Use of Fund resources and stand-by arrangements: An explanation of the manner in which member countries can use Fund resources under these credit arrangements

Members of the Fund may use its resources under its tranche policy and the extended Fund facility (which is for a period of up to three years), the compensatory financing facility, and the buffer stock financing facility. Use of resources under the tranche policy are in most cases made under a stand-by arrangement.

Abstract

Members of the Fund may use its resources under its tranche policy and the extended Fund facility (which is for a period of up to three years), the compensatory financing facility, and the buffer stock financing facility. Use of resources under the tranche policy are in most cases made under a stand-by arrangement.

Omotunde E. G. Johnson

The financial structure of the Fund is broadly built on the quotas of its members which are reviewed periodically (usually every five years). Each member’s quota forms the basis for the magnitude of “purchases” which members can expect to enjoy. It also normally determines the magnitude of resources made available to the Fund. Under the present Articles of Agreement, 75 per cent of a member’s quota is subscribed in the member’s own currency, and the remaining 25 per cent, or gold tranche, normally in gold. A purchase from the Fund takes the form of a purchase by the member of the currencies of other members in exchange for an equivalent amount of its own currency, subject to repurchase in the medium term and charges. Requests for purchase in the gold tranche (i.e., Fund holdings of a member’s currency rising to no more than 100 per cent of the member’s quota, excluding compensatory financing purchases) are not subject to challenge; procedures make it possible to deliver foreign exchange to a member two business days after receipt of the request by the Fund.

For a more extensive presentation of this subject, see The Stand-By Arrangements of the International Monetary Fund by Joseph Gold (Washington, D.C., 1970).

Beyond the gold tranche there are four credit tranches/each equal to 25 per cent of a member’s total quota. Since January 19, 1976, each of these tranches was increased to 36.25 per cent of quota until the date the second amendment of the Articles of Agreement comes into effect, when quotas on the average will be increased by similar amounts. A member may normally purchase up to four credit tranches under the tranche policy.

Conditionality

One of the purposes of the Fund, as stated in its Articles of Agreement, is to “give confidence to members by making the Fund’s resources temporarily available to them under adequate safeguards, thus providing them with opportunity to correct maladjustments in their balance of payments without resorting to measures destructive of national or international prosperity.” Three important aspects of this statement are (1) the resources are to be provided in order to give an opportunity to the member to correct a maladjustment in the balance of payments; (2) the resources are to be made available under “adequate safeguards”; and (3) the use of the Fund’s resources is to be temporary.

The emphasis on policies to be adopted by the member to cope with the balance of payments difficulties and on the temporary nature of the use of Fund resources have been made more explicit in the amended Articles of Agreement now awaiting acceptance. The period of temporary use is related normally to that of the member’s balance of payments problem. The member is expected to pursue policies that will enable it to overcome this problem and to accumulate the necessary reserves to make repayments. By means of these policies the use of Fund resources is made temporary. The period of use of Fund resources under the tranche policy should not extend beyond an outside range of three-to-five years from the date of purchase.

The essence of conditionality is to ensure the proper use of Fund resources according to the Articles, including temporary use. This assurance has been given in the Fund’s Annual Reports for purchases beyond the gold tranche. In the 1963 Annual Report it is stated that:

  • The Fund’s attitude to requests for transactions within “the first credit tranche”—that is, transactions which bring the Fund’s holdings of a member’s currency above 100 per cent but not above 125 per cent of its quota—is a liberal one, provided that the member itself is making reasonable efforts to solve its problems. Requests for transactions beyond these limits require substantial justification. They are likely to be favorably received when the drawing or stand-by arrangements are intended to support a sound program aimed at establishing or maintaining the enduring stability of the member’s currency at a realistic rate of exchange.

Requests for purchases within the first credit tranche can be made in the form of either a direct purchase or a stand-by arrangement. Purchases beyond the first credit tranche (upper credit tranches) are in most cases made under a stand-by arrangement. In the upper credit tranches direct purchases have been rare and are primarily limited to instances where serious balance of payments difficulties have been caused by natural disasters such as earthquakes or drought.

Stand-by arrangements are defined in the second amendment of the Articles of Agreement as follows:

  • Stand-by arrangement means a decision of the Fund by which a member is assured that it will be able to make purchases from the General Resources Account in accordance with the terms of the decision during a specified period and up to a specified amount.

Stand-by arrangements provide a technique by which members can be assured of prompt financial assistance from the Fund, whenever the need arises during the period of the arrangement. In effect, when granting a stand-by arrangement or approving a direct purchase, the Fund conducts an advance review of the member’s position, policies, and prospects. The use of Fund resources, therefore, has been closely associated with the implementation by the members of stabilization programs. The stand-by arrangement has proven a valuable instrument under which the Fund could commit large amounts of resources for a period ahead in support of the member’s policies.

The Fund has not rigidly defined the period for which a stand-by arrangement may be granted. In practice, however, most arrangements have been for 12-month periods and only a few for shorter periods. Recently, the Fund has approved a two-year stand-by arrangement.

The submission of a program in support of which a member requests a stand-by arrangement is preceded by extensive discussions between the authorities and the Fund staff on the member’s economic objectives and policies. These objectives and policies are described in the member’s letter of intent which is submitted to the Managing Director. In presenting the member’s letter to the Executive Board of the Fund with a recommendation for approval of the stand-by arrangement, the Managing Director and the staff assess the extent to which the policies of the member meet the requirements governing the use of Fund resources. These are designed to achieve a medium-term balance of payments objective which is consistent with the temporary use of Fund resources.

The basic policies of the program depend on the nature of the existing and prospective balance of payments problem, while the particular policy instruments used depend on the institutions of the country and its social and economic priorities. So that it may be effective, a program is as specific and precise as possible. In particular, those main policy variables which lend themselves to measurement are stated in quantitative terms. In general, progress in the implementation of a program is evaluated with reference to the policies established by the member for the period of the requested stand-by arrangement.

The principal objectives of stabilization programs have normally been the achievement of a certain balance of payments outcome; maintenance or progress toward freedom from exchange and trade restrictions; and the attainment of a high degree of price stability without sacrificing economic growth objectives. The programs cover a wide range of policy measures, frequently including improvement of the fiscal situation, restraint on the growth of credit, implementation of prescribed price and income policies, and, where necessary, exchange rate action. In certain instances they also include measures for institutional reform in the economic field.

Performance clauses

However, as part of the need to provide “adequate safeguards” that the use of the Fund’s resources would be temporary and consistent with its purposes, protective clauses and “phasing” are used in connection with stand-by arrangements which go beyond the first credit tranche. These safeguards have sought to provide a balance between assurances to the member that it can have access to the Fund’s resources during the period of the arrangement, and assurances to the Fund as to the proper use of its resources by the member. Performance clauses cover those performance criteria necessary to evaluate implementation of the program to ensure the achievement of its objectives, but no others. The policy variables specified as performance criteria must be capable of being expressed in quantitative or objective terms, must be available with only a short time lag, must be significant enough to mirror and/or influence developments in the economy at large, and must be within the control of the authorities.

The specific performance criteria most commonly used are related to the size of the expansion of credit by the central bank or the banking system and to the reliance by the government on bank credit. In certain cases performance criteria include the amount of new short-term and medium-term foreign borrowing, and the minimum level of net foreign reserves that must be maintained. Performance criteria of this nature are normally set for various sub-periods, often coinciding with those used for the “phasing” of the member’s purchases from the Fund. There is almost always a performance criterion requiring the avoidance of new multiple currency practices and the introduction and intensification of restrictions on exchange for current transactions or restrictions on imports.

Failure to observe the performance criteria included in a particular program interrupts a member’s right to purchase under the stand-by arrangement. It is a signal that the position, policies, and prospects of the member should be reviewed, and, therefore, the member would consult with the Fund before requesting further purchases. The right to purchase may be restored when understandings are reached on the circumstances in which further purchases may be made, and amended performance criteria are established.

Consultation and phasing

Various consultation clauses are included in stand-by arrangements. These are clauses that call for consultation between the member and the Fund in certain circumstances, without limiting the member’s right to make purchases under the stand-by arrangement—in contrast to the performance clauses. All arrangements, for instance, include a clause which calls for consultation if it appears that additional measures are necessary to achieve the objectives of the program, or if because of changed or unforeseen circumstances a member finds it difficult to pursue the policies outlined in the stand-by arrangement. Consultation clauses have also been used with respect to more narrowly defined issues.

The purchases available under a standby arrangement are so phased as to ensure that resources will be available to facilitate the steady implementation of the program by the member. Moreover, phasing provides an important safeguard for the Fund against the danger of an overly rapid use of its resources. Phasing may not be used when the Fund considers it essential that the full amount of the stand-by arrangement be promptly available. In these stand-by arrangements, the performance clauses will be so drafted as to require the member to consult the Fund in order to reach understandings, if needed, on new or amended performance criteria even if there is no amount that could still be purchased under the stand-by arrangement.

One of the conditions a member must satisfy to use the Fund’s resources is that it has a need because of an “unfavorable” balance of payments or reserve position, or (once the second amendment becomes effective) because there is an unfavorable development in its reserves. An unfavorable balance of payments is a balance of payments deficit which has generally been measured as being equal to the change in net foreign reserve assets. Need with respect to members’ reserve positions (low reserves) has usually been determined on a case-by-case basis; factors like the seasonal fluctuations of export earnings and access to capital markets have often been important considerations in deciding whether a certain reserve level constituted a compelling case of need. Need with respect to developments in reserves may be related, for example, to an impending discharge of foreign liabilities.

“… in choosing among the available policy instruments, a major consideration is the efficiency with which they can be administered”

Supporting programs

Programs supported by stand-by arrangements are designed to correct a variety of balance of payments difficulties. From the point of view of the nature and the adequacy of the policies constituting a program, the most relevant considerations are the magnitude of the payments problem and the extent to which imbalances have created distortions in the economy. The choice of policy instruments depends not only upon the problems facing the country but also on the level of development and the institutional features of the economy; in particular, the fiscal and banking system, the labor market, and the foreign trade and payments system. Moreover, in choosing among the available policy instruments, a major consideration is the efficiency with which they can be administered.

When the balance of payments problem is relatively mild and not complicated by structural imbalances within the economy, the principal feature of a program has been the establishment of a balance between aggregate supply and demand. This has been effected by controlling expenditures within the broad sectors of the economy, and sometimes within important segments of each sector, while avoiding instruments and policies which lead to or increase reliance upon restrictions on trade and payments and the discriminatory application of any existing restrictions.

Pressures on the balance of payments have often been associated with distortions resulting from persistent domestically induced inflation. The most common factor in generating such inflation has been relatively large fiscal deficits financed by banking system credit. In some countries distortions have arisen because of the nature of development policies, such as the concentration of investment in industries with a relatively high import content but little positive direct or indirect effect on the trade balance forecast for the near future. As a result of continuing inflation, the overvaluation of the currency (when viewed in relation to other macroeconomic magnitudes) and restrictions on imports, the structure of prices and costs may have suffered serious distortions. This situation is often aggravated by the policies of the authorities to insulate certain prices from upward pressures through subsidies and direct price controls.

When persistent inflation and structural maladjustments exist in conjunction with the balance of payments problem, the objective of programs has been not only to control inflation and to arrest the decline in foreign reserves and any build-up of debt service obligations that may have occurred, but also to facilitate a reallocation of real resources. As part of this exercise, an essential step has been to examine the extent to which the exchange rate or exchange rate policy should be adjusted and to determine the financial policies that are consistent with that adjustment.

The adjustment of the exchange rate has often been associated with the removal, or a substantial reduction, of restrictions on trade and payments including the unification of rates in a multiple rate system. Rate adjustments have also been accompanied, on a temporary basis, by the raising or imposition of export taxes on certain primary commodities with short-run inelastic supplies, in order to absorb part of the windfall profits where the members’ taxation systems cannot. Sometimes exchange rate policies have involved periodic adjustments to attain a realistic exchange rate. At other times, the establishment of a realistic exchange rate has been approached by making use of fluctuating exchange rates. Before the general acceptance of managed floating, the use of fluctuating rates was considered a temporary device before realistic fixed rates could be determined.

In order to facilitate effective implementation of a program, key policy variables are identified and specified (as instruments or targets), where possible, in quantitative terms. In this regard, variables connected with expansion of credit by the central bank or the banking system, the budget, foreign reserves or foreign debt have been capable of being expressed in precise quantitative terms.

Of the various ways in which an excessive expansion of demand may be curbed, quantitative credit limitations have been the most useful. Control of demand has therefore been exercised mainly through the establishment of ceilings on the expansion of the domestic assets of the central bank and/or the banking system as a whole. When budget deficits have been the primary reason for monetary instability, a separate ceiling on the extension of credit to the government has been set.

To keep the deficit of the public sector within limits compatible with the monetary objectives, fiscal operations have been reviewed with the possibility of augmenting budgetary resources, reducing the growth of current expenditures, and/or strengthening the financial position of public enterprises.

Some countries have included in their programs specific action with regard to wages and prices. Specific pricing policies have been included to adjust prices to realistic levels, mainly in public enterprises. This has also often meant elimination of price controls. Wage policies have varied depending on the ability of the authorities to influence directly the movement in the general level of wages which in turn has depended upon the institutional framework and the nature of the cooperation of the government and the labor unions.

Finance & Development, March 1977
Author: International Monetary Fund. External Relations Dept.