Chapter

CHAPTER 20 Stand-By Arrangements: Purposes and Form

Author(s):
International Monetary Fund
Published Date:
February 1996
Share
  • ShareShare
Show Summary Details
Author(s)
Emil G. Spitzer

Combating inflation by monetary and fiscal policies has been a recognized task of governments, especially since World War I, even though for much of the interwar period the major economic problems which countries had to face derived from the deflationary consequences of the Great Depression rather than from inflationary pressures. The generally expansionary environment which has prevailed in most parts of the world since World War II has intensified the need for anti-inflationary policies, and has encouraged their embodiment in comprehensive stabilization programs. In its work with its members the Fund has devoted much time and thought to fostering such programs.

The link between stabilization programs and the support of them by the Fund has been provided by the Fund’s policies on the use of its resources (described in previous chapters), and especially by those governing stand-by arrangements. The importance of these arrangements has grown with time. Nowadays a high proportion of all drawings is made under stand-by arrangements. Table 24 at the end of this chapter lists the arrangements inaugurated or renewed down to the end of 1965.

Table 24.Stand-By Arrangements Inaugurated or Renewed, Calendar Years 1952–65 1(In millions of U.S. dollars)
Member19521953195419551956195719581959196019611962196319641965
Afghanistan6.7
Argentina75.0100.0100.0100.0100.0100.0
Australia100.0
Belgium50.0*50.0*50.0*50.050.0
Bolivia7.53.53.5*1.51.5*7.510.010.012.014.0
Brazil37.5160.0125.0
Burundi4.0
Ceylon30.0
Chile35.035.010.08.1*75.040.025.036.0
Colombia25.015.041.275.010.052.510.0
Costa Rica15.011.610.0
Cuba12.5*
Dominican Rep.11.225.0
Ecuador10.05.06.013.012.0
El Salvador7.5*7.5*11.2*11.211.25.020.0
Finland5.0*
France262.5131.2
Guatemala15.015.0
Haiti5.04.06.06.06.04.04.04.0
Honduras3.7*4.57.57.57.57.57.5
Iceland5.61.6*1.6
India72.5100.0100.0200.0
Indonesia41.250.0
Iran17.5*35.035.0
Jamaica10.0
Japan305.0305.0
Korea9.3
Liberia5.74.44.0
Mali9.9
Mexico50.0*50.090.0*90.0
Morocco25.045.0
Netherlands68.7
Nicaragua3.7*7.5*7.5*7.511.211.2
Pakistan25.037.5
Panama7.0
Paraguay5.51.52.73.55.05.0*5.0
Peru12.512.512.512.525.013.027.530.030.030.030.030.0
Philippines40.440.440.440.4
Somalia4.75.6
South Africa25.075.0
Spain25.025.0
Syrian Arab Rep.7.5*6.6*18.5*
Tunisia14.25.6
Turkey37.531.0*21.5*21.5*21.5*
United Arab Rep.42.540.0
United Kingdom738.5738.5738.5500.01,000.01,000.01,000.0
United States500.0500.0
Uruguay30.030.0
Venezuela100.0
Yugoslavia30.080.0

A dot (•) indicates that the country was not a member at the time; a dash (—) indicates that no stand-by arrangement was in effect; an asterisk (*) indicates that the stand-by arrangement was for less than one year (usually for six months).

A dot (•) indicates that the country was not a member at the time; a dash (—) indicates that no stand-by arrangement was in effect; an asterisk (*) indicates that the stand-by arrangement was for less than one year (usually for six months).

ORIGINS OF STAND-BY ARRANGEMENTS

The Board’s decision of February 13, 1952 establishing the policy for the use of the Fund’s resources contained a reference to arrangements by which a member might “ensure that it would be able to draw if, within a period of say 6 or 12 months, the need presented itself.” 1 Such an arrangement had, exceptionally, been made with Mexico in May 1949, when the Board decided to inform the member that the Fund would not object to its drawing $22.5 million within the ensuing twelve months. The passage quoted above was also in the Board’s mind in April 1952 when Australia came to the Fund for a drawing of $30 million and it was decided to permit this to be made at any time before September 30, 1952. However, in neither of these instances was it thought that the right to draw might be, in itself, sufficient to satisfy the member’s requirements without a drawing actually being made. This feature has since been characteristic of stand-by arrangements, even though in many—indeed in most—instances the member has in fact drawn under the arrangement. It was first introduced when Belgium sought the Fund’s assistance in June 1952. As explained to the Board by Mr. de Selliers (Belgium), his country

wished to be able to consider the Fund’s resources as a second line of reserves to help meet any sizable dollar deficit without having to resort to measures that would move away from convertibility. … The request for the stand-by credit … should help give the authorities the confidence they needed to help maintain a liberal economic policy.

The immediate occasion for Belgium’s request was that negotiations in Paris to continue the European Payments Union and to settle the Belgian surplus in the Union had included the consolidation of a $50 million debt to be repaid to Belgium at the rate of $10 million a year starting on June 30, 1953. It was this $50 million for which a stand-by arrangement was asked. The Board’s decision was:

  • 1. The Fund assures Belgium the right for an initial period of six months to purchase the currencies of other members from the Fund in exchange for its own currency so long as such purchases do not bring the Fund’s holdings of Belgian francs above their present level increased by the equivalent in Belgian francs of 50 million United States dollars; provided, however, that the amounts Belgium may purchase under this arrangement shall not be increased by reason of any purchases of Belgian francs by other members.
  • 2. Belgium will pay a charge of one-quarter of one per cent fifteen days after this arrangement is concluded. This charge will be in addition to any charge that may become due under Article V, Section 8 (a).2
  • 3. Belgium’s right to purchase under this arrangement shall be subject only to the eligibility provisions of the Articles of Agreement.
  • 4. Belgium will remain in consultation with the Fund from time to time on its payments situation and its general policies. The arrangement will be renewed for subsequent periods of six months each, unless either Belgium or the Fund determines that conditions have been basically altered so that the arrangement should be terminated. The arrangement will, in any case, be terminated when it has been in effect for five years.

In the event, Belgium drew nothing under the stand-by arrangement until almost the end of the five-year period, when it drew the whole $50 million.

At the conclusion of the meeting which approved the Belgian request, the Managing Director undertook that the staff would submit proposals for standard conditions for stand-by arrangements. These were presented in August 1952, and after considerable debate resulted in the Board’s first general decision on such arrangements, taken on October 1, 1952.3 This dealt only with stand-by arrangements for six months, as some Executive Directors had expressed the view that it would not be possible to foresee conditions in a member country for more than six months, and it was therefore inadvisable for the Fund to commit itself for a longer period. The preamble to the decision contained the following general statement concerning drawing rights:

  • The Fund is prepared to consider requests by members for stand-by arrangements designed to give assurance that, during a fixed period of time, transactions up to a specified amount will be made whenever a member requests and without further consideration of its position, unless the ineligibility provisions of the Fund Agreement have been invoked.

Other clauses in the decision introduced conditions similar to those in the stand-by arrangement with Belgium, covering charges and the possibility of renewing the arrangement after six months. It was also provided that a stand-by arrangement would be for a sum not larger than the member could draw under the terms of Article V, Section 3, subject to the Fund’s powers to waive these limits by the exercise of Article V, Section 4.

In paragraph 5 of the decision the conditions for drawings and for the suspension of drawing rights were elaborated as follows:

  • A member having a stand-by arrangement would have the right to engage in the transactions covered by the stand-by arrangement without further review by the Fund. This right of the member could be suspended only with respect to requests received by the Fund after: (a) a formal ineligibility, or (b) a decision of the Executive Board to suspend transactions either generally (under Article XVI, Section 1 (a) (ii)) or in order to consider a proposal, made by an Executive Director or the Managing Director, formally to suppress or to limit the eligibility of the member.

A clause embodying this paragraph has been included in all stand-by arrangements.

In December 1952 the terms of the decision were made applicable for the first time. Finland requested a stand-by arrangement for six months permitting drawings up to $5 million, and undertook to abide by the terms of the decision. It also undertook to repurchase any drawings under the arrangement within three years of the date of drawing.

A second policy decision on stand-by arrangements, taken on December 23, 1953,4 recognized that arrangements might be for periods of more than six months. Although the preamble and paragraph 5 of the first decision (which became paragraph 4 in the second decision) remained unchanged, the following sentence was added to paragraph 1 of the second decision:

  • With respect to stand-by arrangements for periods of more than six months, the Fund and the member might find it appropriate to reach understandings additional to those set forth in this decision.

In the course of the discussion in the Board, the need for this sentence was explained by the staff as follows:

  • Because of the difficulty of foreseeing a member’s situation for a long time in advance, a stand-by beyond 6 months might have to be based on the expectation that the member would maintain certain policies. If the member changed those policies so as to impair the character of the understanding with the Fund, the Fund should have the possibility of cancelling its guarantee. For example, if a stand-by was arranged for the purpose of supporting an attempt at convertibility and the country later called off the attempt, the basis for continuing the stand-by would be gone. Such a situation might be handled by formal ineligibility proceedings as provided in paragraph 5 of the decision, but in most cases such an extreme action would probably not be desirable. Moreover, there might be cases where there would be no basis for a declaration of ineligibility, but nevertheless the stand-by should be terminated.

The provision for stand-by arrangements for more than six months was first utilized in February 1954, when an arrangement for one year was agreed with Peru. The special conditions incorporated in this arrangement are discussed later in this chapter.5 Here we should note that the arrangement with Peru set a precedent by including as a requirement the offer made by Finland, viz., that drawings under it should be repurchased within three years instead of “within an outside range of three to five years” as prescribed in the decision of February 13, 1952.

It has not been possible to trace a connection between the undertaking offered by Finland and that required of Peru. On the contrary, the immediate reason for stipulating that Peru should complete repurchase within three years appears to have been that Peru had negotiated an arrangement with the U.S. Government parallel to the stand-by arrangement with the Fund, and the U.S. authorities required drawings under that arrangement to be repaid within three years. Mr. de Largentaye (France) suggested, when the Board discussed Peru’s request, that it should be possible for Peru to repurchase more quickly than in three years, since it had a fluctuating exchange rate, which should enable it to rectify its balance of payments more quickly. But Mr. Southard (United States) urged that it would be better for the obligations to the Fund and to the United States to be similar, and the Board agreed.

There has been no formal decision by the Board stipulating that repurchases of drawings under stand-by arrangements should be completed within three years, but this has, in fact, been the practice in all subsequent arrangements. It has been rationalized as follows. Drawings under a stand-by arrangement may take place at any time up to a year from the date when the arrangement is agreed, while the Fund’s commitment begins as soon as the arrangement comes into force. It is therefore desirable that repurchases should be completed within a shorter time than five years, so that the total time that elapses between the date of the Fund’s commitment and the date when repurchase is completed shall not exceed five years. To require drawings to be repurchased within three years ensures, in the circumstances envisaged, that the Fund’s position will be fully restored within four years—i.e., by the mid-point of the period of three to five years applicable to drawings not made under a stand-by arrangement.

STABILIZATION PROGRAMS

Before detailing the process by which stand-by arrangements have been adapted to the varying circumstances of members, and especially to the support of stabilization programs, we should consider briefly the value of stabilization programs in encouraging progress toward the Fund’s objectives.

It has been the experience of the Fund that in most of its member countries the need for a stable financial base is recognized, and that repeated efforts are made to bring about and maintain this stability. The generic term stabilization program is used for such efforts when concerted with the Fund, although this is, in fact, a partial misnomer: the aim both of the country and of the Fund is steady development, not stabilization of the current situation.

Purposes

Stabilization programs supported by the Fund have been designed to cope with a great variety of balance of payments difficulties and internal financial problems. The policies incorporated in such programs have naturally differed according to the source and duration of these difficulties and the magnitude of the problems involved. Frequently the foreign exchange reserves held by member countries have been too low to absorb pressures on their payments position arising from temporary or seasonal variations in export earnings. Such variations may follow, for example, a decline in export prices, or a decline in domestic production for export resulting from a drought or some other factors beyond the control of the authorities. In such instances, the stabilization programs adopted have been able to be limited to short-term correctives.

In many countries, however, the problems have been more serious and more complex, especially where the balance of payments difficulties have resulted from persistent inflation. Excessive credit expansion to finance private investment or consumption has sometimes been an important factor in generating inflation; but large fiscal deficits financed by bank credit have been by far the most common cause of inflationary pressure. These deficits have arisen for a variety of reasons. Some have been caused by financing subsidies to producers or consumers through the budget. Others have arisen from increases in the operating losses of public enterprises or from increases in public investment expenditures at a time when consumption expenditures were rising. Frequently the situation has been aggravated by serious deficiencies in the tax structure and the tax collection mechanism. Sometimes, the simultaneous occurrence of droughts or other natural calamities, political disturbances, or adverse movements in the terms of trade have further weakened the fiscal position by reducing revenues and increasing expenditures.

In some countries the process of economic development itself has generated serious pressures on the balance of payments. There has been a tendency for domestic expenditures to outstrip available resources, as countries have attempted to provide desirable public services to their growing populations and to accelerate economic growth. Development plans have frequently called for a considerable increase in public investment expenditures, but the mobilization of additional resources through taxation or other noninflationary means, to finance the rising levels of both current and investment expenditures, has proved difficult. The absence of appropriate institutions for mobilizing private savings has also been a constraining factor. In these circumstances, recourse to inflationary financing has been substantial.

Elsewhere the balance of payments difficulties have been caused by a concentration on investment in industries with a high import content but with little export potential in the near future, while agriculture and the traditional export sectors have received inadequate attention.

The objective of stabilization programs in inflationary situations has been not only to control inflation, to arrest the decline in foreign exchange reserves, and to prevent an increase in debt service, but also to sustain an improvement in the payments position and lay the foundation for sustained economic growth.

The programs have not necessarily aimed at an unchanged price level or the establishment of a balance of payments equilibrium during the period of the program. Some programs have involved a general upward adjustment of prices, resulting from exchange rate depreciation, and other measures aimed at correcting price distortions. Because most domestic prices tend to be inflexible downward, relative price adjustments have usually entailed a general rise in prices. In circumstances of severe and protracted inflation the programs have not attempted to arrest the rise in prices within one year, but to taper it off over several years.

As to the balance of payments, an essential step in formulating a program has been to examine to what extent the exchange rate needs to be adjusted to correct disparities between domestic and foreign prices. Sometimes, if the necessary financing is available, a large increase in imports is planned, in order to reduce inflationary pressures. Much more commonly, however, it has been reasonable to assume that there would be an immediate lessening of pressures on imports and other payments as aggregate demand was controlled, and as inventories built up during the inflationary period were dishoarded. Another general expectation has been that there would be a return of domestic capital that had sought refuge abroad and an increased inflow of public and private foreign capital.

Problems

A prolonged inflation derives, to a large extent, from a failure to resolve by other means the conflicting claims of different social groups, each aiming at a larger share of the national income. The retrenchment of consumption often proves to be difficult, particularly in developing countries, where public expenditures, for example on welfare, tend to increase with the growth of population and urbanization. In such a situation, not only do the distortions of the price-cost structure deepen with the passage of time, but also the antagonisms become more intransigent, magnifying the difficulty of implementing a stabilization program. The success of a stabilization program in this situation depends largely on the broad acceptance of its objectives (including an appropriate policy for incomes) by the main social, political, and economic forces in the country.

Equally important, in very difficult situations, is the continuity of action over a period of years. A program may be carried through for a year or so, but evolving political and social pressures or unexpected economic difficulties may lead to an eventual slackening of the efforts or even to a reversal of policies. These considerations underscore the obstacles which the authorities face when they feel forced to adopt a gradual attack on inflation—i.e., one which is planned to extend over several years.

The implementation of major policy changes also calls for efficient and stable administrative machinery. The most complex administrative problems have arisen in the fiscal field and have frequently prevented countries from attaining their revenue goals and controlling expenditures. Difficulties have also been experienced in collecting the government’s share in the profits of public enterprises or in obtaining repayment of budgetary loans. Furthermore, when budget receipts have not materialized as planned, many governments have not been able to bring about a corresponding reduction in expenditures.

One major problem, with which the Fund is particularly concerned, is the adjustment of the exchange rate. In an acute inflationary situation it is difficult to determine the extent of the necessary change. For one thing, the increase in prices and costs resulting from a devaluation and other measures must be allowed for in determining the extent of the devaluation itself. Some countries do not realize how large an adjustment may for this reason be needed, with the result that the benefits of devaluation are largely offset by consequential price increases. Unless exports receive the stimulus needed to sustain an adequate level of activity, restrictions on imports may have to remain severe, thus perpetuating structural or price distortions. Moreover, expectations about a further change in the rate may adversely affect the movement of capital. Control over suppliers’ and other short-term and medium-term foreign credits often proves extremely difficult, in both debtor and creditor countries.

STAND-BY ARRANGEMENTS: GENERAL PRINCIPLES

When introducing or pursuing a stabilization program a country often feels the need to reinforce its reserves, not necessarily for immediate disbursement but as a precaution against pressure on the balance of payments. It was to meet such needs that the Fund’s stand-by arrangements were devised. Since the introduction of the technique in 1952, there have been some two hundred stand-by arrangements, most of which have been associated with stabilization programs.

In negotiating a stand-by arrangement, the Fund determines the appropriate degree of conditionality to be applied to drawings under the arrangement in accordance with the particular circumstances, and within the framework of the Fund’s tranche policy. This policy, which relates to stand-by arrangements as well as to outright drawings, was described in Chapter 18.6 In the context of the present discussion it is sufficient to refer to the basic principle of that policy, viz., that “the larger the drawing in relation to a member’s quota the stronger is the justification required of the member”;7 and, further, that “requests for such drawings or stand-by arrangements [in the higher credit tranches] are likely to be favorably received where they are intended to support well-balanced and adequate programs. …” 8

The choice of policy instruments for the implementation of these programs has depended not only on the problems facing the country, but also on the stage of its development and the institutional features of its economy. In order for the Fund to be assured of the effective implementation of a program, it has been necessary to formulate the appropriate policies, as far as possible, in quantitative terms. Thus the practice has developed of placing quantitative limits on the expansion of domestic credit by the central bank or the banking system or on the growth of certain types of foreign debt; or of establishing specific goals for the budgetary or balance of payments position or for the level of foreign exchange reserves during the period of the program. These quantitative limits and specific goals have at the same time provided the authorities of the country concerned with a basis for appraisal of monetary, fiscal, and balance of payments developments, which has enabled them, if necessary, to make adjustments in their policies to conform to the objectives. In such arrangements certain protective clauses (detailed below) are used; these clauses call for consultation with the Fund and frequently also for agreement on new terms in the event that the commitments expressed in quantitative terms or the other specific policy intentions of the member are not observed, or that the policies pursued do not appear to be adequate to achieve the objectives of the program. (The problems experienced in defining the factors to be quantitatively expressed are considered in Chapter 21.)

Where there is strong evidence that the problems have arisen from serious weaknesses in policy and that the member has not made reasonable efforts to cope with them, the Fund applies a high degree of conditionality. This is of particular importance if the member chooses a gradual approach to stability and if the expected price and cost increases during the period of the stand-by arrangement are likely to be incompatible with the maintenance of the existing exchange rate. In such instances, drawing rights are generally made contingent upon the observance of binding conditions expressed in quantitative terms, which may call for a flexible exchange rate policy, i.e., periodic exchange rate adjustments when certain balance of payments goals are not reached.

If the member has not yet established a par value, particular attention is given to the efforts that it is making toward the establishment of a realistic exchange rate and the early adoption of an effective par value.9 In such a situation, it is normally required that the granting of financial assistance be preceded by a reasonably adequate exchange rate adjustment that will enable the country to make progress toward the establishment of an effective par value. In some instances, however, immediate action in the exchange field may not be feasible and a better course of action may be to make the change over time. In either event, if the balance of payments problem of the member indicates a need for continuing policy adjustments, the member has to present a detailed quantitative program and the stand-by arrangement contains an appropriate clause requiring consultation between the Fund and the member.

Form of stand-by arrangements

From the legal point of view a stand-by arrangement embraces two documents: (1) The stand-by arrangement proper, containing certain legal clauses, is designed to fit the operation into the framework of the Articles of Agreement and the Fund’s mechanism of financing. (2) The letter of intent, usually signed by the Minister of Finance and the Governor of the central bank, describes in precise terms the policies and measures comprising the stabilization program, especially in the credit, fiscal, balance of payments, and exchange fields. The letter of intent is annexed to the stand-by arrangement proper, and is referred to in the first paragraph of the latter as a “consideration.” It frequently contains specific commitments on various aspects of these policies, and whenever these commitments involve legally binding undertakings which are not fulfilled, the member is not entitled to make further drawings under the stand-by arrangement until it consults with the Fund and, where necessary, agrees on new terms. During the period of the stand-by arrangement the Fund maintains close and continuing contact with the country through frequent visits by the staff. Sometimes, at the request of the member, the Fund may station one of its officials in the country as a representative accredited to the central bank or the government, or both.

PROTECTIVE CLAUSES

One of the recurrent problems in the development of the Fund’s policy on stand-by arrangements has been to know how to reconcile the assurance to members of their right to draw on the Fund with the duty of the Fund to ensure that proper use will be made of its resources. The general conditions governing all stand-by arrangements, as decided in October 1952 and December 1953, left this matter open; but it will be recalled that the Board’s hesitation about entering into arrangements for longer than six months stemmed from a doubt whether a member’s economic situation could be foreseen for a longer period. Viewed in historical perspective it was this doubt, and the consequential provision in the December 1953 decision that for stand-by arrangements lasting longer than six months “the Fund and the member might find it appropriate to reach understandings additional to those set forth in this decision,” which initiated the Fund’s current policies and practices in connection with stand-by arrangements associated with stabilization programs. Such arrangements are usually concluded for periods of one year. But in the first one-year arrangement—with Peru, in 1954—a provision was included permitting the Fund to give notice of the interruption of drawing rights, although certain reservations were expressed about this provision by some Executive Directors. In the course of time, as stand-by arrangements were adopted increasingly for a period of one year and for members with fluctuating rates, uncertain economic conditions, or complex stabilization programs, the feeling persisted that protective clauses were needed to prevent improper use of the Fund’s resources and to give reasonable effect to the following standard clause, which appears in all stand-by arrangements:

In consideration of the policies and intentions set forth in the annexed letter, the International Monetary Fund agrees to this stand-by arrangement to support these policies and intentions.

The need for effective protective clauses was felt all the more strongly because the Executive Board did not wish to resort to procedures associated with ineligibility under paragraph 5 of the first and paragraph 4 of the second policy decisions on stand-by arrangements.

The “prior notice” clause

As a result of these considerations various types of clauses for stand-by arrangements have been developed. One is the “prior notice” clause, which was first used in paragraph 7 of the 1954 stand-by arrangement with Peru and was then worded as follows:

If the Fund should indicate that developments had occurred that would no longer justify the belief that the Exchange Stabilization Program could be made effective, Peru would not draw further amounts under the stand-by arrangement before consulting the Fund and securing its consent. Under such circumstances Peru would, of course, be free to approach the Fund for financial assistance, but without relying upon the stand-by arrangement.

In presenting the proposed arrangement with Peru to the Executive Board, the management emphasized that “the proposed text of the agreement including paragraph 7 had been adapted to the particular needs of Peru” and that the management “did not want to feel that any fixed pattern had been developed for all countries as a result of the negotiations with Peru. It would not want to regard the Peruvian arrangement as constituting a standard to be followed in other cases.” In the ensuing discussions most Executive Directors stressed the point that the arrangement with Peru did not establish a precedent. Mr. Southard, who strongly supported the arrangement, agreed that it would “still be understood that Fund stand-by arrangements generally should involve irrevocable lines of credit as indicated in the December 1953 decision.” Nevertheless, several Executive Directors remained unconvinced that the arrangement with Peru could properly be called a stand-by arrangement; they felt that the conditions contained in paragraph 7 of the arrangement could be justified in this particular instance only because the arrangement involved a waiver of the quantitative limits on drawings set out in Article V, Section 4, of the Fund Agreement. (This refers to the provision that the Fund may grant a waiver “on terms which safeguard its interests.”)

Under the “prior notice” clause, further drawing rights could be interrupted if, pursuant to a decision of the Board, the Fund gave the member notice to that effect. In most cases, the criteria for giving notice were not made explicit, but were tacitly assumed to be the observance of the policies and intentions in consideration of which the stand-by arrangement was entered into, and the observance of which would ensure that a proper use was made of the Fund’s resources. The clause was included in more than thirty arrangements before the end of 1960; and in one instance, that of Bolivia, the Board decided to give notice.10

There have been variations in the wording of the “prior notice” clause, as the following examples indicate. A typical formulation (more general than that shown above) has been as follows:

[The member] will have the right, unless the Fund gives [the member] prior notice to the contrary, to purchase the currencies of other members.

Or, if the clause was to become operative only after the Fund’s holdings of the member’s currency had reached a certain level:

If the Fund’s holdings of [the member’s] currency are increased to the level described in paragraph—, [the member] will have the right, after 30 days from the date when this level is reached, to make further purchases under this arrangement unless the Fund notifies [the member] to the contrary within the period of 30 days. …

The details of the decision of September 17, 1958 to give notice to Bolivia under the “prior notice” clause are of some interest as showing the kind of criticism to which it was subjected. The decision was:

  • 1. In December 1957 the Fund agreed to a stand-by arrangement with Bolivia to support the stabilization program of the Government of Bolivia as described in the Annex to the stand-by arrangement. During the course of 1958 there were substantial deviations from this program which have created conditions under which it is no longer possible for the Government of Bolivia to use the Fund’s resources under the stand-by arrangement for the stabilization purposes indicated in the stand-by.
  • 2. In these circumstances and in order to establish conditions under which further drawings under the stand-by arrangement will be for the purposes set forth in it, the Fund shall notify Bolivia, pursuant to paragraph 6 of the stand-by arrangement, that no further drawings may be made until the Bolivian Government and the Fund agree on terms for such further drawings.

In the course of the discussion in the Board, Mr. Luzzetti (Argentina), Alternate to Mr. Corominas-Segura, called attention to the fact that when the extension of the stand-by arrangement with Bolivia was discussed by the Board, Mr. Corominas-Segura, as Executive Director of the Fund elected by Bolivia, had objected to the text of the proposed agreement and had pointed out the danger of including, as part of the arrangement with the Fund, government measures which unforeseen circumstances might cause to be modified at any moment. Mr. Luzzetti wished to reiterate Mr. Corominas-Segura’s position and express his concern about the way the Fund was handling the Bolivian case. He saw no reason for taking the drastic measure the staff had proposed.

The Deputy Managing Director (Mr. Cochran) commented that

paragraph 6 of the stand-by arrangement with Bolivia provided that notice for a suspension of further drawings shall be given within 30 days of the date on which Bolivia’s drawings under the stand-by reach a level of 140 per cent of quota, increased by the equivalent in Bolivian currency of US$2 million. This level was reached on September 4.

The “prior notice” clause came in for criticism also on various other occasions on the ground that it had not been incorporated in all stand-by arrangements and that when it had been adopted it had not indicated with sufficient clarity the circumstances in which it could be applied. Moreover, the “prior notice” clause gave the Fund the right to stop drawings that had not yet been requested, apparently for any reason that the Fund thought proper. When these controversial features were discussed in 1961, the Executive Board felt that this formulation did not give members an adequate assurance of their ability to draw. The staff accordingly proposed the elimination of the “prior notice” clause and the addition of the following sentence to the provision in the stand-by arrangement dealing with ineligibility (paragraph 5 of the decision of October 1, 1953 and paragraph 4 of that of December 23, 1953):

When notice of a decision [on ineligibility] is given pursuant to clause (b) of this paragraph, the member will consult the Fund and prior to any further drawings will agree with it the terms on which such further drawings may be made.

This text was not accepted by the Board because some Executive Directors felt that there was no good reason for requiring a member to consult when it had no intention of making further drawings under the stand-by arrangement.

Discussions in the Executive Board led to the conclusion that thenceforth references to the “prior notice” clause in stand-by arrangements should be eliminated in favor of a new official formulation of Fund policy by amendment of the ineligibility provisions; but in formulating the amendment, the Board took into account the objections to the staff proposal mentioned above. The decision agreed on February 20, 1961 included the following:

  • 1. There shall be added to the end of paragraph II.4 of Executive Board Decision No. 270-(53/95) the following sentence for use in all future stand-by arrangements:
  • When notice of a decision of formal ineligibility or of a decision to consider a proposal is given pursuant to this paragraph, purchases under this stand-by arrangement will be resumed only after consultation has taken place between the Fund and the member and agreement has been reached on the terms for the resumption of such purchases.
  • 2. “Prior notice” provisions appearing in existing stand-by arrangements, except for the one approved [for Yugoslavia] shall be understood as if the sentence set forth in paragraph 1 above were substituted for such provisions.11

By this decision, the “prior notice” clause was replaced by a clause which called for “consultation and agreement” on new terms when a member had become unable to draw, either because it had become ineligible or because the Board had decided to consider a proposal that the member be declared ineligible. At the time when the decision was taken there were seventeen stand-by arrangements in effect which contained “prior notice” clauses in the old form. In all instances but one the new decision involved no disadvantage to the members. An exception had, however, to be made for the stand-by arrangement with Yugoslavia, because in agreement with Yugoslavia the standards for the application of the “prior notice” clause in that arrangement had been spelled out in detail, and an amendment of these precise provisions might have been regarded as an action detrimental to Yugoslavia’s interests.

Phasing of drawing rights

Very soon after one-year stand-by arrangements began to be approved, the practice was developed of relating drawings under the arrangements not only to the implementation of certain policies, but also to the period of time during which the need for using the Fund’s resources might be experienced.

This new technique was used for the first time in a stand-by arrangement with Chile, approved by the Executive Board in March 1956, which was the first arrangement granted in support of a comprehensive stabilization program. At that time the Chilean exchange system was being modified to include two free markets with fluctuating rates, viz., (1) a banking free market for permitted imports and exports and associated invisibles and government transactions, and (2) a brokers’ free market for transactions not permitted in the banking free market. Paragraph 1 of the stand-by arrangement, containing a general outline of the stabilization program, stated inter alia:

Chile is undertaking a comprehensive economic stabilization program which includes certain fundamental changes in its exchange system approved by the Fund March 2, 1956. Steps have already been taken toward breaking the wage-price spiral by enactment of legislation providing for the eventual discontinuation of the automatic wage and salary adjustments in relation to changes in the cost of living. Quantitative ceilings have been established on the permissible expansion in bank credit and steps have been taken to limit the use of Central Bank rediscount facilities. The Government of Chile intends to maintain firmly this new restrictive credit policy. As an essential part of the over-all stabilization effort, the Government intends to take measures to increase revenue and reduce public expenditures. … The Government of Chile realizes that the success of the stabilization program requires continued efforts to reduce further the budgetary deficit.

The Fund agreed “in consideration of the stabilization policies and intentions of the Government of Chile” to a stand-by arrangement whereby up to $35 million could be drawn during the period of a year beginning April 1, 1956. Chile’s quota in the Fund at that time was $50 million. The right to draw under the stand-by arrangement was, however, subject to certain conditions which were contained in paragraphs 5 and 6 of the arrangement. In essence, these conditions were that after drawings under the stand-by arrangement had reached an amount of $12.5 million further drawings could not exceed, without the consent of the Fund, an amount of $6.25 million within any thirty-day period.

Parallel arrangements made by the U.S. Treasury and various commercial banks provided supplementary credits of $75 million in support of Chile’s stabilization program.

In the Board discussion several Executive Directors stressed the point that the arrangement should not be regarded as a precedent. As Mr. Luna-Guerra (Mexico) put it, there was no doubt, to his way of thinking, that the conditions attached to the stand-by arrangement modified the generic and essential features of an irrevocable line of credit intended in the original decision, to convert it into a sui generis contract suitable to the specific circumstances in the Chilean case.

Although it cannot be said that the arrangement with Chile was intended to set a pattern for future stand-by arrangements associated with stabilization programs, it did, in fact, initiate the process of adapting the stand-by techniques to the implementation of such programs and of developing the policy instruments used in the supervision of such programs by the Fund.

In the following two years phasing was used infrequently, but since the middle of 1958 phasing clauses have been included in the majority of stand-by arrangements, especially those with Latin American countries: of 141 stand-by arrangements approved between the end of 1957 and the end of 1965, 117 included phasing clauses. In the latter part of this period the use of phasing was even more common: of 101 stand-by arrangements approved between the end of 1960 and the end of 1965, 89 included phasing clauses. The 12 stand-by agreements without phasing which were approved during that period involved only six countries (Iceland, Japan, Pakistan, the Philippines, the United Kingdom, and the United States). In these arrangements the circumstances were such that either the whole amount of the stand-by credit should be available to the members at any time during the period of the arrangement, if needed, or the amount of the drawing was very small or fell within the first credit tranche.

The amounts available for drawings under each phase of a stand-by arrangement have been determined in accordance with the needs of each particular program. In many instances a large proportion of the total amount of the stand-by arrangement has been made available for drawing within a relatively short period. Some typical examples of phasing clauses are shown below to illustrate this point:

(A) Clause limiting amounts of purchases in any thirty-day period (without cumulation):

  • For a period of one year from_____ [the member] will have the right … to purchase from the Fund the currencies of other members in exchange for its own currency in an amount equivalent to US$___ provided that purchases under the stand-by arrangement shall not, without the consent of the Fund, exceed the equivalent of US$___ within any thirty days.

(B) Clause limiting amounts of purchases in any ninety-day period (without cumulation):

  • For a period of one year from_____ [the member] will have the right … to purchase the currencies of other members from the Fund in exchange for its own currency in an amount equivalent to US$____ provided that purchases under this stand-by arrangement shall not, without the consent of the Fund, exceed the equivalent of US$_____ in any ninety-day period.

(C) Clause limiting amounts of purchases in any three months and permitting cumulation:

  • For a period of one year from______ [the member] will have the right … to purchase the currencies of other members from the Fund in exchange for its own currency in an amount of US$____; provided that purchases under this stand-by arrangement shall not, without the consent of the Fund, exceed the equivalent of US$____ in the first three months of the stand-by arrangement and a cumulative total equivalent to US$____ for each subsequent ninety-day period.

(D) Clause limiting amounts of purchases per month and permitting cumulation:

  • For a period of one year from_____ [the member] will have the right … to purchase the currencies of other members from the Fund in exchange for its own currency in an amount of US$_____; provided that purchases under this stand-by arrangement shall not, without the consent of the Fund, exceed at any time a cumulative total equivalent to US$____ plus US$_____per month. …

(E) Clause limiting amount of purchases by specified time periods:

  • For a period of one year from_____ [the member] will have the right … to purchase the currencies of other members from the Fund in exchange for its own currency in an amount equivalent to US$_____; provided that purchases under this stand-by arrangement shall not, without the consent of the Fund, exceed the equivalent of US$_____ in the first three months, US$_____ in the first six months, and US$_____ in the first nine months.

An analysis of stand-by arrangements approved between the end of 1960 and the end of 1965 that included phasing shows that in 40 per cent of these arrangements, 50 per cent or more of the amount could be drawn immediately; in 82 per cent of them, 50 per cent or more of the amount could be drawn within three months; and in 83 per cent of them, 75 per cent or more of the amount could be drawn within six months. Moreover, it should be noted that all stand-by arrangements permit acceleration of the use of resources if the member requests it and the Fund agrees.

“Binding” performance conditions

By the time the “prior notice” clause was abandoned, another type of technique had come into use which made drawings under stand-by arrangements dependent on the observance of certain specified policies, frequently expressed in quantitative terms. This technique (which is usually combined with the phasing of drawing rights) involves an undertaking by members committed to such “objective” policies as limiting credit to a fixed amount or maintaining specified reserve requirements, that if they should deviate from those policies they would not request drawings under the stand-by arrangement without first consulting the Fund and agreeing on new terms for further drawings. This type of clause, based on the “additional understandings” provision in the second policy decision on stand-by arrangements quoted above, has appeared, according to the member’s preference, either in the text of the stand-by arrangement or in the annexed letter of intent. Whichever alternative was adopted, appropriate cross references have been made in the relevant provisions of the arrangement.

The practice of making some of the policy intentions legally binding originated in stand-by arrangements with Latin American countries, and has evolved gradually. The first stand-by arrangement in which binding policy commitments in the credit and fiscal fields (expressed in quantitative terms) were included was that with Paraguay, approved by the Executive Board on July 29, 1957. This arrangement included the following two clauses:

If, at any time before January 1, 1958, the credit ceiling as described in ______ is exceeded, Paraguay will not draw further amounts under this stand-by arrangement before consulting the Fund and obtaining its consent.

and

If, at any time before January 1, 1958, the Government of Paraguay exceeds the maximum commitment level for ordinary budget expenditures or the maximum level for the implementation of the four-year public works program as described in the annexed Report, Paraguay will not draw further amounts under this stand-by arrangement before consulting the Fund and obtaining its consent.

A number of Executive Directors expressed misgivings about the inclusion of such specific performance conditions in the proposed arrangement. Mr. Thorold (United Kingdom) stated that he “would wish the record to show that the decision taken was on the merits of the particular case and was not to be regarded as a precedent for general application,” but did not press for the deletion of these provisions. Several other Directors expressed similar views. Mr. Southard, who favored the inclusion of these specific conditions, stated that in the light of its experience the Fund had learned the advisability of adjusting the terms of its stand-by arrangements to the situation of each country and to the circumstances in which the situation had developed. He emphasized the point that the Paraguayan authorities and the Fund had examined the practical situation and concluded that these provisions were essential and that if the authorities were unable to meet them they would consult with the Fund. Following the discussion, the arrangement with Paraguay (which required a waiver under Article V, Section 4, of the Fund Agreement) was approved by the Board.

A subsequent stand-by arrangement with Haiti, approved by the Executive Board about a year later, contained a wider range of specific policy commitments, including the following clause:

If Haiti, without consultation and agreement with the Fund, departs from the budgetary or credit or other policies and intentions set forth in the annexed letter, Haiti will not draw further amounts under this stand-by arrangement before consulting the Fund and agreeing with it the terms on which further drawings may be made.

Several Executive Directors again expressed misgivings about the conditions attached to the arrangement. Mr. Luzzetti stated that Mr. Corominas-Segura, for whom he spoke, wished to reserve his position with respect to the specific conditions recommended by the staff. Mr. Hockin (Canada) objected to the particularly detailed nature of the specific conditions in the monetary and fiscal fields which, he felt, “went too far, involving as it did judgments of specific detail which the Board had not discussed.” After further debate, in which Mr. Southard supported the arrangement, the Chairman (Mr. Jacobsson) expressed his feeling that there was a definite advantage in having the members submit a detailed program. He added that if the member felt that it would not be able to meet a particular commitment, the staff would submit its recommendations to the management, which in turn would bring any proposal for a major change to the Board for its consideration.

The Board discussions mentioned above illustrate the point that binding specific performance conditions for drawings under stand-by arrangements in their early days had to be defended against the charge that they were not in accordance with the concept of an assured line of credit. It was, therefore, considered advisable to make it clear that if there was a deviation from a condition, this did not necessarily mean that there was no possibility of making further drawings during the remaining period of the stand-by arrangement. For this reason, it was made explicit that the member could resume drawings if it consulted and agreed on new terms. The “consult and agree” clause itself did not interrupt drawings because the interruption of drawing rights had already occurred as a result of the deviation from a condition. The main purpose of the clause was, therefore, at that time to draw attention to the possibility of restoring drawing rights.

The use of legally binding specific performance conditions in stand-by arrangements spread quickly. Since 1959 most stand-by arrangements in the higher credit tranches (and even some arrangements confined to the first credit tranche) have included specific policy commitments and an appropriate protective clause which refers to these commitments. This clause, as included in letters of intent, has been most frequently worded as follows:

During any period in which [the specified limits are exceeded, etc.] [the member] will not request any further drawing under the stand-by arrangement, except after consulting with the Fund and agreeing with it on the terms on which further drawings may be made.

Sometimes, in addition to the above clause, which is designed to interrupt drawings when specific commitments are not observed, another clause is included, in the stand-by arrangement itself, which calls for “consultation and agreement” with the Fund on terms for further drawings when the total drawn reaches a specified amount or increases the Fund’s holdings of the member’s currency to a certain level, as shown in the following examples:

… when purchases under this stand-by arrangement reach a total equivalent to US$____ million [the member] will consult the Fund and agree with it on the terms for further purchases under this arrangement.

or

If … the Fund’s holdings of [the member’s currency] are increased to _______ per cent of the present quota, [the member] will consult with the Fund before requesting any further purchases under this arrangement and will agree with it on the terms on which such further purchases may be made.

The specific policies referred to in stand-by arrangements have varied widely in numbers and range of coverage. In addition to a ceiling (or a number of ceilings) on the domestic assets of the central bank, they have frequently included fiscal, exchange rate, and balance of payments policies. There has been a tendency toward the proliferation of specific limitations and targets, especially in stand-by arrangements with certain Latin American countries which have adopted a gradual approach toward stabilization. When a stabilization program is aimed only at a deceleration of the inflationary process, it has been necessary to maintain a flexible exchange rate policy based on certain balance of payments tests and the achievement of certain net foreign exchange reserve targets. In such arrangements, failure to observe the net foreign exchange reserve target generally carries only the standard obligation “not to request any further drawing under the stand-by arrangement, except after consulting with the Fund and agreeing with it on the terms on which further drawings may be made.” The link of the balance of payments performance test with exchange rate flexibility is provided by the declared intention of the authorities concerning their exchange rate policy. For example, in a stand-by arrangement with Brazil, approved by the Board on February 2, 1966, the letter of intent included the following statement:

  • The Brazilian Government intends to maintain the unification of the exchange rate structure achieved in 1965 and it intends to continue to place major reliance on the exchange rate to achieve a sound improvement in its balance of payments and foreign exchange reserve position. Accordingly the exchange rates quoted by the Central Bank and the Bank of Brazil will follow the fundamental market trends. …(b) In carrying out its policy with regard to foreign exchange commitments, the authorities will ensure that their net foreign exchange assets at the end of each month in 1966 will be, in U.S. dollar terms, equal to, or higher than, those existing at the end of October 1965. …

In some arrangements, however, an explicit link between the balance of payments performance and the exchange rate policy has not been established. For instance, in the letter of intent provided by Paraguay in connection with a stand-by arrangement approved by the Board on November 20, 1964, it was stated that

the Paraguayan authorities believe that the policies described in this letter will be sufficient to avoid an over-all balance of payments deficit during the forthcoming year, although seasonal fluctuations are expected in the level of the international reserves. Accordingly, during the period of the requested stand-by arrangement it will be their policy to avoid a reduction of more than $3.5 million in the net international reserves of the Central Bank below the level of October 23, 1964. …

The letter of intent attached to a stand-by arrangement with Colombia, approved by the Board on December 15, 1965, unlike others before, included a specific reference to what could appropriately be done after failure of a quarterly balance of payments test:

  • Any shortfalls from the balance of payments targets for 1966 described in paragraph 6 above will be corrected as quickly as possible by (i) appropriate adjustments of the exchange rate in the intermediate official market; (ii) shifts of payments from the preferential to the intermediate official selling rate; (iii) increases in tariff duties; or (iv) any combination of these measures. Also, monetary policies could be tightened more than is contemplated in paragraph 9 below.

Circumstances in Colombia and Paraguay, however, were somewhat different from those considered above, in that inflation was less acute and the stabilization program could conceivably be implemented without exchange rate adjustment. (There was disagreement on this point between the staff and the authorities of the countries concerned.)

The “major shift” clause

Following the rejection of the “prior notice” clause by the Board, another technique was developed to fill the gap resulting from the fact that not all policies can be made the subject of specific “objective” conditions. In contrast to the discarded “prior notice” clause, the “major shift” clause which was then introduced has not been given legal force.

In the letter of intent provided in connection with a stand-by arrangement approved by the Board on April 26, 1961, Australia stated:

  • Should any major shift in the direction or emphasis of policy become necessary during the currency of the stand-by arrangement the Australian Government would, at the request of the Managing Director, be ready to consult with the Fund and, if necessary, reach new understandings before any request for a further drawing under the stand-by arrangement is made.

The arrangement with Australia and certain other arrangements in which the “major shift” clause has been used did not contain any “objective” conditions, and originally the clause was undoubtedly intended to be a moral equivalent for those conditions. However, sometimes the clause has been used also in stand-by arrangements which contained numerous “objective” performance conditions. There has even been a tendency to stiffen the clause in some cases. For example, in the letter of intent annexed to the stand-by arrangement with Chile, approved by the Board on February 14, 1964, the clause was worded as follows:

  • Should any major shift in the direction or emphasis of any of the policies outlined in this letter become necessary during the period of the requested stand-by arrangement, the Government of Chile will consult with the International Monetary Fund and, if necessary, reach new understandings before any request for a drawing under the stand-by arrangement is made.

In the stand-by arrangement with the United Kingdom approved by the Board on July 27, 1964, the formulation was substantially the one quoted above for Australia. The staff memorandum contained the following explanation:

  • The staff’s understanding of this formulation is that the member will inform the Fund of any major shift, whatever may be the reason for it. In addition, the staff understands that the member would give the Managing Director such information in sufficient time to enable him to decide whether to request consultation in accordance with the paragraph.

This type of clause calls for consultation if there is a “major shift” of policy, whether or not the member intends to draw again. This is a reasonable requirement in view of the serious implications of a major shift of policy, particularly if there are no “objective” performance conditions that bring about an automatic interruption of drawings. More recently, however, the “major shift” clause has been subject to criticism because of the difficulty of deciding what constitutes a major shift in policy. Although in 1965 the clause was still being used, it was tending to give way to another type of clause which called for consultation when the objectives of the program were not achieved rather than when a shift in policies occurred.

If the amount made available under the stand-by arrangement did not exceed the amount of the first credit tranche, it became the practice to include two clauses, as follows:

  • (A) If at any time during the period of the stand-by arrangement (a) the limits specified in paragraphs ______ of this letter are exceeded, or (b) the intentions set forth in paragraphs _______ of this letter are not carried out, the Government of [the member] will consult with the International Monetary Fund regarding measures to be adopted in order to achieve the objectives of the program described above.
  • (B) If in the opinion of [the member] Government or the Managing Director the policies outlined in this letter turn out to be inadequate to achieve the objectives of the program described above, the Government of [the member] will consult with the International Monetary Fund regarding additional measures to be adopted in order to achieve the objectives of the program of [the member] described above.

Thus, if the amount available under a stand-by arrangement would not raise the Fund’s holdings of the member’s currency above the first credit tranche, the member’s obligation, should the specified limits be exceeded, was to consult the Fund on ways in which to improve its program. In stand-by arrangements above the first credit tranche, on the other hand, the observance of specific policy commitments was normally made binding: if the member deviated from the quantitative limits or targets or other policies specified, it had to consult with the Fund prior to any further drawings and agree with it on the terms on which such further drawings might be made. In addition, the clause shown above in paragraph (B) was used in such arrangements.

1

E.B. Decision No. 102-(52/11), February 13, 1952, par. 1; below, Vol. III, p. 228. For the background of this decision see above, p. 402.

2

See above, p. 429.

3

E.B. Decision No. 155-(52/57), October 1, 1952; below, Vol. III, p. 230.

4

E.B. Decision No. 270-(53/95), December 23, 1953; below, Vol. III, p. 231.

5

Below, p. 478.

6

See above, p. 404.

7

Annual Report, 1955, pp. 84–85.

8

Annual Report, 1957, p. 120.

9

E.B. Decision No. 1687-(64/22), April 22, 1964; below, Vol. III, p. 243.

10

See above, pp. 389–90.

11

E.B. Decision No. 1151-(61/6), February 20, 1961; below, Vol. III, p. 234.

    Other Resources Citing This Publication