Journal Issue

Lending And Conditionality: Getting Back on Track

International Monetary Fund. External Relations Dept.
Published Date:
September 2004
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The IMF provides financial assistance to members with balance of payments problems to support policies of adjustment and reform, including concessional assistance to low-income countries. The financing is for general balance of payments support, rather than for specific purposes or projects, like the financing provided by development banks. All financial assistance by the IMF is approved by its Executive Board.

The volume of IMF lending has fluctuated significantly. The oil shocks of the 1970s and the debt crisis of the 1980s were both followed by sharp increases in IMF financing. In the 1990s, the transition process in Central and Eastern Europe and the former Soviet Union, as well as crises in emerging market economies, led to another surge in the demand for IMF financing.

Over the years, the IMF has developed a number of loan instruments, or “facilities,” that are tailored to address the specific circumstances of its diverse membership. Low-income countries may borrow at a concessional interest rate through the Poverty Reduction and Growth Facility (PRGF). Nonconcessional loans are provided through four main facilities: Stand-By Arrangements, the Extended Fund Facility, the Supplemental Reserve Facility, and the Compensatory Financing Facility (see box on pages 24-25). The IMF also provides emergency assistance to countries recovering from natural disasters and armed conflicts, in some cases at concessional interest rates.

‘When a country borrows from the IMF, its government makes commitments to strengthen its economic and financial policies.’

Except for the PRGF, all facilities are subject to the IMF’s market-related interest rate, known as the “rate of charge,” and some carry an interest rate premium or “surcharge.” The rate of charge is based on the SDR interest rate, which is revised weekly to take account of changes in short-term interest rates in the major international money markets. Large loans carry a surcharge and must be repaid early if a country’s external position permits.

The amount that a country can borrow from the Fund—its “access limit”—varies with the type of loan but is typically a multiple of the country’s IMF quota.

The IMF encourages early repayment of loans. Although it has a standard repayment obligations schedule, members are expected to repay according to a faster schedule when possible.

Conditionality in IMF lending

When a country borrows from the IMF, its government makes commitments to strengthen its economic and financial policies—a requirement known as conditionality. Conditionality provides assurance to the IMF that its loan will be used to resolve the borrower’s economic difficulties and that the country will be able to repay promptly, so that the funds become available to other members in need. In recent years, the IMF has worked to streamline the conditions attached to its financing. The IMF’s Board adopted revised guidelines in September 2002 emphasizing the need to focus conditionality on the key macroeconomic objectives and policy instruments and to promote stronger national ownership of policy programs.

The policies to be adopted are designed not just to resolve the immediate balance of payments problem but also to lay the basis for sustainable economic growth by achieving broader economic stability—for example, measures to contain inflation or reduce public debt. Policies may also address structural impediments to healthy growth—like price and trade liberalization, measures to strengthen financial systems, and improvements in governance.

Together, these policies constitute a member country’s “policy program,” which is described in a letter of intent or a memorandum of economic and financial policies that accompanies the country’s request for IMF financing. The specific objectives of a program and the policies adopted depend on the country’s circumstances. However, the overarching goal in all cases is to restore or maintain balance of payments viability and macroeconomic stability and to set the stage for sustained, highquality growth.

How is compliance assessed?

Most IMF loans feature phased disbursements. This allows the IMF to verify that a country is continuing to adhere to its commitments before disbursing subsequent installments. Program monitoring relies on several different tools:

  • Prior actions are measures that a country agrees to take before the IMF’s Executive Board approves a loan and before the initial disbursement takes place. Such measures ensure that the program has the necessary foundation to succeed. Prior actions could include, for example, adjustment of the exchange rate to a sustainable level, elimination of price controls, or formal approval of a government budget consistent with the program’s fiscal framework.

  • Performance criteria are specific conditions that have to be met for the agreed amount of credit to be disbursed in the subsequent phases. There are two types of performance criteria: quantitative and structural. Quantitative criteria typically refer to macroeconomic policy variables such as international reserves, monetary and credit aggregates, fiscal balances, and external borrowing. For example, a program might include a minimum level of net international reserves, a maximum level of central bank net domestic assets, and/or a maximum level of government borrowing.

In arrangements where structural reforms are an essential part of the economic program, structural performance criteria are also used. These vary widely across programs but could, for example, include specific measures to restructure such key sectors as energy, reform social security systems, or improve financial sector operations.

  • Initially, conditions may be set as indicative targets when there is substantial uncertainty about economic trends beyond the first months of the program. As uncertainty is reduced, and the reforms take effect, these targets will normally be established as performance criteria, and modified as needed.

  • Structural benchmarks are similar to structural performance criteria, except that individual benchmarks are less critical for meeting the program’s objectives. Thus, benchmarks may help the Board assess a country’s progress on structural reforms, but failure to achieve them would not necessarily interrupt Fund financing.

  • Another important monitoring tool is the program review, which serves as an opportunity for a broad-based assessment by the Executive Board of progress with the program. Reviews are used to discuss policies and introduce changes to the program that may be necessary in light of new developments. In some cases, a country might request a waiver for breaching the performance criteria—for example, when its authorities have already taken measures to correct the deviation.

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