When the IMF commits its financial support to a member country, the country is expected to implement policy adjustments and reforms to correct the underlying problems that gave rise to its balance of payments difficulties and its need for assistance.
Why is it necessary?
Conditions for financial support help ensure that borrowing countries solve their external balance of payments problems in an orderly way, without resorting to measures that would harm their own or other countries’ prosperity. By meeting the conditions, a country is assured of continued financing.
To safeguard its resources, the IMF must be sure that the policy adjustments required to achieve medium-term sustainability are being undertaken so that the country can eventually repay its loans.
How should conditionality be applied?
A flexible approach to conditionality is called for because the IMF must take care to treat all its members equitably while considering each country’s circumstances and problems. Conditions should be focused on those policy measures that are critical to achieving the program objectives and should be applied particularly sparingly outside the IMF’s core areas of responsibility.
How is it monitored?
The IMF requires a “letter of intent” or a memorandum from the country’s authorities outlining their policy intentions during the program period; any policy changes they will make before the program can be approved, if necessary; and objective indicators that show whether the country has complied with specific performance criteria. The IMF periodically reviews a country’s progress by assessing if its policies are consistent with the program objectives.
How has IMF conditionality changed?
Conditionality has evolved over the IMF’s history as the circumstances and challenges facing its members have changed. Since the 1950s, the IMF has attached conditions to its lending, focusing initially on monetary, fiscal, and exchange rate policies.
Beginning in the late 1980s, the IMF increasingly emphasized the need to achieve adjustment through improvements in the supply side of the economy. This raised the issue of how IMF-supported programs should try to address structural bottlenecks. The IMF’s response was to increase structural conditionality. Consequently, the average program involved 2 or 3 structural conditions a year in the mid-1980s, climbing to 12 or more by the second half of the 1990s.
The increase in the number of conditions raised concerns that the IMF might be overstepping its mandate and expertise. Excessively detailed policy conditions can undermine a country’s sense that it is in charge of its own reforms. Without such “ownership,” reform will not happen.
Moreover, poorly focused conditionality can overburden countries attempting to implement nonessential reforms at the expense of reforms truly needed for economic growth and continued access to IMF financing.
To ensure continued effectiveness, the IMF has regularly reviewed developments in conditionality. In its latest review, which began in September 2000, the IMF took steps to streamline conditionality to make it more efficient, effective, transparent, and focused. The review also aimed to enhance the effectiveness of programs by concentrating on those conditions that are critical to the success of countries’ macroeconomic objectives while taking account of their decision-making processes and ability to carry out reforms.
September 2000: The IMF Managing Director issued interim guidelines that set out general principles, which IMF staff are now applying in both new and existing IMF-supported economic programs.
March 2001: Papers prepared by IMF staff were posted on the IMF website to invite public comment on the principles and issues related to conditionality. Country officials, academic experts, and representatives of other organizations also added their views. Among their suggestions were the need to pay attention to the sequence and pace of policy implementation and the importance of a clear and coherent strategy for assistance from the international community.
April 2002: The IMF Executive Board agreed on the general principles to be embodied in new conditionality guidelines. These guidelines are to be finalized in the fall of 2002.
Can country ownership be strengthened?
Country authorities should be involved in the early stages of designing a program. They must be convinced that the reforms can be achieved and are in the country’s best interests. Moreover, ownership should involve not only the executive branch of a country’s government but also its parliament and other major stakeholders.
The IMF should be open to programs that differ from the staff’s preferred options, as long as the core objectives of the program are not compromised.
What if a country is not fully committed?
The IMF has to strengthen its analysis of political economy issues to better understand what might block or weaken program implementation. It should develop a more effective dialogue on feasible policy options and become more selective in supporting programs.
In countries with entrenched structural problems in which the IMF is likely to be involved for a considerable period, it is desirable for the country to take charge of building a consensus to strengthen national ownership of effective policies.
IMF technical assistance could be redirected toward the medium and long term and aim at improving countries’ capacity building (including program design). This would help countries take charge of their economic policies.
A country’s authorities should have primary responsibility for communicating policy intentions and program content to the public, with the IMF playing a supporting role.