4 The Role of the Fund and the World Bank in Adjustment and Development
- Saíd El-Naggar
- Published Date:
- September 1987
The title of this paper might suggest an association of the Fund with adjustment and of the World Bank with development. Such an association, though perhaps useful before the 1970s when problems were somewhat more clear cut, does not do justice either to the complexity of the issues that confront member countries today, or to the broader, and at times overlapping, work of the Fund and the Bank in the service of their common membership.
It has been conventional to classify countries, depending on their circumstances, as having a need for “stabilization,” or for “adjustment,” whether macroeconomic or structural. In addition, most countries also have a need for “growth.” Although the classification is not clear cut, stabilization generally refers to a need to correct financial imbalances, whether reflected in domestic inflation (open or suppressed) or in external deficits, or both—as is usually the case. The balance of payments problem often becomes evident in its monetary manifestation, as reflected in changes in net foreign assets of the banking system. Typical instruments used to correct the problem include monetary and fiscal policies, with attention focused on the size of the external imbalance rather than on its structure.
A need for adjustment carries the notion of addressing more fundamental imbalances in the economy, such as those that accumulated over a period of time. These imbalances might be the result of domestic policies, or they might be due to “shocks,” whether of external origin (such as sharp changes in terms of trade as in the case of a rise in the price of energy; a loss of creditworthiness; or shrinkage of external markets) or of domestic origin (such as a change of political regime). Adjustment encompasses an array of policy actions, including measures to contain domestic demand and measures to induce the movement of productive resources into the traded goods, or export-oriented, sector of the economy.
In cases where a currency is overvalued (thus promoting import demand while discouraging exports), the establishment of a realistic exchange rate is critical to both types of policies, that is, of demand management and output-switching. Other supply-oriented actions, such as interest rate changes or changes in taxation, may also be required, in their own right, or in support of exchange rate changes. Unless the economy is already highly flexible and responsive, adjustment to exogenous shocks requires a longer time than payment imbalances that are due to cyclical or excess demand factors.
Structural adjustment refers to situations where there is a need to go beyond changing the broad pattern of existing demand and supply flows. It requires supporting macroeconomic and exchange rate management with policy measures of an economy-wide or of a sectoral character in search of a better resource allocation and improved efficiency in the use of resources. Structural measures typically cover policy interventions in such areas as administrative pricing of major products (for example, energy, food, or major export crops) or of services (for example, irrigation water in an agricultural economy), the allocation of public expenditures, the pattern of public investment, the role of the private sector, the management of public enterprises, trade liberalization, and tariff reforms.
In earlier years, addressing problems of short-term stabilization was regarded as a “classical” area of Fund intervention—especially when dealing with the more developed economies, where disturbances were often diagnosed as cyclical in origin. However, the Fund’s concern and mandate are much broader and cover all aspects of macroeconomic adjustment. Indeed, the Fund’s purview extends to all aspects of economic policy designed to effect a better balance between supply of, and demand for, resources and to promote a sustainable balance of payments position, in this way, fostering sound economic growth.
Attainment of sound economic growth requires increasing the productive capacity of an economy, which includes finding ways of enlarging the supply of investment. If domestic savings are insufficient for this, development finance in the form of loans and grants can help bring about a higher level of investment, as well as ease the foreign exchange constraint. Development finance has a longer-term perspective than balance of payments assistance because loan repayment periods for capacity-creating investment must be long enough to bring production on stream and establish profitability. This in turn implies long-term financing, and development finance institutions such as the World Bank have been established to provide such assistance. There is, of course, a natural link between adjustment and development in the sense that for sound economic growth to take place, countries need to maintain a sustainable balance of payments position. But in their fundamental purposes and approach, lending for balance of payments and lending for development address different needs, even if in much of the developing world at present the connection between the two is a close one.
Responses to Changing Problems
As the foregoing suggests, the role and mandates of the Fund and the Bank are determined by the nature of the problems faced by their members. A particular country may need to avail itself of the resources and assistance of one or both institutions, and since economic problems cannot be precisely classified into separate compartments, there is bound to be a degree of overlap between the institutional interests and activities of the Fund and the Bank. This has been especially the case since the 1970s when the complexity of problems facing countries, in the wake of the particularly turbulent developments of this period, has required both institutions to look beyond their classic mandates. A consequence of this has been to highlight the necessity for deeper collaboration between the Fund and the Bank.
The World Bank
The Bank’s lending in its first decade had a substantial component of nonproject (“program”) lending during the reconstruction phase. Its operations in the next 25 years were largely directed to the financing of specific investments,1 with program lending averaging about 5 percent of annual lending and being justified by “special circumstances.”2 In the early 1960s, the underutilization of industrial capacity was found to be restraining investment in India, and a series of import credits was arranged to finance imports of materials, components, and spare parts. Similar credits were arranged in later years for Bangladesh, Egypt, and Pakistan. In 1971, the Bank concluded that when a country could not obtain, by borrowing only for specific projects, the external resources required to support a development program, program lending was appropriate, provided the country had a satisfactory development program and was following sound economic and financial policies.
As the foreign exchange constraint tightened for the oil importing countries following the 1973–74 and 1979–80 oil price increases, it became evident that acute shortages of foreign exchange were resulting in retrenchment of investment outlays because governments had to focus available foreign exchange on priority consumption and security needs. In this situation, the provision of nonproject finance to borrowing governments could be used to leverage policy reforms designed to mobilize domestic resources and to improve their utilization. Such reforms were essential because it was becoming evident that even the best investments could not yield the benefits expected from them unless the economic policy environment was sound.
Starting in fiscal 1980, this became the basic rationale for policy-based lending in the form of structural adjustment lending (SAL). While the earlier SALs had comprehensive objectives encompassing policy and institutional reforms affecting the entire economy, sectoral credits later came to be more frequently used when the problems to be tackled were not economy-wide. Both SALs and sectoral loans focused on issues that went far beyond project support. These included changes aimed at correcting gross distortions in prices, particularly in agriculture and energy; tariff reductions and trade liberalization designed to improve the balance between export promotion and import substitution; financial sector reform to improve resource mobilization and allocation; upgrading the efficiency of public enterprises; and improved debt management, among other reforms.
Introduction of the extended Fund facility (EFF) in 1974 marked an explicit recognition of the need for the Fund to address policies needed to deal with payments imbalances relating to structural maladjustments in production and trade and where prices and cost distortions had become widespread. Even more significant was the reference in the decision establishing the EFF to the application of the facility to “an economy characterized by slow growth and an inherently weak balance of payments position which prevents pursuit of an active development policy.”3 In recognition of the fact that solutions would require a period longer than that available under existing tranche policies, implementation of an extended arrangement could be spread over three years and the period of repayment could be as long as eight years after each purchase. In 1979, the decision was amended to extend the period of repayment to ten years.
In 1976 the Fund took another step toward a longer period of adjustment when it prescribed that Trust Fund loans (established out of profits from the sale of a portion of the Fund’s gold) to developing countries with low per capita incomes could be repaid over ten years with five years of grace and would carry a concessional interest charge of 0.5 percent a year. Another step in the same direction was taken under the supplementary financing facility (SFF) established in 1977 in order to provide larger resources than were available from the Fund’s ordinary resources by borrowing from a group of oil exporters and industrial countries. The borrowed component specified a repayment period to begin no later than three and a half years after each purchase and to be completed no later than seven years after the repurchase. When the SFF was followed by the enlarged access policy (EAP) in 1981, the repayment period of seven years for borrowed resources was retained. Interestingly, the decision establishing the EAP provided that the period of a stand-by arrangement under it would normally exceed one year and could extend up to three years in exceptional cases. This meant that the longer implementation period under the EFF could be used in regular stand-by arrangements, as well, and presaged the medium-term time horizon within which all Fund lending has been fitted in subsequent years.
Impact of the Debt Crisis
While the Fund and the World Bank were responding to their members’ changing needs in the face of the shocks experienced in the decade of the 1970s, the onset of the debt crisis in the latter part of 1982 produced a sharp shift toward a catalytic role for the two institutions, especially in relation to the middle-income developing countries, which were most affected. Because these countries are substantially market borrowers, the rise in international interest rates in the period 1980–81 sharply increased their debt-servicing obligations just when their capacity to service debt was being eroded by the reduction in export earnings in the wake of the global recession. The outcome was a sudden change in the assessment of their creditworthiness by commercial lenders, who had become the main channel of financial flows to the middle-income developing countries in the preceding decade. The private markets had provided funding in ways that blurred the distinction between balance of payments and development finance. Thus, a sudden reduction in these flows had consequences for the borrowing countries that had a direct impact on both their balance of payments and their growth objectives.
The Fund was propelled to center stage when Mexico sought its help in August 19824 because of the Fund’s customary role as a “crisis-manager” and its ability to respond rapidly with financial support. The Fund’s management recognized that the imbalance that needed to be financed following the virtual cessation of commercial bank lending was simply too large to be handled by the Fund alone and that the commercial banks would have to continue providing funding if there was to be any orderly way for Mexico to manage its economic adjustment. In turn, the commercial banks wanted to be assured that the adjustment effort of the country would be adequate to the magnitude of the task and would be monitored by the Fund. The Mexican authorities negotiated a three-year program with the Fund and agreed to make the results of the Fund’s monitoring available to the banks. The established modalities for monitoring by the Fund, including phasing of disbursements and performance criteria, enabled the banks to find legal formulations that tied their own commitments to those of the Fund. This pattern was followed in a number of other cases (for example, Argentina, Brazil, Chile, and Ecuador). For countries that did not need the Fund’s financial support, special monitoring modalities were developed (for example, Colombia in 1984 and, more recently, Brazil).
In an effort to move the debt problem out of its crisis phase and to enable debtor countries to regain market access on a spontaneous basis, the Managing Director of the Fund proposed in mid-1984 that commercial banks consider multiyear rescheduling arrangements (MYRAs) that would help to flatten the “hump” in the debt profile of indebted countries arising from the short-term debt-relief arrangements worked out in 1982–83. To assure a continuing monitoring role during the stretch-out period, a procedure of “enhanced surveillance” was developed whereby a more frequent review process (that is, more frequent than annual Article IV consultations) would be used by debtor countries entering into MYRAs to convey to their commercial lenders the Fund’s evaluation of their progress with adjustment (for example, Venezuela, Yugoslavia, and Ecuador).
The World Bank
The World Bank, of course, had a major role to play in dealing with the debt problem of members, owing to its long-time role as a center for the collection and analysis of external public debt statistics, and because it was required to assess continuously the creditworthiness of its borrowers in the context of its own portfolio management. As the crisis began to abate and the realization dawned that debt was bound to be a long-haul problem, an enhanced role for the World Bank Group and the regional development banks became mandatory. In 1983, the Bank launched a special action program designed to support adjustment efforts through procedures that would disburse funds more rapidly. In 1985, the Bank helped to develop medium-term growth programs in such countries as Chile, Colombia, and Uruguay and to secure commercial bank finance for these programs through innovative cofinancing arrangements. Lending for specific investments dropped from over 60 percent of total lending in 1980 to a range of 40–50 percent, and broad sectoral investment loans rose to almost 40 percent of the total by fiscal 1985 while the share of adjustment lending (both structural and sectoral) roughly tripled over this period.5
A powerful boost for the Bank’s role came from the so-called Baker Initiative, presented by U.S. Secretary of the Treasury James A. Baker III at the Fund-Bank Annual Meetings in September 1985 to strengthen the debt strategy. Its fundamental point was a recognition that indebted countries could service their debts only if their economies could grow. This required basic changes in their economic policies and institutions, additional financing from the commercial banks and multilateral development banks (MDBs), as well as supportive economic policies in the industrial countries. For an illustrative group of 15 debtor countries, Secretary Baker proposed that the commercial banks and the MDBs increase their respective total exposures by $20 billion each during 1986–88. The World Bank’s “share” of the MDB total would be about $6 billion annually, and the Bank has moved resolutely to increase its lending commitments to major debtors.
In addition, the World Bank has enlarged its catalytic role through various cofinancing techniques to support commercial bank lenders in assembling new money packages and official export credit agencies in restoring cover for medium-term credits. Increasingly, the banks have sought association with the World Bank in addition to the Fund, creating complex three-way relationships.6
An interesting example of these interconnections is the incorporation of two contingency financing mechanisms in the Mexican stand-by arrangement of November 1986. The first involved a provision that in the event that the price of oil stayed below a reference level for a certain length of time, the commercial banks would be expected to make an additional contribution of up to $1.8 billion and the Fund would contribute up to SDR 600 million. The recent evolution of oil prices suggests that this particular contingency will not need to be invoked. The second contingency contemplates additional financing from the commercial banks, half of it guaranteed by the World Bank,7 if the rate of growth (as measured by an index of manufacturing production) falls below a specified level in the year that ends with the second quarter of the program period. While neither the Fund nor the Bank can guarantee a particular economic growth rate, nor can such growth result from an automatic increase in public expenditures, the objective of the contingency mechanism is to assure Mexico that it may count on external help to maintain its public investment program in the face of a less favorable evolution of its economy as long as its adjustment effort remains on track. Commercial banks have asked the World Bank to identify and assess in advance projects that will benefit from their additional funding and that give promise of generating significant employment as well as substantially spilling over into the private sector. The banks have also required that the Fund explain the index used for triggering the growth contingency and confirm that the trigger has been activated before any disbursements take place. Apart from these complex modalities, there is a question whether expenditures can proceed quickly enough to have an effect during the program period. A contingency mechanism has also been mentioned in the Argentine request of January 1987 for a stand-by arrangement.
Fund-Bank Joint Activity—the Structural Adjustment Facility
It is not certain that growth-protecting stipulations, such as those mentioned above, can be built as a matter of course into future Fund stand-by arrangements or that they would necessarily receive assurances of World Bank support. What these innovations demonstrate, however, is the willingness of the two institutions to work together to craft flexible responses to the very difficult problems confronting the middle-income debtor countries.
A significant new channel of joint activity by the two Bretton Woods agencies—this time in relation to low-income countries—emerges from a decision of the Fund adopted in March 1986 to recycle the repayments to the Trust Fund in the amount of S2.9 billion during 1986–91. Structural adjustment facility (SAF) loans would be provided to members that are eligible only for International Development Association (IDA) financing on concessional terms (0.5 percent interest a year with repayment in ten years, including five and a half years of grace) in support of a program of macroeconomic and structural adjustment intended to overcome protracted balance of payments problems and to foster growth. A member country requesting assistance under the SAF submits a policy framework paper (PFP) laying out the country’s strategy for dealing with its major economic problems and challenges. The PFP embodies the general outlines of a three-year adjustment program, including structural measures, and delineates in broad terms the expected path of macroeconomic policies, with greater precision as to the first year of the program. The PFP also identifies the external financing requirements and the likely sources of such financing.
While the PFP is the country’s own statement, it is meant to be prepared in close collaboration with the staffs of the Bank and the Fund and to be reviewed by the Executive Boards of both institutions. This parallel action was contemplated in part because of an expectation that additional resources would be forthcoming from the World Bank Group. The negotiations that culminated in an agreement on an Eighth Replenishment of IDA at a level of $12–12.4 billion envisage that $3–3.5 billion would be available for matching the Fund’s contribution through the SAF.
The first few transactions under the SAF have been based on joint assessments in which both institutions were reasonably clear about the policy requirements and were also conversant with the country’s current thinking. More difficult would be cases in which the Fund and the Bank are not of the same mind, or in which there is a sharp difference of opinion between one or both of them and the country on the diagnosis of the country’s problems and on the policy prescriptions.
Some Issues in Fund-Bank Coordination
The developments of the past decade and a half outlined in the preceding sections have served to bring the activities of the two institutions into a joint focus. The clearer separation of mandates and fields of interest of the early years has been overtaken by developments. It may be recalled that in the mid-1960s it was agreed that the Bank would be primarily responsible for the composition and appropriateness of development programs and project evaluations, including setting development priorities. The Fund was recognized as having primary responsibility for exchange rates and restrictive systems, adjustments of temporary balance of payments disequilibria, and for evaluating and assisting members to work out stabilization programs as a sound basis for economic growth. The overlapping areas were not specifically described, but a few among the range of common interests were noted, namely, the structure and functioning of financial institutions; the adequacy of money and capital markets; the actual and potential capacity of a member to generate domestic savings; the financial implications of economic development programs both for the internal financial position of a country and for its external position; and foreign debt problems.
It is interesting that while certain areas of coordination that have become vital, such as debt problems, were mentioned, there was no reference to other areas that have become so critical in recent times. These recently critical areas include the catalytic role of the institutions in arranging financing from private and official lenders as well as donors, the meeting of technical assistance needs, the requirement for developing medium-term projections, and the dovetailing of mutually reinforcing programs of growth-oriented adjustment.
The emergence of overlapping responsibilities has prompted in both institutions several reviews of coordination issues. A great deal of procedural refinement has been introduced to cover such matters as the exchange of information, the meshing of staff mission schedules, the participation of staff from one institution in missions, or in Executive Board discussions, of the other. Similarly, procedures for the resolution of differences of viewpoint have been clarified. To the extent that these refinements have worked successfully, they have moved the institutions from the stance of avoiding inconsistent policy advice to a determined endeavor to provide effective and coordinated support to growth and stability in member countries. Their closer collaboration has been particularly helpful to countries in filling balance of payments gaps beyond what the institutions themselves could cover. Here the closer relationships that the Fund has with official creditors in the Paris Club and the stronger relations of the World Bank with the donor community through its sponsorship of consortia and consultative groups help to produce synergistic responses that might not be forthcoming if the countries were acting in collaboration with only one institution.
Having said this, one must recognize that certain intrinsic differences deriving from different perspectives and mandates of the two institutions may create difficulties. The Fund as a relatively short- to medium-term lender, working essentially through annual programs, is concerned to ensure that there are no unfinanced gaps. Its adjustment prescriptions therefore tend to emphasize such changes in domestic absorption as would hold the external imbalance in a given period within the limits of what can be financed. The longer-range perspective of the World Bank inclines it toward treating the financing needs of given growth objectives as targets to be attained rather than as constraints to be respected. There is therefore some built-in tension between an approach based on “availability” of finance and another based on the “requirement” of finance. The former tends to treat the rate of growth as a residual, the latter treats domestic and external financing as a residual.
Another difference resides in the rhythms of work in the institutions. The Bank, because of the wide diversity of specializations required to evaluate a public investment program, for instance, may need longer to reach conclusions than the lead time associated with Fund programs. Imperfect synchronization of Bank-Fund operations can lead to inaccuracies in projections of disbursements in estimating the financing of the balance of payments gap during a future period.
Problems of overlap arise not only in lending operations but also in the growing area of technical assistance. The Fund, as a monetary institution has traditionally been engaged in providing technical assistance to central banks. The Bank’s interest in the reform of financial institutions often brings it directly into the same field. Similarly, in the fields of tax policy and expenditure control, the Fund has developed an expertise because of the fiscal origin of balance of payments problems in many cases. Yet the more critical budgetary issues become, the greater the need felt in the Bank to help with technical assistance in the same area. It is inevitable that experts working in the same field will not always agree, and one might therefore run the risk of transferring into the area of technical assistance, conflicting advice on matters that the two institutions have tried to address in the area of direct operations.
There is a general perception among developing countries that the risk of cross-conditionality is inherent in too close a coordination between the institutions. Cross-conditionality may be defined as a situation in which acceptance by the borrowing country of the conditionality of one financial agency is made a precondition for financial support by the other.8 Both institutions abjure cross-conditionality in the sense that no arrangement exists between them whereby a formal action by one in relation to a member (for example, declaration of ineligibility by the Fund) interrupts access to the resources of the other. It is thus informal or implicit arrangements that worry the Group of Twenty-Four.9 The issue is seen as important because of the apprehension that the more coordination there is between the two institutions, the greater the probability that uniformity of advice will result in concerted pressure being applied on the country seeking help from either institution. This could lead to a substantial reduction in the freedom of action of the country in developing and executing its own policies. It could add to the complexity of negotiations and thereby contribute to delay. Even prior to negotiations, the need for the two institutions to coordinate their views may entail delay if differences in views between them require issues move up through their respective hierarchies to levels at which they get resolved. Dilemmas are clearly involved, as illustrated in the following passage from a recent report of the Commonwealth Secretariat on this subject:
If the institutions disagree on a common problem and persist to the extent of offering contradictory advice, they can be accused of inconsistency; if they reconcile disagreement and act on agreed positions, through a common approach to conditionality, they can be accused of bringing concerted pressure to bear on borrowers; if they try to limit their interaction and stick to their traditional complementary and independent roles, they can be accused of failing to carry out their enlarged mandates.10
The necessity of coordination is not to be disputed, however difficult the task. The institutions are not obliged to strain for an identity of views, but each remains under an obligation to give careful consideration to the views of the other. 11 The question becomes whether there are ways in which the interests of borrowers can also be safeguarded. Several ideas have been canvassed to create safeguards, including limiting the areas of institutional overlap, keeping coordination procedures as simple as possible, defining a “lead” role for one agency or the other in particular countries, and creating an external review process by independent experts.
None of these expedients addresses the real issue that arises from the growing scarcity of resources for the developing world. In the case of the middle-income debtor countries, it is the unwillingness of private lenders to enlarge their exposures at a time when their existing portfolios may call for provisioning. In the case of the low-income countries, it is the insufficiency of official development assistance that acts as a constraint. As long as external funds remain scarce, and demands for them intense, a greater regard for the views and preferences of creditors will remain a fact of life.
In this respect, the Bretton Woods institutions have an advantage that should not be underrated. Despite the fact that they operate on the basis of weighted voting, they have developed traditions of consensus building that allow them to act with a great deal of objectivity. They are not part of any lending “cartel,” and their usefulness can be protected through periodic enlargement of their resources. In the final analysis, however, the effectiveness of the two institutions does not depend on the availability of resources alone. It depends fundamentally on the successful pursuit, by their member countries, of policies supportive of adjustment and growth.
Article III, Section 4 (VII) of the Bank’s Articles of Agreement stipulates: “Loans made or guaranteed by the Bank shall, except in special circumstances, be for the purpose of specific projects of reconstruction or development” (italics supplied).
Special circumstances justifying nonproject lending were “created by war or natural disaster, by a sudden fall in export earnings in economies critically dependent on a single export item or by a deterioration in the terms of trade resulting from a sharp rise in import prices.” For additional material, see E. Peter Wright, “World Bank Lending for Structural Adjustment,” Finance & Development (Washington), Vol. 17, No. 3 (September 1980), pp. 20-23.
Decision No. 4377-(74/l 14), as amended, Selected Decisions of the International Monetary Fund and Selected Documents, Twelfth Issue (Washington: International Monetary Fund, 1986), p. 32.
“For a knowledgeable outsider’s description of the Fund’s role, see Joseph Kraft, The Mexican Rescue (New York: Group of Thirty, 1984).
For a detailed analysis of the World Bank contribution, see David Bock and Constantine Michalopoulos, “The Emerging Role of the Bank in Heavily Indebred Countries,” Finance & Development (Washington), Vol. 23, No. 3 (September 1986), pp. 22–25.
See Hiroyuki Hino, “IMF-World Bank Collaboration,” ibid., pp. 10–14. Some examples quoted in the article are as follows: “. . . in one case all disbursements of a commercial bank package required satisfactory performance under a program monitored by the Fund, an important clement of which was the liberalization of the trading system; other aspects of trade liberalization were featured in the program under the Bank’s Trade Sector and Export Diversification Loan. Disbursements of commercial bank loans were also tied to the satisfactory completion of a review by the Bank which included, inter alia, a favorable assessment of macroeconomic policies; the Bank staff were to take into account Fund staff views in making such assessments. In another case, commercial bank participation in a new money package was , . . tied to drawings from the Fund and drawings under the Bank’s structural adjustment lending program.”
The guarantee is payable at final maturity and is equivalent to about 20 percent in present value terms. World Bank guarantees also apply to the rest of the commercial banks’ new money package.
See “Commonwealth Secretariat Report on Co-operation Without Cross-Conditionality, an Issue in International Lending” (London, September 1986).
This worry has surfaced most recently in relation to the structural adjustment facility; a Group of Twenty-Four communiqué at its March 1986 meeting “deplored the recent developments in the IMF Board . . . [whereby] , . . more conditionally would be introduced and cross-conditionality would emerge, especially if a ‘general policy framework,’ worked out jointly by the Fund and the Bank, has to be a precondition before programs are approved.”
See footnote 8,
See J. de Larosière, Address Before the Economic and Social Council of the United Nations (Washington: International Monetary Fund, 1986), p. 9.