Journal Issue
Share
Article

Conditionality: Members commit to reform in exchange for IMF financial support

Author(s):
International Monetary Fund. External Relations Dept.
Published Date:
January 1999
Share
  • ShareShare
Show Summary Details

When it provides financial support to a member country, the IMF must be sure the member is pursuing policies that will ameliorate or eliminate its external payments problem. The explicit policy commitment that members make to implement remedial measures in return for the IMF’s support is known as “conditionality.” This commitment also ensures that members are able to repay the IMF in a timely manner, which in turn allows the IMF’s limited pool of financial resources to be made available to other members with a balance of payments problem. IMF financing, and the important role it plays in helping a country secure other financing, enables the country to adjust in an orderly way without resorting to measures that would harm its own or other countries’ prosperity.

No one reform model suits all members. Thus, each member country, in close collaboration with the IMF staff, designs its IMF-supported program.

Conditions for IMF financial support may range from general commitments to cooperate with the IMF in setting policies, to the formulation of specific, quantified plans for financial policies. IMF financing from its general resources in the “upper credit tranches” (that is, where larger amounts are disbursed in return for implementation of remedial measures) is disbursed in stages. The IMF requires a “letter of intent,” which outlines a government’s policy intentions during the period of the adjustment program; the policy changes it must take before the arrangement can be approved; performance criteria, which are objective indicators for certain policies that must be satisfied on a quarterly, semiannual, or in some instances monthly basis for drawings to be made; and periodic reviews that allow the Executive Board to assess the consistency of policies with the objectives of the program.

Conditionality is flexible

Although IMF conditionality is linked to specific performance criteria, it does not rely on rigid operational rules. The Board’s guidelines on conditionality

  • encourage members to adopt corrective measures at an early stage;

  • stress that the IMF should pay due regard to members’ domestic social and political objectives, as well as their economic priorities and circumstances;

  • permit flexibility in determining the number and content of performance criteria; and

  • emphasize that IMF arrangements are decisions of the IMF that set out, in consultation with members, the conditions for its financial assistance.

How conditionality works

The IMF recognizes that no one reform model suits all members. Thus, each member country, in close collaboration with the IMF staff, designs its IMF-supported program. The process involves a comprehensive review of the member’s economy, including the causes and nature of the balance of payments problems, and an analysis of the policies needed to achieve a sustainable balance between the demand for, and the availability of, resources.

IMF-supported programs emphasize certain key aggregate economic variables—domestic credit, the public sector deficit, international reserves, and external debt—and crucial elements of the pricing system-including the exchange rate, interest rates, and, in some cases, wages and commodity prices—that significantly affect the country’s public finances and foreign trade and the economy’s supply response.

During a Stand-By or an Extended Fund Facility Arrangement (EFF) or during an arrangement under the Enhanced Structural Adjustment Facility (ESAF), the IMF monitors a member’s reform program through performance criteria selected according to the economic and institutional structure of the country, the availability of data, and the desirability of focusing on broad macroeconomic variables, among other considerations. Performance under IMF-supported reform programs is also monitored through periodic reviews by the IMF Executive Board.

Growth-oriented adjustment

Although macroeconomic policies designed to influence aggregate demand continue to play a key role in IMF-supported adjustment programs, it is widely recognized that measures to strengthen the supply side of the economy are frequently essential to bring about a sustained return of external viability and sound growth. Among the IMF-supported policy adjustments that member countries make to enhance the growth potential and flexibility of their economies are measures to

  • remove distortions in the external trade and payments system and in domestic relative prices,

  • improve the efficiency and soundness of the financial system, and

  • foster greater efficiency in fiscal operations. Structural reforms in these areas have been particularly important in programs under the EFF and the ESAF. Given the emphasis on structural reforms in IMF-supported programs, close collaboration with the World Bank has been important.

Social safety nets

For more than a decade, the IMF has addressed the social dimensions of economic policies in its discussions with members. The IMF has of ten advised members on social safety nets, the equity aspects of overall economic policy, and the composition of public spending—encouraging them to reallocate expenditure from unproductive to growth-enhancing outlays. The IMF’s growing interest in social policy issues stems from its recognition that reform programs are more likely to be viable in the long run if they emphasize equity and human resource development. Most bilateral consultations with members now consider the implications of their policies on poverty, health, education, and employment.

IMF-supported programs with low-income members under the ESAF give significant attention to social issues. For example, countries entering into an ESAF Arrangement may be asked to tackle poverty by accelerating economic growth and improving the delivery of basic services to the neediest segments of their populations. To help cushion the poorest members of society against subsidy cuts, ESAF-supported programs of ten suggest protecting or even increasing spending on essential social services.

Although other organizations, including the World Bank, have more of a mandate to address social issues, the IMF has sought to contribute to the task of improving equity by (1) ensuring that a social agenda is defined, (2) working with governments and other agencies to prepare a policy framework that ensures coherence among a country’s economic and social objectives, and (3) encouraging the International Labor Organization’s approach—involving representatives of workers and employers along with governments—in discussions of major changes in economic policy.

Recently, the IMF reviewed social spending in 31 low-income countries that had received support through the ESAF. The results for 1986–97 indicate that these countries, as a group, made good progress in raising public social expenditures and improving social indictors. Despite such progress, social policy implementation has been hindered in many countries by poor data, a lack of administrative ability, weak political commitment, vested interests, and limited foreign assistance. Ultimately, consideration of the human costs involved during reform is essential for the reform effort to succeed.

Other Resources Citing This Publication