Past Fund Experience

23. The idea of the Fund helping members with strong policies to protect against liquidity shocks is not new. It dates back to at least 1972 when the Economic Counselor at the time, Jacques Polak, prepared a note on “possible Fund financing of short-term capital movements”. Other proposals followed in the wake of the capital account crises in the 1990s (see Annex 1). However, initial proposals for such Fund facilities either failed to be adopted (e.g. the STFF in 1994) or did not garner much interest among members once established (the CCL and SLF).

24. The experience with the CCL and the SLF suggests that Fund support needs to be sufficiently predictable and reliable to be attractive. Facilities that are perceived to have excessive safeguards are unlikely to generate interest among the membership as they tend to be insufficiently predictable (e.g., need for an “activation review;” lack of clarity on how eligibility criteria would be applied) and reliable (e.g., a temporary backstop may not last the full duration of the shock). Importantly, excessive safeguards also worsen stigma. Finally, the experience with the CCL illustrates how new modalities for Fund support need to be timely: demand for a liquidity backstop against financial contagion was widespread during the Asian financial crisis but appetite waned as conditions normalized.

25. While the design of the FCL and PLL took these lessons into account, demand remains modest, as highlighted in the most recent FCL/PLL/RFI review.²² In particular, remaining stigma associated with the need to approach the Fund—and perhaps not be granted access under the identified instrument—remains a concern. In the case of the PLL, these issues may have been further compounded by the use of ex-post conditionality and the related sense of tiering relative to the FCL. The 6-month PLL attenuated stigma associated with ex-post conditionality, but usability was affected by the limitations on the repeat use of the instrument.

Reform Options

26. A number of alternatives could enhance Fund liquidity support in ways that improve reliability and minimize stigma. The ideas below are not all new and each have benefits and costs.

• Revisiting the existing toolkit for crisis prevention. Reforms to the toolkit would need to be weighed carefully to ensure that they do not weaken the Fund’s ability to facilitate any needed adjustment in members’ economies or weaken the Fund’s safeguards for the temporary use of GRA resources, a key requirement under the Articles. Piecemeal changes to existing instruments may also fall short of addressing the perceived stigma concerns to the extent that these have already been “tagged” by their experience so far. Against this backdrop, consideration could be given to: (i) revisiting the qualification criteria and duration terms of existing instruments so that more members could avail themselves on a precautionary basis without concerns over whether their duration sufficiently covers the period of anticipated volatility. In addition, to reduce stigma associated with a member having to resort to Fund support through a “request” for an arrangement, the idea of allowing a member to opt in to an arrangement rather than requesting one could be explored; (ii) options to introduce revolving access features to the FCL and PLL could also be explored—allowing members to reconstitute access as repurchases are made after drawings. Revisiting existing instruments, as opposed to introducing new ones, has the benefit of avoiding a proliferation of instruments.

• Use of SDRs for liquidity provision. Pooling and on-lending SDRs could be considered, for example, by creating a separate funding department for liquidity support, carving out General Resources on the Fund’s balance sheet for traditional lending for balance of payments needs. This would require a change to the Articles of Agreement. Whether the SDR could play a broader role in the IMS will be addressed in the forthcoming Board paper.

• Designing a new instrument. A new liquidity facility could encompass the above reform options, while potentially being more effective in dealing with stigma by wiping the slate clean and defining a fresh purpose for the instrument. Such a new instrument could be designed with the additional aim of better promoting and creating incentives for implementing and maintaining good policies, addressing the biggest gap in the GFSN identified in IMF (2016). To avoid a proliferation of instruments in the toolkit, consideration could be given to revisiting the need for existing ones in the context of the forthcoming review of the toolkit for crisis prevention.

Design Features of a New Instrument

27. A new liquidity instrument would need to improve reliability and reduce stigma. This could be achieved by introducing a number of innovative design features—moving closer to “standing” liquidity support, providing credit which is “revolving”, and making support available on the basis of streamlined prequalification and no ex post conditionality for members with strong economic policies and fundamentals. A number of safeguards—outlined below—could also be introduced in the design of the instrument to minimize both moral hazard and risks to Fund resources (credit and liquidity risks). While the design of the new instrument would make it accessible to a wider segment of the membership than the FCL, and more appealing than the PLL, the SBA would remain the Fund’s workhorse instrument, both for members that do not meet the ex-ante qualification criteria for other instruments and for those facing actual balance of payments needs.

28. Establishing a renewable, reliable backstop, similar to the standing BSA network established amongst six of the major reserve currency-issuing central banks would enhance the Fund’s toolkit. The backstop would be aimed at providing support for use in the event of liquidity shocks of the relatively moderate and frequent variety. There would be no exit expectations and less stigma than with other instruments for crisis prevention that are de facto being used as backstops for the occurrence of tail events. It would also reduce incentives for accumulating excessive precautionary reserves and hence improve global resource allocation.

29. The new instrument would need to be designed to meet the requirements in the Articles of Agreement. Article V section 3(a) stipulates that the Fund establish adequate safeguards for the temporary use of the general resources of the Fund to help members resolve their balance of payments problems. Consideration could be given to potential design features to underpin the temporary use of Fund resources that might include:

• Early repurchase expectations that would encourage members to use the instrument only for temporary (typically self-correcting) BOP needs. Setting a relatively short term for repayment, e.g., one year, would help to manage Fund liquidity risks and help preserve the revolving nature of Fund resources.

• Annual re-qualification––i.e., based on an assessment at the time of the Article IV consultations––that would mitigate moral hazard and incentivize members to follow sound policies. If a member did not implement appropriate policies, its qualification for the instrument would lapse at the next annual assessment.

• Limited access, such that the backstop only covers liquidity needs likely to arise under relatively small-scale, short-term volatility. This would limit the aggregate call on Fund resources (see below) as well as minimizing credit risk. For example, one option would be to cap access under the instrument at 145 percent of quota––the current normal annual access limit.

30. Consideration could also be given to the introduction of revolving credit—similar to central bank swap arrangements. Such a move would enable repeated purchases and repurchases under a single arrangement and across arrangements and move the Fund away from granting access under arrangements in terms of flows to one in terms of stocks. Within the prescribed access limit, a revolving-type feature would make the instrument more useful in addressing repeated short-term liquidity shocks, while limiting the impact on Fund resources and credit risk. The possibility of reconstituted access rights within the duration of an arrangement would improve reliability of access and make efficient use of Fund resources.

31. Prequalification and opt-in by qualifying members could also be considered. This might help improve predictability as to which countries would qualify and, importantly, eliminate the stigma associated with the need to approach the Fund and “request” a Fund arrangement. Qualification criteria could be based on well-established analytical frameworks and perhaps be more parsimonious than for the FCL and PLL (see Box 4). Members could be prequalified periodically (e.g., in conjunction with the Article IV consultations), further limiting the stigma associated with requesting a Fund arrangement. Qualification criteria, however, would need to continue to be calibrated to ensure that qualifying members have strong economic policies and fundamentals, and an established track record of implementing appropriate policies. This would provide confidence that qualifying members would undertake adjustment if and when needed and seek to confine the use of the instrument to addressing possible short-term liquidity shocks.

32. If such a new liquidity instrument is established, further refinements to the existing financing toolkit may be desirable to maintain the overall coherence of the toolkit. Clarifying the role of each instrument in the reformed toolkit would be an important task to be undertaken as part of the upcoming review of the FCL and PLL. With a liquidity backstop aimed at providing support against small- to medium-sized liquidity shocks, staff would envisage the FCL as the exceptional-access counterpart, for use as a temporary backstop against extreme shocks/tail events, with an exit expectation. Since there would likely be a significant overlap between eligibility for the new liquidity backstop and the PLL—and given the lack of take-up and the issues of tiering vis-à-vis the FCL—the forthcoming review could consider whether or not to retain the PLL.

Box 4.

Qualification Criteria in the FCL and PLL and in the Prospective New Liquidity Instrument

The choice of qualification criteria for the new instrument would aim to ensure that qualification is predictable and transparent while ensuring strong fundamentals and policies and safeguarding Fund resources. While both FCL and PLL introduced ex-ante qualification as a meaningful step towards increasing predictability, they have only had limited use so far. The new instrument would retain pre-qualification as a key feature but envisage a more parsimonious set of criteria which, nevertheless, provide adequate assurances that members would take the appropriate policy measures when faced by a shock.

The FCL/PLL qualification framework aims to promote predictable and evenhanded qualification. Its core is an assessment that the member’s policies, fundamentals and institutional policy frameworks are very strong (‘generally sound’ in the case of the PLL). The assessment is meant to give markets and the Fund confidence that the member would take appropriate policy actions when facing a shock.

Qualification for the FCL is based on nine qualification criteria, grouped into five areas in the case of the PLL. For the FCL, significant shortcomings on one of the criteria could preclude qualification while the PLL requires strong performance in most of the five areas; substantial underperformance in any area signals that the member does not qualify. A member would not be qualified if any of the following applies: (i) sustained inability to access international capital markets; (ii) need for large policy adjustments (unless credibly set in train); (iii) a public debt position that is not sustainable with high probability; (iv) widespread bank insolvencies. Under the qualification frameworks, an eligible member should also be assessed to have very strong or sound institutional policy frameworks for the FCL and the PLL, respectively.

Box Table 1.

FCL and PLL Qualification Criteria/Areas

Box Table 1.

FCL and PLL Qualification Criteria/Areas

I. External position and market access
	1. A sustainable external position
	2. A capital account position dominated by private flows
	3. A track record of steady sovereign access to capital markets at favorable terms
	4. A reserve position which remains relatively comfortable
II. Fiscal policy	5. Sound public finances and a sustainable public debt position
III. Monetary policy	6. Low and stable inflation, in the context of a sound monetary and exchange rate policy framework
IV. Financial sector soundness/supervision
	7. A sound financial system and the absence of solvency problems that may threaten systemic stability
	8. Effective financial sector supervision
V. Data adequacy	9. Data transparency and integrity

View Table

Box Table 1.

FCL and PLL Qualification Criteria/Areas

I. External position and market access
	1. A sustainable external position
	2. A capital account position dominated by private flows
	3. A track record of steady sovereign access to capital markets at favorable terms
	4. A reserve position which remains relatively comfortable
II. Fiscal policy	5. Sound public finances and a sustainable public debt position
III. Monetary policy	6. Low and stable inflation, in the context of a sound monetary and exchange rate policy framework
IV. Financial sector soundness/supervision
	7. A sound financial system and the absence of solvency problems that may threaten systemic stability
	8. Effective financial sector supervision
V. Data adequacy	9. Data transparency and integrity

The new instrument qualification framework would aim to continue ensuring strong fundamentals and policies, while relying on a more parsimonious set of criteria to enhance transparency and predictability. In particular, qualification for a new instrument could be based on three criteria: (i) a sustainable external position and market access, including adequate reserve coverage, sustainable external debt, and no significant exchange rate misalignment; (ii) sound public finances, as indicated by a sustainable public debt position with high probability; and (iii) no actual BOP need at approval. Moreover, an arrangement would not be approved for a member facing (i) bank solvency problems that pose an immediate threat of a systemic banking crisis; (ii) ineffective financial sector supervision; and (iii) insufficient data transparency and integrity.

Prequalification, the early repurchase expectations, and lower access than the FCL or PLL would all help safeguard Fund resources. Moreover, the annual reassessment of qualification, and the early repurchase expectations would help ensure that eligible members can be relied upon to undertake appropriate policy adjustments.

33. Financial resources necessary to establish a new liquidity backstop could be comfortably accommodated within the current envelope. As shown in Figure 8, net outflows for a group of 21 large EMs during recent episodes of short-term volatility were manageable relative to normal access limits for many countries, although such limits generally fell short of reserve-currency BSAs for those countries that could avail of them. For example, an EM-wide short-term volatility shock²³ would imply total liquidity requirements of around US$90 billion, which is equivalent to the largest existing FCL arrangement. And even in such a situation, the Fund would not be called upon for the full amount, as countries would be expected to partly cover the needs with reserves.²⁴ As an additional safeguard, the instrument could include a clause whereby the policy is subject to a Board review if the resource demands exceed a specified threshold.²⁵

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Normal Access Limits vs. Large Net Portfolio Outflows

Citation: Policy Papers 2017, 070; 10.5089/9781498346160.007.A001

Source: BOP Statistics, IMF calculations.Note: Bars represent peak quarterly outflows in the period from 2006 to 2016.

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Past Fund Experience

37. In the past, the Fund has created a number of instruments for the primary purpose of signaling and policy monitoring. The historical experience provides valuable insights into the trade-offs involved in designing an effective signaling mechanism.²⁸ The key issues that have been raised are:

• The risk of becoming a “rating agency.” There is a tension between informing creditors, often described as the Fund’s catalyzing role, and a desire to leave markets to their own judgment when assessing risk and allocating resources. The Fund has avoided being perceived as a “gatekeeper” or “rating agency” at the risk of weakening market discipline and shifting focus towards certifying potential borrowers. As financial markets have matured and there is increased availability of economic information, however, there may be fewer grounds for concern that private creditors would rely excessively on the Fund’s judgment.

• The difficulty in sending explicit negative signals. Negative signals can play a role in fostering sound policies and also provide credibility and power to positive signals. In practice, there has been a reluctance to send explicit negative signals at the risk of damaging the relationship with the authorities and impacting their access to financing. This issue is intensified when signals are blunt on/off mechanisms. While this challenge also exists for surveillance and Fund financing arrangements, it is mitigated (as noted above) by the growing abundance of economic information in most countries, such that the Fund alone is unlikely to bring a sudden and unexpected reassessment of prospects in a country. In addition, the signaling mechanism could be designed to provide a multi-dimensional assessment, eschewing a simplistic on-track/off-track accounting, provided that policy conditionality is equivalent to UCT standard.

• The credibility of signals without the backing of Fund financing. The lack of a commitment of the Fund’s financial resources could weaken the signal as the Fund does not have a financial stake, unlike other official or private creditors. However, a contrary perspective is also possible: without pressure to provide financing, the Fund could be seen as a more impartial external assessor.

• Misinterpretation if standards are not upper credit tranche (UCT). The standard of UCT conditionality is so well-known that any other standard applied by the Fund in a signaling context could be misinterpreted as equivalent. This would risk undermining the quality of the signal and could adversely affect the perception of UCT-quality programs.

• Tension between on/off signals and more multidimensional assessments. When there are on/off signals, such as if a review is completed or delayed, there can be tendency to give less weight to the multidimensional signal. For example, creditors may place greater importance on the mere presence of an arrangement rather than the content of its assessments. To alleviate this risk, a new signaling mechanism would need to be accompanied by a clear communication strategy to emphasize the importance of the overall assessment provided in reviews.

Policy Monitoring Tools in the Current Fund Toolkit

38. Existing forms of policy monitoring are not appropriate or available in all cases. Within the current toolkit, there are some mechanisms that can play the role of providing policy monitoring and signaling. However, when assessed against the challenges of past experiences and the desire to ensure adequate coverage for all members, it is clear that important gaps remain.

39. Policy monitoring could be achieved through surveillance, but the standard against which policies are assessed would not provide a clear signal. Under the Fund’s surveillance mandate, Article IV consultations provide policy advice and periodic assessments of the economic outlook and policies of each member, typically once a year. However, it would not be clear what standard policies are assessed against. In addition, there are cases where more frequent monitoring is warranted but this is not possible under the current Article IV surveillance framework.²⁹

40. Assessment letters and staff monitored programs (SMPs) play a signaling role but do not involve Board endorsement of policies and are designed for different objectives. Assessment letters are typically produced in response to requests from multilateral or bilateral donors or creditors when an up-to-date Board assessment is not readily available.³⁰ They should provide a clear and candid assessment of the member’s macroeconomic conditions and prospects, and of macroeconomic and related structural policies. But they do not assess policies against any prescribed standard, and are generally not published. This limits their effectiveness as a mechanism for enhancing policy dialogue and monitoring. While staff-monitored programs do enable program-type engagement they are only used for the purpose of allowing countries to build a track record in anticipation of an eventual Fund-supported program, and not for signaling purposes. In addition, as with assessment letters, they do not entail an endorsement of policies by the Fund’s Executive Board.

41. While arrangements used on a precautionary basis or the Policy Support Instrument (PSI) can be effective monitoring and signaling instruments, they are only available for a subset of the membership. A Fund arrangement used on a precautionary basis (e.g., SCF arrangement or SBA) can provide closer monitoring and a clear signal but would not be available for members that have no present, potential, or prospective need to draw on Fund resources, for instance because of substantial market access and/or access to other official sources of financing. Moreover, if the member’s primary interest is to benefit from the structured policy engagement and signaling that the Fund can provide, it would be preferable to deliver this support via a monitoring program rather than tying up Fund resources in an arrangement used on a precautionary basis. The PSI provides such support but its availability is restricted to a subset of PRGT-eligible countries that have no present or prospective balance of payments need, do not require any significant macroeconomic policy adjustment and have sufficient quality of institutions and policies. The PSI helps such members design, implement and monitor policies as well as provide a Board-endorsed signal to donors and investors. There is, however, no comparable form of support available to the large majority of Fund members who are not eligible to use the PSI.

42. There is scope for improving the toolkit by building upon the experience with the PSI. This experience highlights the value that countries, creditors and donors place on the policy elements of a Fund-monitored program. Yet, there seems to be more limited value from the signal provided by the qualification feature of the PSI, and there is often a reluctance to disqualify countries even if performance deteriorates (see Box 5). In addition, there also seems to be a tendency to complete reviews even when there are indications that more time is needed to implement reforms—a phenomenon driven in part by the fixed review schedule. To help overcome these design issues in the PSI and create an instrument that could be used by a wider set of countries,³¹ a new monitoring instrument could have the following characteristics:

Box 5.

Experience with the Policy Support Instrument (PSI)

The PSI was introduced in 2005 to address a gap in the toolkit for PRGT-eligible countries that do not need Fund financial assistance. The PSI offers support to low-income countries (LICs) that have achieved macroeconomic stability and completed basic structural reforms, and do not need Fund financial assistance. For this group of countries, the PSI aims to promote a close policy dialogue with the Fund to help the member consolidate macroeconomic stability and pursue more advanced structural reforms, provide regular assessments of the member’s economic and financial policies, and deliver clear signals that could be taken into account by donors, creditors, and the public.

Since its introduction, the PSI has been used by seven countries. A total of 18 PSIs have been approved to date in the following countries: Cape Verde (2), Mozambique (3), Nigeria (1), Rwanda (2), Senegal (3), Tanzania (3), and Uganda (4). Cases of concurrent use with Fund financial arrangements (to address short-term needs that arise during the implementation of a PSI) have been limited, with only three countries requesting an SCF (Tanzania 2012, Mozambique 2015, and Rwanda 2016).

Official creditors and donors value the signals provided by the PSI and use them in their aid allocation decisions. In a recent staff survey of donors in countries that are PSI users, all respondents agreed or strongly agreed that the PSI delivers clear and timely signals on the strength of country policies. Sixty percent of respondents also indicated that, to varying degrees, the PSI signals have played an important role in their aid allocation decisions, particularly in assessing countries’ commitment to sound macroeconomic policies and management. Donors appreciate their collaboration with the Fund through the PSI, which provides a regular macroeconomic assessment and policy advice that complements the work of individual donors focusing on more sectoral issues. In past surveys, donors also indicated that the PSI was more useful than a surveillance-only relationship in making aid decisions.

PSI users have consolidated economic stability but evidence of sustained improvements in the implementation of structural reform is limited. Quantitative program targets, are generally met, but structural benchmark performance is inconsistent and weakening over subsequent PSI programs (Text Figure 1). The latter could be due to the difficulty of implementing second-generation reforms that follow-up PSIs aim to tackle. It could also be affected by the fixed review schedule under the PSI, which lacks the flexibility to meet targets with a delay.

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Adherence to Conditionality in PSI Users (last ECF/PRGF and successive PSIs)

Citation: Policy Papers 2017, 070; 10.5089/9781498346160.007.A001

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Overall, program performance with the PSI is not weakened by the absence of Fund financing. Comparing PSI users with similar PRGT-eligible countries that are using Fund financial facilities, the experience shows that:¹

• PSI programs have less conditionality relative to comparator countries and other PRGT-eligible countries. This could be a reflection of PSI users having implemented first generation structural reforms and are now aiming for second-generation issues.

• PSI users typically have a higher fiscal deficit compared with comparable PRGT-eligible countries, in part explained by the scaling-up of investment. While the macroeconomic performance of PSI users and their comparators is generally similar (reflecting the selection criteria for the comparators), PSI users have higher fiscal deficits and public investment levels. A regression analysis indicates that the difference in fiscal deficit is driven essentially by higher investment by PSI users. Once investment is accounted for, being a PSI user per se is no longer associated with higher fiscal deficits.

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Extent of Conditionality

Citation: Policy Papers 2017, 070; 10.5089/9781498346160.007.A001

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Implementation of Conditionality

Citation: Policy Papers 2017, 070; 10.5089/9781498346160.007.A001

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Fiscal Balance - Distribution of Median per Year

(in percent of GDP)

Citation: Policy Papers 2017, 070; 10.5089/9781498346160.007.A001

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The quality of signaling from the PSI may have been somewhat less sharp in recent years. Governance issues have affected some PSI users (corruption and large non-transparent off-budget spending) even though their macroeconomic performance has been broadly fine. Given that the assessment of performance under a PSI is mostly focused on macroeconomic issues, this allows completion of a review in circumstances where donors have withheld financial support due to governance issues. Also, the fixed review schedule under the PSI could put pressure for completion of reviews to the detriment of performance: in ten years, the only case where a review under the PSI was not completed is that of Uganda in 2011.

¹ As part of the 2008–09 lending reforms, structural performance criteria were discontinued and monitoring of structural reforms became review-based, though quantitative performance criteria were maintained. Evidence suggests that this did not lead to a weakening in the implementation of the structural reform agenda (see the 2015 Crisis Program Review, IMF 2015).

• Avoid qualification criteria, to permit access for all countries. The main motivation for creating the PSI’s distinct qualification criteria was to provide an on/off signal that identifies a subset of countries which have reached higher standards in terms of macroeconomic stability. Since the motivation for a new instrument is to enable a broader set of countries to benefit from Fund policy monitoring, establishing qualification criteria would unnecessarily restrict access for some countries, result in additional tiering in the membership, and possibly further contribute to stigma. The value of the instrument would derive from the policy dialogue and monitoring provided by the ongoing reviews rather than the binary signal of access to the instrument.

• Require UCT-quality policies, to provide a transparent and consistent standard. The UCT quality of policies is a clearly established standard that is applicable in programs with Fund financing. Maintaining this standard would be important in a new instrument that could be used to unlock financing from other GFSN components.

• Use review-based monitoring of conditionality to provide a clear signal on program performance and reduce stigma. Review-based monitoring of quantitative and structural reform conditionality would explicitly recognize that program reviews provide the context for a more robust and “real-time” assessment of program implementation.³² Quantitative targets and structural reforms would remain central to program design but their monitoring would be modified to help reduce stigma. Specifically, countries would not need to be granted a formal waiver if a particular target is missed, as is currently the case with the PSI. Emphasis would be placed on the staff and Board assessment, which would provide a bottom-line appraisal as to whether policies are on track to meet the specified objectives, rather than focus on small deviations from specific targets.

• A more flexible review schedule to limit pressure to complete reviews but maintain regular updates on program performance. Committing to a fixed review schedule (e.g. every six months) ensures that information on program performance is provided regularly but can also result in pressure to complete reviews to avoid sending an overly negative signal. Creating a limited time buffer around reviews would enable some extra time if there are delays in implementation but avoid prolonged periods without an update on progress.

• Enable accelerated access to Fund-resources if needed. As is currently the case under the PSI, if the monitoring program is on-track this could expedite access to Fund financing in the event of a member’s balance of payments need, subject to existing lending policies.

43. To maintain a streamlined toolkit, consideration could be given for the new instrument to replace the PSI. The proposed monitoring instrument would enable a broader set of countries to engage more closely with the Fund. If introduced, it could replace the PSI, perhaps after a trial period that would help the Board decide whether the new instrument has rendered the PSI obsolete.³³