VI Executive Board Review

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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The IMF’s Executive Board discussed the staff studies on conditionality in June and November 1994. The following report on the Board’s consideration is included in the IMF’s 1995 Annual Report and reprinted here for the information of readers.

The Board periodically reviews member countries’ performance under Fund-supported adjustment programs to assess their effectiveness. During 1994/95, the Board looked at programs supported by its traditional financing at market-related terms—specifically, stand-by arrangements (short-term credits) and extended arrangements (longer-term credits).

The first part of the review, at a June 1994 Board meeting, focused on overall economic results; specific policy issues and outcomes in the fiscal, financial programming, exchange rate, and structural reform areas; and techniques of monitoring and evaluating programs. The conclusion of the review, at a November seminar, was devoted mainly to a broad discussion of the aims of Fund-supported programs and how policy approaches might be modified to improve their effectiveness, particularly in securing an earlier and stronger response of output and employment.

Preparatory to the Board review in June, the staff examined the record of countries for which such arrangements had been approved between mid-1988 and mid-1991—45 arrangements in 36 countries. Program design took a three-pronged approach involving (i) reining in domestic demand through fiscal and credit restraint (for example, controlling public borrowing and money creation and moderating public spending and raising revenues), (ii) mobilizing external financing to support the program (and often to clear external arrears and to provide debt relief), and (iii) adopting structural reforms to promote a supply response and improve the efficiency of resource use. In general, compliance with agreed-upon policy changes was high: countries adjusted policies broadly as envisaged, although there was substantial variation among countries, and some suffered subsequent reversals.

In both the June 1994 discussion and the November seminar. Directors focused on two core issues. First, did the three-pronged approach place too much stress on achieving a short-term balance of payments adjustment, subordinating domestic goals of longer-term growth and better living standards to that of external equilibrium? Second, did the one-year program planning horizon inhibit consideration of medium-term problems and effects?

Macroeconomic Performance and Program Objectives

In their June meeting, Directors observed that the countries under review had notably improved their external positions and addressed debt difficulties: official reserves had risen, half the countries with external arrears had substantially cleared them, some countries had benefited from capital inflows, and current account positions had converged toward sustainable levels of projected capital inflows. By contrast, changes in domestic economic performance were less impressive. Although growth had on average risen during the period, investment and saving ratios had improved little, and developments in inflation had been mixed.

A number of Directors indicated that the more impressive performance of the external accounts was not surprising, since in almost all cases it was the pressure of a severe external financing problem that led countries to seek Fund assistance in the first place.

Although some Directors wondered whether the objective of Fund support should not be defined narrowly as short-run balance of payments adjustment, most Directors urged that Fund programs should support a broader array of macroeconomic aims over the medium term. These Directors recognized a potential conflict in the short term, since the fiscal and monetary policy measures often needed for stabilization and external adjustment could depress growth in the short run. Favorable effects on investment, saving, and output tended to come with longer lags; it might lake consistent performance over a period before stabilization and reform policies became credible in the minds of savers and investors.

This mix of aims and time horizons had a number of implications for program design, which the Board articulated at its November seminar:

  • Programs should not be too ambitious in their short-term projections for growth and investment, and there should be no illusions that countries could normally expect large improvements in both the external position and growth in the short run. Nevertheless, the external position was much less likely to be sustainable if growth remained low over the medium term. In that context, careful attention should be given to an appropriate balance of policies.

  • Programs should be framed in a medium-term context. The forward-looking nature of private sector decision making meant that the effectiveness of policies in the short term depended on their medium-term consistency and credibility. In terms of procedure, a number of Directors suggested that a document like the policy framework paper used for SAF and ESAF arrangements would be a suitable vehicle for ensuring a medium-term perspective and intensified collaboration with the World Bank. Other Directors held that less formal instruments would be suitable, especially in cases in which an external crisis required urgent action.

  • Programs should strive for a transparent and predictable timetable for structural reform to foster credibility and thereby encourage a timely private sector response. From the outset, programs should give priority to a coherent set of structural measures, institution building, and removal of distortions that would stimulate supply response and investment. Staff reports should explicitly discuss the potential costs of settling for “second-best choices”—those that are easier to implement but compromise longer-term growth and policy objectives.

Adequacy of Fund financing was addressed in both sessions. In June, there was agreement that the more a country allowed its economy to deteriorate before undertaking adjustment with external support, the more difficult the adjustment would be. A number of Directors stressed the importance of external finance in facilitating adjustment with growth, although some supported the view that the staff may have placed too much emphasis on generating external finance. At the November seminar a number of Directors noted that, in their view, Fund-supported programs sometimes suffered from inadequate financing; other Directors emphasized that stronger financing, which could now be secured under the new access policy, should lead to stronger programs and eliminate some of the delays in adjustment efforts.

Specific Policy Issues and Outcomes

Most of the review of specific policy issues and outcomes, based on the staff studies, took place in June, with several important follow-up discussions at the November seminar.

On fiscal policy. Directors welcomed the substantial progress in addressing fiscal imbalances during the programs reviewed. Reductions in fiscal deficits, together with a shift from bank to nonbank financing of the budget, helped to redress the overall saving-investment imbalances and restrain government absorption of bank credit. More generally, stronger and more predictable fiscal positions had fostered the more stable financial conditions essential to better prospects for growth and investment.

At their November seminar. Directors voiced the concern that more attention needed to be paid to the quality of fiscal adjustment—specifically, how the structure and level of revenues and spending might affect prospects for investment and growth. Significant efforts in this direction were already being made: the staff study showed that, on average, fiscal adjustment fell about equally on raising revenues and cutting expenditures, that planned revenue increases were largest where initial revenue ratios were lowest, and that it was important to design revenue measures so as to minimize disincentive effects. However, fiscal targets had not been regularly reported in a medium-term framework, and ad hoc, mid-course corrections fell most heavily on spending, especially capital spending. In order to achieve growth objectives, it was recommended that effective tax reform measures be prepared early. Directors had earlier agreed on the need for more concrete analyses in programs of sustainable fiscal positions and for encouraging authorities to formulate spending priorities within a medium-term framework. Even more essential, Directors now emphasized, was wholehearted government commitment to, and ownership of, the program.

In June, Directors affirmed the importance of the financial program in overall program design, noting that restraining credit growth had proved effective for achieving external sector goals, particularly increasing official reserves. Some Directors expressed concern that credit ceilings could even have been too tight, resulting in high real interest rates and potentially destabilizing capital inflows. More generally, credit ceilings had tended to be less effective for controlling money growth—and, ultimately, inflation—in programs that attached high priority to building reserves and preserving competitiveness. To deal with the latter, programs might benefit from more explicit benchmarks for some monetary aggregate.

With regard to exchange rate anchors, on the positive side the Board observed that exchange rate anchors could help to achieve rapid price stabilization or maintain price stability in low-inflation countries. On the negative side, if not supported by strong financial policies, a nominal anchor could weaken competitiveness and produce unsustainable pressures on reserves. As one Director put it, an exchange rate anchor should not be used when the preconditions were not there. Thus, the efficacy of an anchor should be carefully assessed in the specific circumstances of an individual country; it required judgments about market perceptions, the sustainability of tight financial policies, and the balance between external and inflation objectives. Directors urged that each program present the authorities with a careful accounting of advantages and drawbacks of using or not using an explicit nominal exchange rate anchor.

Directors regarded structural reforms in many countries as essential for strong and sustainable growth and discussed them at length in June. In addition to the structural issues in the fiscal areas mentioned above, Directors commented on structural reforms in the financial sector, labor markets, and public enterprises, as follows.

Vigorous financial sector reforms and the general shift to positive real interest rates in most of the countries under review were welcomed as steps that would strengthen the efficiency of resource allocation. Directors expressed concern, however, about the high levels of real interest rates and the widening of spreads between deposit and lending rates observed in several programs. Although episodes of high real interest rates had in general been only temporary, Directors cautioned that such developments could delay the response of private investment and could lead to banks taking excessive risks. To minimize those threats, Directors stressed that programs should try to ensure that supportive policies, such as adequate prudential standards for bank lending and a sizable reduction in public sector borrowing, accompany financial liberalization.

Rigidities in labor markets and insufficient job creation had featured as serious problems in many of the countries under review. Often these problems had not been adequately addressed or analyzed during programs. To a large extent, this situation reflected serious weaknesses in, and frequently the outright absence of, data on employment and nongovernment wages. Because these issues were central to economic growth. Directors urged the staff to encourage authorities to step up efforts to collect adequate data on wages and employment and to give more prominence to an analysis of these issues in program documents.

Although Directors welcomed the advances that had been made in structural reforms, many observed that the actual sequencing of reforms had reflected political and administrative constraints rather than optimal sequencing insofar as it was understood. Nevertheless, Directors recognized that it was important to seize opportunities for reform on as broad a front as possible, unless there were sequencing considerations that clearly militated against a specific approach. In that connection, Directors pointed to several areas in which action had been slow: improving prudential controls and bank supervision, addressing weak bank portfolios, privatization, and restructuring expenditure. They stressed the need to press harder for action in these areas and to provide technical assistance if appropriate.

Because structural measures often required some time to take effect, many might not be achieved without sustained support. In this effort, it was important for the Fund to collaborate closely with the World Bank on issues that lay within the Bank’s expertise and mandate. For example, some Directors felt that the analysis of labor market policies should be addressed directly by the World Bank, although others viewed these policies as central to the effectiveness of macroeconomic adjustment and, thus, requiring greater focus in Fund reports.

Monitoring and Evaluating Programs

Directors agreed that the techniques for monitoring programs—with their emphasis on ensuring compliance with the financial program, preventing external financing gaps, and pursuing structural reforms—supported the broad approach to adjustment. While seeing little need for change, Directors urged that performance criteria be as simple and transparent as possible. With regard to structural reform, they emphasized that no monitoring technique could substitute for the authorities’ commitment to change; overseeing progress in this area was often better handled through reviews than through specific performance criteria. Also, they suggested that more information on the use and effectiveness of prior actions be covered. The number of waivers that had been required drew comment, although Directors noted that, on balance, waivers had provided appropriate flexibility to the application of conditionality, particularly in those countries making satisfactory overall progress.

Many Directors reiterated their long-standing desire to have a separate evaluation unit in the Fund, while others saw no need for one, and still others indicated a desire to consider the specific structure of such a unit.

Agenda for Further Research

At the conclusion of the November seminar, the Board agreed that several issues within the Fund’s primary responsibility required further study. Among them were how the combination of initial conditions, external environment, macroeconomic and structural policies, and key rigidities in the economy had affected the path of saving, investment, and output during the adjustment phase. In light of the forward-looking nature of investment decisions, the study would have to examine the credibility and mediumterm consistency of policies. Another important topic of the investigation would be an in-depth examination of the structural aspects of fiscal adjustment.

Most Directors agreed that it would be useful to examine the experiences of a number of both successful and less successful cases of growth-oriented adjustment from a longer-term perspective, with a view to understanding the lags in policy effects and the dynamics of saving, investment, and growth. There was also some support for examining a few countries that had carried out adjustment policies without Fund financial involvement.

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