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Policy Implementation Under Adjustment Lending

Author(s):
International Monetary Fund. External Relations Dept.
Published Date:
January 1989
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It is eight years since the Bank began lending for structural adjustment. A review of the experience so far

Between 1980 and 1987, 51 countries received one or more Structural Adjustment Loans (SALs) or Sectoral Adjustment Loans (SECALs) from the World Bank, totaling $15 billion. Out of that total, there were 51 SALs for $5.90 billion and 70 SECALs for $9.35 billion. Almost half the number of loans and credits for adjustment went to Sub-Saharan Africa but because of the relatively small size of individual operations in Africa the amounts lent to developing countries in Europe, the Middle East and North Africa, and to Latin America, were substantially larger.

SALs have generally supported programs to increase domestic resource mobilization and improve efficiency (see preceding article by Thomas and Chhibber). SECALs have been more narrowly focused than SALs, but normally support the same broad goals with measures that can have considerable macro-economic impact. These measures include trade and financial sector reforms, and reforms of sectoral pricing, institutions, and public expenditure composition. Both SALs and SECALs have also supported institutional changes to strengthen governments’ capacity to plan and implement reforms.

Policy reforms supported

The conclusions in this article are based on a Bank staff study of experience with 51 SALs and SECALs in 15 developing countries made between fiscal years 1980 and 1987: in Sub-Saharan Africa—Ghana, Kenya, Malawi, Zambia; highly indebted countries—Chile, Colombia, Côte d’Ivoire, Jamaica, Morocco, Mexico, and the Philippines; and other developing countries—Republic of Korea, Pakistan, Thailand, and Turkey. The adjustment lending to all three country groups has supported fiscal and budgetary stabilization, to reduce domestic absorption, and exchange rate policy, to provide appropriate incentives for producing tradable goods. The structural elements of programs—policies to alter incentives, improve efficiency, and strengthen institutional capacities—differ according to countries’ circumstances. All the SALs and most of the SECALs have followed and overlapped with Fund-supported programs.

In Sub-Saharan Africa, the Bank’s adjustment lending has largely been used to support agriculture and institutional reform in the public sector. Reflecting the dominant role of agriculture in these economies and the potential for agricultural exports, emphasis has been placed on raising producer prices, reducing the taxation of farmers, associated with the high profits or low efficiency of marketing boards; and improving public services, especially in agricultural extension and research. Programs for public enterprises and agencies have emphasized improving profitability by raising prices and efficiency, reducing overmanning, restructuring activities and finances, and divestiture.

In the highly indebted countries, the Bank’s support has been largely for trade and financial sector policies. Trade policies have emphasized improving the incentive structure for exports while liberalizing imports through reductions in quantitative restrictions and tariffs. Financial sector changes have emphasized removing controls on interest rates and credit allocations, developing new capital market instruments, and, where needed, strengthening the portfolios of lending institutions through financial restructuring and improved auditing and supervision.

The policy changes supported in the other countries studied resemble those in the highly indebted countries, with somewhat less emphasis on trade and more on energy policy.

Experience

Experience in implementing the policy changes supported by the 51 adjustment loans was examined in detail. The results (see table) show that:

• At the completion of disbursements on the loans, about 60 percent of the policy changes agreed as conditions in SALs and SECALs had been implemented fully or more than fully.

• The degree to which the conditions were met has differed substantially between policy areas.

• Highly indebted countries have been somewhat more successful in meeting the conditions than the Sub-Saharan or “other country” groups, but this probably reflects differences in the composition of conditionality and random factors more than any systematic differences in performance between the three groups of countries.

Patterns in implementing policy changes. The policy changes agreed as conditions on Bank adjustment loans have clearly been implemented quite successfully in some areas, such as exchange rate management, energy policy (especially energy pricing), agricultural pricing, financial sector reforms, and the rationalization of public expenditure programs. Policy change has been slower or less successful in areas such as industrial policies, tax reforms, and some aspects of public enterprise reforms.

There are also differences within policy areas. In trade, for example, conditions on reductions in tariffs and quantitative restrictions have been more fully met than those on improvements in export financing; the latter often involve institutional changes which are more difficult and take more time to implement than changes in import restrictions. Similarly, for export incentives, it has been relatively easy for countries to remove disincentives to exports such as taxes or quotas, but progress has been quite slow in establishing effective duty drawbacks or bonded manufacturing systems, which are technically difficult to set up.

In general, the policy conditions most successfully met have been those involving changes in prices (including exchange rates); those where political sensitivities are the least, as for most types of government expenditure restructuring; and those where major institutional changes, such as changes in staffing, training, procedures, laws, and regulations, are not required.

Performance on key conditions. Most adjustment operations have four or five key conditions which are expected to have an impact within one or two years on savings, the level and composition of investment, budget deficits, or tradable goods production. Key conditions have been more successfully met than have all conditions taken on average. The better implementation of key conditions was even evident in policy areas where implementation was generally not strong, for example public enterprise reforms, tariff changes, and industrial policy. These are important findings because they suggest that it would be worthwhile for the Bank to concentrate its efforts on a smaller number of issues in adjustment lending operations in future.

Implementation beyond the disbursement period. Because policy change is continuous and must be adapted to changing circumstances, and because institutional changes often take a long time to implement, it is important that the reforms supported by adjustment lending be continued after loan disbursements are completed. As of mid-1988, 68 percent of the conditions had been fully implemented, compared with 60 percent during the disbursement periods of the loans analyzed (see table). Adjustment lending thus in general seems to be supporting a process of continuing reform. Progress is still being made in areas where institutional constraints have been important—especially in tax reforms and public enterprise restructuring.

Implementation of conditionality, FY 1980–87(Percentage of conditions implemented)
During the loan periodAs of mid-1988
Conditions fully implemented(1) plus “substantial progress”1Conditions fully implemented(3) plus “substantial progress”1
(1)(2)(3)(4)
Exchange rate70.090.062.587.5
Trade policies54.984.263.489.3
Fiscal policy53.278.369.895.3
Budget/public expenditures68.078.071.784.8
Public enterprise reforms61.386.770.090.0
Financial sector71.485.773.589.8
Industrial policy
(excl. restructuring)53.393.342.985.7
Energy policy79.283.383.388.9
Agriculture policy57.181.658.183.7
All conditions60.383.467.589.0
Source: World Bank; based on an analysis of 51 SALs and SECALs in 15 countries.

Examples of policy reversal appear to be piecemeal and not concentrated in any policy area. Tariff changes stalled in Kenya because of foreign exchange shortages and in Thailand because of potential losses in budget revenues. Public sector price increases were abandoned in Thailand because of political opposition. The only significant case of reversal in the 15 countries studied is Zambia, where reform efforts in foreign exchange auctioning, import licensing, and consumer subsidy reduction were overturned; inflows of Fund and Bank resources could not offset the hardships inflicted by the end of price controls and subsidies and the introduction of a foreign exchange auction. The failure of the program to generate quick and visible benefits allowed political opposition to over-whelm it.

Tranching. To make its adjustment lending easier to monitor and to ensure that progress is adequate in implementing the policy changes agreed on, the Bank usually disburses its adjustment loans in portions, or tranches. Tranches are released when the Bank determines that the government has met, or made substantial progress toward meeting, the important conditions agreed on, or, as in some cases, the government has taken actions that serve the same goals as the actions originally called for. The Bank is increasingly relying on conditions that are specific to individual tranches.

Close to three fourths of all adjustment loans have had tranche releases delayed because of insufficient progress in fulfilling conditions, but almost all tranches have been released eventually. The importance of attaching conditions to tranches is illustrated by experience in the 15 countries: full implementation for 71 percent of first tranche conditions, 62 percent for second and third tranche conditions, and 43 percent for other conditions.

Factors in implementation

The experience reviewed points to several lessons for future adjustment lending.

Agreement on overall program. In addition to agreement on the specific actions that are conditions for loans to become effective or for tranches of loans to be released, the Bank and the government need to reach an understanding on the government’s overall structural adjustment program. This understanding is most useful if it covers the government’s short-term stabilization and longer-term (3–5 years) development objectives, the macro and micro policies envisaged, and the needed institutional changes. It provides assurance that the specific measures that are disbursement conditions for a SAL or SECAL are to be implemented in the context of an agreed overall strategy and program. Unless they are conceived and implemented in this context, the specific measures may not be effective.

Government commitment. Policy changes supported by Bank adjustment loans have been more fully implemented where the government has played the leading role in analyzing the issues, designing the program, and formulating the actions to be taken. There is often a need for substantial Bank assistance in the design of adjustment programs, and the Bank’s experience with programs in other countries can almost always be of help. Serious problems arise, however, if a program is viewed as the Bank’s rather than the country’s own.

The commitment to any economic reform program appears to depend on several factors:

• an understanding and acceptance of the program at political, senior official, and technical levels;

• a clear assignment of responsibilities to the various implementing agencies;

• an institutional capacity in the country for economic and financial analysis and for the formulation of policy advice;

• a longer-term program, as described above, which provides the context for the adjustment measures supported by the Bank loan.

Realism. An adjustment program must be realistic. It must be restrictive enough to be consistent with the financing available, but not so restrictive that it is likely to prove socially and politically unacceptable and therefore unsustainable.

Adjustment and the poor. There are three ways in which the Bank can help borrowers to assist the poor during adjustment. First, adjustment programs themselves can be designed to prevent the poor from suffering unnecessarily from some specific policies. For example, there may be scope for slowing the rate at which food prices increase for the poor, and for protecting government expenditures which benefit the poor, without undermining the adjustment program. Second, when unsustainable fiscal deficits make it essential to reduce government spending, public expenditure which disproportionately benefits the poor should be maintained wherever possible, and other expenditures better targeted. Third, where adjustment has immediate costs for identifiable groups, short-term compensatory programs should be encouraged.

Economic environment. Although there can be short-term trade-offs between stabilization and growth, the two reinforce each other over the longer run. Desirable adjustment measures are likely to be sustained and effective only if reasonable economic growth is maintained. A favorable external economic environment makes adjustment programs easier to implement: in an expanding economy, it is easier to generate resources for financing investment, government expenditures, and imports. Private investment is likely to be more responsive to changes in market signals. Resources are likely to flow more smoothly and quickly between sectors. More generally, the desired allocations of resources must be accompanied by new investments, which are unlikely to take place in an environment of economic recession and pessimistic expectations. Painful policy changes are likely to be more acceptable if people think the pain will not last long. Last, governments can devote more attention to medium-term structural adjustment if they do not have to fight such short-run problems as severe foreign exchange shortages, budget imbalances, or a runaway money supply.

The way forward

Given the high economic and social costs of rapid forced adjustment to the severe shocks of the 1980s, fast-disbursing structural adjustment loans will continue to be a major form of Bank assistance. Structural adjustment seems certain to be necessary for some time. There is thus a need to continue adapting the policies and procedures of structural adjustment lending to increase its effectiveness.

The Bank has begun to take a somewhat more selective approach to adjustment lending for balance of payments support, to provide greater assurance that lending for balance of payments support will complement, rather than substitute for, structural reforms by the borrowing country. Greater selectivity in lending may initially slow down the pace of lending for balance of payments adjustment. Developing a consensus on the appropriate strategy and working out a program that a country genuinely “owns” may also take more time than has sometimes been allowed in past lending. Mobilizing the needed external financing, which is in part outside the control of the country and the Bank, may also take more time, as would agreeing on a tighter program if the financing cannot be found. At the same time, there is need for greater realism about the speed with which supply responses can be expected, especially in the Sub-Saharan African countries, and for greater recognition that changes in the external environment will continue to influence the pace of successful adjustment. The increased emphasis on selectivity and realism should assist the Bank by strengthening the effectiveness of its approach to adjustment problems and reducing the risk to its portfolio; more important, it will assist developing countries by assuring appropriate domestic and external financing to support realistic adjustment efforts.

International Monetary Fund announces

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December 1988.

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