The Importance of Composition

The composition of a fiscal consolidation may well be the most influential element of an adjustment effort, according to Alesina’ and Perotti, who base their conclusions on the experience of 20 industrial countries during 1960–94. Fiscal adjustments that rely primarily on spending cuts on transfers and the government wage bill have a better chance of being successful and may also generate growth. Fiscal adjustments relying primarily on tax increases and cuts in public investment, on the other hand, tend not to last and, moreover, to inhibit growth.

Tax increases and spending cuts can have different effects on the success of a consolidation effort, but, as Alesina and Perotti show, the composition of spending cuts themselves can have an important influence on the permanence of the fiscal adjustment and on its macroeconomic consequences.

• Expectation Effect. Different types of cuts may be more or less permanent. A reduction in public investment—for instance, in maintaining public infrastructures—will have a shorter-lived effect than cuts in welfare obtained by changes in eligibility criteria and government employment. The maintenance of public infrastructure cannot be postponed forever, but structural changes in the parameters that determine coverage of the welfare state can have long-lasting effects.

• Political Credibility Effect. Governments willing to tackle the politically more delicate components of the budget—public employment, social security, welfare programs—can signal that they are serious about fiscal adjustment.

• Labor Market Effect. Cuts in government employment shift the aggregate demand facing labor unions. This improves productivity through a fall in unit labor costs and a depreciation of the exchange rate in a flexible exchange system. But a cut in nonwage government spending does not have these effects, because the private and public sectors will continue to spend on the goods and services included under non-wage government consumption.

Success Linked to Composition. Concentrating on periods of tight fiscal policy, Alesina and Perotti examine data charting the fiscal adjustment efforts of 20 industrial countries during 1960–94. Tight fiscal policy is deemed successful if three years after the tight period, the ratio of the cyclically adjusted primary deficit to GDP is at least 2 percent—and the debt-to-GDP ratio is 5 percent—below the last year of the tight period.

Although the contractions in successful adjustments tended to be slightly larger than the unsuccessful ones, the more striking differences appeared in the composition. In successful cases, 73 percent of the adjustment was on the spending side, compared with 44 percent in the unsuccessful cases.

Even more striking were the differences in composition of different types of spending and sources of revenue. In unsuccessful cases, more than two-thirds of the cuts fell on capital spending, while everything else—particularly government wages—was virtually untouched. Policymakers tend to find capital spending cuts more politically palatable, Alesina and Perotti suggest, because the effects of cuts in public investment—such as postponing maintenance of infrastructure or delaying new capital projects—are less immediately visible to voters than cuts in their salaries or pension checks.

In striking contrast, only one-fifth of total spending cuts in successful adjustment efforts fell on public investment. But the critical difference is that the successful adjustments depend on broad-based spending cuts that do not spare the most politically sensitive parts of the budget—namely, transfers, social security, and government wages and employment; these, in fact, received the largest share of expenditure reductions.

Macroeconomic Consequences. The economies of those countries carrying out successful fiscal adjustment tended to perform far more favorably than those whose efforts were unsuccessful, according to Alesina and Perotti:

• GDP growth was more than 1 percent above the Group of 7 (G-7) industrial country average during successful adjustments; afterward, growth fell but was still higher than the G-7 average. During and after unsuccessful adjustments, on the other hand, growth remained below the G-7 average.

• Unemployment, relative to the G-7, stayed at about the same level before and after successful adjustments; but after unsuccessful cases, it doubled, from less than 1 percent above the G-7 average to almost 2 percent above it.

• A private investment boom occurred during and after successful adjustments, but the rate of growth of investment fell during and after unsuccessful adjustments.

A Leaner, Meaner Fiscal Future? Policymakers in many industrial countries, Alesina and Perotti assert, do not fully appreciate the importance of composition in formulating their adjustment efforts. This has particularly serious implications for the future of European economic and monetary union. The Maastricht criteria, they say, have shifted discussion of deficit reduction too much toward the simple arithmetic of primary surpluses, deficits, and debt-to-GDP ratios, and away from “how” one cuts deficits to meet these criteria.

For many industrial countries, fiscal adjustment is closely linked to reform of the welfare state, which has become more pressing over the last few decades. Any fiscal adjustment that avoids dealing with the problems of social security, welfare programs, and inflated government bureaucracies, Alesina and Perotti conclude, is doomed to fail.

Policy Directions

In outlining the joint IMF-World Bank debt initiative, Boorman listed six basic principles governing its operation:

• to target overall debt sustainability by focusing on the totality of a country’s external debt;

• to link eligibility to a prior track record of reform and sound policies;

• to build on existing mechanisms, including, the IMF’s enhanced structural adjustment facility (ESAF), the World Bank’s International Development Association (IDA) operations, and mechanisms of the Paris Club and other creditors.

• to ensure that additional efforts to address problem cases are coordinated among all the creditors to ensure a comprehensive resolution of the country’s debt problem;

• to preserve the financial integrity of the institutions and their preferred creditor status; and

• to ensure that new external financing for the countries is on appropriately concessional terms.

There is no specific list of countries qualifying for the new debt initiative, said Boorman. The staffs of the IMF and the World Bank had performed forward-looking analyses of the balance of payments prospects for all heavily indebted low-income countries. From this analysis of 41 countries, 8 were judged to have a clearly unsustainable debt burden, and an additional 12 were seen as “stressed.” To qualify for assistance, a country had to meet two criteria, said Boorman: eligibility for the concessional windows of the IMF and the World Bank, and the existence of an unsustainable debt burden even after the application of traditional debt-relief mechanisms.

From start to finish, a two-stage process was envisaged, during which a country would undertake strong adjustment and reform programs, said Boorman. The first three years, or stage one, would begin with the adoption of an ESAF-supported program by a country. During this period, the country would receive a flow rescheduling on Naples terms from the Paris Club and concessional assistance from relevant bilateral donors and creditors. Following this, if the country’s debt burden remained unsustainable, a second phase would ensue, during and at the end of which the country would receive special assistance to assure the. Sustainability of its external debt position. Countries now undertaking programs with the support of the IMF and the World Bank would be considered already to be at some point within this process. Special assistance would be provided to the qualifying countries to help them service their obligations to the IMF in a manner that reduced the present value of its claims on them, Boorman stated. IMF assistance would be made available through long-term highly concessional loans or, in some cases, outright grants. All the major creditors had committed themselves to this operation, said Boorman.

Making It Work

From an African perspective, the new debt initiative was a welcome step forward, said Amoako. By pushing the issue of unsustainable debt to center stage, the international community had committed itself to helping those heavily indebted poor countries for which traditional debt-relief mechanisms had proven inadequate. Amoako also welcomed the initiative’s integrated and coordinated focus on debt reduction covering all creditors and the support for continued financing of basic health and social services.

Implementing the initiative would pose important challenges to the donor community, said Amoako. Efforts should be made to ensure that qualifying countries are provided with adequate financing at the outset. The IMF and the World Bank should also be prepared to render appropriate technical support in the development of those necessary institutions for effective implementation of reform and adjustment programs. Financing provisions of the initiative also concerned Amoako. Translating the agreed minutes of previous Paris Club meetings into actual bilateral debt restructuring agreements had frequently been protracted, he observed. Might similar problems hinder implementation of the current initiative?

While the current arrangement was not the comprehensive, multilateral debt facility that some had called for, it now enjoyed the full support of the international community and should be promptly implemented, said Gwin. To realize its agenda, however, the international community will need to clear up remaining ambiguities, especially regarding matters of the eligibility, timetable, and financing for the debt-relief action. If left unresolved, these ambiguities could create disincentives for both investment and policy reform. The immediate question confronting the Bretton Woods institutions was their readiness to accelerate the time frame during which conditional steps would need to be taken to allow the debt-reduction measures to kick in, noted Gwin. In this respect, provisions within the initiative to give credit for time already successfully spent in an adjustment program were encouraging, she said.

Gwin supported the commitment of the IMF and the World Bank to making good policy the ultimate focus of successful debt relief. Unfortunately, this message had not always gotten home to the right audience, she observed. In many instances, the donor community had ignored strong records of economic reform while failing to note the bad ones. To correct the imbalance, Gwin urged donors to insist on greater selectivity in aid provision, more recipient country ownership of adjustment and reform programs, and strengthened implementation capacity in program countries. Flexible implementation would be the key in determining whether the new initiative became the first step in a new era for indebted developing countries toward an orderly transition to reduced aid dependence and more sustainable growth, she said.

Flexibility and sustainability were the major ingredients of the joint IMF-World Bank debt initiative, said Ahmed. The Bretton Woods institutions did not intend to lock recipient countries into an arbitrary framework but to ensure that the program’s principles were applied to each country on a flexible, case-by-case, basis. Further refinements of the initiative should wait until after the first group of countries had gone through the initial period and their experiences assessed.

Agreeing with Boorman, Ahmed said that the ultimate priority of the Bretton Woods institutions was to provide sufficient assistance to ensure the long-run debt viability of the poorer countries. Ahmed underlined the importance of having sound economic policies in place in the poorer countries before starting the initiative. While the requirements of each debtor would be handled in a flexible manner, recipients and creditors should feel “comfortable” with the adjustment program before debt relief was provided. Once this requirement was satisfied, however, the highly exposed poorer countries would require sufficient debt relief to shield them from external shocks. The immediate task, he said, was prompt implementation of the initiative.

In response to a question of whether the IMF and the World Bank had responded rapidly enough to the debt problems of poorer countries, Boorman said he was impressed with the speed with which the international community had agreed on the architecture of the new initiative. He noted the close working relations established over the previous months between staffs of the two institutions. Boorman also discussed the relationship between the new debt initiative and the role of the private sector in developing countries. An environment free of payments crises would help foster the kind of confidence private entrepreneurs needed to commit resources to invest in these countries, he said.

Responding to a question on actions that might be undertaken to foster greater policy credibility in African countries, Gwin said that a major step in the right direction would be to mobilize more intense peer pressure to encourage improved economic performance in countries that qualified for debt relief under the new initiative. Such a step would also help dispel the generally negative investor perception of Africa.

European Union

Michael Mussa, Counsellor and Director of the IMF’s Research Department, maintained that monetary integration would provide European governments with additional leverage to enact sound policies. Mussa expressed concern, however, that the EMU could be the object of a future political backlash if it were to be burdened with the responsibility for reforming. Europe’s fiscal and social policies.

Europe’s support of monetary union was a “stroke of genius” given its mounting fiscal problems, noted Robert Mundell of Columbia University. To combat unemployment, Europe should adopt an ambitious package of structural measures embracing deregulation, lower taxes, denationalization, and privatization, he said. Rudiger Dornbusch of the Massachusetts Institute of Technology and Ronald McKinnon of Stanford University- both maintained that earlier consensus by European central banks on the need for fiscal consolidation and low inflation had promoted the concept of EMU. Flexible entry criteria would make it possible for the monetary union to occur on schedule, predicted Peter Kenen of Princeton University.

General Reform Issues

Robert Bates of Harvard University called upon economists to devote more attention to assessing the structure of political power in industrial countries to help explain the growing readiness of politicians to surrender power to economic technocrats in the service of reform. The key dynamics underlying economic reform were the crucial interactions among demographic change, the stock of usable knowledge, incentive structures, and the institutional framework within which economic life unfolds, maintained Douglass North of Washington University at St: Louis. Dani Rodrik of Columbia University recommended more research on the “distributional consequences” that frequently overwhelm the efficiency gains of reform programs. Allan Meitzer of Carnegie Mellon University criticized the Bretton Woods institutions for their alleged unwillingness to apply conditionality strictly in a number of African countries. Unnecessary delay in carrying out reform, he advised, should be answered by an immediate interruption of disbursements.

Reform in Transition Economies

Padma Desai of Columbia University spoke i on the optimal pace of reform in countries in transition. Bearing in mind the social costs—particularly unemployment—Desai favored faster reform in view of observed rates of higher growth and lower inflation. Privatization had been accompanied by widespread corruption throughout Russia, said Marshall Goldman of Harvard University. This. outcome was largely preordained by the absence of binding rules governing commercial transactions. As a result, privatization had taken place in an environment of widespread rent-seeking activity and routine violations of commercial law, Goldman said. David Kotz of the University of Massachusetts suggested that a weak state was behind Russia’s current economic difficulties. Higher growth and improved living standards depended directly on the state’s ability to reassert control over the economy, he maintained. Similarly, Stanislav Menshikov of Erasmus University in Rotterdam called upon the Russian government to adopt more interventionist policies to ameliorate social inequality.

Government’s Changing Fiscal Role

The government’s fiscal function had become a complex issue in light of an aging and increasingly mobile global workforce throughout the industrial countries, observed Richard Musgrave of Harvard University. The public sector’s fiscal function should be reformed by promoting greater efficiency in the provision of goods and services, said Musgrave, rather than done away with. Richard Wagner of George Mason University disagreed: the time was ripe for a thorough-going reevaluation of government’s fiscal role, he maintained. Citizens, not government, should have the right to determine the content and reach of fiscal policy. Joseph Cordes of George Washington University suggested that the normative theory of fiscal policy—the functions government should perform—could be usefully integrated with public choice discussions on how specific groups push forward competing fiscal agendas.

Vito Tanzi, Director of the IMF’s Fiscal Affairs Department, observed that ideologically based pressures on governments to spend were beginning to abate. The public had learned that many demands for increased spending came from special interests. Changing attitudes toward spending, especially in Europe, had spawned new thinking about the role of the state, he said. Privatization had become the new buzzword. As a result, ideological and technical pressures to curtail public spending are at least as strong as the more traditional ones to increase spending, Tanzi said. This new intellectual climate was ultimately likely to lead to a reduction in the state’s share of spending.

The IMF in Action

Discussing the IMF’s current role, Michael Mussa focused on surveillance activities. He emphasized that IMF member countries are not compelled to accept IMF policy advice. But even sound IMF advice may—and often does—bow to political exigency. Both the quality of IMF advice and its political effectiveness were improving as the analytical and empirical basis for that advice was becoming more broadly accepted, he said.

Discussing IMF-supported programs, Stanley Fischer, First Deputy Managing Director of the IMF, noted that discussions between the IMF and the government of a member country frequently entailed long—at times contentious—negotiations. Although the design of IMF-supported programs remained an “imprecise art,” assessing the effectiveness of such adjustment programs always required a judgment of what further economic deterioration might have occurred in their absence, said Fischer (see box).

Domingo Cavallo, former Argentine Minister of Finance, lauded the IMF for its catalytic role in helping restore stability during the early 1990s. The IMF’s strong endorsement of Argentina’s reform program in the early 1990s was “key” to his country’s subsequent success. But the IMF and Argentina have also had their differences in the areas of tax cuts and the long-term viability of a currency board, noted Cavallo. While its focus on fiscal adjustment was appropriate, the IMF would be equally well advised to stress institutional reforms.

Fischer also delivered remarks prepared by Yegor Gaidar, former Acting Prime Minister of Russia. The IMF’s role in Russia’s reform process had been limited from the outset, according to Gaidar. A major part of the IMF’s difficulties in Russia derived from the collapse of the Soviet Union and political conflict between the national government and parliament—developments over which the IMF had no control. Since 1995, however, the IMF’s effectiveness in support of Russian reform had grown, especially in the monetary and fiscal areas.

John Starrels

Senior Editor, IMF Survey

UN Conference on Environment and Development

The IMF’s work is relevant for the UN Environment and Development Conference (Rio de Janeiro, June 1992), in that it pays due attention to the link between environmental and macro-economic issues, thereby enhancing prospects for sustainable development. Specifically, the IMF helps member countries achieve sustainable macroeconomic and financial stability—a prerequisite for sustainable development; helps low-income countries using its resources to prepare three-year policy frameworks for macroeconomic and structural policies (including environmental policies); and calls attention to the macroeconomic and financial implications of environmental policies in its policy dialogue with its members wherever necessary. The IMF staff helps members design and implement the structural policies—including subsidy and price reform, trade liberalization, and tax reform—that promote more efficient resource use and facilitate sustainable development, including from an environmental standpoint.

The IMF maintains contacts on environment issues with the World Bank and other specialized UN agencies, including the UN Development Program. It also participates in multilateral forums, including the UN Commission for Sustainable Development, the Inter-Agency Task Force on Environment Statistics, the UN Conference on Trade and Development, and in World Trade Organization discussions on trade and environment.

International Conference on Population and Development

The IMF contributes to promoting the action program of the Population and Development Conference (Cairo, September 1994) mainly through its public expenditure analysis and policy advice; in this connection, it encourages countries to reduce unproductive expenditures, thereby freeing domestic resources for basic social and infrastructure spending.

IMF-supported programs—especially as reflected in policy framework papers required for members seeking concessional financing from the enhanced structural adjustment facility (ESAF) for their adjustment programs—have increasingly emphasized the importance of spending on primary health and education services, particularly for girls. Since mid-1995, collaboration with the World Bank on public expenditure policy issues has been intensified through more regular exchange of information and identification of priority areas at the country, regional, and management levels.

World Summit for Social Development

In October 1995, the joint IMF-World Bank Development Committee urged the World Bank and the IMF to work closely with member governments to help improve their public finances, especially by increasing attention to funding social and economic development programs and cutting excessive military spending and unproductive expenditures. Also in October 1995, the Interim Committee, the IMF’s principal policy advisory body, agreed that cooperation between the IMF and the International Labor Organization (ILO) should be strengthened, with a view to better integrating labor market and social protection issues in IMF policy advice and helping ILO staff further integrate in their policy advice to members the IMF’s view on macroeconomic policies and targets for the country.

The IMF has reinforced its activities with respect to issues raised at the Social Summit (Copenhagen, March 1995), specifically in the areas of surveillance, adjustment program design, technical assistance, and analysis of social sector spending. In the design of adjustment programs, it is giving more attention to the composition of expenditure on the social sectors and on labor market policies and to implementing cost-effective social safety nets and reallocating public expenditure to better meet the needs of the poor and vulnerable. The IMF is also continuing to provide technical assistance aimed at helping countries achieve greater budgetary transparency, build institutional capacity to set and implement expenditure priorities, and raise revenues in an efficient manner. And it is increasing its reliance on the World Bank for information, analysis, and policy options regarding social sector spending. The IMF has also strengthened collaboration with other UN agencies at the country level.

Fourth World Conference On Women

The IMF’s contribution to improving the status and quality of life of women over the medium and long term as discussed at the Conference on Women (Beijing, September 1995), is embedded in the IMF’s policy advice to its members. This advice focuses on macroeconomic polices and structural reforms aimed at achieving high-quality growth to bring lasting gains in employment and poverty reduction for all, including women.

Through appropriate design and phasing of policies, IMF-supported programs have aimed at minimizing possible adverse effects on vulnerable groups, including women in rural areas. To mitigate short-term adverse effects of adjustment, members’ IMF-supported adjustment programs have also increasingly sought to protect the poor and vulnerable by incorporating social safety nets. The IMF’s emphasis on low inflation in its policy advice to members is also aimed at protecting lower-income groups, since the poor—many of whom are women—tend to have fixed nominal incomes and hold a large share of their wealth in cash.

The IMF is giving more attention to the composition of spending on social sectors.

The IMF’s policy advice on public expenditure issues, in collaboration with the World Bank, is placing greater emphasis on spending on basic health and education for women. The IMF’s support of liberalized pricing and marketing policies and labor market and financial sector reforms—including the establishment of small-scale rural financial institutions—helps foster private economic activity and thereby provide women with opportunities to participate in economic development.

Other Global Forums

The program of action of the Ninth UN Conference on Trade and Development (April–May 1996) is directly relevant for the IMF, as it focuses partly on interdependence and global economic issues from a trade and development perspective. These include issues stemming from the Uruguay Round of multilateral trade negotiations, such as helping developing countries improve their investment climates to attract foreign direct investment.

The action plan developed at the World Food Summit (Rome, November 1996) has an indirect bearing on the IMF’s primary role as overseer of the international monetary system. The action plan stresses the importance of ensuring a secure and affordable food supply through the implementation of policies that alleviate poverty; the fostering of a market-oriented world trade regime; the pursuit of participatory and sustainable development; and the creation of a stable social and economic environment. These objectives are once again linked to one of the IMF’s key purposes: to facilitate the expansion and balanced growth of international trade and contribute thereby to the promotion and maintenance of high levels of employment and real income. The IMF also provides financial assistance through its compensatory financing facility to help countries cope with fluctuations in the cost of cereal imports.

Malawi: ESAF

The IMF approved the second annual loan under the enhanced structural adjustment facility (ESAF), in an amount equivalent to SDR 15.3 million (about $22 million), to support Malawi’s economic program in 1996/97. The loan is available in two equal installments, the first of which is available on December 13, 1996.

Medium-Term Strategy, 1996–97 Program Malawi’s medium-term strategy aims to consolidate the gains achieved thus far and to sustain economic growth within a framework of financial stability.

The program for 1996–97 aims to achieve real GDP growth of about 11 percent in 1996 and 5 percent in 1997, an annual inflation rate of 8 percent by end-1997, and an increase in gross official international reserves to the equivalent of 4.5 months by end-1997. To achieve these objectives, the program will rely on the continued pursuit of tight financial policies. The overall budget deficit (excluding grants) will be reduced from 13.6 percent of GDP in 1995 to 9.0 percent in 1996, and to 7.6 percent in 1997.

Malawi: Selected Economic Indicators

¹Preliminary.

²Program.

³Fiscal year is April/March

Data: Malawian authorities and IMF start estimates

Malawi: Selected Economic Indicators

	1994	19951	19962	19972	19982
	(percent change)
Real GDP	–11.6	9.0	10.8	5.0	5.0
Consumer prices (end of period)	66.0	74.9	4.0	8.0	6.0
	(percent of GDP)
Overall fiscal balance3 (excluding grants)	–27.8	–13.6	–9.0	–7.6	–6.9
External current account balance (excluding official transfers)	–17.8	–14.1	–7.6	–6.8	–6.4

¹Preliminary.

²Program.

³Fiscal year is April/March

Data: Malawian authorities and IMF start estimates

View Table

Malawi: Selected Economic Indicators

	1994	19951	19962	19972	19982
	(percent change)
Real GDP	–11.6	9.0	10.8	5.0	5.0
Consumer prices (end of period)	66.0	74.9	4.0	8.0	6.0
	(percent of GDP)
Overall fiscal balance3 (excluding grants)	–27.8	–13.6	–9.0	–7.6	–6.9
External current account balance (excluding official transfers)	–17.8	–14.1	–7.6	–6.8	–6.4

¹Preliminary.

²Program.

³Fiscal year is April/March

Data: Malawian authorities and IMF start estimates

Pakistan: Stand-By Extension

The IMF approved a request by the government of Pakistan to extend the current stand-by credit through end-September 1997 and to augment the amount available under it by SDR 160.7 million (about $231 million), in support of Pakistan’s economic adjustment and reform program. The IMF’s Executive Board took the decision in conjunction with the completion of the second review under the stand-by credit for SDR 401.9 million (about $579 million) approved on December 13, 1995 (see Press Release No. 95/66, IMF Survey, January 8, 1996).

The program supported by the stand-by credit was designed to reduce Pakistan’s macroeconomic imbalances and to address a range of structural issues. However, achievement of these objectives has been undermined by slippages in policy implementation in 1995/96 and the first four months of 1996/97. In particular, Pakistan’s fiscal policy entailed an excessive increase in bank borrowing by the government that put pressure on the balance of payments. These difficulties were compounded by a slowdown in structural reform efforts and had costly consequences in terms of external vulnerability and loss of market confidence. Against this background, the authorities have adopted a stabilization package consisting of a reduction of the budget deficit, an increase in interest rates, and a depreciation of the exchange rate to promote a rapid recovery in the country’s international reserve position. These policies will be supported by far-reaching actions on the structural front, with emphasis on an improvement in the operations of Pakistan’s major banks, broadening of the tax base, and rationalization of government expenditures.

Pakistan: Selected Economic Indicators

¹Program.

Data: Pakistan authorities and IMF staff estimates

Pakistan: Selected Economic Indicators

	1993/94	1994/95	1995/95	1996/971
	(percent change)
Real GDP	4.5	4.4	6.1	5.0
Consumer prices (average)	11.3	13.0	10.8	11.0
	(percent of GDP)
General government budget balance (excluding grants)	–6.0	–5.9	–6.3	–4.0
External current account balance (excluding official transfers)	–3.6	–3.6	–6.9	–5.9
	(weeks of Imports)
Gross international reserves	12.6	12.9	8.2	6.4

¹Program.

Data: Pakistan authorities and IMF staff estimates

View Table

Pakistan: Selected Economic Indicators

	1993/94	1994/95	1995/95	1996/971
	(percent change)
Real GDP	4.5	4.4	6.1	5.0
Consumer prices (average)	11.3	13.0	10.8	11.0
	(percent of GDP)
General government budget balance (excluding grants)	–6.0	–5.9	–6.3	–4.0
External current account balance (excluding official transfers)	–3.6	–3.6	–6.9	–5.9
	(weeks of Imports)
Gross international reserves	12.6	12.9	8.2	6.4

¹Program.

Data: Pakistan authorities and IMF staff estimates

Pakistan joined the IMF on July 11, 1950. Its quota is SDR 758.2 million (about $1.1 billion). Its outstanding use of IMF credit currently totals SDR 960 million (about $1.4 billion).

Press Release No. 96/63, December 18, 1996

Azerbaijan: ESAF and EFF

The IMF approved a combination of two credits for Azerbaijan totaling the equivalent of SDR 152.1 million (about $219 million) to support the government’s economic program for 1996–99. Of this amount, SDR 93.6 million (about $135 million) is available under the enhanced structural adjustment facility (ESAF), and SDR 58.5 million (about $84 million) under the extended Fund facility (EFF).

Social Needs

Azerbaijan will continue to reform the social safety net to provide adequate assistance to the most vulnerable groups of the population. Meanwhile, the government is considering a comprehensive reform plan to establish a financially secure and fair pension system.

Azerbaijan: Selected Economic Indicators

¹Estimate.

²Program.

Data: Azerbaijan authorities and IMF staff estimates

Azerbaijan: Selected Economic Indicators

	1995	19961	19972	19982	19992
	(percent change)
Real GDP	–11.0	1.2	5.1	7.6	8.4
Consumer prices (average)	411.7	19.9	9.1	6.5	6.2
	(percent of GDP)
Overall fiscal balance	–4.3	–2.7	–2.0	–1.4	–0.5
External current account balance	–11.2	–19.1	–15.9	–18.8	–24.0
	(months of imports)
Gross international reserves	1.2	2.0	2.9	3.4	3.5

¹Estimate.

²Program.

Data: Azerbaijan authorities and IMF staff estimates

View Table

Azerbaijan: Selected Economic Indicators

	1995	19961	19972	19982	19992
	(percent change)
Real GDP	–11.0	1.2	5.1	7.6	8.4
Consumer prices (average)	411.7	19.9	9.1	6.5	6.2
	(percent of GDP)
Overall fiscal balance	–4.3	–2.7	–2.0	–1.4	–0.5
External current account balance	–11.2	–19.1	–15.9	–18.8	–24.0
	(months of imports)
Gross international reserves	1.2	2.0	2.9	3.4	3.5

¹Estimate.

²Program.

Data: Azerbaijan authorities and IMF staff estimates

Causes of Energy Arrears

Although there are no clear-cut causes of energy arrears, some common patterns are discernible, including:

• An inability or unwillingness to adjust to new economic circumstances. The declining incomes or profitability and sharply higher prices experienced during the transition to a market economy have undermined consumers’ ability and willingness to pay for energy supplies.

• Payments discipline. In many instances, suppliers have failed to cut off deliveries to nonpaying households and customers, particularly where the government views these customers as suppliers of strategic goods and services. Penalties for delinquent payments have rarely been enforced, and consumers have come to expect accumulated arrears to be netted out among state enterprises and/or bailed out by the government.

• Weak collection efforts. Slippages by energy companies have been compounded by difficulties in measuring energy consumption brought on by a shortage of meters.

• Government intervention. Regulation, particularly of payments and pricing arrangements, has adversely affected payments for energy supplies from both domestic and foreign sources. Governments have set a bad example by frequently failing to pay their own energy bills and designating privileged strategic users that benefit from subsidized rates and are exempt from penalties on delinquent payments.

Economic Consequences

Given the importance of the energy sector in these economies, accumulation of arrears tends to have a ripple effect—weakening the energy sector’s payments ability and thus the ability and discipline to pay in the rest of the economy. Where the energy sector is an important taxpayer, accumulation of arrears often severely disrupts tax payments, with serious budgetary consequences and implications for macro-economic stability. Arrears also reduce transparency and make it difficult to judge the financial health of enterprises.

Energy payments arrears can promote the inefficient use of energy resources and disrupt energy supplies, with adverse consequences for output and productivity. Also, uncollected tax revenues may result in expenditure cuts, notably in infrastructure, that can further weaken production and growth. If countries are unable to generate financial surpluses for investment or attract foreign capital, there may also be long-term energy production and transmission difficulties.

Finally, failure to enforce payment of energy bills can skew income distribution, since nonenforcement disproportionately subsidizes higher-income groups. Persistent payments arrears can also considerably damage creditworthiness in domestic and foreign financial markets, and external payments arrears to energy suppliers can have serious adverse consequences for these countries, as in the case of Turkmenistan. Without corrective measures, the adverse consequences of energy arrears are likely to intensify.

Response to Arrears

A number of these countries have introduced rigorous measures under borrowing arrangements with the IMF; others are moving more slowly. The Baltic countries have taken important steps to improve revenue collection and tackle weak energy sector finances through more appropriate pricing policies and steps to improve efficiency and cut costs. All of the Baltic countries have cut off supplies to delinquent consumers, established repayment schedules, strengthened billing and collection procedures, and adopted plans to privatize and restructure energy sector enterprises. In addition, Lithuania has tightened enforcement of penalties for nonpayment, and Estonia has ended the government’s role in importing energy. All three countries reduced energy arrears over the past year.

Progress has been more limited in Russia. Various nonmonetary instruments designed to clear mutual arrears have helped reduce budgetary arrears to energy companies, but interenterprise energy arrears outside the budget have persisted. Moreover, federal programs to supply fuel to agriculture by providing tax breaks to oil companies have largely been undertaken off-budget and without adequate consultation with the tax collection authorities.

In cases of persistent energy arrears, governments have abetted the problem by not paying their own bills.

Under an economic reform program—supported by an IMF extended Fund facility (EFF) arrangement—the Russian authorities are currently considering a number of measures to encourage commercial, profit-oriented energy markets. These include the removal of legal barriers—such as preferential arrangements—to normal commercial practices; strengthened treasury control over public expenditure on fuel and power to avoid the recurrence of public sector arrears; and privatization of regional power companies to improve corporate governance and reduce public sector interference in pricing and arrears policies.

In Ukraine, payments difficulties in the domestic energy sector have for the most part translated into large external arrears to the country’s major gas suppliers, Russia and Turkmenistan, necessitating substantial rescheduling agreements. To improve payments discipline by consumers, the government, beginning in 1996, decided not to renew payments guarantees for gas imports. New import arrangements also permitted a number of wholesalers—representing regional monopolies supplying gas in different regions—to import gas directly for sale in the domestic market.

While payments discipline has improved somewhat, arrears have persisted. The government appears to have continued interfering in the domestic gas market, but since it no longer provides import guarantees, the settlement of external payments arrears has become the obligation of private regional importers. Given understandings reached within the framework of a prospective EFF arrangement, Ukraine is expected to take steps to improve payments compliance for gas use and develop (with the help of the World Bank and the European Bank for Reconstruction and Development) a plan for setting up a competitive gas market with appropriate regulatory bodies.

Armenia, Georgia, and Moldova are focusing on increasing energy tariffs and improving the payments discipline of energy consumers, partly by stopping deliveries to delinquent households and enterprises. These countries have also terminated government payment guarantees for energy imports, and Armenia and Georgia intend to begin privatizing certain energy sector activities in 1997.

Kazakstan plans to adopt measures in 1997 to cut off nonpaying customers and require deliveries of services by utilities to be made upon receipt of payment. At the same time, the government intends to examine closely the financial situation of the major energy and utility companies and authorize international audits. The Kyrgyz Republic is negotiating a rescheduling of its domestic energy arrears. It is also cutting off supplies to enterprises and government organizations that are in arrears, modernizing its billing and collection system, and initiating restructuring and privatization of the national energy company. Last year, the Kyrgyz Republic engaged in a three-way operation to settle energy company tax arrears, which involved ofsetting Kyrgyz official debt to Kazakstan against Kazak arrears to the Kyrgyz energy company, and the clearing of the Kyrgyz energy company’s arrears to the Kyrgyz government. Measures elsewhere generally reflect a similar thrust, although the extent and pace of implementation vary. Among this group, Belarus stands out as a country that has failed to make a serious attempt to address its energy arrears.

Broad Lessons

Where energy arrears have persisted, governments appear to have abetted the problem by not paying their own energy bills or instituting practices that impede collection efforts by energy companies. Energy payments arrears have encouraged, and been encouraged by, a broader culture of nonpayment. Notably, such arrears, particularly by governments or privileged users, have caused tax arrears by energy companies.

Although it is essential to phase out energy subsidies and more closely align domestic with international energy prices, periodic large increases in energy tariffs have tended to aggravate payments difficulties. In a number of cases, domestic nonpayment has triggered substantial payments arrears for energy imports and led to sizable external arrears. Ad hoc measures to clear arrears, such as netting-out arrangements, have not prevented their reemergence and, indeed, may have encouraged new arrears. The experience of these countries suggests that effectively reducing payments arrears will require a range of measures. These include:

• eliminating government intervention in the domestic energy market and terminating government guarantees on payments for energy imports;

• strengthening payments discipline through improved billing and collection procedures, including the removal of restrictions on energy companies to cut off supplies in the event of nonpayment, as well as the stricter enforcement of penalty fees on delinquent customers; and

• speeding up the restructuring and privatization of energy enterprises.

Emine Gurgen

IMF European II Department