalize the pattern of protection. Second, reforms of price systems to make prices more accurately reflect opportunity costs (e.g., in agriculture, energy, and state enterprises).

• Institutional strengthening to help foster adjustment with growth. A variety of reforms are being pursued in different countries depending on their needs. In some cases the aim is to strengthen institutions whose performance is critical to the success of other reforms, for example, agricultural extension in support of agricultural policy, improvements in the customs service linked to trade reform, or general tax collection related to broader tax reform. In other instances, reforms are sought in broader macroeconomic or public sector management or take the form of specific improvements in institutions providing public services. There is little distinction between the policy reforms supported by structural adjustment loans and sector adjustment loans. The main difference lies in the comprehensiveness of the policy and institutional reform involved. Relatively few countries have prepared comprehensive and implementable adjustment programs that can be supported by SALs. On the other hand, there are certain policy areas, for example fiscal reform, that are best tackled through an economy-wide approach. In several cases, SELs have been used to initiate the adjustment process which, as it becomes more comprehensive, may be supported by a SAL. In Ghana, for example, two Reconstruction Import Credits in fiscal year 1983 and fiscal year 1985 and an Export Rehabilitation Credit in fiscal year 1984 were followed by a SAL in fiscal year 1986. In some other cases, sector adjustment loans serve to deepen the adjustment process initiated by the SALs. In Turkey, for example, a series of SALs in 1980-84 was followed by an Agricultural Sector Loan in 1985, and in the Republic of Korea a Financial Sector Loan in 1985 followed the earlier SAL.

Experience with policy reforms

This review of policy issues should not be viewed as an evaluation of the impact of past Bank structural and sector adjustment lending. It is very difficult to determine what would have been the recipients’ policies and performance in the absence of the programs. This is a familiar problem, which reduces most analyses to contrasting country performance after the assistance to performance before. Such an approach is dangerous because: (1) it assumes that countries would have made no policy changes to improve their situation in the absence of the Bank programs, while in fact their policies may have been unsustainable, and (2) it does not take into account changes in the international environment or other exogenous events that influence country performance. In addition, it is difficult to distinguish the effects of Bank-supported programs from those supported by the Fund, which has been actively working in almost all the countries which the Bank is assisting through SALs or SELs. Finally, this analysis does not address a number of implementation issues, such as the size of SALs, nature and size of disbursement (“tranches” of loans), the scope of conditionality and the like, all of which have a bearing on the question of program effectiveness.

Perhaps the most general conclusion that can be drawn from the Bank’s experience to date is the importance of the recipient’s commitment to a particular course of reform for the ultimate success of the policy package. The most successful cases of reform supported by the Bank have been in countries (e. g., the Republic of Korea and Turkey) that have adopted a series of reforms over time and stuck by them. The least successful were those where, for a variety of reasons, policies were reversed after a time and the direction and purpose of reform was confused and uncertain (Bolivia, Guyana, and Senegal in the early 1980s). Some of the main lessons of policy reform in particular areas are discussed below.

Domesticresourcemobilization. Past Bank involvement with resource mobilization has mainly focused on supporting government efforts to reduce budget deficits through revenue raising or expenditure reducing measures. Bank efforts typically supplement Fund programs in this area. In all instances, Bank programs aim to strengthen public sector performance and to reduce, directly or indirectly, public sector deficits which tend to crowd out private investment and to produce financial and balance of payments disequilibria. Reforms in this area have focused on raising public agencies’ revenues or reducing their expenditures by, for example, raising prices of services or establishing user fees, or eliminating or retargeting subsidies, so as to reduce public sector expenditures. In other cases, Bank efforts have focused on administrative reforms of the tax system or the introduction of new taxation. Deficit reduction and reform of parastatals have often required cuts in public sector employment; in a period of stagnant growth, such cuts have entailed transitional costs with which governments and the Bank have had to deal.

In addition to fiscal reform, resource mobilization has been pursued through efforts to improve the functioning of the financial sector and to eliminate distortions in interest rate policy. Examples of such activities include the Industrial Finance Project in Korea and the Morocco Industrial and Trade Policy Loans. The financial systems of many developing countries have also been severely strained in the last five years in coping with the debts of financially ailing enterprises—sometimes in the public sector. This has prompted Bank sector loans designed to support rehabilitation of the financial system in a number of countries such as Chile and the Philippines.

Broadly speaking, the key issues that have arisen from the Bank’s experience with financial market and banking sector reforms are the need to ensure an orderly transition for banking systems saddled with a lot of nonperforming loans (sometimes of public enterprises), and the liberalization of previously controlled lending and deposit rates.

Improvingpublicsectorperformance. This effort has included three main components: (1) rationalization of public investment programs; (2) improved public sector enterprise performance; and (3) rationalization of the size of the public sector, including divestiture of public holdings.

Since 1977, the Bank has undertaken about 50 public investment reviews. A large number of these were undertaken in conjunction with Fund programs that required such reviews or depended on them. While many had common features, these reviews varied considerably in scope—ranging from relatively brief analyses to major reviews in Jamaica and Turkey.

Most reviews recommended changes in investment priorities. In addition to overall resource constraints, the key problem usually was that projects underway were not accompanied by necessary actions in other fields that would make those projects viable. In general, such reviews have been most effective when they have been based on thorough Bank sectoral analyses and have actively involved member governments.

For the future, an important dimension of the Bank’s role should be to strengthen (and in some cases to help create) the institutional capacity that would permit developing countries to undertake effective investment reviews as a regular feature rather than in times of crisis. It will also be important to link such reviews to other elements of government policy such as prices and policies for reallocating resources toward export and efficient import-competing sectors. Finally, these investment reviews can greatly strengthen the process of aid coordination. All too often—especially in Africa or other countries where the internal investment review process has been weak—donors have supported activities without taking into account the budgetary implications of their maintenance and recurrent costs.

Improving the financial performance of public sector enterprises has also been an objective of many SALs (e.g., in Jamaica, Senegal and Turkey). The effort has focused both on better internal management of parastatals (e.g., in Jamaica) and on raising prices to reflect marginal production costs and to reduce the drain on the public budget. While there is evidence that objectives in this area have been achieved in some cases, the experience has been less encouraging in others. In Jamaica, for example, reductions in public sector enterprise deficits were in part offset by higher central bank losses. In Turkey, higher prices in some state enterprises that provide inputs to other entities under monopolistic conditions have harmed export competitiveness. Meanwhile, considerable progress is being made in Africa with reforms of state enterprises involved in marketing and distributing agricultural products (e.g., in Senegal).

More generally, the Bank has also been helping member countries to reassess the role of government as an owner or operator of specific public enterprises. In several cases this has led country authorities to undertake divestiture programs. Such programs have been announced by many countries (e.g., Brazil, Chile, Costa Rica, Jamaica, Malaysia, Mexico, the Philippines, and Turkey), but progress has been difficult. One of the problem areas has been the handling of financially ailing entities: closing them down has meant increasing unemployment during periods of crisis; without prior rehabilitation, they are not attractive to potential buyers; domestic capital markets are frequently underdeveloped and may not be able to finance the purchase of such enterprises, and sale to foreign investors is not always welcome—even if there was interest by foreign investors, which usually is not the case. The temptation is therefore for the government to continue to run the entity, even though it may no longer believe it to be desirable or appropriate to have the entity in the public sector.

Reformoftraderegimes. Reform of the structure of incentives affecting the production of exports and import-competing goods has been a key feature of almost all SALs and many sectoral loans. On the export side, the Bank has emphasized two sets of measures: (1) the provision of financial incentives through tax rebates, subsidies on imported inputs to offset import controls, and preferential access to imports and credit (e.g., in Jamaica, the Philippines, Senegal, and Turkey); and (2) reform of administrative procedures and the establishment of better institutional support for exporters (e.g., in Jamaica, Kenya, and the Philippines).

In most instances the competitiveness of exports was expected to be enhanced by parallel liberalization and rationalization of systems of protection for import-competing activities. For example, the SALs for Jamaica, Kenya, the Philippines, Thailand, and Turkey supported the reduction of quantitative restrictions and the lowering and liberalization of tariffs. Sectoral loans to Mexico and Colombia in fiscal years 1983 and 1985 and to Argentina in fiscal year 1986 have also been designed to correct the anti-export bias of incentives by promoting export rebates, import liberalization, and so on, and by strengthening the institutional base for export development.

Finally, the trade reform components of SALs and SELs were expected to be buttressed by changes in other policies that would result in a supportive real devaluation. Most of the loans referred to the maintenance of competitive exchange rates as an essential condition for the success of the loan. Monitoring of such provisions was left to the Fund.

The results of the early lending operations have been mixed. Of all the countries assisted, perhaps Turkey, and more recently Chile and Ecuador, have made the most progress in reforms. The financial incentives were introduced on schedule or with small delays in most cases. Progress in improving institutional support was generally slow, however, and, while most countries took some steps to rationalize the trade regime, the process was frequently halted short of the desired objectives or even reversed. In about half of the countries that had received a SAL before 1985, the real effective exchange rate appreciated within a year of the relevant SAL commitment.

On balance, this experience confirms the conclusion that implementation of trade reforms is not very successful when it is not accompanied by other measures to assure a shift in the real exchange rate—which is needed to produce the desired shifts in incentives. Experience also suggests that future reforms should ensure that export expansion programs are accompanied by significant import liberalization and action on the exchange rate. Experience does not suggest that import liberalization should be undertaken only after export reforms have increased the supply of foreign exchange. This kind of sequencing is likely to be self-defeating, since it is extremely difficult to reorient producers toward export markets as long as heavily sheltered domestic markets offer them sizable assured profits.

Otherpricingpolicies. Changes in agricultural and energy pricing were also common features of many SALs and SELs. Agricultural pricing reforms almost invariably tried to raise producer prices to a level closer to international market price equivalents, and cut input and consumer subsidies (e.g., in Senegal and Pakistan). Agricultural sector loans to Morocco and reconstruction credits to Ghana had a similar approach. The same kinds of objectives were pursued in pricing energy in the SALs to Jamaica, Kenya, the Philippines, and Turkey.

Experience with these loans suggests that most of these reforms, especially those related to the energy sector, were implemented with significant benefits to the recipient. In several cases there has been evidence of increased agricultural production and improved rural incomes (e.g., Ghana and Thailand), and of increased conservation and efficient import substitution of energy resources.

An important issue in this area is how to deal with the transitional costs entailed by raising the foodstuff prices paid by politically powerful urban consumers. This issue has caused serious difficulties in at least one recent case. A key concern about Bank programs in support of adjustment and growth has been the extent to which such programs have adequately addressed the effects of adjustment on the poor. A review of the Bank’s experience in this area suggests that programs which supported effective reforms to improve efficiency and increase productivity benefited the poor through the restoration of overall growth. Past experience also suggests that such programs have a positive effect in promoting a more equitable distribution of income over time. But there are frequently transition costs to the adjustment. In recognition of this, the Bank has also designed programs specifically aimed at poverty issues related to adjustment. Greater attention needs to be directed to the distributional impact of public sector consumption expenditures, however, as well as to designing employment assistance programs that would ease the burden of structural adjustment in the short term.

Conclusion

The Bank has a variety of lending instruments to support policy reform in member countries. Over the last six years, the Bank has increased the proportion of its total commitments represented by sectoral and structural adjustment lending in support of broad economic and sectoral policy reforms. The increase has been especially pronounced for the two sets of economies currently facing the most serious problems of adjustment and growth, namely, the countries of Sub-Saharan Africa and the heavily indebted middle-income countries.

Experience with such lending suggests that consistent pursuit of the kinds of policy reforms the Bank has supported in recent years will promote adjustment and growth in member countries. Given the problems facing developing countries today, the direction of policy reforms already pursued by the Bank should be maintained. In the light of uncertainties about the appropriate pacing and sequencing of such reforms, however, it is important to be flexible in implementing adjustment programs. This means that country reform programs will need to be reviewed frequently to ensure that they are on track, and that the Bank will have to be prepared to support modifications in policy reform packages in the light of both domestic and international developments. Where policy reforms to promote generally desirable structural change give rise to transitional costs for the poor, the Bank will continue working with governments to develop programs to address such problems.

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