The Web edition of the IMF Survey is updated several times a week, and contains a wealth of articles about topical policy and economic issues in the news. Access the latest IMF research, read interviews, and listen to podcasts given by top IMF economists on important issues in the global economy.


The Web edition of the IMF Survey is updated several times a week, and contains a wealth of articles about topical policy and economic issues in the news. Access the latest IMF research, read interviews, and listen to podcasts given by top IMF economists on important issues in the global economy.

IMF Work Advances on Debt Initiative For Poorest Countries

The IMF and the World Bank are working to provide special assistance for heavily indebted poor countries. The objective is to reduce to sustainable levels the external debt burden of a number of countries pursuing sound policies. The initiative would entail the participation of other international financial institutions, and the Paris Club and other bilateral creditors. Jack Boorman, Director of the IMF’s Policy Development and Review Department, offered his thoughts on the debt issue in a conversation on July 2 with the Editor of the IMF Survey.

IMF Survey: How did the IMF and World Bank decide on the need for a special initiative to reduce the debt burden of heavily indebted poor countries?

Boorman: We identified 41 heavily indebted poor countries [see box, page 230] and examined the situation of each in detail. We found some in which the external debt situation had become dire, whether for reasons of political turmoil, failed policies, worse-than-expected terms of trade developments, or other factors. These countries were in a situation where, even with strong adjustment and reform programs and the benefit of current debt-relief mechanisms, their potential to service their external debt on an ongoing basis appeared limited. We concluded that something more had to be done, with multilateral institutions playing their part, to help these countries put their debt-service burdens on a sustainable basis. By sustainable, I mean a position in which their export earnings, capital flows, and aid flows would enable them to service their debt without an undue burden.

IMF Survey: What are the basic features initiative?

Boorman: In designing the framework, together with the World Bank, we asked the following question: If the heavily indebted countries adopted strong reform and adjustment programs and persisted with them, how would their external debt situations evolve? In particular, we asked whether current mechanisms—including concessional lending by multilateral agencies, aid operations by bilateral creditors and donors, and existing debt-relief mechanisms—would be sufficient to put these countries’ debt burdens on a sustainable basis.

In looking at the experience of a large number of countries, we determined that the criteria for sustainability should be a debt-service ratio [debt-service payments as a percent of export earnings] in the range of 20-25 percent, and a present value of all claims on the country not exceeding 200–250 percent of export earnings. To these criteria we added a third: a set of “vulnerability factors” by which to determine in each case whether to target the lower or the upper end of the two ranges. Vulnerability factors include the country’s reserve position, its vulnerability to shocks, its dependence on a single or small number of commodity exports, and the impact of debt service on its fiscal position.

It is important to keep in mind that these indebted countries will continue to require bilateral and multilateral assistance. Even countries pursuing strong adjustment and reform programs over a number of years will—because of the structure of their balance of payments—remain dependent on aid flows. Indeed, even if the debt of a number of these countries were totally written off, they would remain heavily dependent on aid, given their very large, noninterest, current account deficits.

IMF Survey: How do you define assistance to reduce debt burdens in the context of this initiative?

Boorman: For all creditors, we define it as a reduction in the net present value of the claims on the indebted country [see box, page 233]. For many creditors, this can be achieved by writing off some or all of their claims on the country. However, since it is not possible for the IMF and some other multilateral institutions to write down their claims, these institutions will provide debt-service relief to the relevant countries. This could take various forms. For example, the IMF’s Executive Board has agreed that the IMF should provide resources on a more concessional basis than under the enhanced structural adjustment facility (ESAF), the IMF’s concessional lending facility for low-income countries engaged in comprehensive adjustment. The idea of the IMF providing more concessional assistance than at present for countries qualifying under this initiative has also been endorsed by the Group of Seven countries in Lyons [see page 234].

Overall Assessments of “Debt Sustainability” For 41 Heavily Indebted Poor Countries

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IMF Survey: How will the various other creditors participate?

Boorman: The initiative must involve all the creditors of the indebted country so that through actions by these creditors, the country would be put in a sustainable external debt position. Mechanisms have been developed over a number of years for providing relief on a country’s debt to commercial creditors; the Paris Club has provided increasingly concessional terms in its flow reschedulings and has moved to provide stock-of-debt reduction for the poorest countries; and some non-Paris Club bilateral creditors have provided comparable terms as well. From Paris Club and other bilateral creditors, the initiative calls for stock-of-debt relief at the end of a prescribed adjustment period of up to 90 percent, instead of the 67 percent stock-of-debt reduction granted to date. Commercial creditors and non-Paris Club bilateral creditors would have to provide at least comparable relief.

IMF Survey: How does a reduction in the net present value of IMF claims on an indebted poor country tie in with the IMF’s ESAF?

Boorman: Among the possible ways in which the ESAF would be used, two have garnered strong support: one is to extend the maturities of IMF claims—mostly ESAF—on those countries. For example, by extending the maturity of such claims from the current 10 years and 5 years’ grace, to 20 years and 10 year’ grace, the concessionality and the grant element of such loans are approximately doubled. Another possibility is to provide a grant to the country to help it service its obligations to the IMF. Both of these mechanisms would, in a financial sense, achieve the same result: a reduction in the net present value of IMF claims on the indebted country. We will look at the profile of the debt-service burden facing each country to decide which mechanism is most appropriate.

IMF Survey: You mentioned that 41 heavily indebted poor countries could potentially be eligible for support under the proposed debt initiative. How many countries are now eligible?

Boorman: Among the 41 countries, most of them in Africa, we have categorized 8 as “unsustainable,” and another 12 as “possibly stressed.” The remaining countries now appear to be in “sustainable” external debt positions, meaning that current mechanisms—such as Naples terms—would be sufficient. Thus, about 20 countries may qualify for action under this initiative. But the situation of some of these countries could worsen, while that of others could improve. Therefore, countries’ eligibility will be assessed case by case.

IMF Survey: Would countries in protracted arrears to the IMF be eligible?

Boorman: Yes, these countries—Sudan, Somalia, and Liberia—could potentially be eligible, but our information about these three is at present limited, and it is difficult to make judgments about their prospects, given their current circumstances. We will deal with these countries when they are in a position to adopt appropriate economic reform programs.

IMF Survey: What of the concern about moral hazard, or reducing the incentives of those countries already successfully engaged in sometimes difficult adjustment?

Boorman: I don’t believe that a country that has adjusted successfully and managed its debt situation well would in any way see its incentives for continuing its good policy performance weakened by limited additional assistance provided to a few of the poorest countries in serious debt difficulty. The reward for good policy performance lies in economic growth and improved living standards. If these countries sustain sound policies, they will continue to receive the support of multilateral institutions and bilateral creditors and donors and will see greater inflows of private investment.

IMF Survey: Will the IMF do as much as the World Bank under the proposed initiative?

Boorman: Yes, the proposed initiative provides that in each case, the various institutions will provide relief proportional to their exposure to the indebted country. If the IMF is the major creditor to a country, it will provide relatively more assistance to the country than other multilateral institutions; in other instances, the reverse will be true. One of the factors influencing the design of the initiative, and which led us to shy away from a global solution to the debt-service problems of these countries, was the dramatic difference in the profile of the indebted countries’ debt obligations to various creditors. While all the eligible countries are heavily indebted to bilateral creditors, some countries—such as Zambia—are also heavily indebted to the IMF; others are indebted mainly to the World Bank’s IDA [International Development Association, the Bank’s highly concessional lending arm]; while others are heavily indebted to the African Development Bank or the InterAmerican Development Bank. Because of the different profiles of these countries’ debts, we have to determine the amount of assistance to be provided by each institution in each case.

IMF Survey: How does the proposed initiative build on rescheduling by bilateral creditors?

Boorman: The initiative builds on existing mechanisms to the greatest extent possible. For a number of the poorest countries, one of the primary debt relief mechanisms has been the application of Naples terms. In applying such terms, the Paris Club provides a flow rescheduling that reduces the annual debt-service burden of the country in the context of a three-year ESAF-supported adjustment program. At the end of that process, if the country has performed well under the reform program, the Paris Club—as it has done for Uganda, Bolivia, and more recently Burkina Faso, Guyana, and Mali—provides stock-of-debt-reduction.

Under the proposed initiative, countries would continue to complete the first three-year phase of ESAF- and World Bank-supported adjustment. At the end of that period, it will be determined whether Naples terms, together with at least comparable relief by non-Paris Club bilateral creditors and commercial creditors, would be sufficient to put the country in a sustainable external debt-service position, allowing it to exit from the rescheduling process. If the answer is yes, that would be the end of the process and Naples terms would be applied. If the answer is no, the adjustment process would continue, supported by additional ESAF arrangements from the IMF and programs with the World Bank and other involved creditors and donors. As those follow-on arrangements begin, the Paris Club and other bilateral creditors would continue reschedulings, but they would increase the amount of debt relief they provide—from the Naples terms net present value reduction of up to 67 percent up to a suggested 90 percent under the proposed framework.

The World Bank is considering providing additional assistance during this period, in the form of supplemental IDA allocations through grants. We will be examining similar mechanisms within the IMF. A country that pursues this second phase of adjustment, supported by a second three-year ESAF arrangement and a Bank program, will be promised relief from both bilateral creditors and from multilateral institutions in an amount sufficient at the end of that process to assure debt sustainability. This will involve a stock operation from Paris Club and non-Paris Club bilateral creditors. If commercial banks are involved, they would be expected to provide at least comparable relief as well. Multilateral institutions such as the IMF and the World Bank will commit to providing the additional assistance necessary to bring the total debt stock of eligible countries, in net present value terms, down to the threshold level I mentioned earlier: 200-250 percent debt to exports, and a debt-service ratio no higher than 20-25 percent.

The IMF would use either grants or highly concessional loan operations to bring about the desired reduction of the net present value of its claims, while the Bank and other multilateral institutions would use resources from a “multilateral debt-reduction fund”—which would be funded from the Bank’s net income, from bilateral contributions, and possibly from other multilateral institutions. Bank management has already recommended that its Executive Board set aside $500 million this year for a special trust fund to be used as the Bank’s initial contribution.

IMF Survey: Will the IMF’s contribution come at the same time as others?

Boorman: All involved creditors will provide additional assistance. The timing of the decisions will determine the contributions of the various creditors. As I mentioned earlier, at the end of the first phase of the adjustment process, all creditors will have to examine the country’s situation to determine if it can exit from rescheduling through the application of existing mechanisms, or whether more is needed. If more is needed, each involved creditor will commit to providing additional relief to the country during the second phase of the adjustment program or at the completion of that program. The critical thing is that all major creditors be involved so that a genuinely comprehensive solution is achieved.

IMF Survey: Some critics have complained that the required six-year adjustment track record is too long and rigid. How do you respond?

Boorman: The adjustment period will not necessarily be six years for all countries. Of the countries that we expect to qualify for assistance under this initiative, a number are already well advanced. Uganda, for example, has completed the first phase of adjustment and has received Naples terms debt-stock reduction. It is then a matter of reassessing Uganda’s situation to see if additional assistance is required. If so, the current three-year ESAF-supported adjustment program may well provide the basic performance necessary to earn the additional relief provided under this initiative.

IMF Survey: Will the proposed initiative help boost investment and growth in beneficiary countries?

Boorman: Yes, certainly, but an onerous debt burden is only one of many problems confronting these countries. Helping them reduce their external debt burden to a sustainable level should help increase investor confidence and remove one impediment to growth. But these countries also need to develop institutions of effective economic policymaking and address infrastructure development problems, as well as problems of governance—particularly as they influence investor confidence, such as the existence of commercial codes of conduct, functioning judicial systems, and the effective application of the rule of law. Such difficult issues will not be resolved overnight. If a country wishes to reform its economy and tackle all of these problems, the IMF will be engaged with it for a significant number of years. This goes back to the issue of whether requiring two sequential three-year IMF-supported adjustment programs is excessive. The idea that a six-year adjustment effort is unduly long is consistent neither with the reality of the problems confronting these countries nor with the experience of successfully reforming economies.

IMF Survey: You’ve explained that the ESAF is the facility through which the IMF will participate in the proposed initiative. Why is this the instrument of choice?

Boorman: Because the ESAF has been a successful mechanism for assisting the IMF’s poorer members since 1987, and all of our members agree on this. But I’d like to correct the misperception that the ESAF in its current form will be the mechanism through which we will support the poorest countries under the proposed debt initiative. This misperception has led some critics of the IMF to suggest that we are not proposing anything new or additional, or that the initiative amounts to business as usual. This is clearly not the case. The ESAF will form the economic policy basis for the IMF’s operations in the proposed initiative, and the needed financial resources will come from the same pool of resources used to support normal ESAF operations. However, the essential and important difference is the greater degree of concessionality to be provided under the new initiative.

IMF Survey: Making the ESAF self-sustaining appears critical for IMF participation in the proposed debt initiative. How is this effort proceeding?

Boorman: We expect the IMF to be in a position by the year 2005 to put in place a self-sustained ESAF, whereby resources within the IMF will be available, on a revolving basis, to provide concessional assistance to eligible countries for the indefinite future. Current ESAF operations are made possible by the last round of funding in 1994. We expect these resources to last until about 1999, possibly to 2000. We are then faced with an interim period—between 2000 and 2004—for which we do not now have resources available to support ongoing ESAF operations or this debt initiative. We are trying to secure these resources to continue ESAF operations at a level of about SDR 1 billion annually from 2000 to 2004 and to fund the IMF’s participation in the debt initiative.

For regular ESAF operations, two possibilities exist for raising the resources to cover the loan principal. We may continue to borrow from creditors outside the IMF, as we have done in the previous two rounds of ESAF funding—from such institutions as the Japan Export-Import Bank, the KfW in Germany, Caisse Centrale in France, or governments and other agencies in other countries. The other possibility is to switch to using the resources of the IMF’s general resources account. In either case, we would still have to find the money to subsidize those resources.

IMF Survey: What is the status of the proposal for the IMF to sell a limited amount of gold to finance its part in making ESAF self-sustaining for the interim period?

Boorman: It is in the context of raising the subsidy resources for a self-sustaining ESAF that the question of gold sales arises. The IMF’s Managing Director has, in the light of budgetary constraints faced by many bilateral donors, sought to limit the IMF’s request for bilateral contributions—both for the ESAF and, within that context, for the proposed debt initiative. He has thus suggested that about half the required subsidy resources come from bilateral contributions, with the other half coming from the sale of a modest amount of IMF gold. His proposal is to sell up to about 5 percent of the IMF’s gold, or 5 million ounces—the amount necessary to cover the difference between the resources raised from bilateral contributions and the total estimated subsidy requirement. This proposal has not yet won universal support, although it received a further push forward last week at the G-7 summit in Lyons. Those still opposed are concerned about using the IMF’s capital base, which is its gold stock. To take some account of those concerns, the proposal provides that in selling gold, the profits from the gold sales themselves would not be used; rather, the profits would be held and invested, and only the interest income would be used to help finance the needed subsidy. In this way, the proposal maintains the IMF’s capital stock and in fact diversifies it in a modest way out of gold to an income-earning asset that would then be permanently available to the IMF.

Net Present Value of Debt

The face value of the external debt stock is not a good measure of a country’s debt burden, if a significant part of the external debt is contracted on concessional terms, for example, with an interest rate below the prevailing market rate. The net present value (NPV) of debt is a measure that takes into account the degree of concessionality. It is defined as the sum of all future debt-service obligations (interest and principal) on existing debt, discounted at the market interest rate. Whenever the interest rate on a loan is lower than the market rate, the resulting NPV of debt is smaller than its face value, with the difference reflecting the grant element. For the heavily indebted poor countries as a group, the NPV of external debt at the end of 1994—based on the World Bank’s 1996 World Debt Tables—was approximately $190 billion, compared with a nominal external debt stock of $241 billion.

We have been asked by the Interim Committee to offer concrete proposals for funding the ESAF during the interim period at the Committee’s September 1996 meeting. It will be urgent for us in the next weeks and months to continue to seek a consensus on gold sales and to secure as large a volume of bilateral subsidy contributions as we can and to push forward the decisions necessary to complete the ESAF funding.

IMF Survey: So you are optimistic?

Boorman: Cautiously so! The support for ESAF and its continuance is universal among IMF members. We must make concrete proposals to the Interim Committee, both to assure a continuation of ESAF and because our role in the proposed debt initiative demands that we be assured in advance of the required funding. The IMF needs soon to be in a position to indicate clearly how it will finance its participation.

IMF Survey: Does a self-sustained ESAF not take the IMF in the direction of becoming a development institution?

Boorman: I don’t see a hard line between development, on the one hand, and stabilization, adjustment, and reform, on the other. It is clear that certain activities in the poor countries are properly classified as development—infrastructure development, perhaps, being the best example. On the other hand, we have learned over the last 10 or 15 years that beyond stabilization—which is clearly necessary to provide the confidence to the private sector to invest—many changes need to take place in poor countries to develop the institutions of policymaking and improve governance if they are to enter successfully onto a development path.

Economic and structural adjustment is needed in all countries, including the most advanced industrial countries, to keep up with the changes in the world. It is now a permanent feature of all economies, whether it is the adjustment that the industrial countries must make to globalization, the adjustment that middle-income countries must make to open trading and financial systems, or the adjustment that developing countries must make in these and other areas. This requirement of permanent adjustment has blurred further the line between development, on the one hand, and stabilization and reform, on the other. As for the IMF’s role in this new environment, it has the expertise in macroeconomic policy management, in the development of institutions of economic policy management, and in other areas that permit it to contribute in an important way to this worldwide process of ongoing adjustment.

Much Is at Stake for G-7 in Today’s Globalized World All Countries Share in Effects Of Globalization

Following is a summary of an address by IMF Managing Director Michel Camdessus at the Group of Seven (G-7) summit in Lyons on June 24.

What is at stake for the seven major industrial countries in today’s globalized world has ramifications extending well beyond the G-7 themselves, according to Managing Director Camdessus. Because all countries share in the effects of globalization—both its opportunities and risks—how the G-7 exercises its increasingly shared leadership has profound global implications.

The forces of globalization, Camdessus said, are completely revamping the economic and financial relationships among countries. By the year 2004, assuming continued annual growth in the industrial and developing countries at their current rates of 2.5 percent and 6.5 percent, respectively, the output of the developing countries will outstrip that of the industrial countries.

The experience of many developing countries that have reaped the rewards of globalization has shown that economic success has less to do with a country’s geographic location than with the credibility and quality of its economic policies, its capacity to ensure economic security, and, hence, its ability to attract investment.

But globalization carries major risks as well. The global economy remains vulnerable to costly financial crises such as the Mexican peso crisis of late 1994. The international community has managed to cope with these episodes so far, said Camdessus, but will it be prepared for the next one? Another risk is marginalization. Countries unable to participate in the expansion of world trade or to attract large amounts of private investment may be left behind by the global economy.

Responding to Mexican Crisis

Among its responses to the December 1994 Mexican financial crisis, the G-7, during its 1995 summit in Halifax, recommended that the IMF strengthen its surveillance over its members’ economic policies and secure the financial resources necessary to continue to support its members’ adjustment efforts. The IMF, Camdessus said, had completed much of the G-7’s recommended agenda. Its surveillance over member country policies and performance has become more intensive and more probing. Further, members are required, as a minimum, to provide the IMF with certain core data, so that the IMF will be in a better position to evaluate the sustainability of financial flows and developments in countries potentially at risk. In addition, to promote transparency vis-à-vis the capital markets, the IMF has invited all countries—but especially those tapping or seeking to tap the international markets—to subscribe to a special data dissemination standard. By the end of 1996, the IMF plans to implement a general dissemination standard applicable to all members.

The IMF is also seeking to ensure that its financial resources are adequate to meet its responsibilities. Camdessus said he hoped the ongoing Eleventh Review of Quotas will yield a doubling of quotas. And steps have been taken to double the borrowed resources available to the IMF under the General Arrangements to Borrow—as called for by the G-7 in Halifax in 1995. Finally, discussions are far advanced on how to put the IMF’s concessional lending facility—the enhanced structural adjustment facility (ESAF)—on a self-sustaining basis early in the next century.

The Three Virtues

A renewed strategy is needed that goes beyond emergency measures, Camdessus said. He recommended the adoption of three virtues to maximize the opportunities and minimize the risks of the first decade of the third millennium: responsibility, solidarity, and a confident and imaginative approach to change.

Responsibility. In today’s world, responsibility entails the twofold obligations of universal and permanent adjustment and the search for stable markets and financial institutions. Camdessus identified three aspects of adjustment:

Transparency and rigor. Nothing is more essential for containing the risks and maximizing the opportunities of globalization than the probity of government leaders and rigorous economic management. Rigor is required, first, of the G-7 because of their systemic responsibilities. But it is also required of the emerging market countries that must establish or enhance their credibility in the markets and of the poorest countries threatened by marginalization. As experience with adjustment has shown, it is the seriousness of these efforts that creates a greater likelihood of external support and balanced growth. For the poorest countries, in particular, putting off the necessary effort can have dramatic consequences; for them, the only alternative to rigor is marginalization and stagnation. All countries, Camdessus stressed, must strengthen macroeconomic discipline to guarantee a stable environment for domestic and foreign investors.

High-quality growth aimed at human development. It must be made clear to all that the goal of this discipline and sacrifice is sustainable growth—growth that is capable of ensuring full employment and lasting poverty reduction, promoting greater equity and equal opportunity, and respecting human freedom, cultural diversity, and the environment—all of which is more likely to be achieved in the context of democratic participation and a sustained effort to improve governance. In implementing policy, the political authorities must look beyond the parameters of their macroeconomic mode to ensure that spending to combat poverty and promote human development increases, and the burden of financing these policies is distributed in a way that helps reduce inequality. They must curtail unproductive spending, particularly military spending, in favor of social outlays. Finally, they must combat corruption and criminal behavior.

Government reform. A condition for the proper integration of every country into the world economy is government’s ability to shoulder the tasks of sovereignty and solidarity. One aspect of responsible management is to reduce potential sources of instability in each country and in the international monetary system as a whole. First of all, a country must ensure that its banking systems are secure and sound. The Mexican crisis demonstrated that countries with weak and inefficient banking systems are more vulnerable to contagion and less able to manage the effects of volatile capital flows and exchange rate pressures. In addition, the spillover effects in some Latin American countries showed how weak banking systems can magnify and prolong the effects of such crises on other economies.

The supervisory authorities in the major industrial countries have long been aware of such risks, and in recent years considerable progress has been made in strengthening bank regulation and supervision in the Group often (G-10) industrial countries. There is now widespread agreement, said Camdessus, that these improvements need to be extended worldwide. The dissemination of a clear set of internationally accepted standards could provide the basis for the regulation and supervision of banking systems around the world.

Camdessus said he believed that a new initiative is called for and that the IMF, because of its legitimacy and universal responsibility for surveillance, has a role to play in facilitating this globalization of standards for bank supervision developed in Basle and put in practice in the G-10 countries.

In an era characterized by massive flows of goods and capital, disorderly exchange rates can pose another serious obstacle to sustainable global prosperity, Camdessus said. Although the 30-year controversy over how to put in place and maintain a viable exchange rate grid has yet to be resolved, there is one point on which agreement is firm and unanimous: the first two conditions for stabilization are the soundness of macroeconomic and monetary policies in the G-7 countries and the quality of G-7 cooperation.

The G-7 countries must therefore consolidate the major parameters of their respective economies. The IMF works closely with G-7 countries in their mutual surveillance and their efforts to coordinate macroeconomic and monetary policies. What happens when, despite these efforts, exchange rates deviate from their so-called zones of plausibility? Camdessus said he favored enhanced cooperation along the now largely abandoned trajectory of the Plaza and Louvre accords. He was heartened, therefore, by the discreet and remarkably successful cooperation among the G-7 last spring and summer when coordinated economic policy and some appropriate signals to the markets enabled the seven countries to restore a much more reasonable constellation of exchange rates. There can be no doubt, he said, that exchange rate stability can be greatly enhanced if the major countries take to heart their responsibilities as the issuers of reserve currencies. The next stage in renewing the international monetary system will be largely dominated by the most important and most promising monetary development in the post-Bretton Woods period—the advent of the euro.

Solidarity. A keener sense of responsibility in the conduct of internal affairs in every country is the first, and most essential, step toward solidarity in a world where the success or failure of one country has such a pronounced impact on its neighbors, said Camdessus. For solidarity to be practiced more effectively, slippages in three areas need to be contained:

Development assistance. Official development assistance has been stagnant for many years at half the United Nations target of 0.7 percent of GDP, and it is now dwindling. Many advanced countries—using the fallacious alibi of budgetary savings—are making cuts in their development assistance budgets. This slippage and so-called donor fatigue must be vigorously combated if the international community is to steer the world away from the crises that extreme poverty will engender. At the same time, developing countries must remain keenly aware of their duty to manage the donor funds available to them in an exemplary manner.

Assistance to countries in transition to market-based economies. Aiding the economic transformation in the countries of Eastern Europe is a major task for the end of the century, Camdessus said. These economies are taking off again, and governments are working to develop strategies that the IMF supports as best it can. The indicators are positive, but social and political tensions remain high, and these countries require support from the developed world.

Constructive support of multilateral institutions. The international institutions must be provided with the means to carry out their tasks. How, asked Camdessus, can we call on the United Nations [UN] to spearhead human development when members’ arrears on their dues have driven it into bankruptcy? How can the World Bank retain its major role in the fight against poverty and development if support for IDA [International Development Association] is maintained on a downward path? As for the IMF, the institution is seeking to mobilize all its resources prudently—including its gold—so as to be able to play its role, including that of supplier of balance of payments support for the poorest countries. Camdessus underscored the importance of efforts to put the IMF’s ESAF on a self-sustaining basis, both to allow the IMF to fulfill this role and to finance the IMF’s participation in the joint debt initiative with the World Bank [see page 229].

Aid resources are not limitless, Camdessus acknowledged. It thus makes sense to concentrate scarce concessional resources in countries where they will be put to most effective use. Countries seeking international assistance need to do their utmost to establish a domestic policy environment in which this assistance can be used productively. Those countries that ensure law and order, provide reliable public services, establish a simple, transparent regulatory system that is equitably enforced, guarantee the professionalism and independence of the judiciary, and integrate themselves pragmatically and openly into regional groupings will win the race for development.

The IMF has a role to play in facilitating the globalization of standards for bank supervision.

Imaginative Approach to Change. The G-7 must show itself capable of change in every area, said Camdessus. He suggested a few themes:

Government reform. The volume of available technical assistance resources is insufficient and current methods are ill-suited, especially when a government is crumbling. The kind of assistance to be provided in such efforts must be reinvented.

Role of the private sector and non-government organizations. It is recognized that these entities have a role in development, and a way must be found to share this responsibility constructively.

The role of the UN. The ongoing reform of the UN is proceeding in the worst way, prompted by the “empty purse” and the risk of bankruptcy. Would it not be more reasonable, Camdessus asked, for the economic and social responsibilities of the UN to be fashioned into the fourth social and humanitarian pillar of the system, whose other pillars are the IMF, the World Bank, and the World Trade Organization [WTO]?

Worldwide representation. At a time when globalization is advancing so rapidly, we need to find suitable structures through which the formulation of global economic strategies can be improved. It has frequently been said that there is a need for a forum in which all countries are represented in accordance with rules they recognize as legitimate and where they might be supported by a secretariat of acknowledged professionalism and integrity. The Interim Committee of the IMF already fulfills this role, at least in part, and has all the means necessary to carry it out more fully. We are trying to ensure that it does so, while cooperating increasingly with other institutions such as the ILO [International Labor Organization], the WTO, etc., so that leaders broaden their vision beyond the macroeconomic and incorporate social, trade-related, and other dimensions.

But it may not be prudent to turn over the fate of the global economy to the world’s Ministers of Finance, Camdessus observed. In his view, it would be good to seek out opportunities in which the elected leaders of the peoples of the world would meet to examine the major strategic choices of this shared management. The invitation of the four heads of international institutions to the Lyons Summit for almost half a day is perhaps a step in that direction.

Group of Seven Summit in Lyons: G-7 Communiqué Calls for Stronger Cooperation

Since the last meeting in Halifax, economic developments in the Group of Seven (G-7) have been positive on the whole and disparities in economic performance have been narrowing, according to the G-7 economic communique issued in Lyons on June 28. Outside the G-7 sphere, the adoption of sound macroeconomic policies and progress toward market-based institutions have contributed to improved economic performance in many developing countries and countries in transition.

Summit participants observed that better prudential regulation and supervision in the financial markets constituted an essential element in preserving the stability of the international monetary system. To achieve further progress, the G-7 endorsed the following actions:

• enhanced cooperation among the authorities responsible for the supervision of internationally active financial institutions;

• stronger risk management and improved transparency in the markets and connected activities; and

• adoption of stronger prudential standards in emerging economies and increased cooperation with their supervisory authorities.

Summit participants noted that the increased integration of global capital markets, as well as changes in the magnitude and composition of financial flows and the increased diversity and number of creditors and borrowers presented new opportunities and challenges. To promote monetary stability, a number of measures were proposed at Halifax [in 1995] to strengthen the ability of the international financial system—notably the role of the IMF—to respond to these challenges. Summit participants accordingly:

• welcomed the agreement reached on a framework for doubling the resources currently available to the IMF under the General Arrangements to Borrow;

• indicated that the IMF should remain a quota-based institution that provides resources to accomplish its traditional tasks and requested that the eleventh quota review be completed as soon as possible; and

• indicated that the IMF should continue to reflect on the role of the special drawing right (SDR) within the international monetary system.

Efforts to streamline the operation of the international financial institutions had intensified over the past year, according to the G-7 communiqué. The World Bank and the IMF are cooperating closely, with tangible results.

The G-7 communiqué expressed a commitment to a continuation of the enhanced structural adjustment facility (ESAF) as the centerpiece of the IMF’s support for the poorest countries. The G-7 welcomed IMF Managing Director Michel Camdessus’s proposals for greater concessionality in ESAF lending for a limited number of poor and highly indebted countries as the IMF’s contribution to putting them in a sustainable position. Participants indicated their readiness to examine constructively and positively the options for financing the needed subsidies, using primarily resources held by the IMF, without excluding bilateral contributions. If necessary, the IMF should consider optimizing its reserves management to facilitate the financing of the ESAF.

Photo Credits: Padraic Hughes for the IMF, pages 229 and 231.

The G-7 welcomed the progress achieved in the alleviation of debt problems and the Paris Club’s active implementation of the Naples terms for stock-of-debt reduction. For some heavily indebted poor countries, however, participants acknowledged the need for additional actions to reduce debts owed to multilateral institutions and other bilateral creditors that are not members of the Paris Club. Citing proposals developed by the Bretton Woods institutions, participants looked forward to a concrete solution to this problem by next fall at the latest. Among the chief items to be included in a debt relief initiative were the following:

• an exit from unsustainable debt positions, based on a case-by-case approach adapted to the specific situation of each indebted country; and

• continuation of the ESAF to provide the basis for a reduction in the burden of debt to the IMF for eligible countries.

Summit participants expressed support for Ukraine’s efforts to continue with political and economic reforms and its further integration into the world economy. They welcomed the latest agreement with the IMF and encouraged Ukraine to implement fully the agreed reform program.

The G-7 also supported Russia’s ongoing political reform and its commitment to democracy. Their communique welcomed the agreement between the Russian authorities and the IMF on an extended Fund facility arrangement. This arrangement testifies to Russia’s continued commitment to financial stabilization and economic reform.

Globalization Requires Attention to Social Dimension, Says Camdessus

Following is a summary of remarks by IMF Managing Director Michel Camdessus at the sixteenth world conference of the International Confederation of Free Trade Unions, in Brussels, on June 26.

The IMF and the world’s trade unions have a common objective, Camdessus said: to reduce unemployment and poverty and, in so doing, minimize the risks of globalization and maximize its positive potential.

Camdessus emphasized that globalization has a number of positive aspects. The movement to lower trade barriers and open trade has undoubtedly increased incomes and raised standards of living globally, though not for each individual. It is clear that the countries that have entered thoroughly and enthusiastically into this freeing of trade have gained the most, and the whole world has benefited from their gains. Without the buoyant activity of about forty developing countries that have accepted the discipline of an open economy, the entire world would have experienced a true recession in 1991–93, when a number of major industrial countries experienced recession.

The explosion of trade has also created new industries and, frequently, better paid jobs, while foreign investment has become increasingly important in the creation of jobs and improvement of living standards in developing countries. Although some see dangers in this, foreign investment is only volatile if it is under threat. Under a well-defined legal system and sound economic policies, investment will remain and expand. This unsurprising fact puts the onus on governments to behave responsibly.

The negative aspects of globalization, Camdessus said, may be encapsulated in the twin evils of exclusion for individuals and marginalization for countries. He listed several frequently cited—often erroneous—explanations for poverty and global unemployment and stressed that each could be addressed:

Structural unemployment. A commonly expressed fear of the global labor market is that it allows extremely low-paid workers in developing countries to undercut the wages of less-skilled workers in developed countries. This phenomenon is not exclusively related to an excessive globalization of trade but rather to production changes in both industrial and developing countries. Trade unions have a role to play in helping workers retrain and ensuring that social entitlements are maintained at an adequate level and pensions are transferable.

Low growth in developed countries. Raising growth rates to sustainable levels and reducing financial instability could help arrest the decline in the willingness of firms to invest and employ more workers. Better international cooperation in macroeconomic policy design and structural policy reform might help achieve this.

Technology. The speed of technological change contributes to an increasing feeling of insecurity, even among the fully employed. Society reaps the benefits of technology, but has the corresponding responsibility to ease the adaptations required through better education and job training, so as to ensure workers’ continued “employability.”

Structural adjustment. Structural adjustment and globalization, Camdessus emphasized, far from being the main sources of unemployment, can be taken advantage of in a strategy for better growth and employment. There are, of course, human costs of adjustment, he said, but nothing causes higher human costs than the refusal to adjust, as it leads, sooner or later, to the collapse of economies and societies. Structural adjustment programs, such as those promoted by the IMF and the World Bank, applied with perseverance can contribute to improving living standards. But structural adjustment cannot automatically bring about such improvement nor can an economic model alone prevent the major plagues infecting our societies from spreading: the growing distortions in the distribution of income at the expense of the poorest, risks of growing poverty, corruption and criminality, the risks to the environment, and cultural differences. What economic models cannot deliver, it is the imperative task of governments to provide; and no government will accomplish this task except under the pressure of public opinion, particularly the permanent pressure of strong trade unions in the framework of a tripartite dialogue and within the context of strengthened international cooperation.

Linking the Three Hands

The IMF’s general response to this “panoply of problems,” Camdessus said, has not been to give the exclusive and final word to the markets. To Adam Smith’s “invisible hand” must be added a second and not so invisible hand—that of justice guaranteed by the state. This sets the framework under which markets can work reliably and efficiently, including the rules governing workers’ rights. Among the responsibilities of the state is the establishment of an independent and objective judiciary and the proper macroeconomic framework to optimize growth potential.

Finally, Camdessus said, there is a third hand—the hand of social solidarity. This hand has a national dimension—the responsibility to help promote fair income transfers from the rich to the poor, the healthy to the sick, and the employed to the unemployed; and an international dimension—through monetary cooperation, development aid, and aid to countries in transition to market systems.

The IMF seeks to ensure that the three hands work together. At the national level, the IMF recognizes the social costs of adjustment and works with the authorities to review the budgetary provisions for social transfers to protect the most vulnerable members of society. At the international level, and particularly in Africa, the IMF works to design and put in place effective instruments to help the poorest—for instance, by putting on a permanent footing its instrument for making loans at an interest rate of 0.5 percent, and, together with the World Bank, by finding a way to help reduce the burden of multilateral debt. But in order to ensure that the international contribution is sufficient to maintain the risks of marginalization, the IMF needs the active support of the world’s free trade unions.

The key point, Camdessus said, is that the three hands must be interlinked. A harmonious society requires the appropriate degree of emphasis on the market mechanism, the role of the state, and internal and external solidarity. Within this framework, the tripartite dialogue between employees, employers, and government now faces new challenges stemming from globalization.

Markets are ruthless, Camdessus concluded, and will vigorously challenge those who do not adapt. The world’s common good will be greatly helped by unions using their strength and their place at the table to help workers adapt and to engage employers and governments in dialogue to ensure that those who are unemployed through structural change are helped to retrain, to find new jobs, and to carry their entitlements from job to job.

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96/44: Inflation Targeting in the United Kingdom: Information Content of Financial and Monetary Variables

96/45: Taxation and Unemployment

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No. 47: Luxembourg

No. 48: Luxembourg (Appendix)

No. 49: Belize

No. 50: Trinidad and Tobago

No. 51: Uganda

No. 52: Ethiopia

No. 53: Brunei Darussalam

No. 54: Lao PDR

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No. 56: Spain

No. 57: Spain (Appendix)

No. 58: Dominican Republic

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No. 138: Aftermath of the CFA Franc Devaluation

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From the Executive Board

CFA Franc Countries: Article VIII

In a concerted action, the governments of Benin, Burkina Faso, Cameroon, Chad, the Congo, Côte d’Ivoire, Equatorial Guinea, Gabon, Mali, Niger, Senegal, and Togo formally notified the IMF that they have accepted the obligations of Article VIII, Sections 2, 3, and 4 of the IMF Articles of Agreement, effective June 1, 1996. IMF members that accept Article VIII obligations undertake to refrain from imposing restrictions on making payments and transfers for current international transactions or from engaging in discriminatory or multiple currency practices without IMF approval. A total of 128 countries have now assumed Article VIII status.

As the IMF states in its Articles of Agreement, two of its goals are to facilitate the expansion and balanced growth of international trade and thereby contribute to the promotion and maintenance of high levels of employment and real income; and to assist in the establishment of a multilateral system of payments in respect of current transactions between IMF members. To achieve these objectives, the IMF exercises firm surveillance over the exchange rate policies of its members, and oversees the elimination of exchange restrictions that hamper the growth of world trade.

By accepting the obligations of Article VIII, member countries assure the international community that they will pursue sound economic policies that will obviate the need to use restrictions on making payments and transfers for current international transactions, and thereby contribute to a multilateral payments system free of restrictions.

Press Release No. 96/34, June 25

CFA Franc Countries Assuming Article VIII Status

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Algeria: CCFF

The IMF approved a credit for Algeria equivalent to SDR 174.6 million (about $252 million) under the compensatory and contingency financing facility (CCFF). The drawing relates to an excess in the cost of cereal imports during the period July 1995-June 1996, reflecting the exceptional increases in world grain prices that have been taking place over the last year.

Algeria joined the IMF on September 26, 1963; its quota in the IMF is SDR 914.4 million (about $1.3 billion); and its outstanding use of IMF credit currently totals SDR 1.1 billion (about $1.6 billion).

Press Release, No. 96/35, June 26

Congo: ESAF

The IMF approved a three-year loan for the Congo under the enhanced structural adjustment facility (ESAF) equivalent to SDR 69.5 million (about $100 million) to support the government’s economic reform program for 1996-99. The first annual loan, equivalent to SDR 27.8 million (about $40 million), will be disbursed in two equal semiannual installments, the first of which will be available on July 15, 1996.

The Congo’s economic performance has improved substantially since mid-1994, as the authorities tightened fiscal, income, and credit policies to support the devaluation of the CFA franc. They also sought to increase the economy’s ability to respond to the improved structure of relative prices by initiating or implementing a broad range of structural reforms in the oil, financial, and public enterprise sectors, as well as by improving the legal framework. The government’s management capacity has been strengthened; the primary budget balance improved by more than 11 percentage points of GDP between 1993 and 1995; and civil service salaries and employment have been brought to more manageable levels. As a result, inflation has been brought back to low levels, and real non-oil GDP recovered modestly in 1995, after a large decline in 1994.

Medium-Term Strategy And 1996/97 Program

The main objectives of the medium-term program are to accelerate output and employment growth, attain sustainable fiscal and external positions by the end of the decade, and achieve external public debt sustainability over the long term. The main macroeconomic objectives for the 1996-99 program supported by the ESAF loans are to achieve an average annual real GDP growth rate of more than 6 percent; cut end-period inflation from 5.5 percent in 1995 to 2 percent during 1997–99; and reduce the external current account deficit, excluding official transfers, from about 25 percent of GDP in 1995 to about 11 percent by 1999.

Within this medium-term strategy, the first annual program, which covers the period April 1996-March 1997, aims at accelerating real GDP growth to 6 percent in 1996 and 9.5 percent in 1997; lowering inflation to 3 percent in 1996 and 2 percent in 1997; and reducing the external current account deficit to about 22 percent of GDP in 1996 and to about 15 percent in 1997. To achieve these objectives, the 1996 budget calls for a virtual doubling of the primary surplus to almost 12 percent of GDP, encompassing both an increase in revenue and a decline in spending. On the revenue side, the oil sector reforms and a projected increase in oil output are expected to raise government oil receipts from 13 percent of GDP in 1995 to 15.1 percent of GDP in 1996, and non-oil revenue is projected to increase from the equivalent of 11.8 percent of GDP in 1995 to 13.6 percent of GDP in 1996, through tax reforms, a broadening of the tax base, and a further strengthening of tax administration. On the expenditure side, non-interest expenditure will be reduced from 31.4 percent of GDP in 1995 to 29.5 percent of GDP in 1996, by reducing the civil service wage bill. Monetary policy by the regional central bank will continue to be directed at validating the parity of the CFA franc vis-à-vis the French franc. The rehabilitation of the banking system is a major objective of the authorities in the period ahead.

Congo: Selected Economic Indicators

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Program projections.

Data: Congolese authorities and IMF staff estimates

Structural Reforms

To unlock the Congo’s growth potential in the non-oil sector and to stimulate the development of the private sector, the program entails, besides reforms in the civil service and the financial sector, a front-loaded range of reforms in the public enterprise sector and a further liberalization of the legal and institutional framework. Civil service reforms are expected to enhance the effectiveness of the central administration, and together with the emphasis on decentralization, should strengthen the provision of government services at the regional level and help reverse migration to urban areas.

The public enterprise reforms are aimed at dismantling monopolies and divesting the state from directly productive activities, thus opening up opportunities for private sector expansion; improving the provision and lowering the cost of key services (for example, electricity, water, telecommunications, and transportation); and reducing the potential financial drain on the budget. The reform program focuses on the outright privatization, or the privatization of the management and operations, of the six largest public enterprises.

Addressing Social Costs

Under the program, a number of measures will be taken to alleviate the impact of adjustment on vulnerable groups, such as the retrenched public sector employees, the unemployed, and the poor. These measures will include the payment of severance benefits, the resumption of the regular payment of retirement and other social security benefits, assistance in finding new employment, and the improvement of agricultural support services. More broadly, the government is committed to fighting poverty in all its forms; to this end, outlays on the social sectors will be raised substantially, both in real terms and as a proportion of total expenditure, starting with the budget for 1997.

Executive Directors Visit Middle East to View Economic Reform in Progress

To give members of the IMF’s Executive Board a first-hand view of the economic situation in member countries, the policy challenges facing the authorities (including political and social constraints), and the macroeconomic and structural policies being pursued, a group of six Executive Directors and Alternates visited Egypt, the Republic of Yemen, and Jordan in late June. Participants in the group visit were A. Shakour Shaalan, host Director and Executive Director for the constituency including Egypt, Jordan, and Yemen; Alberto Calderón (Colombia); Ian Clark (Canada); Karin Lissakers (United States); Hachiro Mesaki (Japan); and Jon Shields (United Kingdom).

The trip was the first in a pilot program in which two groups of Executive Directors and Alternates will visit countries other than those in their own constituencies. The program is intended to provide the members of the Executive Board—the IMF’s decision-making body, representing all 181 member countries—with close-up views of the challenges of economic adjustment policies and their various effects. In this way, Executive Directors broaden their understanding of member countries, enhancing their participation in Board discussions on country items relating to IMF surveillance and members’ requests for financial support. Although the visiting Executive Directors do not engage in negotiations, such contacts can enhance countries’ awareness of the role of the Executive Board. In the course of the visit, Directors met with government officials, members of the private sector, legislative bodies, employer and employee organizations, other nongovernmental organizations, and the media. Ian Clark, who coordinated this first visit, noted that each of the participating Directors had learned a great deal from the experience. A report on the visit is scheduled to be made to the Executive Board in July.

The Challenge Ahead

With appropriate policies and debt relief, the Congo’s balance of payments position and external public debt outlook should improve significantly over the medium and long term. However, even after taking into account expected disbursements from bilateral and multilateral creditors, the Congo will face a large financing gap in 1996 and relatively smaller and gradually declining gaps in subsequent years. Therefore, sustained policy implementation will be imperative for achieving the medium-term program objectives and securing adequate external financial assistance.

The Congo joined the IMF on July 10, 1963. Its quota is SDR 57.9 million (about $84 million). Its outstanding use of IMF credit currently totals SDR 12.5 million (about $18 million).

Press Release No. 96/36, June 28

Economic Forum Highlights Need to Tackle Unsustainable Fiscal Deficits

Over the past two decades, public debt has reached unsustainable levels in a growing number of industrial countries. This development and its results—higher interest rates, lower investment, and slower growth in living standards—have stimulated efforts by policymakers to find solutions to swollen budget deficits.

Because fiscal policy is central to the economic challenges facing most countries, a recent IMF Economic Forum was held to explore fiscal challenges in industrial and transition economies and to suggest means for addressing them. The presentations made at the forum were based in part on research and analysis contained in the IMF’s May 1996 World Economic Outlook. Moderated by Graham Hacche, Chief of the World Economic Studies Division in the IMF’s Research Department, the seminar included as participants Alberto Alesina of Harvard University, Robert Wescott of the IMF’s Research Department, and Henri Lorie of the IMF’s European II Department.

Selected IMF Rates

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The SDR interest rate, and the rate of remuneration, are equal to a weighted average of interest rates on specified short-term domestic obligations in the money markets of the five countries whose currencies constitute the SDR valuation basket (the U.S. dollar, weighted 39 percent; deutsche mark, 21 percent: Japanese yen, 18 percent; French franc, 11 percent; and U.K. pound, 11 percent). The rate of remuneration is the rate of return on members’ remunerated reserve tranche positions. The rate of charge, a proportion (currently 109.4 percent) of the SDR interest rate, is the cost of using the IMF’s financial resources. All three rates are computed each Friday for the following week. The basic rates of remuneration and charge are further adjusted to reflect burden-sharing arrangements. For the latest rates, call (202) 623-7171.

Data: IMF Treasurer’s Department

Fiscal Problems of Industrial Countries

Alberto Alesina listed three main fiscal trends at work in the industrial countries since the early 1970s: deficits have grown dramatically; variations among them are large; and the structure of expenditure has shifted from public consumption to transfer and entitlement programs.

Conventional theories, such as Keynesian models of demand management, have failed to shed adequate light on the underlying causes and consequences of fiscal deficits, said Alesina. The gap has been partially filled, however, by a new body of theory that focuses greater attention on political and institutional variables. Alesina observed, for example, that game theoretic models of “distribution conflict” can deepen understanding of the budgetary dynamics surrounding coalition and single party governments in industrial countries. Narrowing the focus to the United States, he noted that new theories of legislative-executive conflict may ultimately provide useful guideposts for proponents of budgetary reform.

Ballooning public debt in industrial countries has reached critical proportions, said Robert Wescott, and action to reverse this trend is long overdue. Taking issue with some observers who dismiss the importance of persistently large budget deficits, he said that such dissaving lowers national saving and future living standards. Larger budget deficits and higher levels of public debt, Westcott added, also weaken investment and undermine long-term growth prospects. Wescott suggested that the run-up in industrial country public debt over the past fifteen years had increased global interest rates by 100–250 basis points.

Drawing on data contained in the May 1996 World Economic Outlook, Wescott noted that:

• The big shift in industrial country fiscal positions took place in the mid-1970s. Until then, government revenues and expenditures roughly kept pace with each other; beginning with the first oil crisis in the mid-1970s, the fiscal positions of most industrial countries began to worsen—widening dramatically after 1980.

• These shifts in fiscal fortune do not appear to be the result of declining revenues. The ratio of revenue to GDP has increased for nearly every industrial country over the past couple of decades—rising for the group as a whole to 44 percent in 1994 from 28 percent in 1960. Rather, modern fiscal imbalances stem from an even more dramatic jump in expenditures over this period—to 50 percent of GDP in 1994 from 28 percent in 1960.

• While public consumption has also increased, the larger growth in government expenditure, Wescott said, is attributable to rising transfers (including public pensions), subsidies, and interest payments. By 1992, expenditure on the first two categories nearly tripled to 21 percent of GDP from 8 percent in 1960. Such payments, for example, now account for roughly one third of GDP in France, Italy, Norway, and Sweden.

• The “peace dividend” has not offset these trends. Defense budgets, especially in the United States, have been cut noticeably over the past decade, but the average savings derived from these reductions have amounted to about 1 percent of GDP; the peace dividend has been more than absorbed by the increase in transfer payments.

• As a result of growing imbalances between expenditures and revenues, public debt has increased sharply in relation to GDP in almost all industrial countries—rising for the group as a whole to 70 percent in 1995 from 40 percent in 1980. Most of these countries—including Belgium, Canada, Denmark, France, Germany, Japan, the Netherlands, Sweden, and the United States—experienced roughly a doubling of their gross public debt ratios over this period, while Greece and Italy had gross debt ratios near or over 100 percent of GDP by 1995.

• The fiscal situation in industrial countries becomes more serious when budget estimates take into account unfunded liabilities of public pensions. With the expected aging of industrial countries’ populations, there will be more elderly people to support, a smaller share of the population to work and pay taxes on labor income, and much higher medical bills that most governments have promised to fund. When these future liabilities, together with likely future tax revenues, are taken into account, the budget prospects of industrial countries look dramatically worse. This is sometimes referred to as the invisible debt problem.

Policy Alternatives. Until recently, efforts to reform fiscal policy were hampered by policymakers’ adherence to the Keynesian argument that the presumed impact of lower government purchases or high taxes depressed aggregate demand, income, and output, said Wescott. But is this actually the case? Contemporary analyses focusing on “expectations” effects indicate, however, that far from impeding economic activity, effective fiscal adjustment might instead stimulate it. In support of this argument, Wescott provided the following summary of a study, carried out under IMF auspices, that analyzed fiscal adjustment experiences across a wide range of industrial countries over a 25-year period:

Consolidation and growth. Tight fiscal consolidation efforts need not trigger a recession. A number of countries have experienced positive growth both during and following needed fiscal contraction.

Industrial countries’ fiscal situation is more serious when budget estimates include unfunded pension liabilities.

Transmission mechanisms. Confidence effects—a result of successful deficit reduction—appear to lower long-term interest rates, thereby creating a virtuous circle between economic growth and fiscal adjustment.

Moreover, if growth can be maintained through lower interest rates, fiscal tightening is more likely to stimulate a declining ratio of debt to GDP.

Size of consolidation. Ambitious fiscal consolidation efforts are more likely to be successful than modest ones. To ensure permanent spending reductions, however, caps should be placed on overall government expenditure.

Composition of consolidation. Long-term fiscal viability is more likely to result from spending reductions than from tax increases. This can best be achieved through cuts in the government wage bill, other government consumption, and transfer payments.

The global environment. It is better to undertake fiscal adjustment in a buoyant global environment. Even so, there are only a handful of years when the world economy would have exerted a significantly negative effect on fiscal consolidation efforts.

Certain factors that one might have expected to play important roles in fiscal consolidation ended up playing little, if any, role. For example, real exchange rate movements did not appear to figure prominently in successful cases of fiscal consolidation.

Fiscal Adjustment in Transition Economies

Transition economies have recently made impressive strides toward reducing fiscal imbalances, said Henri Lorie. Focusing on the Baltic countries, Russia, and the other countries of the former Soviet Union, he noted that cuts in cash expenditure had brought about a decline in fiscal deficits for the region as a whole to about 4 percent of GDP in 1995 from 10 percent in 1994 on average. This was mainly the result of large reductions in enterprise subsidies, military spending, and capital expenditures. Despite these spending cuts, however, outlays for social services (such as schools and hospitals) and social security have remained relatively stable, relative to GDP. Over the same period, general government expenditures fell on average to 30 percent of GDP from 38 percent.

Future Challenges. While the Baltic countries, Russia, and the other countries of the former Soviet Union have made solid progress over the past few years toward fiscal consolidation, macroeconomic stabilization will require additional reductions in inflation and successful implementation of the following:

Structural reform. In many cases, the restructuring of enterprises and the financial system has just begun. An environment conducive to restructuring and economic growth requires further structural reform of the tax system, and especially the public expenditure system. In removing barriers to market forces, scarce financial resources could be made available for needed investment.


Major Industrial Countries: Revenues and Expenditures

(In percent of GDP, all countries with equal weight)

Citation: IMF Survey 25, 001; 10.5089/9781451937442.023.A014

Data: 1964-76 data from OECD, Historical Statistics 1960-93 (Paris, 1995); 1977-94 data from OECD, Economic Outlook (Paris, December 1995).

Improved revenue collection. Weak administrative structures have inadvertently encouraged lax tax collection practices throughout the region. This, in turn, has led to a proliferation of tax loopholes and exemptions that hinder revenue collection, and to a resulting loss of equity and efficiency, as the tax burden on those who comply with the law remains high. To enhance revenue mobilization and economic efficiency, Lorie called for a broadening of the tax base to include the private sector and enhanced efforts to reduce tax evasion.

Political leadership. The ultimate success of fiscal policy reform in the Baltic countries, Russia, and the other countries of the former Soviet Union, however, may rest as much on political as on economic leadership, Lorie observed. Despite obvious incentives to placate the public, pressures to achieve fiscal consolidation cannot ultimately be resisted, he explained. Instead of waiting for public reaction, governments should be encouraged to make hard choices at the outset and should declare their own spending priorities—what should be retained, and what should be eliminated—before the budget is implemented.

The continued need for fiscal consolidation reflects the paramount importance of a more balanced policy mix conducive to stronger sustained growth in both the industrial countries and the economies in transition. For the industrial countries, the main challenge is to make adequate progress toward budgetary consolidation, particularly on the expenditure side; such a step is preferable to tax increases, as Wescott noted earlier.

In this connection, the biggest challenge will be to arrest—if not reverse—the growth in entitlement spending and transfers, as well as to address the challenge of unfunded pension liabilities.

The transition economies, alternatively, must take action on both the spending and revenue sides of the ledger. In addition, greater political leadership of the reform process will be necessary—especially in formulating long-term fiscal adjustment policies.

David M. Cheney, Editor

Sara Kane • John Starrels

Senior Editors

Sheila Meehan

Assistant Editor

Sharon Metzger

Editorial Assistant

Lijun Li

Staff Assistant

Philip Torsani

Art Editor

In-Ok Yoon

Graphic Artist

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