2 Adjustment Challenges and Strategies Facing Arab Countries in Light of Recent Experience and New Initiatives
- Saíd El-Naggar
- Published Date:
- September 1987
Despite its popular usage in the jargon of international economics, the term “adjustment” has a variety of different meanings and connotations. For some it is anathema, synonymous with austerity, the antithesis of growth. A more widely accepted interpretation of adjustment is of a controlled process of change in an economy designed to reduce or eliminate domestic or external imbalances through a variety of policy changes as a basis for achieving sustainable growth.
The process of fostering orderly adjustment in the latter sense, both within individual countries and throughout the world economy, goes to the heart of the purposes and functions of the International Monetary Fund. The Fund is often described as the “agent of adjustment” in the world economy. It is the institution charged with promoting and encouraging the adoption of sound domestic policies in member countries that will help them achieve financial stability and realize their growth potentials. In the difficult and often turbulent conditions that have characterized the world economy in recent years, the Fund has taken on an expanded and more active role in assisting its member countries to devise and implement adjustment strategies that are consistent with these goals and, thus, with a stronger and more dynamic world economy.
The mechanisms through which the Fund assists members toward these ends take a number of forms, including surveillance over many aspects of economic policies, technical assistance, and financial support. Perhaps the most conspicuous aspect of the Fund’s work in recent years has been its financial activities, particularly those operations centering on the major debtor countries in Latin America and the low-income countries of Africa. Only a handful of Arab countries have had programs with the Fund in recent years.1 This reflects a number of circumstances, not least the fact that for more than a decade most of the countries of the Arab world benefited directly or indirectly from the oil-borne stimulus to economic growth and development.
Over the past few years, however, Arab oil exporting countries have felt the economic winds of change in the world oil market which led up to the collapse of oil prices early in 1986. Indeed, the need for domestic policy reforms has become increasingly apparent in a number of these countries over the past few years. The same is, of course, true for the non-oil countries in the region, some of which have already been facing deteriorating external positions and declining growth rates. The events of the past year have increased the scale and urgency of the adjustment now facing many of these countries.
This paper begins with a review of the nature and extent of the adjustment problems now facing Arab countries, focusing on two broad subgroups—the oil exporting countries and the non-oil countries. The second section seeks to show, in light of the recent experience of countries in other parts of the world, where adjustment pressures have often been intense, why timely and appropriate policy action in dealing with emerging problems is of the utmost importance. The last section of the paper examines the relationships between growth and adjustment and outlines recent efforts to enhance growth-oriented adjustment.
Current Policy Issues and Challenges Facing Arab Countries
In the following survey of policy issues and challenges, the Arab countries are divided into two groups, the oil exporting countries and the non-oil developing countries. It should be emphasized, however, that while this distinction offers a convenient approach to organizing the discussion, the countries within each group are by no means homogeneous. On the contrary, conditions and circumstances vary markedly from one country to another, with the result that the scope for generalization is limited. The same point, of course, holds true in devising adjustment strategies and programs, a subject I will come back to later.
Oil Exporting Arab Countries2
For almost a decade after 1973, following the escalation of oil prices, the oil exporting Arab countries faced the uncommon challenge of adjusting to a massive increase in foreign receipts and large external payments surpluses.3 Typically, the immediate policy response was to increase government spending with a view to redistributing part of the increased oil earnings, promoting domestic absorption, and encouraging private sector investment. This was a sound and desirable policy strategy not only from the standpoint of domestic development but also from that of global adjustment. Domestically, the challenge for the oil exporting countries was to foster more balanced economic development while maintaining the financial stability that had historically characterized their economies. Broadly, these countries achieved a considerable measure of success in bringing about more balanced growth and realized important gains in terms of diversification. Virtually all major sectors in the oil exporting countries—particularly manufacturing, construction, and services—witnessed rapid growth. However, in some countries, lags in the development of infrastructure led to bottlenecks, aggravating inflation and exerting upward pressure on real (inflation-adjusted) exchange rates. Where this happened, the continued growth of non-oil sectors and the development of import-substituting industries were undermined.
From the standpoint of global adjustment, the very strong growth of imports of goods and services by oil exporting countries from the rest of the world (averaging 43 percent annually in dollar terms over the five years 1974–78) provided an important offset to the recessionary tendencies in the world economy in the mid-1970s. At the same time, the oil exporters took the opportunity to accumulate large holdings of official reserves and other foreign assets. Meanwhile, liberal exchange systems facilitated external investment by private holders of wealth. Together, these official and private capital movements constituted the essential “recycling” process which underpinned the continued growth of international trade and investment during a period of unusually large international payments imbalances. Moreover, the large official holdings of external assets that were built up during this period and which were, on the whole, invested wisely, have more recently served as a valuable cushion for the oil exporting countries as the world oil market weakened and adjustment for oil exporting countries took on its more normal meaning, namely, the process of adapting to reduced foreign earnings.
Indeed, these adjustment challenges have been increasing. What in a more general context are bright spots in an otherwise lackluster world economy—namely, lower oil prices and reduced interest rates—loom as the major adverse developments for those countries that are overwhelmingly dependent on oil revenues and interest earnings on assets held abroad. Oil exporting countries, without exception, experienced a sharp decline in foreign exchange earnings in 1986 associated with lower oil prices and, to a lesser extent, continued export restraint and reduced interest income. In most cases, the drop in foreign earnings, compared with 1985, was very large, ranging up to 40 percent, and it followed three or four years of stagnation or decline. For example, total export earnings for the group as a whole declined from over $200 billion in 1980 to $83 billion in 1985; they are estimated to have fallen further to $60 billion in 1986.
Faced with a substantial decline in foreign receipts, virtually all oil exporting countries have sought to reduce aggregate demand in order to limit the loss of external reserves. To this end, they have focused on cutting government expenditure, typically the primary source of liquidity creation and demand growth in these economies. Progress, however, has been mixed. While cuts in development spending have been facilitated by the completion of major infrastructural projects, fiscal retrenchment has been tempered by a desire to continue to provide some support to private, non-oil sectors and, in some cases, by defense priorities. As a result, budget deficits have generally remained high (in several cases in the range of 10–20 percent of gross domestic product (GDP)) or are continuing to rise. Given the relative importance of fiscal policy and the absence of restrictions on capital movements in most oil exporting countries, monetary policy has, on the whole, continued to play a subordinate and passive role. However, with declining inflation in most countries, real interest rates have generally risen, thereby compounding the effects of recession and weakening confidence on reducing private demand for credit.
As regards external policies, Arab oil exporting countries have generally continued to maintain liberal and open exchange and trade regimes. However, protectionist tendencies are manifested in tighter domestic procurement rules for government contracts and frequently heavy subsidies to domestic producers. Also, counter-trade in oil, which has been on the rise over the past few years, is continuing. The currencies of all countries in the group have depreciated significantly over the past year or so in real effective terms, and, in certain cases, this tendency has been augmented by discrete downward adjustments.
Despite sharply reduced imports, the fall in foreign exchange earnings has led to a situation in which most oil exporting countries are now in deficit on current external account. In some cases, external current deficits in 1986 are expected to be very large, in the range of 10–20 percent of GDP. Those countries not yet in deficit on current account have seen their current surpluses sharply reduced. At the same time, private capital outflow is continuing and may, indeed, be on the increase. In these circumstances, there are widespread drawdowns of official reserves or reserve funds. While, in most cases, reserves remain very large in relation to imports, allowing countries considerable room for maneuver in implementing policy reforms, a few countries have already had recourse to external commercial borrowing and one or two are known to have accumulated substantial external arrears.
With considerable uncertainty surrounding prospective developments in world oil markets, oil exporting countries will continue to face difficult policy choices in the period ahead. Typically, private sectors are contracting sharply rather than picking up the slack, as had been hoped. Domestic banking systems have come under strain in one or two countries because of the doubtful quality of banks’ domestic assets, necessitating greater vigilance in banking supervision. These developments are often creating strong political pressures for increased government support to bolster flagging domestic demand and revive private investment. However, at a time when foreign resources are declining, it has become more difficult for governments to continue to lend support to domestic investment that has often been inefficient—as indicated by the need for continuing subsidies in many cases—at the expense of drawing down still relatively high-yielding foreign investments; in some countries interest on foreign investment has come to account for a high proportion of foreign exchange earnings and budgetary receipts. A more general issue is how these countries can devise the most effective policy strategy to foster structural adjustment and exploit such scope as exists for efficient diversification.
Non-Oil Arab Countries4
Despite the obvious benefits accruing to the non-oil countries from lower oil prices, the sagging fortunes of the oil exporting countries have had profound implications for their non-oil neighbors which depend on them, in greater or lesser degree, for financial support, outlets for their surplus labor (and associated remittances), and export markets. In addition, the adverse developments in the world economy at large (especially the relatively unfavorable trading environment over much of the recent past and the prolonged weakness of commodity prices) have also impinged on the non-oil Arab countries as else where.
Pervasive weaknesses in domestic policies (compounded in several countries by hostilities and civil strife) have been at least as important as the external environment in explaining the severe deterioration in domestic economic performance and external positions that characterize virtually all countries in this group. The patent shortcomings in domestic policies and delays in implementing needed policy adjustments over the past few years put these countries at a great disadvantage in coping with the setbacks they are now facing as a consequence of the deepening recession and uncertain prospects in the region.
Output has been stagnant or on the decline in virtually all non-oil Arab countries, and economic developments have been characterized almost uniformly by mounting domestic and external imbalances. At the root of these problems are large and, in most cases, growing fiscal imbalances. Typically, expenditures have been continuing to rise in the face of stagnating or declining revenues, with the result that budget deficits are ratcheting upward from already unsustainable levels. Currently, budget deficits range from 10 percent of GDP to upward of 20 percent. The liquidity expansion associated with the financing of these deficits, together with rigidities in administered prices and interest rates, are fueling excessive demand pressures as reflected in high or rising rates of inflation and weakening external positions.
External adjustment policies have also been lacking. Many countries continue to maintain overvalued exchange rates and complex exchange systems. Recent pressures have also been reflected, in part, in the steep depreciation of currencies in parallel markets. Also, trade restrictions have been intensified in several cases while payments arrears have been incurred. Some countries have resorted to foreign commercial borrowing on a significant scale, and one or two are experiencing serious difficulties in servicing that debt. Nearly all countries now have low or vulnerable external reserve positions.
This brief overview of developments and policies in Arab countries brings out the fact that in most countries—both oil exporting and non-oil—domestic and external imbalances are increasing, primarily as a consequence of lower world market prices for oil. Domestic adjustment policies are lagging, as reflected in rising fiscal deficits and passive monetary policies. On the supply side, policies are often characterized by rigidities in key prices; as a result, subsidies are tending to increase, and exchange rate overvaluation is becoming a problem in Arab countries, particularly in the non-oil subgroup.
Though it is clear that individual country situations differ enormously, the underlying growth in the external deficits of many Arab countries calls for appropriate policy reforms. At one end of the spectrum are a number of the non-oil countries that, as a consequence of a long period of insufficient adjustment, are already heavily burdened with debt, have low reserve holdings, and are therefore particularly vulnerable to recent adverse developments; for them, the adjustment challenge is a formidable one, and one which cannot be delayed. At the other end of the spectrum are a few oil exporting countries with very large reserve holdings and which, though now in deficit, are well placed to embark on orderly adjustment programs aimed at promoting diversification and growth.
Adjustment and Financing: Lessons of the Recent Past
This section examines the adjustment challenges now facing Arab countries in light of the experience of other parts of the world where adjustment pressures in recent years have often been intense, and where the contrasting experiences of two broad groups of countries with different policy strategies provide an illuminating insight into the virtues of timely and effective adjustment policies. The first group of countries, which will be designated as Group A, postponed adjustment by resorting to heavy external borrowing from the mid-1970s and eventually encountered severe external financial difficulties with dire consequences for domestic growth and living standards. A second group of countries, described as Group B, undertook adequate adjustment policies, managed to maintain external stability, and achieved a much better growth performance. This section concludes with a summary of the elements of sound adjustment strategies based on the experience of the latter group.
Contrasting Experiences of Adjusting and Nonadjusting Countries
One of the most striking distinctions between Group A and Group B countries is found in the contrasting stances of their demand management, with such policies being noticeably lax in the former group. Thus, in the years leading up to 1982, when widespread financial problems emerged among developing countries and the so-called debt crises erupted, budget deficits were rising alarmingly in many of the countries that were eventually to encounter such difficulties. In the three major borrowers in Latin America, for example, public sector deficits rose from the equivalent of 7–8 percent of GDP in 1979 to a range of 14—18 percent of GDP in 1982. Though imbalances of this magnitude were at the higher end of the scale, the trend toward rising public sector deficits was common to most countries having large-scale recourse to external borrowing. Growing deficits reflected a variety of different factors, including rising expectations of the role of government, overambitious spending plans, and a tendency for subsidies to rise out of all proportion to the original objectives as officially set prices lagged behind inflation. Over the period, government expenditures increased rapidly. Meanwhile, revenues showed little or no growth relative to GDP, reflecting in part the inelasticity of the tax system in many countries, as well as resistance to tax increases. When budget deficits get out of hand, the consequences are typically revealed in excessive monetary growth. Thus, Group A countries experienced very rapid rates of monetary expansion, ranging from 40 to 50 percent annually during 1978–82. On the other hand, monetary growth was kept to about half that annual rate in the countries that managed to avoid debt problems.
As might be expected, the weaker demand management policies of Group A countries were associated with higher rates of inflation. And, indeed, over the period 1978—82, Group A countries experienced rates of inflation averaging 3 percentage points above those of Group B countries. However, the primary consequences of excess demand pressures were revealed in external payments positions. While Group A countries incurred very large external current account deficits up to 1982, averaging some 25 percent of exports of goods and services, the current account deficit for Group B countries remained slightly below 10 percent of exports. A closer examination of the diverging current account trends of the two groups shows that export performance of Group A countries fell far short of that of Group B; in value terms export growth averaged 11 percent and 16 percent a year, respectively, during 1978—82. Because of this, Group B countries, while keeping their current external deficits and foreign borrowing within manageable limits, were able to expand their imports at twice the annual rate of Group A countries during the period.
Movements in real effective exchange rates clearly had a crucial bearing on export performance. One study showed that countries that had to reschedule their debt had allowed their currencies to appreciate in real terms by more than 20 percent in the two years leading up to their debt problems, while the currencies of those countries that did not need to reschedule showed only a marginal appreciation.5 Countries with appreciating currencies are those that increasingly resorted to trade and exchange restrictions, which are themselves inimical to growth. More generally, empirical studies in the Fund covering the period 1973–82 have shown that those developing countries that maintained external competitiveness were better able to maintain their share of export markets and achieve a stronger trade account than the rest.6 This was also found to be true for the low-income countries, which export mainly primary products, despite the generally perceived lower substitution possibilities in these countries.
Large-scale foreign borrowing was the inevitable counterpart to the higher current external deficits of Group A countries. Much of the borrowing was, moreover, on commercial terms and at variable rates of interest, which made the borrowing countries highly vulnerable to the subsequent surge in interest rates. Over the period 1978–82, Group A countries saw their debt-to-exports ratio escalate from 180 percent to 240 percent, whereas the corresponding ratio for Group B countries declined somewhat to about 90 percent. Likewise, the debt-service ratio for the former group rose from 28 percent to 40 percent, while that for Group B countries rose only slightly to 14 percent.
The adverse consequences of the policy stances of Group A countries are graphically portrayed in developments in their real economies. Did high rates of monetary expansion, currency appreciation, and the enormous foreign borrowing that Group A countries were undertaking stimulate investment and growth? The answer is very clear: Investment ratios of Group A countries, besides declining from 27 percent of GDP in 1978 to 23 percent in 1982, remained consistently lower than those in Group B countries, where the investment ratio moved narrowly around an average of 28 percent of GDP. Even more marked was the divergence in growth rates between the two groups, with real GDP growth in Group B countries averaging 5 percent a year during 1978–82, more than twice the rate achieved by Group A countries. These developments suggest that not only did Group B countries do better in terms of domestic resource mobilization, that is, in financing higher investment through domestic rather than foreign savings, but that the resources were put to more efficient and productive use.
Essentially, the greater domestic resource mobilization of Group B countries was made possible through policies geared to promoting domestic savings and retaining them in the countries. Such policies included realistic interest rates and exchange rates, such that individuals were assured of a reasonable real rate of return on domestic financial assets. In the absence of such incentives, capital flows out of a country. Indeed, capital flight has been a perennial problem in debt-ridden countries.
Events following the onset of the debt crisis in 1982 are even more telling. It may be useful to begin by recalling that the immediate trigger to the debt crisis in 1982 was the profound deterioration in world economic conditions. The decline in the volume of world trade in 1982, following two years of stagnation, falling commodity prices, and the surge in real interest rates as the industrial countries tightened monetary policies, had severe short-term implications for developing countries the world over. What is important, however, is that among the two highly diverse groups that we have been examining, all countries faced much the same world environment, yet its impact varied considerably. The most poignant conclusion is that countries with weak policies were the most vulnerable to the deterioration in external conditions. As financial conditions tightened in the second half of 1982, Group A countries saw their access to external financing, which had averaged $70 billion a year during 1980–82, plummet to an average of $20 billion a year in the following three years (and on a steeply declining trend); much of this financing had, moreover, to be orchestrated and was, therefore, not spontaneous. Group B countries, on the other hand, were able to obtain about $30 billion annually of market financing abroad after 1982, or about the same amount as in the preceding few years.
The consequence was that Group A countries had to slash their imports by 15 percent in volume terms in 1982 and by the same rate again in 1983; import volumes have since continued to fall, though at a lower rate. As a result, the dollar value of imports in Group A countries in 1986 is still expected to be some 35 percent below the level of 1981, the year before the debt crisis. By contrast, the countries that avoided debt problems were able to finance higher import volumes in the postcrisis period, with the result that their imports continued to rise. Finally, while real per capita GDP fell in Group A countries by a cumulative 6½ percent during 1982–85, Group B countries were able to achieve sustained per capita income growth totaling 14½ percent.
Elements of Growth-Oriented Adjustment Policies
The implications of this survey for domestic policies should be clear. Sound and timely adjustment strategies are essential for assuring financial stability and growth. In general terms, such strategies must be geared to maintaining a set of incentives favorable to exporting, domestic saving, and an efficient allocation of resources.
First this means ensuring that real exchange rates and real interest rates are kept in line with market realities. One of the most durable lessons—applicable to developing and industrial countries alike—is that exporting and saving flourish only when they are profitable relative to other economic activities. When exchange rates are allowed to become overvalued, the production of tradable goods is discouraged and domestic producers are unable to compete effectively in world markets. Similarly, when real interest rates are kept too low, private savings suffer. Where both exchange rates and interest rates get out of line, there is a recipe for both trade deficits and capital flight. All Fund programs evaluate the appropriateness of the level of the exchange rate and interest rates, and where necessary, recommend adjustments. In this connection, it is relevant to note that over half of all Fund programs in 1980–84 involved adjustment of exchange rates, while about a third involved interest rate reform.
If private investment is to be encouraged, it is important to ensure that business profitability is not unduly eroded by wage movements that bear little relationship to labor productivity; that the private sector has adequate access to credit; and that government deficits do not absorb an unduly high share of private savings. That is why the Fund, in helping to design programs and in providing advice, has consistently favored wage moderation, limitations on credit to the public sector, and stringent reviews of government expenditure programs. A recent staff study suggests that this attention to private investment is well founded: developing countries in which the share of private investment in total investment was relatively high were found to have relatively high ratios of total investment to income and relatively high average growth rates.
The liberalization of foreign trade regimes likewise contributed to both growth and external adjustment by providing competitive discipline for domestic producers and by improving the availability of imported inputs to exporters. The elimination of multiple exchange rates, the reduction of exchange and import licenses, the lowering of the dispersion of tariffs, and the replacement of quantitative restrictions with tariffs—all have a useful role to play. Often we find countries placing undue reliance on such restrictions; in these cases, the Fund recommends liberalization. As an illustration, over half of all 1980–84 Fund programs included specific commitments for liberalization of the trade or foreign exchange system. Again, empirical evidence is supportive. Countries that maintained a rough equality between the incentives for exporting and for import-competing activities grew faster in the long run and adjusted better to external shocks than did those with incentive structures favoring import-competing activities.
A greater receptivity to foreign direct investment also aids the growth and adjustment process. In addition to the potential benefits it offers for upgrading the level of technology, it provides greater protection than borrowed funds against sudden changes in the international cost of capital. With equity investments, the payout to the investor is usually closely linked to the return on the investment project (that is, they rise and fall together). Debt financing, in contrast, often requires a fixed payout and sometimes involves even an unpredictable one (floating rate debt)—regardless of the return on the investment. This kind of protection associated with equity financing would have been helpful to developing countries during periods when world interest rates rose sharply but their export earnings did not.
Finally, an environment of overall financial stability is an important facilitating mechanism for all other policy incentives. There is simply no such thing as a high and stable rate of inflation. Instead, very high rates of inflation reduce the information content of the price system, distort individuals’ comparative advantage, and introduce additional uncertainty into all types of economic transactions. Prudent monetary and fiscal policies are, of course, the first line of defense, but structural and incomes policies can also make a contribution.
Adjustment and Growth
Despite the obviously close interdependence between adjustment and growth, which can be readily established both theoretically and empirically, why is it so often contended that adjustment policies are harmful to growth and such policies are resisted? This is the subject of this final section. We begin with a discussion of some of the factors that have contributed to the perceived hardship in implementing adjustment in a number of countries and then go on to discuss certain initiatives that have recently been taken to strengthen and augment growth responses to countries’ adjustment efforts.
Apparent Conflicts Between Adjustment and Growth
Though adjustment is a necessary and indispensable condition for growth, recent experience shows that it is frequently not an easy option. Indeed, in many countries it has been associated with periods of austerity, involving considerable hardship and sacrifice. This has given rise to questions of whether adjustment is manageable or politically feasible. These are legitimate questions. But they tend to divert attention from the real issue: although adjustment may involve austerity compared with some preceding period, previous developments are, by definition, untenable and options are limited. Moreover, as we have sought to show in the previous section, the ultimate costs of unplanned and delayed adjustment clearly outweigh those of a timely and managed adjustment process.
Nevertheless, there is still a clear tendency for adjustment to be unduly delayed. Four factors may help to explain why this is the case. In the first place, the severity of adjustment measures invariably reflects the seriousness of the country’s predicament. The Fund’s experience shows that adjustment programs are much easier to implement and proceed far more smoothly when they are undertaken at an early stage of a country’s emerging difficulties. Indeed, there are many examples to demonstrate that programs with members are most successful when adjustment is brought about in an orderly way through the timely adoption of corrective measures. On the other hand, when a country postpones adjustment for too long and allows its external payments deficit to become excessive, foreign financing becomes difficult, if not impossible to obtain, and local residents lose confidence in the currency, which leads to large-scale capital flight. In these situations, adjustment is forced on a country in circumstances that are sometimes socially and politically hard to bear, as well as being disruptive to the economy.
A second consideration is that the short-term impact of a reorientation of policies frequently involves immediate losses in uneconomic sectors while the realization of the benefits in viable sectors is a more gradual process. For example, currency depreciation and the elimination of restrictions can be expected to lead to immediate cutbacks in those import-substituting industries or activities that have been protected; the offsets in the form of expanded activity and output in viable export sectors would normally take much longer to accrue. Similarly, cuts in government expenditures or more realistic prices for public services as part of an effort to reduce a fiscal imbalance may involve short-term costs to some sectors while the ultimate benefits resulting from reduced demand pressures and more rational incentives follow with a lag.
Third, the task of adjustment will also depend, in part, upon the world trading climate. Clearly, it is much easier for a country to adjust when world trade is expanding strongly. In much of the recent past, however, these conditions have not existed, and deficit countries have had to adjust in an environment marked by falling commodity prices and depressed world trading conditions with protectionist pressures intensifying. These developments have made balance of payments adjustment that much harder for deficit countries, since the brunt of their adjustment has fallen on imports.
Finally, adjustment efforts inevitably reflect the availability and terms of external financing. Recent experience has shown how financing flows fall when uncertainties arise about the capacity of borrowing countries to service their debt. For example, net lending by commercial banks to developing countries fell precipitously in the second half of 1982, and there was no appreciable increase in the other principal components of financing—official flows or direct investment. The contraction of external financing forced the pace of adjustment. Meanwhile, the dramatic reversal in the early 1980s, in the terms of financing—from a period of negative real interest rates to high positive real interest rates, as well as a shortening of maturities—added enormously to the debt-service burden and, hence, the task of adjustment confronting borrowing countries.
It is for these reasons that adjustment has been such an uphill struggle for many developing countries and why growth in the developing world has been set back so seriously in recent years.
Efforts to Strengthen Growth-Oriented Adjustment
In order to mitigate the pressures on adjusting countries, and to speed up the process of resuming sustainable growth, a number of new approaches are being pursued. At least three such approaches deserve mention.
To begin with, Fund surveillance has been reinforced through more frequent, more comprehensive, and more candid consultations with member countries. In most cases, consultations are now held on an annual basis and have been broadened to include more rigorous attention to trade policies and indebtedness. Also, medium-term scenarios, which aim at depicting the consequences of alternative policy strategies, have come to form an important focus of the consultation exercise. The object of these adaptations is to bring to the attention of the authorities in member countries, where necessary, the need for early action to deal with impending problems effectively.
A second set of approaches relates to financing. During the past year or so, much thought has been given to how an enhanced flow of capital to countries undertaking strong adjustment measures might best be achieved. In particular, the U.S. authorities launched a constructive set of proposals in the fall of 1985 that have come to be known as the Baker Plan.
In sum, these proposals comprise three major elements: first, the adoption by principal debtor countries of comprehensive macroeconomic and structural policies geared to promoting growth, balance of payments adjustment, and low inflation; second, a continued central role for the Fund, in conjunction with increased and more effective structural adjustment lending by the multilateral development banks (in particular the World Bank) in support of the adoption by principal debtor countries of market-oriented policies for growth; and third, an appeal to commercial banks to support these growth-oriented adjustment programs to the tune of $20 billion during 1986–88 for an indicative group of 15 major debtor countries. The Fund, in close collaboration with the World Bank, has been playing an active part in assisting the membership and the financial community to translate the U.S. initiative into concrete actions.
More generally, it is clear that marshaling the necessary financing for adjustment involves the combined efforts of commercial banks, official lenders, and multilateral institutions. The banks, for their part, must provide new money and restructuring on realistic terms to debtor countries heavily encumbered with commercial debt and making forceful adjustment efforts. In this connection, trade finance and project lending by banks has been assuming greater importance in supporting exports, investment, and growth, and multiyear rescheduling arrangements have proved beneficial to both borrowers and lenders. At the same time, official financing—particularly official development assistance—remains of fundamental importance in helping those countries with as yet limited access to commercial credit to meet their financing needs. Many low-income countries fit this description, including a few in the Arab world. For them, these funds act not only as a shock absorber against unforeseen domestic and external disturbances but also provide valuable breathing space to begin the necessary broadening of their structures of production.
Turning to the multilateral organizations, the World Bank Group—through both its lending and its expertise on investment strategies and other aspects of long-term structural reform—is making a vital contribution to the adjustment and development process. We in the Fund are cooperating closely with the World Bank and are drawing on its expertise so that the design of our programs is satisfactory from a medium- to long-term viewpoint. The Fund itself will continue to help countries design appropriate adjustment strategies and will provide and help mobilize financial support for them. In this connection, the recent decision to continue the enlarged access policy in 1987 and the introduction of the structural adjustment facility put the Fund in a strong position to continue to make a contribution to balance of payments financing on a meaningful scale. However, the scale of Fund lending in the recent past and the need to protect the revolving nature of its resources imply that the Fund’s “catalytic role” in unlocking other sources of financing may assume greater importance over the medium term.
Finally, attention should be drawn to the recent improvements in the discipline and coordination of macroeconomic policies in the industrial countries, which should help to improve the world economic climate and thereby facilitate the adjustment efforts of the developing countries. A major program of fiscal consolidation has begun in the United States; inflation rates have continued on their downward trend; exchange rates have moved in the right direction; and there has been a most welcome increase in coordinated actions against systemic problems. The agreement reached in New York in September 1985 among the five largest industrial countries (the Plaza Agreement), the coordinated interest rate reductions in the spring of 1986, and the recent commitments to closer coordination of economic policies on the part of the major countries attest to that. All of this has clearly been of great help in facilitating the adjustment efforts of developing countries. To cite but one indication, the 4½ percentage point decline in international interest rates since 1984 represents a savings of almost $16 billion on an annual basis in net interest payments of indebted countries.
Adjustment is a worldwide necessity; no country is exempt. Pressures for adjustment can rise or fall depending upon the external environment or domestic policies. But it needs to be an ongoing process. The recent experience of the heavily indebted countries bears ample testament to the consequences for those countries that fail to take timely or adequate adjustment measures.
Though the Arab countries reaped considerable benefit from high energy prices in the decade from 1973, conditions in the world oil markets have been changing over the past few years, culminating in the sharp fall in oil prices this year. In the new and uncertain conditions now confronting them, a number of Arab countries presently face the task of implementing major policy reforms in order to cope with a changed external climate and to strengthen and diversify their economies. In general terms, the content and direction of such policy reforms are clear, but actual programs need to be carefully devised on a case-by-case basis to reflect the specific circumstances, conditions, and priorities in each country.
It is the Fund’s role to assist member countries in devising and carrying out the necessary adjustment strategies through the provision of technical and financial support, as appropriate, and to work with the entire membership in order to foster the global economic and financial climate in which the adjustment efforts of individual countries can succeed.
In this paper, Arab countries are defined as those within the purview of the Funds Middle Eastern Department, namely, Bahrain, Egypt, Iraq, Jordan, Kuwait, Lebanon, the Libyan Arab Jamahiriya, Oman, Qatar, Saudi Arabia, Sudan, the Syrian Arab Republic, the United Arab Emirates, the Yemen Arab Republic, and the People’s Democratic Republic of Yemen.
Iraq, Kuwait, the Libyan Arab Jamahiriya, Oman, Qatar, Saudi Arabia, and the United Arab Emirates.
For a fuller discussion of the adjustment policies of oil exporting countries during this period, see Jahangir Amuzegar, Oil Exporters’ Economic Development in an interdependent World, Occasional Paper No. 18 (Washington: International Monetary Fund, April 1983).
Bahrain, Egypt, Jordan, Lebanon, Sudan, the Syrian Arab Republic, the Yemen Arab Republic, and the People’s Democratic Republic of Yemen.
See Donal Donovan, “Nature and Origins of Debt-Servicing Difficulties; Some Empirical Evidence,” Finance & Development (Washington), Vol. 21, No. 4 (December 1984), pp. 22–25.
International Monetary Fund, World Economic Outlook, 1983, Appendix A-5 “Exchange Rate Policies of Developing Countries, 1973–80” (Washington: International Monetary Fund, 1983), pp. 131–37.