- Adam Bennett, Louis Dicks-Mireaux, Miguel Savastano, María Carkovic S., Mauro Mecagni, Susan Schadler, and James John
- Published Date:
- September 1995
The IMF staff periodically carries out reviews of adjustment programs supported by IMF financial resources with the broad aim of evaluating the appropriateness of policies and the progress made toward sustainable economic conditions. The present review, which is part of this process, describes and assesses the design of programs supported during a recent period by the IMF’s stand-by and extended facilities—two windows through which the IMF lends at market-related interest rates subject to conditions that commit countries to implementing agreed-upon adjustment policies (a requirement known as “IMF conditionality”). The specific objectives of this study are to understand the nature and strength of the economic adjustment undertaken, whether adjustment strategies were appropriately tailored to the problems being addressed, and the extent of sustained improvement in macroeconomic performance.
Scope and Methodology
This review examines the records of 36 countries for which 45 upper credit tranche stand-by and extended arrangements were approved by the IMF’s Executive Board between mid-1988 and mid-1991 (for 8 countries more than one arrangement was approved during the period; see Chart 1-1 and Box 1-1). The papers presented in the pages that follow are part of a two-volume study. Part 1 (Occasional Paper No. 128) provides an overview of experiences during the arrangements reviewed: it describes the initial conditions faced in these countries, the adjustment strategies adopted, the degree to which programs were implemented, and the extent of sustained adjustment experienced. This second part comprises five papers that examine, in depth, policy issues that were of particular interest in the countries reviewed:
The composition of fiscal adjustment.
The behavior of interest rates in the face of financial liberalization and changes in fiscal financing.
The use of the exchange rate as a nominal anchor.
The role of wage controls in transition economies.
The effectiveness of policy measures for raising private savings.
These issues also arise in other countries, so that any wisdom culled from this review should have broader benefits.
The papers rely predominantly on comparing target-actual and before-after calculations across groups of countries that adopted different approaches to adjustment and across individual countries. When the short period under review and the diversity of the countries covered prevented meaningful econometric investigation, these comparisons were considered to be the best vehicle for summarizing the adjustment strategies, their implementation, and the developments during the programs. It must be recognized, however, that without systematic controls for sample selection bias, exogenous influences, and initial conditions, the before-after comparisons in particular cannot be interpreted as indicating the independent effect of IMF support. Rather, they must be seen as broad indicators of developments during programs that resulted from a range of influences endogenous and exogenous to the program.
Preview of the Papers
In “Record of Fiscal Adjustment,” Adam Bennett, Maria Carkovic, and Louis Dicks-Mireaux review the strategies planned for fiscal adjustment and their implementation. They examine the targeted changes in the main fiscal variables (interest and noninterest current expenditure, capital expenditure, revenues, various categories of domestic and foreign financing, and the overall balance) to determine whether adjustment strategies were differentiated to address the source of countries’ imbalances. They then examine outcomes for the fiscal accounts relative to targets and attempt to determine what accounted for overperformance and underperformance relative to targets. The extent to which fiscal adjustments were sustained after the programs reviewed is also examined. The paper concludes by considering the degree to which programs that went off track—that is, drawings were halted because outcomes for policies and macroeconomic developments deviated from targets by large amounts—reflected the failure to implement programmed fiscal policy changes.
Chart 1-1.Stand-By and Extended Arrangements1
1 Countries for which an arrangement was approved during July 1988–June 1991. Circles indicate the date of approval, original expiration, and extended expiration; extension periods are indicated by a broken line. Triangles indicate cancellation dates. For countries that were not eligible to make all purchases, asterisks indicate the last date on which they were eligible to purchase. EFF = extended Fund facility; SAF = structural adjustment facility; ESAF = enhanced structural adjustment facility.
2 Hungary had had three previous arrangements with the IMF but is included with the other Central European countries in this review because of the common influences they faced.
Box 1-1.The Arrangements in Brief
The types of credit arrangements (“facilities”) the IMF extends to its member countries include regular facilities (stand-by and extended arrangements), concessional facilities for low-income countries (SAF and ESAF), and various special facilities.
The two types of regular IMF arrangements have different terms and conditions, but both provide credit at market-related terms.
Stand-by arrangements typically cover periods of one to two years and focus on macroeconomic policies—such as fiscal, monetary, and exchange rate policies—aimed at overcoming balance of payments difficulties. Most performance criteria to assess policy implementation—such as budgetary and credit ceilings, reserve and extended debt targets, and avoidance of restrictions on current payments and transfers—are applied during the period of the arrangement, and purchases are made in installments.1 Repurchases are made in 3¼ to 5 years. Most programs supported by stand-by arrangements also include some policies to address structural or supply-side weakness, although because of the short duration of these arrangements, this focus is not as strong as in extended arrangements.
Under the extended Fund facility (EFF), the IMF supports medium-term programs through extended arrangements that generally run for three years (sometimes four years), and are aimed at overcoming balance of payments difficulties stemming from macroeconomic and structural problems. Typically, a program states the general objectives for the first year; policies for subsequent years are spelled out in program reviews. Performance criteria are applied, similar to those in stand-by arrangements, and repurchases are made in 4½ to 10 years.
Concessional Facilities for Low-Income Countries
The structural adjustment facility (SAF) and enhanced structural adjustment facility (ESAF)—set up in March 1986 and December 1987, respectively—offer highly concessional loans to support macroeconomic adjustment and structural reform in low-income countries. Under both facilities, the member, with the help of the IMF and the World Bank, sets out structural and financial policies for a three-year period in a policy framework paper (PFP). Within this framework, detailed yearly policy programs are formulated and are supported by SAF/ESAF arrangements, under which annual loan disbursements are made. The interest rate on loans is 0.5 percent and repayments are made in 5½ to 10 years.
A number of facilities have been created throughout the IMF’s history in response to members’ special needs. Such assistance is additional to that available under other IMF facilities, but members cannot finance the same balance of payments needs under both regular and special facilities.
Arrangements Under Review
The IMF periodically undertakes reviews of adjustment programs supported by its facilities. The present review assesses the experience of 36 countries under 45 stand-by and extended arrangements that were approved between mid-1988 and mid-1991 (that is, more than one arrangement was approved for 8 countries during the period; see Chart 1-1). The commitment of IMF resources was SDR 18.7 billion (about US$25 billion), over half of which was in support of six extended arrangements. Annual average access amounted to 50 percent of quota (a member’s share in the IMF’s capital) under stand-by arrangements and 66 percent under extended arrangements. In 11 of the arrangements, all purchases were completed, and in 5 no purchases were made. In the remaining 29 arrangements, 52 percent of commitments were utilized. In eight of these, only the first scheduled purchase, that available upon approval of the arrangement by the IMF Executive Board, was made.1Under regular IMF facilities, a member does not “borrow” from the organization; it purchases usable (hard) currencies with its own domestic currency. A member country repays the IMF by repurchasing its own currency with currencies acceptable to the IMF.
They conclude that for the 36 countries reviewed, planned fiscal adjustment strategies were tailored, in crucial respects, to the specific nature of the countries’ fiscal imbalances. Fiscal adjustment, on average, was to derive about equally from revenue increases and expenditure restraint. However, planned expenditure cuts were largest in countries with the highest initial expenditure ratios and planned revenue increases were largest where initial revenue ratios were lowest.1 Also, targeted changes in overall deficits were greatest in the countries with the largest initial imbalances.
The analysis of outcomes shows that fiscal adjustment was on average close to that targeted. With the available data and the short period considered, it is impossible to distinguish precisely between the roles of discretionary policy changes, exogenous influences, and cyclical factors. On average, spending restraint was somewhat greater than planned, and revenue increases were slightly short of target. Capital spending was restrained proportionately more on average than current spending, and it tended to bear the brunt of mid-program adjustments to reach deficit targets.
In a paper on the behavior of nominal and real interest rates, Adam Bennett examines some of the factors underlying a rather widespread shift from negative to positive levels of real interest rates during the programs. The most obvious influence was the remarkable progress in liberalizing financial sectors during the programs under review—the lifting of controls on interest rates and the development of new financial instruments. A rather prevalent switch from bank to nonbank financing of fiscal deficits is found also to have played an important role. The paper goes on to examine several influences in countries that failed to achieve positive real interest rates. One group with notably poor success in this regard were the Central European countries: the paper argues that important influences there were both the undeveloped state of financial markets and the prevalence of bad debts, particularly those of fledgling commercial banks.
The review reveals that in many countries real interest rates rose to what were considered “excessive” levels—levels significantly above those in industrial countries even after correcting for inflation differentials and normal risk premia. Often, excessive real interest rates were accompanied by large spreads between deposit and lending rates. In most cases, “excessive” interest rates did not persist much beyond one year. The paper examines possible explanations of such high real interest rates and finds three to be most plausible: high levels of government borrowing before fiscal adjustment took effect; financial liberalization without adequate supervision; and insufficient policy credibility during the early stages of disinflation.
Mauro Mecagni assesses the experience of the 15 countries that used the exchange rate as a nominal anchor and compares their performance in a number of key areas with countries that followed more flexible exchange rate policies. He finds that several considerations guided the 15 countries’ decisions to adopt an exchange rate anchor: the need to reduce high initial inflation, the ambitiousness of disinflation and fiscal adjustment targets, the fear that price reforms would ignite inflation, and the desire for a disciplining device. The adequacy of reserves to defend a particular exchange rate path and to withstand a deterioration in competitiveness was also a prominent determinant.
Although the study cannot fully separate the effects of underlying adjustment policies and a nominal anchor on macroeconomic developments, Mecagni’s evidence suggests that exchange rate anchors did add to the effects of strong and credible adjustment policies in reducing high inflation or sustaining low inflation through a variety of mechanisms: helping to break inflation expectations, reinforcing policy discipline, stabilizing traded goods prices, and setting in train forces that lowered fiscal deficits. In fact, among the countries reviewed, the rate of success in reducing high rates of inflation or maintaining low rates was considerably higher for countries with an exchange rate anchor than for countries without such an anchor. Nevertheless, within the short period reviewed, the benefits of an exchange rate anchor for inflation appear to have come at a cost, certainly in terms of competitiveness, but possibly also in terms of short-term output growth.
The study also shows that the beneficial effects of an exchange rate anchor for inflation were sustainable only when underlying fiscal, monetary, and structural policies were compatible with low or reduced rates of inflation. In instances when they were not, the nominal anchor either ended in a disruptive foreign exchange crisis or, in less adverse circumstances, contributed to weakened competitiveness, a worsening of the external accounts, and lower growth. The study considers some of the ways in which countries have attempted to minimize the adverse effects of an exchange rate anchor: for example, well-timed exit strategies and once-off exchange rate adjustments in the face of real shocks.
In “Wage Controls During IMF Arrangements in Central Europe,” James Morsink considers the frequent use of wage controls in the early programs in the Central European countries. These controls were in marked contrast to the general move toward reliance on market mechanisms in these countries. The paper addresses three principal questions: (i) what are the distinctive rationales for the maintenance of wage controls in transition economies?2 (ii) were wage controls designed to mitigate their distortive effects? and (iii) how effective were the controls in restraining nominal and real wage increases? The paper also questions whether the conditionality attached to and monitoring of wage controls was appropriate.
Two possible roles for wage controls beyond that of supporting disinflation are presented: to help improve corporate governance when ownership is unclear and to provide an incentive for labor shedding. The paper argues, however, that the potential for distortive effects was particularly important in these economies because controls could ossify a structure of wages that was distorted at the outset. The design of the controls minimized the potential for such distortion by exempting, to the extent possible, the private sector, setting wage ceilings on firm-level variables, enforcing the ceilings through tax penalties, and limiting their coverage to easily observable types of compensation.
Definitive judgments on the effectiveness of the controls in restraining wages requires the investigation of counterfactuals, which for the short period considered could not be estimated. Morsink instead uses comparisons of actual wage behavior to projections and of wage behavior when controls were in place to that in the (limited) periods when they were not in place to cull some impressions. This analysis leads him to several tentative conclusions: that wage controls on average were not binding during the initial stages of price liberalization and stabilization; that adherence to targets for credit growth, rather than the presence of wage controls, was the most important determinant of adherence to nominal and real wage targets; and that—absent a counterfactual—there is not compelling evidence that wage controls enhanced the role of restrictive fiscal and monetary policies in improving corporate governance or stimulating labor shedding.
Miguel Savastano addresses the behavior of private saving during arrangements. He sets the stage by briefly describing recent analytical and empirical work on short-term influences on private saving. On the basis of the findings in those studies, he presents several hypotheses on how private saving should have responded to the adjustment programs. After describing the actual outcomes, he uses a simple regression analysis to sort out the major quantifiable determinants of private saving during the programs. He supplements this with a detailed assessment of the determinants of private saving in Mexico and Tunisia—countries that had four-year extended arrangements with a sizable structural component, but where the experiences with respect to private saving were different.
The evidence does not reveal clear policy channels for raising private saving in the short term. The study finds that on average, and regardless of the length of IMF involvement, national and public saving rates increased while private saving rates fell during the programs. Declines in private saving occurred more frequently and were on average larger than rises in private saving. In the countries where declines occurred, they typically were an important offset to increases in public saving. Of the various quantifiable factors tested in the regression analysis, changes in output growth, and in the rates of public and foreign saving, were found to have the largest and most systematic effects. Increases in public saving contributed importantly to higher national saving but tended to elicit partially offsetting declines in private saving regardless of whether they were driven by higher public revenues or lower current expenditures. Other policies frequently implemented in arrangements—raising interest rates and currency devaluation—were found to have weak and unpredictable short-run effects on private saving.
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A vast amount of data are assimilated in the papers that follow, and answers to the questions posed are by no means definitive. The authors present these papers hoping that they not only will prove helpful to the design of future adjustment programs, but also, by placing in sharp relief some important issues in the design of adjustment programs, will stimulate further research.
This outcome is the result not only of discretionary policy adjustments, but also of the tendency for reversion to the mean following temporary disturbances.
While wage and other price controls have a widely acknowledged role in heterodox stabilization programs, they were employed in several of the transition countries well after the initial surge in inflation had been tamed.