IV Policy Outcomes

Louis Dicks-Mireaux, Miguel Savastano, Adam Bennett, María Carkovic S., Mauro Mecagni, James John, and Susan Schadler
Published Date:
September 1995
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Most of the countries reviewed adjusted policies broadly as envisaged, although many suffered setbacks or reversals before the end of the programs under review. In a small number of countries, planned policy changes never occurred or, in light of adverse exogenous or political developments early in the program period, became clearly inadequate to reach minimum objectives. Separating out countries that failed to adhere to the spirit of their programs is necessary for a meaningful examination of the implementation and effects of programmed policies; but, the choice of any objective criterion for doing so is somewhat arbitrary, A generous criterion is adopted: any arrangement in which a country was eligible for at least one purchase after approval is considered to have influenced policies to some degree as envisaged. On this criterion six countries—Brazil, the Congo, Guatemala, Madagascar, Uruguay, and Yugoslavia—are excluded from the review of policy outcomes and macroeconomic developments (Box 2).28

Box 2.Countries Unable to Purchase After Approval

In six countries (Brazil, the Congo, Guatemala, Madagascar, Uruguay, and Yugoslavia), the programs under review went off track immediately after approval of the arrangement and remained off track for the duration of the arrangement,1 In each country, except Madagascar, the government did not implement measures agreed upon in the program and crucial to some aspect of performance.2 Performance criteria were missed, and agreement could not be reached on the policies that would put the economy on an acceptable, even if not the original, adjustment path. In the Congo and Yugoslavia, domestic political upheavals played a large role. In all countries except Uruguay, subsequent macroeconomic developments continued to diverge from a sustainable path. The following briefly reviews why programs went off track and subsequent developments. (The dates in parentheses indicate the duration of the arrangements as approved.)

In Brazil (August 1988-February 1990), the performance criterion on the public sector borrowing requirement was missed by large amounts at the first and second test dates, and that on the operational deficit was exceeded by a small amount at the second test date. The larger-than-programmed borrowing requirement reflected mainly the large increase in expenditures to maintain the real value of the public debt (“monetary correction” expenditures) in the face of rising inflation. Inflation rose because of the uncertainties associated with the fiscal consequences of a new constitution adopted shortly after approval of the arrangement, preemptive price markups in anticipation of a new price freeze, the effect of bad weather on food supplies, and the temporary effects of eliminating some subsidies.3 Inflation remained high, averaging over 1,000 percent a year during 1989-92, and, although a relaxation of demand restraint led to a temporary recovery of output in 1989, by 1992 real GDP per capita was 10 percent below its 1989 level. Nevertheless, the approval of the arrangement helped Brazil reach a rescheduling agreement with its official and commercial creditors in 1988, and thereby helped improve the external position.

In the Congo (August 1990-May 1992), departures from the program were prompted by political upheavals stemming from the transition from a one-party state with a strong military presence to a multiparty political system. Also, pressing financial constraints that had helped spur the move toward reform were temporarily eased by the increase in oil prices, which also emboldened the labor unions in their demands. The government yielded to pressure for wage increases in the state sector, and wage bills rose by as much as 70 percent more than programmed; civil service reform was shelved; and the privatization of key enterprises was abandoned. Performance criteria on the accumulation of external payment arrears, noninlerest current expenditure, and non-oil revenue were missed early in the program. By 1992, when the transition to democratic rule was completed, the Congo faced macroeconomic and structural problems of extraordinary proportions. Although inflation remained low, growth was weak and the fiscal position was racked by an enormous wage bill and large-scale support for public enterprises. External debt had increased to 180 percent of GDP, and large external arrears had led donors to suspend project lending.

In Guatemala (October 1988-February 1990), the program went off track mainly because of problems in the monetary area, specifically the early redemption of stabilization bonds by the central bank well in excess of that programmed.4 The performance criteria on net domestic assets and, relatedly, net international reserves of the central bank at the first and second test dates were missed by large margins. Also, weakening tax enforcement and expenditure overruns led to a higher-than-programmed combined public sector deficit. Thus, the ceiling on contracting public and publicly guaranteed external debt was missed at the first test date. Also, contrary to program understandings, which called for a managed float, the exchange rate was held fixed from the beginning of the arrangement until August 1989, giving rise to a real appreciation of 9 percent. The slippages in policy implementation appear to have contributed to capital flight and an acceleration of inflation in 1989-90. The liquid reserves of the Bank of Guatemala were depleted, and external payments arrears rose.

In Uruguay (December 1990-March 1992), performance criteria on the public sector deficit, net domestic assets, and public external debt were missed early in the arrangement, but the principal issue in the derailment of the program was the failure to eliminate, as agreed, a policy of backward-looking wage indexation: public sector wages were increased far more than programmed, and it was announced that real wages in the central administration would be maintained. Wage contracts in the private sector also continued to provide a high degree of backward-looking indexation. As a result, overall wages rose by over 90 percent in 1991, against about 30 percent envisaged in the program. Progress was made, however, in reducing the public sector deficit, slowing credit growth, and furthering structural reform during the program period. In a favorable external environment, these changes led to an improvement in most macroeconomic variables in 1991—a pickup in economic activity and even a decline in inflation, albeit by far less than programmed. Following a restructuring of debt with foreign commercial creditors in early 1991, Uruguay began to regain access to international capital markets.

In Yugoslavia (March 1990-September 1991), a six-month freeze on nominal wages—a crucial anchor of the disinflation program—was not implemented because the federal government was unable to prevent republican and provincial authorities from granting exemptions to the freeze. Larger-than-programmed wage and pension payments at all levels of government led to large expenditure overruns. Consequently, the performance criterion on wages and the ceiling on public spending were missed early in the program. The political consensus between federal and republican governments underpinning the disinflation program adopted in late 1989 unraveled quickly. This unraveling was precipitated in part by the multiparty elections held in the republics in 1990, which stirred up long-standing ethnic and regional rivalries. The failure to implement wage and fiscal policies, together with an accommodative monetary policy, led to a resurgence of inflation during the program period. The fixed nominal exchange rate initially attracted large capital inflows, but a substantial real appreciation by late-1990 hurt export performance and, with the sustainability of the exchange rate in doubt, gave rise to capital outflows. Enterprises were squeezed by the large wage increases and high real interest rates, and gross social product is estimated to have declined sharply in 1990.

1 However, each of these countries entered into arrangements with the IMF after the period under review.2 In Madagascar, after initial adverse developments, policies were implemented broadly as planned, but the program was canceled and replaced by an ESAF arrangement.3 The new constitution limited the ability of the federal government to raise taxes, mandated higher transfers to states, reduced the scope for privatization of state enterprises, and expanded social security outlays.4 The stabilization bonds were originally issued to foreign suppliers in 1983-84 to settle outstanding private arrears; over time they were held mostly by residents. The large redemption was officially explained by the need to ease the high servicing burden, given the premium over international interest rates.

In reviewing the experience, the poor quality of the data for many countries and the frequent inconsistency of definitions, particularly for fiscal and monetary data, across countries must be recognized. A particularly serious problem is the wide variation in the coverage of fiscal accounts—from central government only in many to the full public sector in a few. Moreover, quasi-fiscal losses are frequently not known or recorded. Improving the quality of data and, specifically, broadening the coverage of public sector accounts is crucial to strengthening program design and ensuring uniformity of treatment.

Fiscal Policy

On average, the fiscal outcomes were close to targets. There was, however, a wide range of outcomes.

At one end of the spectrum were the Central European countries (except Romania) and several of the new users, where deficits were considerably larger than targeted (Table 1). At the other end, most of the oil producers (principally countries that had had one previous arrangement) overperformed by a sizable margin. In Central Europe, the excesses over targets reflected mainly difficulties in reducing noninterest current spending; revenues, though falling, were actually stronger relative to GDP than projected. Outside Central Europe, increases in both revenues and outlays tended to be below those targeted. Most of the countries where deficits were lower than targeted (mainly countries with one or more previous arrangements) benefited from improvements in the terms of trade that, in a few cases, boosted revenues, but more systematically appear to have resulted in lower-than-targeted increases in noninterest outlays relative to GDP. By contrast, fiscal underperformers (mostly among the new users) experienced a mix of revenue shortfalls and expenditure overruns.

Table 1.Fiscal Adjustment: Deviations from Targets1(In percentage points of GDP)
Overall BalanceRevenuesNoninterest OutlaysInterest OutlaysCapital Outlays
Several previous arrangements20.6–0.3–0.6–0.3–0.4
One previous arrangement1.01.20.2–0.3
New users excluding central Europe3–0.6–2.0–1.0–0.50.3
Central Europe–
Sources: IMF staff estimates.

Average of actual changes between the year before and the last year of the arrangements under review less the average of target changes during the same period in each country. Excluding the six countries ineligible for any purchases after approval and those that did not target interest payments explicitly (Costa Rica, Pakistan, Papua New Guinea, and Poland).

Excluding Argentina, where revisions to GDP preclude comparison.

Excluding Jordan, where revisions to GDP preclude comparison.

Sources: IMF staff estimates.

Average of actual changes between the year before and the last year of the arrangements under review less the average of target changes during the same period in each country. Excluding the six countries ineligible for any purchases after approval and those that did not target interest payments explicitly (Costa Rica, Pakistan, Papua New Guinea, and Poland).

Excluding Argentina, where revisions to GDP preclude comparison.

Excluding Jordan, where revisions to GDP preclude comparison.

Cumulatively, overall fiscal deficits relative to GDP fell on average by 4 percentage points over the average two and a half years of IMF involvement (Table 2). Outside Central Europe, every country except Cameroon and Papua New Guinea improved its fiscal position, and by 1992 all but nine had realized a primary surplus. In general, these gains reflected desired improvements in the structure of the fiscal accounts: in the countries that had had several previous arrangements, a combination of revenue increases and principally noninterest expenditure restraint; in the countries with one previous arrangement, sizable reductions in capital outlays, albeit supplemented by revenue increases; and in the new users outside Central Europe, revenue increases (although considerably below those needed) and expenditure restraint. Not all of the improvement stemmed from policy changes; in about a third of the countries, principally oil exporters, improvements in the terms of trade were also important (Table 3). These, however, tended to be transitory; backtracking in some of the countries that had benefited from terms of trade gains meant that by 1992 the sustained fiscal adjustment was similar in the two groups.

Table 2.Outturns for the Fiscal Accounts(In percent of GDP)
Overall BalanceInterest PaymentsPrimary Balance
Pre-Program Year1Last Program Year1992Pre-Program Year1Last Program Year1992Pre-Program Year1Last Program Year1992
All countries, excluding Central Europe2–8.1–4.1––
Countries with several previous arrangements3–6.7–2.3–
Countries with one previous arrangement4–8.7–2.8––
New users5–9.5–7.3––5.9–2.4–1.0
Central European countries6–3.7–6.1––1.2–1.1–1.8
Noninterest Expenditures
Pre-Program Year1Last Program Year1992Pre-Program Year1Last Program Year1992Pre-Program Year1Last Program Year1992
All countries, excluding Central Europe221.222.922.523.521.821.
Countries with several previous arrangements320.021.320.719.318.518.
Countries with one previous arrangement424.328.227.727.124.925.
New users520.621.521.626.523.922.
Central European countries645.941.440.247.142.542.
Source: IMF staff estimates.

Year preceding first program.

Also excluding Guyana, where ratios were so much higher than in other countries that they dominated the averages; Zaire owing to insufficient data through 1992; and the six countries ineligible for any purchases after approval.

Argentina, Costa Rica, Cote d’lvoire, Ecuador, Haiti, Jamaica, Mali, Mexico, Morocco, and the Philippines.

Algeria, Egypt, Gabon, Nigeria, and Tunisia.

Cameroon, El Salvador, Jordan, Pakistan, Papua New Guinea, Honduras, Trinidad and Tobago, and Venezuela.

Bulgaria, Czechoslovakia, Hungary, Poland, and Romania.

Source: IMF staff estimates.

Year preceding first program.

Also excluding Guyana, where ratios were so much higher than in other countries that they dominated the averages; Zaire owing to insufficient data through 1992; and the six countries ineligible for any purchases after approval.

Argentina, Costa Rica, Cote d’lvoire, Ecuador, Haiti, Jamaica, Mali, Mexico, Morocco, and the Philippines.

Algeria, Egypt, Gabon, Nigeria, and Tunisia.

Cameroon, El Salvador, Jordan, Pakistan, Papua New Guinea, Honduras, Trinidad and Tobago, and Venezuela.

Bulgaria, Czechoslovakia, Hungary, Poland, and Romania.

Table 3.Primary Fiscal Balances(In percent of GDP)
Pre-Program YearProgram AverageLast Program Year1992
Countries where terms of trade Improved during programs1–
Countries where terms of trade deteriorated during programs2–2.4–
Source: IMF staff estimates.

Ecuador, Gabon, Haiti, Mexico, Nigeria, Romania, Trinidad and Tobago, and Venezuela.

Algeria, Argentina, Bulgaria, Cameroon, Costa Rica, Cote d’lvoire, Czechoslovakia, Egypt, El Salvador, Honduras, Hungary, Jamaica, Jordan, Mali, Morocco, Pakistan, Papua New Guinea, the Philippines, and Tunisia.

Source: IMF staff estimates.

Ecuador, Gabon, Haiti, Mexico, Nigeria, Romania, Trinidad and Tobago, and Venezuela.

Algeria, Argentina, Bulgaria, Cameroon, Costa Rica, Cote d’lvoire, Czechoslovakia, Egypt, El Salvador, Honduras, Hungary, Jamaica, Jordan, Mali, Morocco, Pakistan, Papua New Guinea, the Philippines, and Tunisia.

Fiscal developments should be assessed relative to measures of the sustainable fiscal position.29 In broad terms, three standards for fiscal sustainabilily could be used: where debt financing is important, standard calculations of the primary position consistent with a stable ratio of debt to GDP; where financing consists mainly of bank credit, the fiscal position consistent with inflation targets; and where external grants are important, the deficit consistent with sustainable external financing given the savings-investment gap of the nongovernment sector. Although such exercises are not reported for most countries, the fact that many countries had high rates of inflation and depended substantially on exceptional finance means that their fiscal adjustment cannot be seen as complete, even though they often had substantial primary surpluses. For the numerous countries (particularly among the countries that had had previous programs) that fit this description, further primary adjustment will undoubtedly be difficult. Thus, prospects for stabilizing debt ratios, particularly as governments shift from bank to nonbank domestic financing, rest largely on countries’ success in raising growth rates.

In general, programs would benefit from a more explicit exploration of what constitutes a sustainable fiscal position, even though this would be neither a precise nor an unvarying standard. There are limitations to such medium-term analyses, especially in countries facing disruptive short-term crises or major structural transformations, such as in Central Europe, where potential revenues and the capacity to reduce expenditures are unusually uncertain. The beginnings of this process are evident in some recent IMF staff reports and other staff papers.30

Financial Programs and Interest Rates

The success in meeting fiscal targets, together with a shift in deficit financing from banks to domestic nonbanks, often beyond that programmed, meant that outside Central Europe, net bank credit to the government was, on average, close to program targets (Table 4); large excesses over target, however, occurred in Jamaica, Honduras, Nigeria, and the Philippines. In most countries (except Cameroon and Mexico) excesses over targets for bank credit to the nongovernment sector were small. It is difficult to draw any conclusions about the degree of crowding in or crowding out of bank credit to the private sector because data for net bank credit to the government cover the broad public sector for only 15 countries and therefore do not reveal whether changes in net bank credit to the government were offset by opposite changes in bank credit to other levels of the public sector. In Central Europe, there were large excesses relative to target in both overall net bank credit growth and the growth of net bank credit to the government.

Table 4.Summary of Financial Programs1(In percentage points, end-of-period data)
Difference Between Outturns and Targets
Contribution to broad money growth
Of net credit to the governmentOf net domestic assetsOf net foreign assetsBroad moneyActual Broad Money Growth
All countries excluding Central Europe0.
Of which: initial inflation over 10 percent–1.1–
Countries with several previous arrangements21.
Countries with one previous arrangement3–1.9–
New users40.1–
Central European countries10.614.87.021.942.1
Source: IMF staff estimates.

Averages for annual financial programs. Positive numbers indicate excesses over targets. Excluding Argentina, Guyana, and Zaire (because of problems in the data), and the six countries ineligible for any purchases after approval.

Costa Rica, Côte d’lvoire, Ecuador, Haiti, Jamaica, Mexico, Mali, Morocco, and the Philippines.

Algeria, Egypt, Gabon, Nigeria, and Tunisia.

Cameroon, El Salvador, Honduras, Jordan, Pakistan, Papua New Guinea, Trinidad and Tobago, and Venezuela.

Bulgaria, Czechoslovakia, Hungary, Poland, and Romania.

Source: IMF staff estimates.

Averages for annual financial programs. Positive numbers indicate excesses over targets. Excluding Argentina, Guyana, and Zaire (because of problems in the data), and the six countries ineligible for any purchases after approval.

Costa Rica, Côte d’lvoire, Ecuador, Haiti, Jamaica, Mexico, Mali, Morocco, and the Philippines.

Algeria, Egypt, Gabon, Nigeria, and Tunisia.

Cameroon, El Salvador, Honduras, Jordan, Pakistan, Papua New Guinea, Trinidad and Tobago, and Venezuela.

Bulgaria, Czechoslovakia, Hungary, Poland, and Romania.

Targets for broad money growth were overshot by wide margins in about two thirds of the program years. In most countries, this reflected mainly larger-than-expected net foreign assets.31 In general the overrun in net foreign assets stemmed from stronger-than-projected current account positions and, in a small number of countries (Costa Rica, Egypt, El Salvador, Honduras, Jordan, Mexico, and Morocco), unexpectedly large capital inflows, typically to the private sector.

A pattern of domestic credit restraint and sizable increases in net foreign assets persisted on average throughout programs. Consequently, there was a considerable shift from net domestic asset creation to the accumulation of net foreign assets, but little change, or, in about 60 percent of the countries, an increase in the growth of broad money (Chart 5), Typically, this occurred while velocity remained steady or rose so that in many countries monetary developments had little restraining effect on inflation. The principal exceptions were the countries that adopted an explicit nominal anchor, mostly using the exchange rate.

Chart 5.Monetary Developments

(Period t–1 refers to the year preceding the program(s) under review)

1 Algeria, Bulgaria, Cameroon, Costa Rica, Côte d’Ivoire, Czechoslovakia, Ecuador, Egypt El Salvador, Gabon, Haiti, Honduras, Hungary, Jamaica, Jordan, Mali, Mexico, Morocco, Nigeria, Pakistan, Papua New Guinea, the Philippines., Poland, Romania, Trinidad and Tobago, Tunisia, and Venezuela, Excludes Argentina, Guyana, and Zaire because of data deficiencies.

2 Where available, data exclude valuation changes.

3 Czechoslovakia, Egypt, Mexico, and Poland, Excludes Honduras because it dropped its nominal anchor in 1992.

4 Bulgaria, Costa Rica, Ecuador, El Salvador, Hungary, Nigeria, Romania, and Venezuela, Romania is included because it underwent a major price liberalization.

There, the evidence suggests that the exchange rate anchor enhanced the effects of strong fiscal adjustment on inflation, thereby slowing the growth of demand for nominal money balances even as velocity fell; money growth, therefore, decelerated—although still, on average, by less than targeted—despite often large increases in net foreign assets. These developments illustrate the power of financial programs in general, and credit restraint in particular, for building reserves but their weakness for curbing money growth and, ultimately, inflation, particularly when the exchange rate is not used as a nominal anchor.

Remarkable progress in reforming financial markets complemented efforts to restrain credit growth. At the outset of the programs, most countries, particularly the new users, were at a relatively early stage of reform; about three quarters had undeveloped financial markets and pervasive controls on interest rates. By the end, about two thirds of the countries had auctions for central bank or government paper; most of these (and a few others that had not introduced auctions) had removed controls on a significant range of interest rates. These steps provided the institutional capability for indirect credit control and a shift from bank to non-bank financing of the deficit. Both these developments were critical to increasing real interest rates to positive levels.

In fact, real interest rates, which prior to the arrangements had been negative or well below foreign levels in about two thirds of the countries, rose significantly or remained at positive levels in most countries (Chart 6).32 In several countries, financial reforms or changes in the structure of fiscal financing late in the arrangement affected interest rates, mainly after the programs under review. Thus, by 1992, real interest rates were negative in only about a quarter of the countries. In Central Europe, where liberalization was recent and success in reducing large-scale bank financing of the public sector was elusive, countries had considerable trouble in attaining positive real interest rates.33 The experience of the countries under review does not point to a significant role for higher interest rates in raising savings. Rather, the principal effect of the shift from negative to positive real interest rates is likely to have been in transforming the role of the banking system from redistributing resources to promoting the efficient allocation of resources.

Chart 6.Real Interest Rates1

(In percent a year; period t-1 refers to the year preceding the progrom(s) under review)

Sources; IMF. International Financial Statistics, various issues, and staff estimates.

1 Annual average of monthly short-term nominal interest rates adjusted by actual 12-month centered increases in consumer prices.

In about half of the countries, concern arose about high levels of real interest rates—levels well in excess of recent growth rates and real interest rates abroad—and large spreads. Usually one or more of three influences were at play: oligopolistic banking structures or weak prudential controls and supervision that hindered normal market restraints on interest rates; a large shift from bank to nonbank-financing requirements; and, in countries with aggressive disinflation programs supported by an exchange rate anchor (Mexico and Poland), the need to defend the exchange rate in the face of initial market skepticism and lags in the adjustment of inflationary expectations. High real interest rates in most of the CFA franc zone countries reflected the need to stem capital outflows while real interest rates in France rose to historically high levels. Outside the CFA franc zone, the problem of high real interest rates tended to be transitory. Even within the life of programs, most countries that had very high real interest rates saw a drop as adjustment to the newly liberalized regimes took place and the fiscal conditions that pushed up real interest rates were corrected.

These experiences suggest that financial liberalization and shifts in fiscal financing are successful in conferring a market-clearing role for interest rates, but care is needed to avoid excessive levels of real interest rates. Programs should be attentive to two particular issues in the liberalization process; (i) improving prudential controls and bank supervision to deter banks from excessive risk-taking rewarded by high real interest rates; and (ii) ensuring that the shift from bank to nonbank budget financing is accompanied by adequate reductions in overall borrowing requirements.

Exchange Rate Policy

Countries that used the exchange rate as a nominal anchor differed in distinct ways from those that managed their exchange rates more flexibly. Thirteen countries explicitly or effectively used the exchange rate as a nominal anchor.34 All except the CFA franc zone countries and Papua New Guinea adopted the anchor at or near the beginning of their first arrangement covered by this review. Initial inflation in these countries ranged from over 50 percent a year to very low levels, although they were concentrated in the very high and low ranges. The reasons for using an exchange rate anchor differed between high- and low-inflation countries. In the high-inflation countries, the goal was to break inflationary expectations, provide discipline for policies, and directly affect inflation by stabilizing prices of traded goods. In the low-inflation countries, the aim was either to prevent a prospective adjustment in administered prices from setting off a wage-price spiral (Morocco and Trinidad and Tobago) or to provide a standard for policy discipline (Papua New Guinea and the CFA franc zone countries).

In general, the countries that used the exchange rate as a nominal anchor were successful in reducing inflation or maintaining it al a low rate.35 The cost, however, was typically a loss of price competitiveness as inflation fell but still remained above that in trading partners (Chart 7). In some countries, the real appreciation probably overstates the decline in competitiveness because improvements in economic conditions, including lower inflation, raised productivity; in others, such as the CFA franc zone countries, however, the measure probably understates the real appreciation as inadequate adjustments in nominal wages given terms of trade losses squeezed profits. In Argentina (1989), where fiscal adjustment fell significantly short of target, the anchor quickly proved unsustainable and had to be abandoned in the midst of a severe speculative attack.36 In Poland, the fixed exchange rate was later adjusted in a move toward greater flexibility.

Chart 7.Nominal and Real Effective Exchange Rates in Countries with Exchange Rate Anchors1

(Average 1990 = 100)

Sources: IMF. Information Notice System, and staff estimates.

Note: SBA = stand-by arrangement; EFF = extended Fund facility.

1 Downward movements represent improvements in competitiveness, For Morocco, see Chart 8; for Argentina, see Chart 9.

2 Average for Cameroon, Cote d’lvoire, Gabon, and Mali, For Cameroon, Information Notice System data are based on inflation estimates after September 1990.

3 Average January-September 1990=100. Staff estimates are for the Czech Republic, which are the best approximation for the former Czech and Slovak Federal Republic. Data prior to 1990 are not available.

4 Nominal effective depreciation of 61 percent in 1986 and 56 percent in 1987.

5 Nominal effective depreciation of 34 percent in 1986, 45 percent in 1987, 29 percent in 1988, and 90 percent in 1989.

The other countries under review actively managed the exchange rate during all or most of their programs.37 In none was there a truly free float. Rather, exchange rate policies in these countries were oriented in varying degrees toward objectives for the real exchange rate. At one end of the spectrum were Ecuador, Jamaica (prior to mid-1990), and Pakistan, where real exchange rate rules were subject to performance criteria; at the other was El Salvador, where intervention was primarily to smooth exchange rate movements. Where on this spectrum countries lay was related to the aggressiveness with which they had pursued or were to pursue particular targets for external competitiveness. In a rough sense, this tended to reflect the adequacy of recent export growth, expected terms of trade developments, and the planned fiscal adjustment. Many countries had achieved large real depreciations just prior to these programs, and the period under review was marked more by efforts to consolidate past gains than by aggressive use of nominal depreciation to improve competitiveness.

Six countries (Costa Rica, Ecuador, Jamaica, Morocco, Pakistan, and Tunisia) were closest to the real rule side of the spectrum (Chart 8).38 In each of these countries, except Morocco, there had been a sizable real depreciation two to three years before the programs under review and, in the interim, broad stability in the real exchange rate. These real depreciations had elicited large increases in export volume growth. Efforts to maintain competitiveness during the program period were broadly successful: real exchange rates generally varied within a 10 percent band although there were moderate level adjustments in Morocco, Pakistan, and, to compensate for tariff reductions, Costa Rica. These countries were subject to the risk that the destabilizing effects of any real shocks would be exacerbated. Moreover, there was a risk of pushing up inflation if the level at which the real rate was targeted was below that compatible with fiscal policy and wage demands, and the risk of weakening growth if the level was too high.39 That the real rate had generally been stable for some time provided some assurance that these problems would not arise. However, in several countries (Ecuador, Jamaica, and Pakistan) inflation did rise or remained at very high levels.

Chart 8.Nominal and Real Effective Exchange Rates in Countries with Real Exchange Rate Targets1

(Average 1990 = 100)

Source; IMF, Information Notice System.

Note: SBA = stand-by arrangement; EFF = extended Fund facility.

1 Downward movements represent improvements in competitiveness.

2 The NEER depreciated by 36 percent during 1986 and by 38 percent during 1987.

Most of the eight countries (Algeria, Argentina, El Salvador, Hungary, Jordan, Nigeria, the Philippines, and Venezuela) that followed a more discretionary approach to exchange rate policy had sought significant adjustments in the real exchange rate, with varying degrees of success, in the year preceding the first arrangement under review. Several had further large adjustments during the arrangements (Chart 9).40 The inevitable uncertainty about the adequacy of these adjustments militated against adherence to a real rule. Faced with declines in the terms of trade, a reversal of earlier real depreciations, or weakening export growth, three of these countries (Algeria, Jordan, and the Philippines) and Jamaica, which had earlier followed a real rule, undertook sizable adjustments in their nominal exchange rates with the aim of affecting the real rate. In Jamaica and Jordan these were supported by strong fiscal adjustment and were largely reflected in the real rate. In Algeria and the Philippines, however, policy support was weaker than planned, and the nominal change was quickly eroded by inflation. Other countries saw broadly stable (El Salvador) or rising (Hungary, Nigeria, and Venezuela) trends in their real exchange rates.

Chart 9.Nominal and Real Effective Exchange Rates in Countries with Managed Floating/Adjustable Peg Exchange Rates1

(Average 1990 = 100)

Source: IMF. Information Notice System.

Note: SBA = stand-by arrangement: EFF = extended Fund facility.

1 Downward movements represent improvements in competitiveness.

2 The NEER depreciated by 16 percent during 1986.

3 NEER data for Argentina do not fit the plot scale.

4 The NEER depreciated by 5 percent during 1986.

5 The NEER depreciated by 74 percent and the REER by 71 percent during 1986.

6 The NEER depreciated by 44 percent during 1986, depreciated by 16 percent during 1987, and appreciated by 2 percent during 1998.

In four countries (Guyana, Haiti, Romania, and Zaïre) exchange rate policy was dominated by efforts to unify a dual system.41 In general, these countries had seen large increases in parallel market premia during the period preceding the programs under review as restrictions on access to the official market had increased. The main thrust of exchange rate policy was to lower the official rate to the parallel market rate and shift transactions from the official market to the parallel market. A lasting unification was achieved in Guyana and Haiti, but a sizable spread between the interbank and foreign exchange bureau exchange rates reemerged for extended periods in Romania. In Zaïre dual rates remain in place.

The differing approaches to exchange rate policy reflected the tension between the roles for the exchange rate—anchoring inflation expectations and disciplining policies, on the one hand, and maintaining or improving competitiveness, on the other. In the first-best world, financial policies would have been sufficiently restrictive to allow the exchange rate to be used as an anchor, with adjustments only in the face of real disturbances. In fact, adjustment was not always this strong and there frequently was a short-term trade-off between inflation and competitiveness. The experience does not support the primacy of either as the main objective for exchange rate policy. Programs should, however, clearly address the trade-off in designing exchange rate policy. Moreover, this trade-off needs to be kept under review recognizing, as in Poland, that an anchor—for example as part of a disinflation program—may well have to give way to greater flexibility in the face of adverse terms of trade movements or a protracted loss of competitiveness.

Structural Policies

There was a broad measure of success in accomplishing structural reform, usually pursued in the context of contemporaneous structural adjustment loans from the World Bank. A few countries undertook truly sweeping structural changes: in Central Europe, price decontrol, trade liberalization, and current account convertibility were often introduced immediately, while plans were laid, and in some countries executed, for a revamping of the financial sector and restructuring or privatization of publicly owned enterprises;42 in Mexico, the extended arrangement supported a major structural reform program, initiated in the mid-1980s and encompassing exchange and trade liberalization, tariff reform, financial sector liberalization and development, tax reform, and privatization.43 In other countries, changes were usually part of a less comprehensive process. Medium-term plans for reform were generally better spelled out in extended arrangements than in stand-by arrangements, but progress achieved, in the few extended arrangements reviewed, was not uniformly greater. Nor was the record of implementing structural reforms necessarily linked to the success in adhering to the financial program: in Cameroon and Pakistan, financial programs went off track but many planned structural reforms were implemented.

The greatest accomplishments in the countries outside Central Europe were in addressing exchange and trade restrictions, tariff systems with high and dispersed rates, and the problems of repressed financial sectors.44 Outside of the CFA franc zone countries and a handful of others that entered their arrangements with liberal exchange and/or trade systems, all countries took significant measures to reduce restrictions. Whereas about two thirds of the countries (mainly new users) had restrictions on current payments before the programs reviewed, less than half had restrictions at the end of the period. For many, this involved shifting from quantitative restrictions to tariff protection, but even in this context, most also achieved some improvement in the structure of tariffs. Reflecting the relatively undeveloped stale of financial markets in many of the countries, financial sector reforms were concentrated on freeing interest rates and introducing new financial instruments. Progress in addressing the weak portfolios of commercial and central banks as well as inadequate prudential controls and bank supervision—problems faced by many of these countries—was less, although about a third of the countries outside Central Europe at least took first steps.

Many countries undertook fiscal reforms, although typically these fell somewhat short of program expectations. The most common were tax reforms—in Mexico, the Philippines, Trinidad and Tobago, and Tunisia, the introduction of a value-added tax and, in other countries, less ambitious measures to raise revenues and reduce distortions. In about a quarter of the countries outside Central Europe, incremental price liberalizations or increases in administered prices also strengthened public finances. In four countries (Algeria, Egypt, Venezuela, and Zaïre) long-sought and politically sensitive adjustments in fuel prices, even if not as great as needed, were implemented. Structural measures to limit government spending obligations, especially through pension schemes, were notoriously difficult to implement. Also, on the expenditure side, there remained many uncertainties about the need for restructuring public investment and the risks for growth of at times relying considerably on capital spending restraint to achieve fiscal adjustment.

Progress in addressing the weak financial position of public enterprises was disappointingly slow. Only a few countries, notably Argentina, Jamaica, Mexico, the Philippines, Tunisia, and Venezuela, undertook substantial actions to restructure, liquidate, or privatize public enterprises during the arrangements under review. However, a number of countries (Brazil, Honduras, Nigeria, and Pakistan) proceeded at a faster pace, particularly in the area of privatization, in the period following the arrangements.

Labor market rigidities were prevalent but were addressed only to modest degrees. The central problem was a lack of responsiveness of real wages to labor market conditions. De facto or explicit backward-looking wage-indexing arrangements existed in many countries with high and intermediate inflation rates, and modifying them was essential to lowering inflation, reducing real wages where needed, and girding economies for disruptions from possible real shocks.45 In most of these countries, notwithstanding recognition of the problem, a political consensus for changing indexation practices could not be secured. The exception was Mexico where, after a temporary wage freeze in 1988, forward-looking wage agreements were adopted in a wage-price pact between government, business, and labor. In the Central European countries, programs formally endorsed wage controls to act as secondary nominal anchors and to reduce the risk of excessive increases in labor’s share of value added in state enterprises. The success in containing wage increases varied and was closely related to the accompanying restraint on the growth of credit to enterprises.46

Even where wages were not indexed, high wages in the organized sector dampened external competitiveness and impeded growth and job creation. In general, issues concerning the level of wages were addressed in the context of public sector wages and, implicitly, exchange rate policy. This was understandable: often data on wages outside the public sector were weak and the public sector dominated the labor market and wage determination. However, it meant that adjustments to the level of wages were more a function of the fiscal targets than the clearing of labor markets, and that changes in real exchange rates were assumed to reflect commensurate changes in real wages. Consequently, the degree to which excessive real wages were a fundamental constraint on employment and growth was often not fully addressed.

Coordinated programs for structural reforms would have been desirable but were generally not politically or administratively feasible. It is appropriate, therefore, that programs supported the second-best strategy of seizing opportunities for reform on as broad a front as possible. This process cannot give a large role to sequencing considerations, but these are not unambiguous and could unduly slow the process. Barring steps that have resulted in crisis in other countries—liberalizing interest rates when prudential controls are clearly inadequate is the most notorious—this strategy should create tensions that ultimately spur reform. Areas that should command larger roles in program design are improving prudential controls and bank supervision, addressing weak bank portfolios, privatization, and public expenditure restructuring. Also, the importance of wage developments to employment and potential growth warrants greater attention to collecting wage and employment data and applying analytical techniques such as wage gap analyses common in more advanced economies.

Social Safety Nets

Although adjustment programs benefited the poor in a number of respects—over time as growth and employment could be expected to rise and inflation to fall, and more immediately as agricultural prices rose or real depreciations increased returns to the rural poor—in virtually all programs, the issue of mitigating the impact of adjustment on the poor and others seriously affected by reforms was raised. The strength of efforts to address this issue varied. These differences seem to have reflected resource constraints, histories of attentiveness to social issues, and views on the appropriate amount of government intervention in helping the poor. In addition, efforts to address social issues complemented the World Bank’s long-term programs to alleviate poverty.47

Most of the countries concentrated on relieving the worst effects of adjustment on the poor and on those most seriously affected by reforms through subsidies, price controls on essential goods and services, and spending on social sectors—education, health, nutrition, and housing. In about a third of the countries where programs were on track after the initial purchase, attention to social considerations within the program was confined to preservation of existing subsidies, price controls, or social expenditure programs when these might have been cut or eliminated in the process of reducing fiscal deficits. More concerted changes to strengthen social safety nets took three main forms. The first—pursued in another third of the countries that progressed past initial purchases—were reforms to replace or supplement existing consumer subsidies with better-targeted instruments. The second—implemented in about a quarter of the countries that progressed past initial purchases—were public works, retraining programs, or severance pay for the recently unemployed. These often figured prominently in countries that significantly curbed public employment. The third were improvements in the cost effectiveness of social security systems through changes in the eligibility for or the level and duration of benefits. Such measures were envisaged in Argentina, Costa Rica, Hungary, Tunisia, and Uruguay but were often stymied by lack of political acceptance.

Social safety nets were given greatest prominence in Central Europe and absorbed higher levels of resources—estimated at about 10 percent of the budget—than in other countries. Actions focused on improving unemployment compensation, pension and family benefits, cash transfers to households, and training programs for the unemployed. Concerns that initiatives outstripped resources that could be devoted on a sustained basis are apparent in the IMF staffs attention to the need to improve the actuarial soundness of social programs and the targeting of assistance.

Three other arrangements—Costa Rica (1989), Nigeria (1991), and Poland (1991)—went off track immediately after approval. The review includes developments in Nigeria and Poland because the previous arrangement (also covered by this review) had been more successful, and in Costa Rica because early deviations from performance criteria were small enough to have been waived had the arrangement not been largely precautionary in nature.

See Edwards (1989) for a broader criticism of the degree to which intertemporal considerations enter the design of programs.

See Parker and Kastner (1993) and Home (1991) for a discussion of approaches.

The unusually large role of excesses in net domestic assets in Central Europe reflects entirely the sharp expansion of credit in Romania at end-1991 to clear interenterprise arrears. Average excesses over money targets reflected small excesses in net domestic assets in Bulgaria and Poland but excesses in net foreign assets in Czechoslovakia and Hungary.

Real interest rates are measured as annual averages of monthly short-term nominal interest rates adjusted by actual 12-month centered increases in consumer prices. The lagged component of inflation was included to capture the inertia in inflation expectations.

Bennett and Schadler (1992) discuss the difficulty of maintaining positive real interest rates when a sizable portion of borrowers cannot meet debt-service payments. Bennett (1995) in Background Papers discusses these developments in detail.

Argentina (1989), Cameroon, Côte d’Ivoire, Czechoslovakia, Egypt, Gabon, Honduras (1991), Mali, Mexico, Morocco (1990), Papua New Guinea, Poland, and Trinidad and Tobago. The Congo and Yugoslavia are not considered in this section because their programs went off track immediately after approval.

Sec Mecagni (1995) in Background Pupea,

After abandoning the peg in late 1989, Argentina largely floated until April 1991, when it established a currency board supported, later in the year, by a stand-by arrangement outside the purview of this study.

Honduras and Morocco managed their exchange rates through the first six months and two years, respectively, of the period reviewed before fixing.

Jamaica used a real exchange rate rule in its 1988 and 1990 arrangements but thereafter depreciated its nominal exchange rate to achieve a large real depreciation.

For discussions of the inflationary risk of real exchange rate targeting see Adams and Gros (1986) and Calvo, Reinhart, and Végh (1994) and of the costs for output of targeting a high real exchange rate see Lipschitz and McDonald (1991).

Argentina abandoned a fixed exchange rate in late 1989 and largely floated until adopting a currency board in April 1991, Bulgaria also had a managed float hut does not have data on nominal and real effective exchange rates.

Several other countries under review had dual exchange rates, but the parallel market was generally neither as large nor as much of a focus as in the four countries mentioned here.

Bruno (1992) summarizes the reforms undertaken in the early stages of the transition covered by this review.

These reforms are discussed in Loser and Kalter (1992).

This is similar to the pattern observed in the 1993 review of ESAF arrangements. See Schadler, Rozwadowski, Tiwari, and Robinson (1993).

In Argentina, Costa Rica, and some Central European countries, public sector and, in some, private sector wages were formally indexed. Discretionary, but de facto virtually full, indexation existed in Algeria, Egypt, Mexico, and Venezuela. In Brazil and Uruguay (where programs rapidly went off track) formal wage indexation also existed: in Brazil changes were discussed but not included in the program; in Uruguay the failure to abolish indexation as agreed derailed the program. In Argentina indexation practices were abolished in 1991.

See Morsink (1995) in Background Papers.

The World Banks’s extensive work on poverty reduction is discussed in the World Development Report 1990 and Poverty Reduction Handbook (World Bank, 1992); its work on health care and social security issues is discussed in the World Development Report 1993.

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