9 Adjustment Policies and Experiences, 1979—Mid-1982
- Margaret De Vries
- Published Date:
- March 1987
In 1979, Fund officials, under the leadership of the new Managing Director, undertook to design specific policies for balance of payments adjustment that they felt were appropriate in the troubled circumstances. They formulated policies that they could recommend to members and that the Fund would be prepared to support with its financial resources. The policies soon took the form of adjustment programs. Although adjustment programs were the responsibility of the member concerned, Fund staff, in Close consultation with the Managing Director, often helped a member formulate an adjustment program that they believed they could confidently recommend to the Executive Board.
Considerations Underlying the Fund’s Policies
In developing their ideas about appropriate adjustment programs from 1979 to mid-1982, Fund officials were necessarily heavily influenced by what they considered a realistic assessment of the world economic and political environment. It was a very troubled one, as described in Chapter 8. Fund officials started with the premise that the circumstances prompting the need for adjustment of balance of payments disequilibria in 1979 and in the next few years were fundamentally different from the circumstances that had often prompted the need for correction of balance of payments disequilibria in the 1950s and 1960s. In previous decades, as seen in foregoing chapters, financial stabilization of the domestic economy that could be effected in a short-term period—one year or even less—was usually sufficient to bring about adequate correction of a current account deficit. Financial stabilization in the short term worked successfully not only in industrial members but also usually in developing members, although developing members also required more use of exchange depreciation and technical assistance to set up the necessary monetary and fiscal instruments to help make financial stabilization policies more effective.
From 1979 on, however, circumstances were different. Simply put, very high oil prices made it necessary to curb the growth in the overall use of energy and to develop sources of energy other than oil. The transfer of real resources from oil importing to oil exporting members was inevitable. Moreover, the current account surpluses of oil exporting members following the second round of oil price rises were likely to last longer than the surpluses in the 1974–78 period after the first round of oil price increases. Imports by oil exporting members were not likely to keep on increasing at the high rates of the 1974–78 period. In short, no longer could adjustment to higher oil prices be postponed. In fact, it probably should have come earlier.
Another parameter that dominated thinking in the Fund in 1979–81 was that for nearly all non-oil developing members the measures needed would have to go beyond the general macroeconomic policies, such as fiscal and monetary policies, that facilitated balance of payments adjustment in the 1950s and 1960s. Changes in exchange rate and interest rate policies and in the policies that many members used for determining the administered prices charged by their numerous state enterprises would also have to be made with a view to bringing about profound changes in the allocation of resources in members’ economies. These basic adjustments in resource allocation could not be effected in the short term. They had to take place over the medium term. Hence, extended arrangements, under the extended facility that had been introduced in 1974, as described in Chapter 6, rather than shorter-term stand-by arrangements were considered appropriate for many members, and from 1979 to 1981, considerably more use was made of extended arrangements.
At the same time, adjustment programs were still to rely heavily on demand-management policies. Fund officials were convinced that fiscal and monetary policies in many developing members had been too expansionary, especially in the 1974–78 period after the first oil price rise, and that strong demand-management policies were essential, if not primary, to policies that affected resource allocation. The guiding principle was that when adjustment had to be carried out over a period longer than one year, it was important to ensure that in the course of managing the demand side a reorientation of the member’s economy also take place and that available capital inflows be directed in large part toward investment that strengthened the external sector. Because many of these areas of concern were in the province of the World Bank and because staff of the World Bank had more expertise and experience with structural changes in a developing member’s economy than did Fund staff, Fund staff began to carry out assessments of measures that influenced the structure of members’ economies in close collaboration with the World Bank. The Executive Board, as well as the management and staff, emphasized that such collaboration was essential to helping members devise the most appropriate adjustment policies.
Fund officials were mindful of the acute problems of adjustment faced by the non-oil developing members. Developing members found themselves in the uncomfortable position of having to cope simultaneously with three kinds of external shock. There was the increase in the price of oil, which had a direct effect on their current account positions through the higher import bill for oil and an indirect effect through the cost of imports of industrial goods whose prices were likely to increase faster as a result of higher energy costs. There was the implementation of anti-inflationary policies in industrial members, which had already resulted in a sharp rise in nominal and real interest rates in world financial markets. And then there was the slowdown of economic activity in industrial members, partly due to the anti-inflationary policies, which had already begun to reduce the demand for imports from developing members. Since prospects for higher export earnings by non-oil developing members were not good, adjustment of current account deficits for these members meant reductions in their imports. White a few non-oil developing members might ease the reduction of imports by increasing their domestic production of import substitutes, most would not have the option. For them, adjustment would have to involve a lowering of domestic absorption. To the extent that additional domestic output or changed composition of production could alleviate the lowering of domestic absorption, the process of adjustment would entail less reduction of current real income.
How Much Financing and How Much Adjustment? Another element in the Fund’s approach to adjustment that had to be worked out beginning in 1979 was the particularly difficult question of the appropriate mixture of financing and adjustment. What constituted a “judicious” blend of the two? The Fund management and staff, supported by the Executive board, were convinced that to rely too much on financing rather than adjustment in the belief that external conditions would soon improve would be a serious mistake for non-oil developing members. The Fund’s assessment of the economic environment, as seen in Chapter 8, was that the world economy would be in dire straits throughout the first part of the 1980s, if not longer.
At the same time, although Fund officials continued to emphasize that the answer as to how much financing should occur should be heavily influenced by reference to critical statistical indicators, such as the ratio of debt to gross national product, they also stressed the importance of the profitability of the investment financed with borrowed funds. As long as the expected return on investment over the long run exceeded the cost of borrowing abroad, higher foreign indebtedness could be regarded as sound policy for both lender and borrower because the higher level of investment financed by foreign borrowing would eventually be reflected in additional net export capacity. The staff believed that the concept of what was a reasonable amount of foreign indebtedness also could be revised upward, at least for some non-oil developing members, for two reasons. From a global perspective it seemed sensible that the increased savings of oil exporting members as a result of the new higher oil prices be matched with at least an equal amount of investment in the rest of the world. Otherwise, global savings would exceed total investment, causing a net drain on the world economy, with deflationary consequences. This had been the danger that Mr. Witteveen had particularly tried to avoid in 1974, at the time of the first oil crisis. In any event, the most important reason why Fund officials revised upward the magnitude of what was viewed as a reasonable amount of indebtedness was a simple and pragmatic one. Overall liquidity in international financial markets would in all likelihood be increased through the placements in those markets of funds from oil exporting members. In short, bankers would have huge sums and would be seeking to lend those sums, and debtor members had external payments deficits that they were eager to finance. Inevitably, external debt was going to continue to rise.
The implication for the mix of financing and adjustment of the causes of balance of payments deficits also had to be decided. If the external payments deficits of non-oil developing members were caused more by exogenous elements than by domestic circumstances or policies, should more emphasis be placed on financing rather than adjustment? Authorities of some developing members and some economists, for instance, were arguing that balance of payments deficits that were the result of external shocks should be financed; developing members should not have to alter their domestic policies to accommodate deficits for which they were not responsible. In fact, to do so would seriously disrupt their economic development of the past several years.
By early 1980 Fund officials had the answer that they considered appropriate in so far as use of the Fund’s resources were concerned. Use of the Fund’s resources had to be temporary. The resources had to be regarded basically as reserves “lent” for a limited time by one member to another through the Fund. The Fund could not be used for long-term loans. Fund officials, therefore, had to safeguard the revolving character of the Fund’s resources by formulating policies that would ensure that a member using these resources would be in a position to repay the Fund in a few years.
This consideration was uppermost in the minds of Fund officials when they focused on the question whether a balance of payments deficit caused by factors external to the member should be treated differently insofar as Fund policy was concerned than a balance of payments deficit caused by a member’s international circumstances and policies. The answer lay in the length of time that the balance of payments deficit was expected to last. Although the causes of the increased current account deficits of non-oil developing members were largely external in origin, they were not likely to be transitory. Adjustments in domestic policies were therefore unavoidable. As far as Fund policy was concerned, the important distinction was not between internal and external causes of balance of payments deficits but between balance of payments difficulties that were temporary and likely to be quickly reversed and those that were long lasting. In general. Fund officials concluded that in most non-oil developing members circumstances were such that there was a case for both financing and adjustment, with the relative weight of each depending on the particular economic situation of each member.
Other questions pertinent to the relative size of financing versus adjustment were also intensively examined within the Fund. What constitutes a “sustainable’’ balance of payments position? The Fund staffs answer was simple in concept: it was a current account deficit that could be financed by spontaneous, that is, voluntary capital inflows over the medium term. Obviously this answer applied primarily to a developing member with a balance of payments deficit. While the concept of a sustainable balance of payments position might be hard to define, the Fund staff stressed that in practice no major problem arose in determining a “sustainable” current account. In most instances of members coming to the Fund for financial assistance, the direction of the necessary adjustment was not in doubt. A member usually came to the Fund when the discrepancy between the projected current account deficit and the available means of financing was already large, that is, when the member’s own foreign exchange reserves were close to exhaustion and when its access to other external sources of finance was severely curtailed. A long-standing cardinal rule for any Fund-supported stabilization or adjustment program was that the projected current account deficit could be expected to be fully financed. Financing had to come from use of the member’s own foreign exchange reserves, the amount of resources that the Fund itself was prepared to commit, and the member’s access to other sources of balance of payments finance. In these circumstances, the problem presented was not to determine an optimum size for the current account deficit but rather to find ways to tailor plans for domestic expenditure to the constraint imposed by the total foreign financing available. In practice, once the magnitudes of other financing and of the use of reserves were determined, the limits of the flexibility that the Fund had in supporting a stabilization or adjustment program were thus essentially set by the amount of the resources that the Fund was prepared to commit to the member concerned.1
Another crucial question examined internally was the speed at which the desired current account position should be achieved. The Fund management and staff normally aimed at a sustainable position by the end of the program period. In the past, the period had customarily been one year. Now in 1979–81, most programs covered a longer period, often three years.
Other Elements in the Fund’s Approach to Adjustment A number of other issues involved in determining the features of adjustment programs that the Fund could support in the circumstances of 1979–81 were also examined. How much emphasis should be placed on controlling inflation? Were the Fund’s practices for determining credit ceilings resulting in ceilings that were excessively low? Did the Fund’s experience confirm that depreciation of the exchange rate did lead to improvements in the external payments position, and how quickly? What alternatives existed to a change in the exchange rate? In what specific ways should Fund staff collaborate with staff of the World Bank in evaluating members’ investment and pricing policies? What measures should be included in adjustment programs with regard to state economic enterprises? How Fund officials answered these questions and the Fund’s experience with the resulting adjustment programs are described in the last section of this chapter.
The staff studied other questions, too, and some of the studies were published. What were the relative roles of external and domestic factors in causing balance of payments deficits for non-oil developing members and what conclusions could be drawn for the need for efforts to adjust? A study concluded that while both external and internal factors played pivotal roles in the substantial determination of current account positions of non-oil developing members as a group in the years from 1973 to 1981, substantial adjustment efforts were necessary. The study also concluded that evidence of insufficient adjustment in a number of non-oil developing members could be seen in the way their real effective exchange rates had appreciated and their fiscal deficits had expanded during this period.2
Do policies limiting credit expansion reduce output and growth and how do they relate to the development of the current account and the overall balance of payments? The principal conclusion of a study of this question was that limiting overall credit was not enough. Reduction of price distortions and particularly the adoption of appropriate exchange rate and interest rate policies had to be an integral part of any program that contained limitations on domestic credit.3
Do stabilization or adjustment policies generally impinge on economic growth? A study concluded that past stabilization policies had not seemed to require a sacrifice of growth except in the short run. Members that had been most successful in dealing with the external payments shock of 1974 and in moderating inflationary pressures were by and large, but with important exceptions, the ones that had best maintained their real economic growth. The staff again concluded that the main area of policy that could help to improve output and growth was rationalization of the price structure. The removal of cost-price distortions could help to improve the allocation of resources and the efficiency of investment decisions, as well as to raise the overall level of savings and investment. However, because cost-price distortions had usually arisen for a variety of social or political reasons their removal was difficult.4
Does exchange rate depreciation actually divert economic resources toward the external sector, thereby improving the balance of payments, reducing inflationary pressures over the longer run, and laying the ground for sustained economic growth? A study of several actual cases concluded that the answer was mixed. On average, actual export performance exhibited a striking improvement in the postdepreciation period, especially over a three-year period. The effect of depreciation on the volume of imports differed markedly, however, from one case to another. Where programs involved import restraint, real import growth declined noticeably. This decline reflected the intended “expenditure reducing” effect of the exchange depreciation. Where programs involved a liberalization of imports, partly as a result of measures to liberalize the exchange and trade system, the volume of imports usually rose sharply. On average, the differential between the rates of inflation in members with adjustment programs and world inflation rates remained about the same; abstracting from the once-and-for-all inflationary effect of the depreciation, however, some improvement was recorded relative to world inflation rates. For import-restraint programs, average economic growth declined sharply, in both the short run and the long run; the converse was true for the liberalization programs.5
How successful was the innovation in stabilization programs of pre-aunouncing the future path of the exchange rate as a way to reduce inflationary pressures? A study suggested that, in certain circumstances, particularly as an integral part of a comprehensive stabilization program, preannouncement of exchange rate changes might be very useful.6 What repercussions do stabilization programs have on the distribution of income? It was found that in the short run, changes in income distribution may occur that, from a short-run egalitarian perspective, may be undesirable. Over time, however, these changes may help stimulate foreign capital inflow and increased investment with benefits to all.7 Also investigated was why the position of the current account had largely replaced the balance of payments as a barometer of the need for adjustment in a member’s macroeconomic policies and what constituted an equilibrium level and appropriate distribution of current account positions among members.8 Fundamentally, the current account is the difference between the economy’s savings and investment. Hence, any criterion for determining the appropriateness of adjustment action depends on a corresponding assessment of the levels of savings and investment that underlie the current account. All in all, the Fund was developing a considerable analytical base to be used in its policy formation.
The Fund’s Policies
The general thrust of the Fund’s policies on adjustment is probably revealed best in the many explanations of those policies from 1979 to 1981 by the Managing Director. In Dakar in January 1980, for example, Mr. de Larosière was particularly candid.9 While be recognized the part played by adverse external factors in the economic deterioration of most African members in the previous several years, he stated frankly that in many members domestic policies were also to blame. Often these policies had tended to be too expansionary; many members had adopted “unduly permissive” fiscal and monetary policies. African members, whose domestic incomes and prices were heavily affected by changes in import and export prices, had not formulated their fiscal and monetary policies so as to neutralize the undesirable effects of these fluctuations on their incomes and prices. As a consequence, distortions had emerged in their domestic economies, and, more important, their balance of payments positions had come under pressure, and the members had had to borrow- externally in order to fill in both budgetary and balance of payments gaps.
Accordingly, an adjustment effort that was “comprehensive, encompassing not only the financial measures but also actions to improve the saving performance and the efficiency of investments” could no longer be postponed.10 Financial policies had to be changed, with changes in fiscal policies being primary. Public expenditures had to be reduced. It was particularly essential that the losses by public enterprises that were financed by either treasury resources or bank borrowing be curtailed. The experience of members in Asia and Latin America, as well as in Africa, put in question the often-mentioned limitations on the effectiveness of monetary policy in developing members. The present stage of financial markets in Africa permitted the pursuit of a vigorous and well articulated monetary policy. Monetary aggregates could be controlled. Interest rates could be made higher. There was also a need for exchange devaluation. These measures would all help increase output as well as reduce demand.
Throughout 1980 and 1981, Mr. de Larosière reiterated publicly that adjustment was necessary because the external payments crisis was of an “unfortunately persistent nature.” The answer to the increasing criticism of Fund-supported adjustment programs that they involved primarily a severe cutting back of demand was that the adjustment programs which the Fund required borrower members to adopt involved not only prudent demand management—particularly with respect to government spending and the money supply—-but also the conditions required to improve the productive base of the economies in question.11 Members should pursue not only sound fiscal and monetary policies but also measures to provide better incentives for production, to remove bottlenecks, and to eliminate distortions in cost-price relationships. The adjustment programs that the Fund would support would thus be an integral part of a longer-term strategy for fostering investment and economic growth.12 Provision by the Fund of larger amounts of financing and the stretching of adjustment over longer periods should enable members to undertake the kind of structural measures required in existing conditions, phased in a way that was compatible with their particular circumstances.13
Need for Complementary Actions by Industrial Members By the first half of 1982, as the worldwide recession of 1980–82 was reaching a trough, the Fund’s emphasis was increasingly on the need for “complementarity” in the economic adjustment efforts of industrial and developing members. It was “imperative—from the standpoint of global equilibrium as well as from the domestic standpoint—that the industrial countries break loose from stagflation.”14 The high and rising level of unemployment in so many industrial members was one of the most tragic manifestations of stagflation. And there was a close tie-in between the economic situation of the industrial members and the problems of adjustment facing the developing members.
Fund officials, nevertheless, continued to emphasize that the fight against inflation to which all the major industrial members were committed, as described in Chapter 8, had to remain the key priority of policy. The current recession was the price that had to be paid for the failure of past policies. But anti-inflationary policies had to be accompanied by other policies since structural rigidities were also hindering adjustment in industrial members. Rigidities in shifting resources out of traditional exports and support for ailing industries were causing protectionism. Rigidities in wage bargaining and price setting made wage demands out of line with the prospects for growth of real output, productivity, and employment. Fiscal rigidities—particularly rigidities in the downward scaling of government expenditures—were causing large and persistent budget deficits. Hence, if the industrial members were to grapple successfully with stagflation, demand-management policies, though essential, were not sufficient. Elimination of the rigidities and of other impediments to resource mobility and to structural change was equally necessary.
Thus, industrial members could take various actions that would help promote the conditions for sustainable growth and economic recovery in their economies. Fiscal discipline had top priority. The fiscal policy followed by many members in the decade from 1972 on had been a “basic ingredient of stagflation.” Rather than being the “stabilizing factor” advocated by Keynes, fiscal policy had, in many members, become one of the major destabilizing forces. The lax system, too, had contributed to stagflation in industrial members, as taxes had often raised costs while discouraging production. The Managing Director called the need to restructure fiscal systems so as to reverse their deleterious effects on growth and the efficiency of the economy “paramount.”15
The impact on developing members of the policies industrial members were taking in grappling with stagflation was also a prime subject of the Found’s emphasis.16 What was critical from the standpoint of developing members was that the policies undertaken by industrial members to deal with stagflation should be outward looking or internationally cooperative. In other words, as industrial members took policies to light inflation, they should take into account the effects on developing members. Thus, if interest rates were to decline to more reasonable levels, industrial members had to reduce their budget deficits while not relaxing their restrictive monetary policies. Industrial members also had to keep their markets open, strongly resisting the protectionist tendencies that were increasing as unemployment rose in industrial members. Also, despite cuts in budget expenditures, industrial members had to resist pressures to reduce their external economic assistance. At the same time, firm and strong adjustment efforts by developing members themselves were needed although the Fund recognized that the adjustment efforts being required of developing members in the prevailing circumstances were “formidable.” Somehow, however, their combined current account deficit of $100 billion simply had to be very much reduced.
When they met in Helsinki in May 1982, monetary authorities expressed similar views. The communiqué of the Group of Ten, issued after their meeting on May 12. emphasized, for example, the need for industrial countries to strengthen their fiscal discipline and for developing countries to persevere in their adjustment efforts.17 The Interim Committee, after meeting on May 12 and 13, called, in general terms, for industrial members to pursue a “balanced set of policies aimed at reducing inflation, improving productive efficiency, and putting external positions onto a sustainable basis.” In specific terms the Committee called for “fiscal policies consistent with firm monetary policies . . . budgetary discipline, and smaller fiscal deficits . . . [and] supply-side policies.” While the Interim Committee also expressed deep concern about the “current plight” of non-oil developing members and recognized the impact on developing members’ external deficits on current account of “factors beyond their control,” it also emphasized the exacerbating role of inflationary policies in the developing members themselves. Broadly, the need was for “international economic cooperation on many fronts.”18
These themes dominated the 1981 Annual Meeting. In his opening address, Mr. de Larosière clearly recognized the “intensity of the external shocks” that the non-oil developing members had experienced.19 They were suffering from deteriorating terms of trade, slack demand in the industrial members, and rising interest rates. But the current account deficits of the non-oil developing members were still excessive and reinforcement of their adjustment policies was essential. The Fund placed emphasis not only on rigorous demand management, particularly in the area of public finance—which was always at the heart of Fund-supported programs—but also on measures of improved economic efficiency to strengthen the productive base of members’ economies. Realistic pricing, adaptation of exchange and interest rate policies, trade liberalization, and financial reform of the public sector or public enterprises were often necessary.
These policies were again endorsed by the Interim Committee.20 Indeed, at the closing session, Mr. de Larosière stated that he was very gratified by the action of the Interim Committee in stressing the importance of the Fund’s role in the promotion of balance of payments adjustment, and in strongly endorsing the major emphasis that the Fund had been placing on the implementation of effective adjustment programs by members making use of the Fund’s resources in the upper credit tranches.21
Review of Arrangements Approved from 1979 to 1981
The 1979 decision on use of resources required for the first time that the Executive Board conduct annual reviews of the Fund’s experiences with its financial arrangements. The numerous extended arrangements and stand-by arrangements that the Fund had approved from 1979 to 1981 in support of adjustment programs were thus reviewed in mid-1982. Summarizing the Fund’s experience with these arrangements as a group, based on this review, is more indicative of the-Fund’s experience than describing its experiences with the arrangements approved for a few selected individual members, as was done in earlier chapters.22
From January 1979 to December 1981, the Fund had approved 21 extended arrangements for 17 different non-oil developing members, for commitments totaling about SDR 14 billion.23 Of the 21 arrangements, 5 were approved in 1979,6 in 1980, and 10 in 1981. Commitments as a percent of a member’s quota amounted on average to over 300 percent, with one case, Morocco, amounting to 540 percent. In 1980 and 1981. the Fund also approved numerous stand-by arrangements, also all for non-oil developing members. Commitments approved were also large multiples of quotas, even in 1981 after the new larger quotas under the Seventh General Review had gone into effect.
Circumstances Faced by Members Undertaking Arrangements In almost all the members undertaking an extended arrangement or an upper credit tranche stand-by arrangement with the Fund from 1979 to 1981, a balance of payments problem prevailed at the time the adjustment program was introduced and the financial arrangement with the Fund agreed. In half of the members concerned the external payments problem was acute. In over two thirds, the balance of payments difficulties were caused at least in part by adverse terms of trade, in particular by rising prices for imports. Nearly as often, however, balance of payments difficulties were linked also with declining export volumes. Declines in export volumes were attributable to a number of causes. These causes included disruptions in domestic supply, a worsening competitive position in world markets, falling profits for domestic producers in real terms and low agricultural prices for local producers that had brought about curtailment of production for export and a decline in demand in major trading partners. Weak world prices of export commodities contributed to the balance of payments difficulties in only about one fourth of the members concerned. In many members, an overvalued exchange rate had hindered the growth of exports.
For an overwhelming majority of the members concerned, a large growth of imports in volume terms had also been an element in bringing on balance of payments problems at some time or other. In only a limited number of members, however, had import growth been an acute problem in the immediate preprogram period. In a significant number of instances, in fact, members had already experienced a decline in imports relative to gross national product in the year immediately before the adjustment program and arrangement with the Fund was introduced. Low levels of exchange reserves and lack of access to international markets, the latter often reflecting a precarious if not unsustainable external debt situation, had frequently forced a decline in imports relative to gross national product, and often even a decline in absolute terms. Members had usually had to bring about an involuntary reduction of imports, or at least limit their further increase, by intensifying trade and payments restrictions. Often they had had a rapid buildup of external payments arrears. In about half the members undertaking arrangements with the Fund from 1979 to 1981, the rate of domestic inflation was in excess of the world average at the inception of the adjustment program, in some members substantially so.
Some members entering into extended or upper credit tranche standby arrangements with the Fund were experiencing rapid real growth at the time they entered into the arrangement. Others had been having unsatisfactory growth experiences. On average the growth rate of members entering into arrangements in the year prior to the introduction of the accompanying adjustment program was 4.7 percent, 5.2 percent for members with stand-by arrangements, 4 percent for members with extended arrangements. These figures compare with an average real growth rate of non-oil developing members in 1978 of 6.4 percent and in 1979 of 5 percent. In some members entering into arrangements with the Fund, a low volume of investment in the domestic economy was a major cause of balance of payments difficulties. More frequently, the balance of payments problem stemmed from the poor quality of domestic investments, that is, investments which emphasized nonproductive or low-yielding prestige projects or nonviable import substitution industries. In a number of instances, an inappropriate structure of investment, often reflecting relative internal price distortions, had exacerbated balance of payments problems, and hence problems of economic growth. Difficulty in controlling the growth of expenditure in government and state economic enterprises was common. Internal political considerations frequently made it hard to adjust to unforeseen setbacks, such as a failure of an export crop owing to had weather or the unexpectedly slow growth of tax revenue because of administrative difficulties. Tax revenue in real terms often did not increase as imports or exports rose because of lags in tax collection or because tax revenue did not keep pace with rising prices. With a constraint on borrowing abroad, the pursuit of ambitious public sector investment programs preempted private sector savings, leading to compressed private investment, and to rising aggregate demand, larger imports, and balance of payments pressures.
In brief, the Fund’s review in mid-1982 suggested that in many of the non-oil developing members that came to the Fund for financial assistance in the three years from 1979 to 1981, problems causing the balance of payments difficulties had been building up over a number of years. These problems were then compounded by the sharp rise in oil prices in real terms in 1979–80. The situation, moreover, following the second round of oil price increases differed substantially from that following the first round. In 1974–78 not all raw material exporting members suffered a loss in real income. Abnormally high export prices, at first for industrial raw materials and then later for coffee, tea, and cocoa, actually improved the terms of trade for some non-oil developing members, despite higher costs for their imports. Exceptionally high export earnings permitted the pursuit of expansionary domestic policies. As a result, by the late 1970s, when the prices for industrial raw materials and agricultural products were returning to lower levels, some of these members had committed themselves to highly ambitious developmental and social tasks, with government expenditures rising rapidly and revenue from taxation on trade increasing slowly, if at all. The resulting growing budget deficits were mirrored in adverse developments in the balance of payments, as imports expanded and export proceeds fell in real terms. In essence, in many non-oil developing members adjustment of domestic policies to the first round of oil price rises had been postponed by the commodity boom. Gradually a variety of imbalances developed in the domestic economy and by the time of the second round of oil price increases, in 1979 and 1980, these members had very little room in which to maneuver.
Characteristics of Adjustment Programs and of Performance Criteria In these circumstances, in appraising the adjustment programs that the 48 members concerned undertook, the Fund management and staff were guided by the criterion that the program aim primarily at “attaining or safeguarding a viable balance of payments in the medium term while also encouraging real growth and the achievement of lower levels of inflation.” The Fund management and staff believed that these programs had all been so planned and intended. The adjustment programs adopted, especially those supported by stand-by arrangements, customarily relied heavily on measures to restrict aggregate demand. They usually aimed at reducing the current account deficit in the short run, that is, in about one year. In addition, in some programs, especially those supported by extended arrangements, financial measures were taken also to help address structural problems.
The Executive Board’s review of mid-1982 examined members’ experiences with the policies making up adjustment programs. The review showed that the policies applied to the public sector of the economies of the members concerned were designed to operate both on the aggregate demand side of the economy and on the aggregate supply side. Substantial reductions in the overall public sector deficit were customarily planned, with the emphasis in most members placed on reducing expenditures rather than increasing revenues. While the overall stance of fiscal policies was aimed at restraining demand, many of the individual policy measures, especially in the area of prices for local producers, prices charged by public enterprise, taxes, and investment, were aimed at increasing supply. Thus, tax and pricing policies were usually included in all adjustment programs with a view to increasing national savings and improving economic efficiency by correcting price distortions within the economy. In half the programs that the Fund approved, members intended to formulate a public sector investment program. In helping members formulate overall adjustment programs, the Fund staff was guided by the assessment of the staff of the World Bank on the microeconomic aspects of public sector investment programs.
An increasingly frequent feature of the adjustment programs that the Fund approved in 1979–81 was depreciation of the exchange rate. After 1973 exchange rate policy had become much more commonly used in all Fund members and hence Fund officials were much more inclined than in the 1950s and 1960s to recommend exchange rate action. Another frequent feature of adjustment programs was a general restraint on wage increases. While wage restraint was seen to have beneficial effects on inflation, it was emphasized especially as necessary to support depreciation of the exchange rate. Where real interest rates had become increasingly negative, higher rates were planned. Higher interest rates were seen as necessary to promote private saving, rationalize domestic investment, and improve the capital account of the balance of payments.
With regard to credit ceilings, the adjustment programs of 1979–81 generally broadened the assets and liabilities that were made subject to overall ceilings. There was more frequent reliance on a ceiling for credit expansion by the total banking system and less reliance on one by the central bank alone. Use of subceilings on net credit expansion to the government also increased significantly. Thus, whereas during the 1960s subceilings were used in only about one half the programs the Fund supported, with ceilings on credit expansion to the central bank not being used in programs containing ceilings on credit expansion by the total banking system, after 1979 a separate ceiling was placed on government operations in virtually all programs. Targets for the growth of credit to the public sector usually involved a greater rate of deceleration of credit than those for total domestic credit. A relative decline in credit to the public sector reflected the aim of freeing additional credit for the private sector. Also, after 1979, use of adjustable credit ceilings became more frequent. The most common type of adjustable credit ceiling was an automatic downward adjustment for net inflows of foreign capital that exceeded the levels planned in the initial program.
The Executive Board’s review of mid-1982 also examined experience with performance criteria, that is, the criteria by which the Fund monitored adherence to the adjustment program and on the basis of which Fund officials made decisions as to whether the member could make further drawings under the arrangement. In nearly all extended arrangements and stand-by arrangements in the upper credit tranches, credit ceilings were used as performance criteria. Performance criteria typically included ceilings on the expansion of overall domestic credit or on the growth of net domestic assets of the banking system. Nearly all arrangements included ceilings on the contracting of new nonconcessional medium-term and long-term foreign loans. The use of ceilings on the incurring of external debt had two purposes: to help members avoid or alleviate debt service difficulties and to prevent the member’s circumventing the limits placed on domestic credit. In all arrangements, undertakings not to intensify restrictions on trade and payments were a performance criterion. In addition, a quantitative ceiling on external payments arrears was included as a performance criterion in arrangements with members where arrears had emerged. Moreover, in about half of the arrangements that the Fund approved in 1979–81, the reaching of understandings with the Fund about future adjustment policies and about performance criteria formed performance criteria. Unlike the performance criteria, which were limited to specific policy undertakings, these reviews often covered the whole range of policies in tire adjustment programs. They therefore provided the Fund management and staff with a way to monitor the members’ pursuit of the entire adjustment program.
Implementation of Policies The mid-1982 review revealed that of the extended and upper credit tranche stand-by arrangements approved in 1979–81, on average somewhat over half of all members implemented the policy measures of the adjustment program more or less as planned. As had been the Fund’s experience in earlier years, once again it was clear that members had considerably more difficulty implementing the policies applying to the public sector than they did implementing exchange, trade, wage and price policies, and that they had least difficulty implementing the policies with regard to the incurring of external debt. The limited implementation of policies relating to the public sector lay behind some of the other problems that developed in implementing adjustment programs. In particular, lack of adherence to public sector policies was closely related to the extent to which domestic credit expansion exceeded the ceilings. Relatively more members implemented measures restraining total expenditure than were able to implement measures to improve the tax structure, to effect tax reform, and to control and to rationalize expenditures by public enterprises.
In most arrangements, the Fund had to interrupt drawings by the member under the arrangement at some stage because the member was not observing the performance criteria, including those relating to the reaching of understandings with the Fund about new programs and policies or credit ceilings. On average, drawings were interrupted within a year after the arrangement was approved. Nearly three fourths of all nonobservance of performance criteria was with regard to domestic credit ceilings. In two thirds of the cases in which drawings were interrupted, drawings were again later resumed.
In the great majority of cases what lay behind interrupted drawings was a larger government budget deficit than planned. Five major causes were responsible for the deviation. One, unforeseen shocks reduced government revenue or raised expenditure. These shocks were sometimes internal. Agricultural production might have been lower than expected owing to had weather or disease, and as a result exports and export tax revenue were lower than planned. Other shocks were external. Lower prices for exports in world markets might have led to lower export tax revenue, or increased prices for imported foods or other basic consumer items might have led to higher budget subsidies. Higher world interest rates might have forced higher payments for debt service.
Two, lack of political will occurred when governments did not feel strongly committed to the adjustment program from the beginning. Three, weak administrative systems often meant that the member’s systems for authorizing and monitoring public expenditure and for planning and coordinating decisions were inadequate or that the government had little control over the performance of nonfinancial public enterprises. Four, targets for the government deficit were sometimes inappropriate. Five, in a few instances, expected inflows of development assistance were delayed or not forthcoming.
Members that succeeded in making progress toward balance of payments viability were primarily those where the policies of the adjustment programs were fully implemented. Absence of adverse exogenous developments was not a necessary condition for programs to succeed although the poorest performances were by members facing particularly severe external shocks.24
All in all, Fund officials concluded from their review in mid-1982 of the Fund’s experience with members carrying out adjustment programs supported by extended arrangements and upper credit tranche standby arrangements in the previous three years that the features of adjustment programs and of the performance criteria used by the Fund were mote or less appropriate to the circumstances. There seemed to be no need to change the policies the Fund was using.
Mr. de Larosière also expressed to the Board of Governors at the 1981 Annual Meeting confidence in the Fund’s policies. Admittedly not all Fund-supported programs had been successful. In a number of cases, drawings had to be interrupted when programs strayed. In most cases, however. Fund assistance had contributed substantially to adjustment, and frequently it had also served as a catalyst for financial assistance and capital flows from other sources. Statistics showed that the continuing expansion in the current account deficits of non-oil developing members was largely accounted for by those members that had not entered into upper credit tranche arrangements with the Fund in either 1979 or 1980.
Where programs with members had been successful, the adjustment had been brought about by the adoption of fundamental policy measures, rather than being forced on the members through the sudden unavailability of external resources. Containment of the current account deficit had come about partly by export growth. In fact, certain members with Fund programs had shown dramatically improved export performances in 1981 and were also expected to do well in 1982. Without strong adjustment programs, a number of members would have had to resort to severe restrictions on imports; and there might have been a number of cases of default on external commitments. The Managing Director concluded that the evidence so far suggested that when programs had been implemented the Fund’s policies on adjustment and financing had been effective.25
Adjustment in Industrial Members
By mid-1982 the major industrial members had made progress not only in the effort to fight inflation but also to adjust their external imbalances. By 1981 the combined current account position of the industrial members had rebounded from the huge deficit into which it had fallen as a result of the 1979–80 oil price increases. From a peak of some $66 billion, the aggregate deficit of industrial members shrank to $25 billion in 1981. The largest single factor in the upswing of some $40 billion was a marked reduction in the volume of oil imports of the industrial members. An almost equal contribution came from improvement of the net volume of exports and imports in non-oil trade. The current account balances were quite unevenly distributed, however. In 1981, Japan again had a current account surplus ($6 billion), the United States continued to have a surplus ($9 billion), the United Kingdom’s surplus had become sizable (nearly $ 18 billion), and the current account deficit of the Federal Republic of Germany ($1 billion) was considerably smaller than it had been. Only Canada, among the larger industrial members, had a larger current account deficit in 1981 than in 1980.
Volatility of exchange rates for major currencies in the short run continued, however, and beginning in mid-1980 the U.S. dollar appreciated substantially. It was becoming increasingly evident that floating exchange rates were not working to help effect balance of payments adjustment and Fund officials were also increasingly stressing that the exchange rate developments of recent years highlighted the importance of strengthening the Fund’s surveillance over members’ exchange rate policies.26