Conditionality: Past, Present, Future
  • 1 0000000404811396https://isni.org/isni/0000000404811396International Monetary Fund

This paper describes early contributions of Staff Papers to international economics. The paper highlights that Staff Papers has, since its inception in 1950, been an important vehicle for the dissemination of research done by the IMF staff. This paper discusses three areas in which articles published in Staff Papers up until the 1970s made major contributions to the literature in international economics. The areas covered are: the absorption approach and the monetary theory of the balance of payments; the Mundell-Fleming model; and foreign trade modeling.

Abstract

This paper describes early contributions of Staff Papers to international economics. The paper highlights that Staff Papers has, since its inception in 1950, been an important vehicle for the dissemination of research done by the IMF staff. This paper discusses three areas in which articles published in Staff Papers up until the 1970s made major contributions to the literature in international economics. The areas covered are: the absorption approach and the monetary theory of the balance of payments; the Mundell-Fleming model; and foreign trade modeling.

The paper first discusses the rationale for conditionality and its analytical framework. It then traces the practice of conditionality as developed by the IMF and its membership over the first 45 years of the institution’s existence. Next, the paper focuses on current issues and practices in the implementation of conditionality. The challenges that conditionality is likely to confront as the IMF moves into the next century are examined. Finally, the paper broadly assesses the role and effectiveness of conditionality and discusses some of the broader issues that the IMF will face in an increasingly interdependent and global economic environment. [JEL E5, E61, F33]

THE INTERNATIONAL MONETARY FUND was created half a century ago with a clear and specific mandate: the promotion of economic and financial cooperation among its member countries. Such cooperation was believed to be the best means for the attainment of a number of international economic objectives that were considered essential for the economic welfare of the world community. These objectives, which were explicitly laid out in Article I of the IMF’s Articles of Agreement, included: the expansion and balanced growth of international trade; the promotion of exchange stability; and the elimination of foreign exchange restrictions through the establishment of a liberal multilateral system of current international payments and transfers. These broad aims would provide the basis for the promotion and maintenance of high levels of employment and real income through the development of the productive resources of all members.

To these ends, the institution was “to give confidence to members by making the general resources of the Fund temporarily available to them under adequate safeguards, thus providing them with an opportunity to correct maladjustments in their balance of payments without resorting to measures destructive of national or international prosperity” (Article I (v); emphasis added). In this manner, the duration and degree of disequilibria in country external payment balances would be contained. Therefore, from its very inception, it was foreseen that the IMF would act as a source of financial support to member countries facing actual or potential balance of payments problems. In the process of discharging this responsibility, the institution has come to play a central role in the international monetary sphere.1 The principles to which the institution’s financial assistance must conform are already explicit in the general formulation of Article I(v), which calls for the IMF to adopt policies on the use of its resources: (1) that would assist members to overcome their balance of payments difficulties; (2) in a manner consistent with the purposes of the institution; and (3) under adequate safeguards to ensure that such use would be temporary.

During its long and close relationship with a varied and growing membership, the IMF has developed, and has adapted continuously, a pragmatic and flexible body of policies and procedures to govern the access to, and the use of, its resources by member countries. This body of policies and procedures has come to be known by the term conditionality. As a principle, conditionality applies in most of the IMF’s financial support operations with its members. This is clearly required by the Articles of Agreement. Its actual implementation, though, takes account of developments in the international economic environment. Therefore, practices of conditionality have been formulated throughout the IMF’s existence in response to the needs of its members and those of the world economy.2 Of particular importance within this evolution has been the existence of a general consensus that the IMF’s financial assistance should be conditional on the adoption and implementation of adjustment policies.

The purpose of this paper is to examine the principle and the practice of conditionality as both of them have evolved since the inception of the IMF. The paper first discusses the rationale for the concept of conditionality. Then, it outlines its analytical framework and the corresponding conceptual underpinnings and economic policy implications. Against this background, the paper traces the practices of conditionality as developed by the IMF and its membership over the first four and a half decades of the institution’s existence (the past). The paper then focuses on current issues and practices in the implementation of conditionality (thepresent). And from there, it turns to an examination of the challenges the exercise of the IMF policies on conditionality is likely to confront as the institution moves into the next century (the future). Finally, the paper concludes with a broad assessment of the role and effectiveness of conditionality as well as a discussion of some of the broader issues that the IMF will have to face in an increasingly interdependent and global economic environment. As supporting background, the Executive Board decision that lays out certain key aspects of conditionality and a summary description of IMF financial facilities are included as annexes to the paper.

I. Rationale

The prescriptions that the use of IMF resources should be temporary and that it should be made subject to adequate safeguards contained in Article I (v) receive further elaboration in the Articles of Agreement, in particular in Article V, Section 3. Essentially, the elaboration is to make clear that the institution’s financial support is intended to assist members in the correction of their external imbalances “in a manner consistent with the provisions of this Agreement” (Article V, Section 3(a)). Or to put it differently, a central aim of the provision of IMF resources is to ensure the observance of the institution’s code of conduct. And members seeking to use them are expected to have an actual or potential balance of payments need, which they undertake to eliminate by the adoption of measures compatible with their obligations under the Articles of Agreement.3 These general principles were then translated into operational procedures by means of Executive Board decisions, which adapted the implementation of conditionality as the world and members’ economies evolved.4 Behind these prescriptions in the Articles there were a number of important aims, which provide a rationale for conditionality and warrant explicit discussion.

Moral Hazard

In common with other instances of government or official intervention in the economic sphere, the availability of IMF financial assistance could have undesirable effects on member country behavior. It is conceivable that a country’s concern about the avoidance of imbalances could be unduly lessened by the prospect of the financial support that the institution is mandated to provide. IMF resource availability can carry with it, therefore, a risk of moral hazard, which needs to be contained. A first aspect of conditionality in the use of IMF resources that must be stressed, as a consequence, is its character as an instrument to contain moral hazard. Apart from the direct economic terms of IMF resources (that is, their interest and amortization payments or, as they are institutionally labeled, charges and repurchases), the access to and disbursement of those resources is contingent on the adoption and pursuit of economic adjustment measures that give an assurance that the imbalance will be redressed.

This aspect of IMF financial support was behind early discussions of the right to draw on the institution’s resources, which sought to balance the need to protect the member’s interests with those of the IMF. On the one hand, it was felt that it would be desirable to provide members with certainty about their right to draw on the resources of the institution. In the extreme, this line of reasoning led to the advocacy of automaticity in drawing rights.5 On the other hand, an equally important consideration was the need to protect the institutional interest by ensuring that members using IMF resources would undertake the required adjustment effort. This line of argument, of course, led in the direction of conditionality in drawing rights and, as already noted, is the one on which consensus was finally reached.

In sum, the availability of IMF financial assistance provides a measure of insurance against adverse shocks and the emergence of external imbalances. In common with all insurance activities, it raises the specter of moral hazard in the form of less determination on the part of member countries toward the adoption or maintenance of appropriate policies. By making its resources conditional on the implementation of adjustment measures, the risk of moral hazard is thus contained.

IMF Asset Portfolio Protection

A related, but separate, aspect of the extension of financial assistance is concerned with the protection of the quality of the IMF’s asset portfolio. Through its lending to member countries, the IMF invests its resources in them and therefore, its asset portfolio cannot but be contingent on their economic performance. Given its focus on the appropriateness of country economic policies, conditionality is therefore also an instrument to protect the quality of the institution’s assets. As such, conditionality procedures represent the essence of the “adequate safeguards” prescribed by the Articles of Agreement. From this standpoint, it is only natural that the IMF has consistently urged members to adopt corrective measures at an early stage of their imbalances, measures that could, of course, be supported by use of the institution’s resources. Here the aim has been to contain not only the adjustment cost to the member, but also the risk to the IMF’s investment in the latter’s adjustment effort. When members unduly postpone those efforts and allow the imbalance to grow, the costs of correction are likely to increase, and with them, the risks embedded in IMF financial support.

Cooperative Nature of Arrangement

A third aspect of IMF financial assistance on which conditionality has a strong bearing is the cooperative nature of the institution. Such nature, on the financial front, arises from the fundamental sources of IMF loanable funds, which are the quota subscriptions of members.6 All members have the same rights and obligations under the Articles of Agreement. One implication of this is that countries facing an actual or potential external imbalance and willing to undertake a commensurate adjustment effort are all in principle entitled to request the institution’s resources in support of that effort. Such potential entitlements require that the institution continuously ensure that sufficient funds are prospectively available. In turn, given the overall constraint on IMF resources, this entails that the use of those resources be revolving. Not only that, but in an uncertain environment such as the one that typically characterizes the international economy, they will also require that the IMF’s resource portfolio exhibit a significant measure of liquidity. Optimally, IMF lending should be indeed temporary. But further, it should not normally exhaust the supply of the institution’s loanable resources. In effect, the IMF should not generally be loaned up, so to speak, so that its portfolio, as a norm, may remain appropriately liquid. Only thus can the revolving nature of IMF resources and the monetary character of the institution both be preserved.

In sum, conditionality in the use of IMF resources is indeed a multifaceted instrument. Its basic aim is to enable members to overcome their balance of payments problems by aligning their adjustment efforts with their adjustment needs. But in the pursuit of this aim, the exercise of conditionality helps balance a multiplicity of interests. Nationally, it contributes to the containment of adjustment costs relative to what they would otherwise be, thereby enhancing economic welfare. Internationally, it helps to limit moral hazard risks, protects IMF assets, and safeguards the institution’s monetary identity.7

II. Framework

The attainment of all these diverse goals called for the development of an operational framework for an objective implementation of conditionality. And such a framework evolved over time based on the relationship that could be established between an external imbalance (what has been called above adjustment need) and the economic policy measures required to correct it (what has been referred to above as adjustment effort). This is a dynamic relationship that reflects country-specific characteristics as well as those of the international economy. But it does exhibit a basic set of features that are founded in economic theory and reality, on which conditionality practices are anchored.

Adjustment Need

A central element in the implementation of conditionality is an assessment of the nature and characteristics of the disequilibrium that requires correction. On the most general level, an actual or potential imbalance may arise in a variety of manners and for a variety of reasons, all of which will have a bearing on the strategy for its elimination. Indeed, the perceived dimensions of an economic imbalance also evolve with time, this being an important factor behind the continuing adaptations of conditionality.8

Broadly speaking, an imbalance arises whenever the sum total of demands for resources in an economy exceeds the amount of those resources that can be generated internally plus those that can be attracted from abroad on an appropriate scale and on sustainable terms. But it can also surface because of inefficiency in the use of the resources that are available; that is, on account of distortions that constrain the level or rate of expansion of aggregate supply and thus keep the economy operating under its capacity or below its potential rate of growth. Aggregate imbalances that conform to this general description recur in all economies. And important for their resolution will be an assessment of their origin (e.g., are they the result of internal or external factors?); and their nature (e.g., do they reflect exogenous or endogenous causes? are they transitory or permanent?)9

All these characteristics are critical for the design of a corrective strategy, although it must be admitted that they are not generally easy to ascertain in practice. But there is one issue that needs to be kept under close examination in this context. That is the correspondence in time between the development of an imbalance and the implementation of a plan for its correction, both of which are flow concepts. The extent to which both are commensurate in scale and timeliness will determine whether or not the imbalance is being passed on from one period to the next. Such adjustment delays are important, if only because they affect the characteristics of the imbalance by tending to let it cumulate into a (larger) stock disequilibrium. In this manner, for example, a transitory imbalance that is not corrected opportunely may turn out to be less temporary than originally envisaged. Or one that is created exogenously, if not corrected promptly, may give rise to endogenous distortions that compound it.10

Adjustment Goals

Strategies for the adjustment of economic imbalances invariably seek to attain a broad range of objectives. And the choice among those objectives reflects economic as well as other considerations. Goals typically pursued on economic grounds include a sound growth rate, an appropriate level of employment, domestic price and exchange rate stability, and a viable balance of payments position. There are also other policy objectives pursued on the basis of economic, social, and political considerations, such as those that relate to the equity and distributional consequences of economic policies.11 Clearly, the scope for the attainment of the full range of such diverse aims is bound by the relationship that prevails between the amounts of required and available resources as well as by the efficiency in their allocation and use. The process calls for delicate and complex choices on the mix of objectives and the relative speed of their achievement, choices that are an integral part of economic policy decision making and government responsibility. Indeed, the appropriateness of such choices can be the critical element for the sustainability of the adjustment effort.

Within the broad array of policy goals all countries seek to attain, the IMF’s mandate directs its attention toward those of an external nature, e.g., exchange arrangements, exchange rates, and the balance of payments. The institution shares an interest with members on the attainment of other economic policy goals, particularly since such attainment will often be important for the maintenance of a viable external payments position. The perspective, though, is their contribution to the purposes and aims of the institution, that is, to the maintenance of a balanced national and international environment in the context of a liberal multilateral payments regime. For these reasons, the IMF exercises an important measure of circumspection with regard to the domestic policy objectives of member countries. Subject to this proviso, IMF conditionality practices have made increasingly explicit the connection between economic policies and domestic policy aims, and in the process, they have underscored the relevance of these aims for the external performance of country economies and for the international system as a whole.

Adjustment Effort

A country’s adjustment effort, that is, the formulation and implementation of policy measures to correct an aggregate imbalance, will be inevitably linked to the particular characteristics of that country. And conversely, these characteristics are behind the range of economic policies on which IMF conditionality practices focus.

Amount of Resources and Macroeconomic Balance

It follows from the above discussion of adjustment need that a key function of economic management is to keep the level and rate of growth of aggregate demand in line with those of the economy’s productive capacity and resource base. For a given scale of the latter and for a given structure of relative prices and costs, this will entail domestic financial policies that are consistent with macroeconomic balance in the economy. Three major policy areas can be identified in this respect.

Expansion in aggregate demand frequently reflects imbalances in the fiscal accounts and, more broadly, in the public sector finances.12 The correction of disequilibria originating in the public finances encompasses the fiscal dimension of macroeconomic management. This includes policy measures that seek to curtail fiscal spending or raise fiscal revenues to restore viability to the public sector finances. The specific mix of measures chosen will influence the general performance of the economy, which will vary depending on whether the strategy is based on measures to control outlays or on revenue-raising actions. The former will tend to restore balance to the economy by lowering the weight of the public sector in aggregate demand. In contrast, raising revenue will likely entail a reduction in the share of private demand. The mix of fiscal measures will also influence the speed and certainty of the adjustment process. This is because expenditure reductions and revenue mobilization are not equally effective: a government’s scope to control its outlays usually exceeds its ability to increase its receipts.

There is a close relationship between fiscal outcomes and the broader sphere of financial policies, that is, those related to developments in credit and money flows in an economy. Indeed, it is not always easy to distinguish them unambiguously, as fiscal policy basically determines the public sector borrowing requirement, in general, and, in particular, its need for domestic bank financing, which is a key aspect of monetary policy. It is well known and accepted that maintaining aggregate demand on a sustainable path calls for some control over the flows of domestic financing and specifically over the rates of monetary and domestic credit expansion. This is the monetary dimension of macroeconomic management. It stresses the importance of the link between domestic credit expansion and money supply increases, on the one hand, and their relationship with aggregate expenditure and income, on the other. Or to put it differently, it highlights the fact that a discrepancy between the supply and demand for money (a money market imbalance) has a counterpart in an imbalance between expenditure and income (a goods market disequilibrium). Restoration of a sound relationship of expenditure to income, therefore, will entail keeping domestic credit expansion in line with the prospective path of desired money holdings in the economy. These considerations are behind the emphasis placed on domestic credit expansion as a policy variable in the application of conditionality.13

Consistency requires that both fiscal and monetary policies be complemented by appropriate foreign borrowing strategies, the external debt dimension of macroeconomic management. The macroeconomic implications of external debt management policies derive from the direct influence they can have on the expenditure-income flow and from the substitutability that exists between foreign and domestic credit. In essence, a central aspect of macroeconomic management is to keep the total (i.e., domestic and foreign) flow of financial resources in the economy compatible with a sustainable pattern of expenditure and income. The importance of external debt management is obvious because foreign borrowing can make it temporarily possible for an economy to keep demand and growth beyond the levels that it can sustain.

Efficiency and Economic Incentives

So far, the analysis has assumed that the economy’s productive capacity and the structure of its relative prices and costs were given. But both of these are affected by macroeconomic policy actions, and this influence is relevant in the context of conditionality. A sustained adjustment effort requires that macroeconomic balance be attained by setting incentives that guide decisions toward an efficient allocation and use of resources in the economy. The adequacy of the structure of relative prices and costs is critical on this front. Imbalances, particularly when they are allowed to persist, often result in price-cost misalignments among sectors in the economy as well as between the economy and the rest of the world. In these circumstances, the conduct of macroeconomic management in its various dimensions needs to be supported by suitable adjustments in key prices and costs for balance to be durable.

These considerations unmask the interaction of macroeconomic and microeconomic factors in the policy domain. In the realm of fiscal policy, they bring to the forefront issues like the efficiency and composition of public spending; the structure of the tax system; and public sector pricing policy, all of which are critical for efficiency in resource allocation. In the sphere of monetary and credit as well as external debt policies, the importance of appropriate domestic interest rates can hardly be overstressed. They are essential for purposes of domestic saving mobilization, an aim that calls for adequate real rates of interest. But they are also crucial to retain domestic resources and attract those from abroad, both of which require internationally competitive interest rates. A third area of enormous importance concerns exchange rates and competitiveness. Persistent imbalances in an economy typically result in movements and patterns of domestic prices and costs that diverge significantly from those prevailing abroad. Resource allocation is thus distorted and competitiveness eroded, and with them balance of payments and growth performance falter. Thus, exchange rate adjustments or flexibility in exchange rate management are essential ingredients of macroeconomic management. In their absence, flexibility in other key variables in the economy, such as factor prices—in particular, wages—is required to restore competitiveness and balance of payments viability. And last but not least, the liberalization of exchange and trade regimes is also essential to ensure that economic incentives and price signals fulfill their functions.

III. Past

The framework just described will provide the setting for an examination of the evolution of IMF conditionality practices. In the process, it will be made clear the extent to which imbalances, the policies designed to deal with them, and, correspondingly, the exercise of conditionality have varied over time.

Rules Under Bretton Woods

The conditionality practices developed during the Bretton Woods period (approximately 1945-1970) reflected the prevalence of the rule-based regime agreed at the 1944 Bretton Woods conference that established the IMF. The world economy was then characterized by relative stability in inflation and growth rates and by substantial progress toward the liberalization of international trade and payments and current account convertibility under a par value system.

The principle of conditionality was soon incorporated into the institution’s lending activities.14 An early consensus emerged that the IMF’s attitude toward a member’s request for financial assistance would be guided primarily by the Fund’s judgment on whether the member’s policies were adequate to cope with its balance of payments problem so as to enable it to repay the institution within three to five years from the date the resources were received, as prescribed by the Articles of Agreement (Article V, Section 7(c)).

The IMF developed the stand-by arrangement as the main instrument to provide members with conditional access to its financial resources. The stand-by arrangement represented a line of credit outlining the circumstances under which a member could make drawings on the IMF.15 In the early days, the arrangement was conceived mainly as a precautionary device to assure members that had no immediate need for IMF resources but felt they might require such financing in the near future (hence, the label “stand-by”) that they would have access to it. It rapidly became evident, though, that the stand-by arrangement was also a particularly well-suited vehicle for channeling IMF conditional resources to countries with urgent balance of payments financing needs.

The stand-by arrangement, in its link of a member’s access to IMF funds to its adoption of a program of action, represented the first formal manifestation of the institution’s belief that its assistance would be most effective if it was provided to support a member’s policies designed to correct its external imbalance. The policy programs, at that time, did not extend beyond one year, a period short enough to permit an economic forecast to be made, but long enough to allow an assessment of the implementation of policy measures as well as a judgment on whether these measures called for adaptation or modification. Of course, this practice did not mean that adjustment was expected to be completed within such a limited horizon. In fact, members often entered into consecutive stand-by arrangements, a strategy that provided them with assurances of continued IMF financial support and the institution with evidence of policy continuity and determination.

With experience, it became clear that to be effective, an economic policy program had to be as specific and precise as possible. In particular, the main policy targets and instruments capable of relatively accurate measurement came to be stated in the financial programs in explicit quantitative terms.16 These quantified instruments and targets in turn became the guideposts for assessing whether programs were being implemented satisfactorily and their objectives were being attained correspondingly. For the reasons elaborated in the discussion of the framework, the variables most frequently used related to the expansion of domestic credit by the central bank or the banking system; the reliance of the government or the public sector on domestic bank financing or on short- and medium-term foreign borrowing; the management of international reserves; and the establishment of realistic prices and appropriate incentives. A qualitative condition common to all stand-by arrangements was the avoidance of reliance on the introduction or intensification of exchange restrictions as a means of coping with balance of payments problems.

The formulation of quantitative policy programs was accompanied by two developments that became common features of stand-by arrangements. The first related to the way IMF resources were made available. Because policy actions were undertaken over a given period, access to the resources came to be phased over that period, to provide incentives to policy implementation and to prevent unduly rapid rates of drawing. In the process, the total amount of assistance came to be disbursed at specified intervals in installments that were linked to the periodic quantified policy implementation targets.17

The second development was the inclusion in stand-by arrangements of provisions, referred to as performance criteria, that had to be observed to ensure continued access to IMF resources. Here again, the rationale for these operational features of the arrangements was that failure to comply with the performance criteria served as a signal that the policy program should be reviewed. The restoration of drawing rights in case of deviations required either an amendment of performance criteria or new understandings on the policies to be pursued and measures to be taken over the remainder of the program period. In practice, the resumption of the right to draw under an arrangement was based on the following: the extension of a waiver for the noncompliance with performance criteria (typically in situations of small or reversible deviations); a modification of the criteria (when their fulfillment became unfeasible); or the replacement of an old arrangement with a new one (when modifications appeared insufficient).

The conditionality practices developed during the 1950s and 1960s were reviewed by the IMF’s Executive Board in 1968. This general review encompassed all aspects of the subject and concluded with a decision that summarized the major elements of prevailing policies on access to IMF resources.18 The decision stressed the importance of ensuring adequate safeguards to preserve the revolving nature of those resources and the need to allow for flexible, yet uniform, treatment of all members. Subsequently, the Executive Board undertook periodic reviews of experience with specific performance criteria, such as those involving domestic credit ceilings, foreign borrowing limitations, and balance of payments tests. These reviews and the resulting Board decisions helped to further define and adapt the IMF’s conditionality policies.

Discretion in Policy Design and Implementation

By the time the policies on use of IMF resources were thus being consolidated, pressures had begun to mount on the international economy and, with them, on the Bretton Woods regime.19 A succession of crises in foreign exchange markets during the late 1960s had cast growing doubts on the continued viability of the par value system. By 1971, the fixed (but adjustable) exchange rate regime established at Bretton Woods had ceased to be operative, and by early 1973, it had been abandoned by the major industrial countries. For many of these countries, an international monetary system based on flexible exchange rate arrangements came into effect. Thus, the rule-based international monetary regime that had been introduced in Bretton Woods came to an end. And to replace it, a discretion-based system was adopted that has prevailed since then.

The Turbulent 1970s

Early in the decade, it became evident that the changes in the international economic environment and regime would require significant adaptations in the IMF’s conditionality practices. Relatively large increases and marked shifts in external payments imbalances called for a blend of adjustment and financing that differed from that formerly incorporated in stand-by arrangements. And a reconsideration of the size and length of those arrangements was also in order.20

The payments imbalances facing many member countries in the early 1970s, judging by their scale and nature, required longer periods of adjustment than envisaged in the conditionality practices prevailing at the time. Correspondingly, they also involved larger amounts of assistance than could be made available normally under stand-by arrangements. Consequently, the IMF established in 1974 an extended facility to provide member countries experiencing particularly severe balance of payments problems with commensurate medium-term assistance.

The extended facility was designed to alleviate two main categories of payments problems: (1) severe payments imbalances that were due to structural maladjustments in production and trade, where cost and price distortions were widespread and long-standing; and (2) imbalances that were due to a combination of slow growth and an inherently weak balance of payments position that constrained the pursuit of active development policies. Arrangements under the extended facility covered periods of up to three years (which now may be extended to four years in exceptional circumstances), and the assistance they provided was to be repaid within four and a half to ten years from its receipt.

The framework for conditionality discussed earlier remained applicable for operations under the extended facility. The adaptation they entailed was not so much in the degree of conditionality as in the strong assurance given by the member that the adjustment effort would be sustained over the medium term. The assurance was embedded in comprehensive economic programs that included policies of the character and scope required to correct structural imbalances in production, trade, and prices. Particular attention was given to measures intended to mobilize domestic and foreign resources, to improve their utilization, and to reduce impediments to international transactions.

As the decade evolved, further adaptations had to be made, particularly in the scale of IMF financial assistance. External payments imbalances besetting the international economy were so large and persistent that the need for conditional resources remained historically high. The IMF therefore took decisions that allowed for appropriate expansions in the amounts of assistance it could make available to foster orderly adjustment and help promote sound expansion in the world economy.21

The important adaptations to the IMF lending practices in the 1970s led the Executive Board to undertake a second general review of conditionality in 1978-1979. This review concluded with the adoption of a decision setting out broad guidelines on the use of IMF resources.22 These guidelines stressed the importance of early adjustment, encouraged members to seek IMF assistance promptly, and acknowledged that the adjustment process stretched over the medium term. They also recognized that measures likely to be required affected key and sensitive policy areas—fiscal, credit, incomes, foreign borrowing, and exchange rates, as well as trade and payments restrictions. They emphasized the need for the IMF to pay due regard to members’ objectives and circumstances and to ensure that institutional lending conditions would be limited to those variables that were essential, because of their macroeconomic impact, for the effectiveness of the member’s policies. The guidelines also confirmed the need for adequate safeguards for the institution and therefore called for reasonable assurance that programs would be carried out, a judgment that might call for the prior adoption of measures critical for policy implementation. Lastly, the guidelines provided the basis for periodic reviews of conditionality practices, which have since taken place regularly.

The 1980s: Decade of External Debt

The 1980s will likely go down in economic history as the decade of the international debt crisis. This was a period in which debt-servicing difficulties in the developing world became a virtually constant feature of the international economic scene.23 From the outset, the IMF played a critical role in the resolution of the systemic threat posed by the debt crisis, a role that called for innovative approaches and continued adaptations to conditionality practices.

At the time, the essential challenge confronting the IMF and its members was to underpin the crucial, but elusive, relationship between adjustment, financing (including external debt flows), and growth. Strengthening the relationship in a universal setting required the participation of all major parties. These considerations underlay the approach taken by the IMF to deal with problems of external indebtedness. The approach, as usual, entailed direct IMF financing for debtor countries; but its essential focus was more than ever on the adjustment efforts of those countries. Thus, the IMF became the vehicle to which were attached all other elements of a cooperative strategy for the resolution of indebtedness problems.

The central notion behind the strategy was that there was no substitute for sound domestic management in the debtor country. Thus, appropriate, sustained economic policies were seen as necessary conditions for the solution of debt-servicing difficulties. The conditionality practices of the IMF sought to ensure that those necessary conditions were met and they were suitably adapted toward this end. In the early phases of the implementation of the debt strategy, the main (though not exclusive) focus was on macroeconomic management so as to balance resource demands with their availability. As it became progressively clear that the completion of adjustment would extend over the medium run, conditionality practices focused also on structural reforms and microeconomic measures to ensure efficiency in resource allocation and use as well as a resumption of growth.

Despite their obvious importance, debtor adjustment efforts were not seen as sufficient conditions for the restoration of balance. It was also critical that those efforts be appropriately supported by the international community. This consideration led to an important innovation in IMF conditionality practices: the introduction of “concerted” lending packages.24 The IMF began to require creditors to provide firm assurances of the availability of external financing before it would move with its own support of the debtor adjustment program: a “critical mass” of commitments of external assistance thus became a prerequisite for the completion of an arrangement with the IMF. In this way, the IMF helped catalyze capital flows toward countries willing and able to undertake an adjustment in their economies. The aim was to attain a balanced distribution between the efforts required from debtors—that is, adjustment—and those required from creditors—that is, financing. In the process, a measure of conditionality came to be exercised on creditors as well.

The policy programs also reflected the realities faced by debtor countries, which called for emphasis on the growth and structural reform aspects of the adjustment process. The scope of conditionality was correspondingly broadened. Adaptations were made on the financing side as well. The concerted lending approach, originally focused on new loans and rescheduling or refinancing of old loans, evolved into progressively sophisticated money packages, which introduced innovative financing modalities and techniques (such as debt-equity swaps, debt buybacks, exit bonds, and the like). The approach also involved voluntary debt relief in the form of debt and debt-service reduction options.25

The debt crisis led to substantial innovations to conditionality practices, many of which still remain. It also demonstrated the difficulties of bringing together a group of separate and diverse interests. This simply reflected the tendency of each party to protect what it perceived as its immediate interest. Frequently, but not surprisingly, the resulting pressures were directed toward the entity that pursued the common interest, in this case, the IMF. Possibly undue weight was given to the apparent substitutability between adjustment and financing. This led debtors to stress the importance of financing (the contribution of creditors), and creditors to underscore the necessity of adjustment (the contribution of debtors). There was a measure of logic in these tendencies, but from a fundamental standpoint, they concealed that adjustment and financing can be complementary, in that the sounder and more credible the adjustment, the more accessible the financing. This complementarity was the dimension of the relationship on which the IMF, in which both debtors and creditors are represented, based its approach to indebtedness issues. In the process, the institution contributed to the containment of moral hazard risks. Concern over the strength of adjustment efforts served to limit those risks on the part of debtors, as they would ensure the restoration of debt-servicing capacity. But the risk of moral hazard can also arise with respect to creditors, and the requirement that they support the process with new financing or debt relief or both served to contain it. Thus, balance was sought in the management of these two opposite moral hazard risks.

As already noted, many of the adaptations to conditionality practices undertaken in the 1980s have remained in effect since. The emphasis on efficiency, aggregate supply management, linkages between macroeconomic and microeconomic performance, as well as the relevance of adequate financing packages were incorporated into IMF lending policies. Growth-oriented adjustment programs reflected an explicit concern with ensuring that the correction of external imbalances be effected in ways that would not impair growth prospects, a concern that had already been stressed in the extended facility, which underscored the importance of structural reforms. Continued efforts were also made to protect adjustment efforts from unexpected adverse contingencies, resulting in the addition of a contingency component to the already existing compensatory financing facility. And the equity and distributional consequences of the adjustment process, always a matter of concern, were made more explicit.26 Operationally, this led to the establishment of concessional facilities, that is, the structural adjustment facility (SAF) and the enhanced structural adjustment facility (ESAF), intended for, and available to, low-income developing member countries.

IV. Present

Recent years have witnessed marked changes in economic ideas as well as in realities in the international economy. These changes reflected a progressively widespread philosophy based on principles of democracy and freedom, which stressed the primacy of individual over collective rights. As the world economy entered the current decade, views in many countries on the role and scope of economic policy had begun to conform to this trend, exhibiting many characteristics in common with those that the IMF had been advocating in its conditionality and surveillance activities.27 At the same time, the institution, together with its policies, was yet to confront one of the most difficult and important challenges of its existence: the integration into the international monetary system of the economies in transition from central planning to market-based economic regimes.

Consensus

Until relatively recently, general views on economic policy management were based on an active, indeed dominant, presence of government in the economic process. This reflected the notion that besides providing public goods and correcting market failures, governments were also alone responsible for stabilizing cyclical economic fluctuations as well as for growth and development in the economy.

Experience with the pursuit of this principle gradually changed the perceived role of government. In the process, a certain common view developed on economic policy that fosters a new pattern of interaction between government and market forces. Rather than have government directly involved in the economic process through participation in the production and distribution of goods and services, government action should be directed toward fostering market forces, safeguarding competition, and encouraging private initiatives. Thus, instead of competing and interfering with market forces, governments are to focus on establishing a framework in which those forces can operate efficiently.

This economic policy consensus has spread widely across the IMF’s membership, both in the industrial and developing world.28 It lays out basic responsibilities of government, which can be grouped into three broad categories. First, the establishment of a stable macroeconomic setting and the timely undertaking of policy adjustment efforts, whenever these become necessary to preserve or restore stability to the economy. Second, the protection and maintenance of the country’s economic infrastructure, broadly interpreted to encompass investment in both human and physical capital. And third, the establishment, development, and safeguard of the economy’s institutional infrastructure. This responsibility includes a host of traditional (and in some cases, not so traditional) governmental activities, such as the provision of an appropriate legal, regulatory, and social framework to support the functioning of market forces. Key ingredients of such a framework, therefore, will be an adequate incentive system and a favorable climate for competition, both of which will require the prevalence of an open and liberal economic regime.

Clearly there are significant areas of common ground between this economic policy consensus and the policy framework underpinning IMF conditionality practices, both in concept and in practice. The attainment and maintenance of a stable macroeconomic setting invariably calls for sound fiscal and monetary policies as well as for prudent external debt management, three key dimensions of the conditionality framework. And the provision of an environment favorable to market forces, with its emphasis on competition and openness, coincides broadly with the IMF’s emphasis on appropriate incentives, preservation of competitiveness, and its institutional mandate of fostering liberal exchange and trade regimes. As has been remarked in a different context, this coincidence of ideas and policy approaches augurs well for economic management in the world in general, and for the acceptance of conditionality in particular.29 Thus, the present can be described as a period in which IMF conditionality practices are enjoying a good measure of general concurrence.

Challenge

The international community faces a most difficult, but also stimulating, challenge as it seeks to integrate into its monetary system the economies of the countries in transition from central planning to market-based regimes of economic organization. As far as the IMF as an institution is concerned, the challenge encompasses all its major activities. From the outset, the IMF’s contribution started with the provision of technical assistance on monetary, exchange, and fiscal as well as statistical and legal issues. It also entails the exercise of surveillance in its extension of economic policy advice and periodic assessment of policy implementation. And it also, of course, involves the exercise of conditionality and the corresponding extension of financial support to help these members overcome the balance of payments needs arising during the process of reform. The economic policy consensus described above has provided a good setting for this purpose. Emphasis on the traditional policy areas on which IMF conditionality practices focus—that is, appropriate macroeconomic management, rational pricing, and open economic systems—is of course necessary for the process of reform to succeed. But the question of whether this is sufficient has to be addressed since transition economies initially lack markets as well as a market-supporting institutional framework. Economic policy analysis generally presupposes the existence of these elements, and IMF conditionality practices have been based on them. Therefore, it has been necessary to supplement the traditional instruments of conditionality by focusing on the microeconomic and institutional aspects of reform.30 Accordingly, the IMF sought to adapt (and innovate on) its conditionality practices to suit the needs of the reforming economies.

In addition to activating fully its technical assistance and financial support capabilities from the outset of the reform process, the IMF also established a new instrument designed to address the specific needs of the transition to market-based regimes—the systemic transformation facility. This facility is intended to provide financial assistance to member countries with balance of payments difficulties stemming from disruptions to traditional trade and payments arrangements in the transition to multilateral, market-based trade. In particular, it covers balance of payments problems resulting from a sharp fall of total export receipts as trade moves from nonmarket to market prices; a substantial and permanent increase in net import costs, owing to the same shift from nonmarket to market prices; or a combination of both.

Access to the resources of this facility is subject to the general condition that the member requesting them will cooperate with the IMF in solving its balance of payments problems and that it will adopt as soon as possible policy programs that can be supported by the regular IMF facilities. Specifically, access to the systemic transformation facility requires significant policy action in a number of areas: economic stabilization; containment of capital flight; and the implementation of structural and institutional measures needed to foster a market-based economic environment.31 The country is required to issue a policy statement describing the policy objectives, the macroeconomic outlook, the structural, fiscal, monetary, and exchange rate measures to be implemented, and, as applicable, a technical assistance program. At the latest before the second purchase under the facility, a quantified quarterly financial program is required. Finally, the country must make a commitment to avoid introducing or tightening exchange and trade restrictions.

In essence, the innovations introduced by the systemic transformation facility were twofold. One was to ensure that support could be provided during the stage of the reform process when the necessary conditions were not yet present for a fully quantified phased macroeconomic program, as would be required by the regular IMF facilities, such as stand-by or extended arrangements. Instead, the stress was on specific policy actions that would help ensure that reform was proceeding and that policy implementation capabilities were being developed. The other innovation was the explicit introduction of a technical assistance program into the conditionality requirements of the facility.32 The IMF had been moving in this direction from the outset of its relations with countries in transition. Examples of this approach can also be found in financial operations with other members in the developing world. In bringing out explicitly the link between conditionality practices and technical assistance activities, the institution sought to enhance the importance of institution building as an element of the reform strategy. In this fashion, all aspects of the policy process have entered into the framework of conditionality: policy institutions, assessments and measurement of policy stances, and specific policy implementation tools.

V. Future

As the international economy moves into a new century, the IMF and its conditionality practices will continue to face challenges that will test the institution’s ability to adapt and innovate. One of those challenges is, of course, to continue to support the reform programs of the economies in transition. Progress toward their goal of establishing market-based regimes and their complete integration in the international system has so far been uneven and conditional financial support from the IMF will therefore continue to be needed.

Global Markets

Another challenge, and one that has been evident already for some time, is that posed by the increasing globalization of financial and capital markets and the consequent growing interdependence of national economies that characterizes the world economic system. Progressively integrated capital markets are the logical result of the past fifty years’ worth of effort by the IMF’s members to fulfill their objective, and the institution’s mandate, of opening and liberalizing trade and current account balances. Open national markets for goods and services, leading to growing trade flows, could not but enhance closer financial and credit ties among trading nations, which is an essential factor behind the internationalization of capital flows.

The presence of global capital markets carries important implications for the IMF’s activities. On the surveillance front, it affects the code of conduct in the Articles of Agreement, which still envisages controls on capital movements as an instrument that may be used by countries to regulate them, as necessary.33 This provision, a relic from the original Bretton Woods par value regime, reflected several considerations of relevance at the time. One was the need to set priorities, which, given the disruptions to international economic relations owing to the World War II hostilities, focused on the restoration of trade and current account flows. Another was the aim of preserving a measure of independence for national economic policy and, in particular, for monetary management. Yet another was that the scale of capital flows had until then been relatively limited. However, those flows of relevance for international trade relationships were duly acknowledged and properly treated in the Articles of Agreement, though indirectly by including them in the definition of current transactions.34

Despite the provision allowing for capital controls, as the years passed the international economy exhibited progressively liberal capital flows among countries. This trend, as noted above, was to a degree an inevitable consequence of the effectiveness of the integration of national markets for goods and services. And it was also probably fostered by the change of regime from par values to flexible exchange rates in the international economy.

The challenge for surveillance, therefore, is to restore logic to the code of conduct. The gains from trade argument does not distinguish by the nature of the transactions involved, so what suits current transactions also holds for capital flows. Such restoration of logic will also serve to bring the code of conduct closer to the current reality of the international economy, instead of remaining, as at present, well behind.35

As for conditionality, the current international economic setting poses difficult challenges indeed, both country-specific and systemic. Global capital markets increase the mutual interdependence of individual member countries and, with it, their exposure or vulnerability to external developments. Conditionality practices will have to adjust in order to contain the resulting risks to national economies.

The way to do this is to adapt conditionality practices as well as the policy on access to IMF resources so that adequate financial support can be made available to underpin members’ policy efforts to cope with balance of payments problems associated with capital account transactions.36 This goes to the core of conditionality practices, particularly with regard to the phasing of drawings, their relationship with policy performance, and their repayment. Capital account problems typically require a rapidly agreed and relatively large financial support package, in which a substantial share of the funds is made available up front. It may also be the case that, as the strategy works, not all the financing available to the country will be necessary. Or if it is, it may be repaid promptly. These features call for appropriate adaptation of IMF conditionality practices— an adaptation that is likely to be complex, particularly in the area of assurances that disbursements go hand in hand with policy implementation.

In a financially integrated world economic setting, an additional challenge for the IMF and its conditionality practices will be potential threats to the system’s stability and soundness. Such threats could also arise, of course, in more restrictive contexts. But the more open and liberal the environment, the greater their probability and scale. These potential systemic threats will require the IMF to be ready to assist its members in a fashion similar to that of a central bank that stands ready to help its national banking system. In addition to calling for conditionality practices capable of helping to resolve capital flow problems, systemic challenges will also require adaptations in surveillance procedures to provide for monitoring of developments in the system as a whole.37

Moral Hazard and Market Failures

The evolution of the world economy has thus returned to the forefront the essential specific rationale for IMF conditionality, that is, the containment of moral hazard and the protection of IMF resources in a cooperative setting. Of critical importance in this context is the interaction between governments’ economic policies and the operation of market forces. This means the IMF must focus on the role of government as well as on the scope of market discipline. Generally, market forces contribute to the recognition of imbalances and, as such, they provide incentives for the correction of those imbalances. But occasions also arise where market financing flows act instead to delay necessary policy adjustments. The challenge is to design and implement economic policies that will support market forces when they act to favor the correction of imbalances, but also to have policies in place that can contain those forces when they let imbalances prevail.

IMF conditionality practices are the institution’s contribution to this endeavor. However, market failures are easier to describe in theory than to identify in practice, making efforts to recognize and counter them risky. Market failures are rarely perceived as such by all, so action to cope with them calls for willingness to risk official financial resources in a bet that may be seen by others as unrealistic. Such odds can arise in a country-specific context, but they become critical in a systemic setting. So once again, the challenge for conditionality is to foster policies in member countries that guide, give certainty, and favor market forces; but also to promote and garner support for policies that offset market failures, when these arise.

There is an important implication here for IMF surveillance, too. As has often been pointed out, in addition to market failures, there are also (and perhaps more frequently) government policy failures. And it may be argued that a market failure defined as an inability or an unwillingness to identify an imbalance as it arises has as a counterpart the policy failure that causes it. Such market failures are often behind the “market overshoots” that occur when the imbalance has been allowed to cumulate over time. The other side of this argument is the coexistence of policy failures that in fact represent “policy undershoots,” these being phenomena that surveillance is intended to limit, if not eliminate.

In sum, IMF conditionality practices, appropriately supplemented by the exercise of surveillance, are an instrument to protect the financial integrity of the institution by the provision of public goods to the membership. These public goods include the support and guidance of market forces, the compensation of market failures and the containment of moral hazard risks.

VI. Assessment

Possibly the most interesting question about IMF conditionality is whether it has made a difference—how effective and how efficient it has been. In practical terms, questions of this nature have led to concrete examinations of the experience of countries that have undertaken policy programs supported by IMF conditional resources. The nature of the subject is such, though, that it would be futile to expect universal or categorical answers to those questions from the analyses of those experiences, even if there were agreement about the appropriate methodology for dealing with them.38 As the purpose of this paper has been to discuss IMF conditionality practices, rather than to examine how they have been applied in the specific context of member countries, such an assessment will not be undertaken here.39

Instead, an attempt will be made to evaluate the role that conditionality has played as an instrument to protect the code of conduct and to foster its observance, that is, its contribution to the functioning of the international monetary system. The assessment will basically be normative and reflects a particular interpretation of events in the international economy over the past five decades. As conditionality is not independent of the nature of the international economic regime in effect, the assessment will be divided according to the experience during the three broad periods discussed in the paper.

Rules and Conditionality

During the Bretton Woods period, the international monetary regime was the fixed (but adjustable) par value system. The commitment to currency parities, together with the obligation of countries to establish current account convertibility for their currencies, represented both a standard and a constraint for their economic policies. On the one hand, appropriate policies were those compatible with both the par value and an open current account in the balance of payments. On the other hand, policies that conflicted with these commitments would soon run against a balance of payments constraint.40

The role of conditionality in this setting was relatively straightforward. Its aim was to support either policies that would require neither par value changes nor current account restrictions (thus fostering the observance of the rules), or policies that, requiring a par value adjustment, would undertake it and ensure its sustainability at the new parity level without resort to current restrictions (thus exercising discretion, as permitted by the regime).

The par value system was to a large measure self-enforcing and therefore the use of conditionality was relatively unobtrusive. As has been noted elsewhere, during the Bretton Woods period, the exercise of conditionality was “episodic in character” and the balance of payments problems that it addressed were quickly resolved.41 From this standpoint, IMF conditionality practices clearly made a difference by contributing to the rapid adjustment of external imbalances. To this should be added the contribution that conditionality made to the understanding of the transmission mechanism between policy instruments and policy objectives,42 and the strong impulse that conditionality practices gave to the quantification of analytical relationships as the basis for policy implementation.

This was a period in which the IMF membership, by its agreement to accept and observe common rules, demonstrated readiness to contain the scope of national policy autonomy for the benefit of the system at large. To the extent that, as a result, the environment proved to be more stable than otherwise, the limitations derived from the cession of autonomy were more apparent than real. After all, the basic argument in favor of political autonomy is to protect the national economy from external disturbances. If the latter occur only rarely, the advantages of autonomy diminish.

Discretion and Conditionality

The international monetary regime, by adopting the principle of flexibility in exchange rate arrangements following the abandonment of the Bretton Woods framework, established discretion as the key concept in monetary relationships between countries. As such, the regime ceased being virtually self-enforceable and thus called for an agent of enforcement of international order. This was to be the IMF’s mandate, a mandate that, rather than being to exercise discretion under agreed rules, became one of enforcing certain rules in a discretionary environment. As the rules became less transparent in terms of members’ commitments and obligations, their enforcement called for a substantial measure of judgment on the part of the institution.43

The exercise of conditionality in a setting where members exercise discretion and where their obligations are therefore a matter for collective judgment and agreement became increasingly, and predictably, complex. And the evolution of the international economy in the decades following the Bretton Woods period added to that complexity.44 Nevertheless, a good case can be made that IMF conditionality practices made a difference during this period. By their continuing adaptation to changing world and country circumstances, they assisted in the correction of external imbalances owing to oil price rises (and declines), in the adjustment of imbalances that reflected structural factors and required longer periods of corrective policy implementation, and in the effective resolution of the systemic threats posed by the debt crisis.

In the process, conditionality practices helped make operational the link between macroeconomic and microeconomic management by stressing its importance for balance of payments adjustment. They also brought to the forefront the importance of adequate financial support for sound adjustment efforts. And they brought home the message that exchange rate flexibility was no panacea for economic problems.

Over the Bretton Woods period, the emphasis was on the preservation of national policy autonomy, an objective that was, in principle, made possible by exchange rate flexibility. On the other hand, this was the time when capital flows began to become a predominant force in the international economic environment. And IMF conditionality practices continued to seek openness in external current accounts and markets. These two factors together set limits to the scope of national policy autonomy. Thus, while during Bretton Woods there was little, if any, loss of autonomy, in the period that followed it, little, if any, gain was made on that front.

Markets and Conditionality

The presence of global markets and their impact on country economic policies and performance are central features of the world economy now and in the period ahead. The difference that IMF conditionality will make in these circumstances is, of course, yet to be seen. But a few considerations merit attention even at this early stage.

The wide scope given to market forces by most governments in both the national and international domains have broadened and strengthened the impact of market discipline on their own policies and economies. IMF conditionality practices and IMF surveillance are also instruments of policy discipline. Their effectiveness will depend on their ability to underpin market forces when they point to needed adjustments. But it will also be contingent on their skill in guiding market forces away from any tendency they exhibit to delay policy correction.

From these perspectives, effective surveillance can go a long way toward averting the “policy undershoots” that often are behind market misperceptions. And effective conditionality, in turn, can serve to defuse the “market overshoots” that can occur when inadequate policies are allowed to persist for long. Thus, although in a certain sense all instruments of policy discipline—market forces, conditionality, and surveillance—can be seen as competing, they can also complement one another. A good test of whether the IMF and its conditionality practices will make a difference in today’s and tomorrow’s world economic setting will be their ability to underpin market discipline and to prevent market forces from underwriting inappropriate policies. And an essential message to bear in mind is that the limits on national policy autonomy that have prevailed in the past—during periods of rules or of discretion—will likely be tightened severely in a setting of globalized market forces.

Annex I Guidelines on Conditionally45

The Executive Board agrees to the text of the guidelines on conditionality for the use of the Fund’s resources and for stand-by arrangements as set forth [below].

Decision No. 6056-(79/38)

March 2, 1979

Use of Fund’s General Resources and Stand-By Arrangements

1. Members should be encouraged to adopt corrective measures, which could be supported by use of the Fund’s general resources in accordance with the Fund’s policies, at an early stage of their balance of payments difficulties or as a precaution against the emergence of such difficulties. The Article IV consultations are among the occasions on which the Fund would be able to discuss with members adjustment programs, including corrective measures, that would enable the Fund to approve a stand-by arrangement.

2. The normal period for a stand-by arrangement will be one year. If, however, a longer period is requested by a member and considered necessary by the Fund to enable the member to implement its adjustment program successfully, the stand-by arrangement may extend beyond the period of one year. This period in appropriate cases may extend up to but not beyond three years.

3. Stand-by arrangements are not international agreements and therefore language having a contractual connotation will be avoided in stand-by arrangements and letters of intent.

4. In helping members to devise adjustment programs, the Fund will pay due regard to the domestic social and political objectives, the economic priorities, and the circumstances of members, including the causes of their balance of payments problems.

5. Appropriate consultation clauses will be incorporated in all stand-by arrangements. Such clauses will include provision for consultation from time to time during the whole period in which the member has outstanding purchases in the upper credit tranches. This provision will apply whether the outstanding purchases were made under a stand-by arrangement or in other transactions in the upper credit tranches.

6. Phasing and performance clauses will be omitted in stand-by arrangements that do not go beyond the first credit tranche. They will be included in all other stand-by arrangements but these clauses will be applicable only to purchases beyond the first credit tranche.

7. The Managing Director will recommend that the Executive Board approve a member’s request for the use of the Fund’s general resources in the credit tranches when it is his judgment that the program is consistent with the Fund’s provisions and policies and that it will be carried out. A member may be expected to adopt some corrective measures before a stand-by arrangement is approved by the Fund, but only if necessary to enable the member to adopt and carry out a program consistent with the Fund’s provisions and policies. In these cases the Managing Director will keep Executive Directors informed in an appropriate manner of the progress of discussions with the member.

8. The Managing Director will ensure adequate coordination in the application of policies relating to the use of the Fund’s general resources with a view to maintaining the nondiscriminatory treatment of members.

9. The number and content of performance criteria may vary because of the diversity of problems and institutional arrangements of members. Performance criteria will be limited to those that are necessary to evaluate implementation of the program with a view to ensuring the achievement of its objectives. Performance criteria will normally be confined to (i) macroeconomic variables, and (ii) those necessary to implement specific provisions of the Articles or policies adopted under them. Performance criteria may relate to other variables only in exceptional cases when they are essential for the effectiveness of the member’s program because of their macroeconomic impact.

10. In programs extending beyond one year, or in circumstances where a member is unable to establish in advance one or more performance criteria for all or part of the program period, provision will be made for a review in order to reach the necessary understandings with the member for the remaining period. In addition, in those exceptional cases in which an essential feature of a program cannot be formulated as a performance criterion at the beginning of a program year because of substantial uncertainties concerning major economic trends, provision will be made for a review by the Fund to evaluate the current macroeconomic policies of the member, and to reach new understandings if necessary. In these exceptional cases the Managing Director will inform Executive Directors in an appropriate manner of the subject matter of a review.

11. The staff will prepare an analysis and assessment of the performance under programs supported by use of the Fund’s general resources in the credit tranches in connection with Article IV consultations and as appropriate in connection with further requests for use of the Fund’s resources.

12. The staff will from time to time prepare, for review by the Executive Board, studies of programs supported by stand-by arrangements in order to evaluate and compare the appropriateness of the programs, the effectiveness of the policy instruments, the observance of the programs, and the results achieved. Such reviews will enable the Executive Board to determine when it may be appropriate to have the next comprehensive review of conditionality.

Annex II IMF Financial Facilities46

The IMF’s financial resources are made available to its members under a variety of facilities and policies, depending on the circumstances, especially the nature of the macroeconomic and structural problems to be addressed.

The IMF makes resources available under both its general resources and its concessional financing facilities.47 Member countries use the general resources of the IMF by making a purchase (drawing) of other members’ currencies or SDRs with an equivalent amount of their own currencies. The IMF levies charges on these drawings and requires that members repurchase (repay) their own currencies from the IMF with other members’ currencies or SDRs over a specified time. Concessional financing under the structural adjustment and enhanced structural adjustment facilities is made available in the form of loans.

Regular Facilities

Reserve Tranche

A member has a reserve tranche position to the extent that its quota exceeds the IMF’s holdings of its currency in the General Resources Account, excluding holdings arising out of drawings made by the member under all policies governing the use of the IMF’s general resources. A member may draw up to the full amount of its reserve tranche position at any time, subject only to the requirement of a balance of payments need. A reserve tranche drawing does not constitute a use of IMF credit and is not subject to charges or to an expectation or obligation to repay.

Credit Tranches

IMF credit is made available in tranches (or segments) of 25 percent of a member country’s quota. For drawings in the first credit tranche, members must demonstrate reasonable efforts to overcome their balance of payments difficulties. First credit tranche drawings are not phased nor are they subject to performance criteria.

Upper credit tranche drawings are made in installments and are released, provided policy implementation is in line with an agreed program. Such drawings are normally associated with stand-by or extended Fund facility arrangements. These arrangements typically aim at overcoming balance of payments difficulties as well as supporting structural policy reforms where appropriate. Performance criteria and periodic general program reviews are used to assess policy implementation.

Stand-By Arrangements

Stand-by arrangements give members the right to draw up to a specified amount during a prescribed period. Drawings are phased on a quarterly basis, and their release is conditional on meeting performance criteria and the completion of periodic program reviews. Performance criteria generally cover credit policy, government or public sector borrowing requirements, trade and payments restrictions, foreign borrowing, and reserve levels. These criteria allow both the member and the IMF to assess progress and may signal the need for further corrective policies. If performance criteria are not met, members can make further drawings only if the IMF and the member country reach understandings on the resumption of drawings.

Stand-by arrangements typically cover a 12-18 month period (although they can extend up to 3 years), and repayments are to be made within 3¼ to 5 years of each drawing.

Extended Fund Facility (EFF)

The extended Fund facility provides assistance to member countries for longer periods and in larger amounts than under credit tranche policies. Extended arrangements generally run for three years (and can be extended for a fourth year). They are aimed at overcoming balance of payments difficulties stemming largely from structural problems and requiring a longer period of adjustment. A member requesting an extended arrangement is expected to present a program outlining the objectives and policies for the whole period of the arrangement, and to present a detailed statement each year of the policies and measures it will follow in the next 12-month period. The phasing and performance criteria are comparable to those of stand-by arrangements, although phasing on a semiannual basis is possible. Countries using extended Fund facility resources must repay the currencies they have drawn within 4½ to 10 years of the drawing.

Special Facilities

Systemic Transformation Facility (STF)

This temporary facility was created in April 1993 to respond to the needs of economies in transition. It provided financial assistance to members experiencing balance of payments difficulties as a result of a shift from significant reliance on trading at nonmarket prices to multilateral market-based trade. Access was limited to not more than 50 percent of quota, which could be made in two drawings and was in addition to financing obtained under other IMF facilities. Since May 1, 1995, first drawings under the STF can no longer be made, but members that have had a first drawing approved by then are eligible for a second drawing by end-December 1995.

Compensatory and Contingency Financing Facility (CCFF)

The compensatory component of this special facility provides members that demonstrate a balance of payments need with resources to help compensate for temporary shortfalls in export earnings and services receipts and/or temporary excesses in cereal import costs that arise from events largely beyond their control.

The contingency element helps members with IMF arrangements maintain the momentum of their reform efforts when faced with unforeseen adverse external shocks. Financing is provided to cover part of the net effect of unfavorable deviations in highly volatile and easily identifiable key variables affecting the member’s current account. The variables could include main export or import prices and international interest rates. Workers’ remittances and tourism receipts may also be covered if they represent a significant element in the member’s current account. Deviations are measured in relation to baseline projections, which are established at the start of an arrangement. The contingency mechanism is triggered once net deviations exceed a threshold level and it is clear they will not be offset by positive movements of other key variables. Favorable deviations—such as an unexpected increase in export prices—may trigger a symmetry provision, under which a higher reserve target, a reduced drawing, or an earlier repayment would be required.

Buffer Stock Financing Facility

Under this facility, the IMF provides resources to help finance members’ contributions to approved international buffer stocks, if the member demonstrates a balance of payments need. Drawings must be repaid within 3¼ to 5 years. No drawings have been made under this facility for the past ten years, and no credits under the facility are currently outstanding.

Emergency Assistance

In the context of balance of payments assistance under its credit tranche policies, the IMF provides emergency assistance, allowing members to make drawings to meet balance of payments needs arising from sudden and unforeseeable natural disasters. These drawings do not entail performance criteria or a phasing of disbursements, although they often precede an arrangement with the IMF under its regular facilities.

Concessional Facilities

Structural Adjustment Facility (SAF)

Established in 1986, arrangements under this facility provided low-income member countries with loans on concessional terms in support of medium-term macroeconomic adjustment policies and structural reforms. In November 1993, the IMF’s Executive Board agreed that no new commitments would be made under the structural adjustment facility.

Enhanced Structural Adjustment Facility (ESAF)

Established by the Executive Board in 1987, the ESAF was extended and enlarged in February 1994. With the decision to halt new commitments under the SAF and to expand significantly the resources available under the ESAF Trust Fund (the funding source for ESAF arrangements), ESAF arrangements became the principal means by which the IMF provides financial support, in the form of loans and on concessional terms, to low-income member countries facing protracted balance of payments problems.

ESAF resources are intended to support strong medium-term structural adjustment programs. Eligible members seeking the use of ESAF resources must develop, with the assistance of the staffs of the IMF and the World Bank, a policy framework for a three-year adjustment program. A policy framework paper describes the authorities’ economic objectives, macroeconomic and structural policies, priorities, and the measures they intend to adopt during the three-year period. It assesses external financing needs and major sources of financing, and serves as a means of strengthening Bank-IMF collaboration and of attracting external financial and technical assistance in support of the adjustment program. The paper is updated annually.

Adjustment measures under the ESAF are expected to help achieve a substantial strengthening of the balance of payments position and foster growth during the three-year period. ESAF arrangements are funded by ESAF Trust resources, which are derived from loans and grants as well as from transfers from the Special Disbursement Account. Monitoring under ESAF arrangements is conducted through quarterly financial and structural benchmarks. In addition, semiannual performance criteria are set for key quantitative and structural targets. ESAF loans are disbursed semiannually, initially upon approval of an annual arrangement and subsequently based on the observance of performance criteria and after completion of the midterm review. ESAF loans are repaid in ten semiannual installments, beginning 5½ years and ending 10 years after the date of each disbursement. The interest rate on ESAF loans is 0.5 percent a year.

The enlargement and extension of the ESAF Trust became effective on February 23, 1994, and is being financed by a broad cross-section of the IMF’s membership. To date, commitments have been received from more than 40 countries, about half of which are developing countries. The target amount of lending for the enlargement is SDR 5 billion, which, together with the SDR 5.1 billion available before the enlargement, would expand the total lending capacity to SDR 10.1 billion. The commitment period extends to December 1996, with disbursements to be made through the end of 1999.

Appendix

Table A1.

Arrangements Approved During Financial Years Ended April 30, 1953-95a

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Sources: IMF, Annual Report (1995); IMF Memorandum; IMF staff calculations.

For abbreviations of facilities, see Annex II.

For STF, number of drawings; most countries have drawn twice.

For STF, amounts drawn.

References

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*

Manuel Guitián is the Director of the Monetary and Exchange Affairs Department. He is a graduate of the Universities of Santiago de Compostela (Law) and Madrid (Economics) and received a Ph.D. in economics from the University of Chicago. Conditionality is one of the subjects under permanent examination in the institution in Board reports, staff papers, and other published and internal documents. For the preparation of this paper, the author relied extensively on these materials as well as on his own paper on conditionality of a decade and a half ago; see Guitián (1981).

1

This role encompasses responsibilities that go beyond the purely financial domain, such as those the IMF has on the jurisdictional and surveillance fronts. See, for elaboration, Guitián (1992a); for a detailed examination of the history and activities of the IMF through the late 1970s, see Horsefield (1969) and de Vries (1976 and 1985). And for a recent review of the role of the IMF in international monetary cooperation, see James (1996).

2

A recent and excellent examination of the evolving character of IMF’s conditionality practices will be found in Polak (1991 also Finch (1989). Earlier discussion is contained in Guitián (1981) and Williamson (1983).

3

The references to the Articles of Agreement in the text are to those amended effective November 11, 1992; see IMF (April 1993). Broadly speaking, the analysis applies also to earlier versions of this basic charter. See Horsefield 1969), Vol. 3 for the original text of the Articles of Agreement. See also Gold (1979) for an extensive discussion of conditionality under the first and the second amendments of the Articles of Agreement.

4

See IMF (1994), in particular Executive Board Decision No. 6056-(79/38) on Guidelines on Conditionality (reproduced in Annex I). See also Gold (1979).

5

Up to a maximum limit in relation to a member’s quota. Quantitative limitations were, from the beginning, generally agreed by all parties; see Horsefield (1969), Vol. 1, p. 67 ff.

6

Over time, the IMF has been able to supplement its quota-based resources by contributions of specific members under a variety of schemes, such as the General Arrangements to Borrow, the (now lapsed) supplementary financing facility, and the (also lapsed) enlarged access policy; see IMF (1994).

7

It should he stressed, though, that conditionality is not the only instrument on which the IMF counts to further its institutional interests and purposes. Surveillance over members’ economic policies is the other, as important, if not more so, instrument at its disposal. See Guitián (1992a) for elaboration. On the monetary identity of the IMF, see Duisenberg and Sz€sz (1991). See also Guitián (1994a).

8

The use of varying economic terminology in connection with the process of adjustment is one of the indications of these diverse perceptions. Thus, we have seen terms like stabilization, adjustment, structural adjustment, development, and growth replace one another as key features of the process in the last five decades.

9

See, for further discussion, Guitián (1981), Nowzad (1981), and Tanzi (1987).

10

Considerations of this nature are behind the emphasis that conditionality practices put on the timely introduction of corrective measures; see Executive Board Decision No. 6056-(79/38) on Guidelines on Conditionality, reproduced in Annex I to this paper.

11

For a recent example of recent discussions of these issues in the IMF, see the papers presented at a conference on Income Distribution and Sustainable Growth held at IMF headquarters on June 1-2, 1995, and in particular those conducted in the session on Equity Issues in IMF Policy Advice. In practice, the IMF has responded to members’ concerns with their multiple aims by making explicit the relationship of economic policies to a variety of objectives, including, for example, poverty alleviation and the environment; see Polak (1991).

12

This is a policy area on which views have been significantly adapted since the IMF was established, most particularly in recent years. The adaptation reflects a new consensus on the role of government in the economy, which has moved in the direction of favoring support of market forces rather than interference with them. See, for further discussion, Guitián (1996).

13

For further elaboration on this point, see Guitián (1973 and 1994b) and Polak (1991).

14

See in particular Executive Board Decision No. 102-(52/ll), pp. 56-58 in IMF (1994), where general criteria are set out for use of IMF resources. For a discussion of early conditionality practices, see Mookerjee (1966).

15

See Annex II to this paper for a summary description of IMF facilities. And for a complete analysis of the evolution of stand-by arrangements during the 1950s and 1960s, see Gold (1970).

16

For an excellent discussion of financial programming, see Robichek (1971 and 1985).

17

See Executive Board Decision No. 7925-(85/38), as amended by Decision No. 8887-(88/89), in IMF (1994), pp. 87-89, for further elaboration.

18

See Executive Board Decision No. 2603-(68/132), reproduced in Guitián (1981), pp. 44-45.

19

For a detailed exposition of this period, see de Vries (1976).

20

The adaptations included the introduction of transitory facilities that provided resources with relatively low conditionality standards. Thus, in 1974 an oil facility was established to assist members in the financing of oil import-related balance of payments deficits. This facility was extended in 1975. Recognizing, however, that adjustment to new oil price levels required specific measures, the conditionality standards were tightened. The oil facility was terminated in March 1976. In that year the IMF also introduced, on a temporary basis, the Trust Fund, a facility for the benefit of low-income countries. As a source of direct balance of payments loans the Trust Fund was terminated in 1981. See Guitián (1981) for further discussion of this subject. See also Annex II to this paper for an updated description of IMF facilities.

21

The expansions in the scale of IMF conditional financing came first in the form of a temporary supplementary financing facility that became effective in 1979. Its resources were fully committed by early 1981, and the facility was then replaced by the enlarged access policy, which permitted the IMF to assist members in coping with “payments imbalances that are large in relation to their quotas.” The assistance was to be provided under stand-by or extended arrangements. See Executive Board Decision No. 6783-(81/40) in IMF (1994), pp. 181-4. An important adaptation in this area was the shift from the concept of limiting total cumulative use of IMF resources in relation to quota to the principle of annual use of those resources, albeit within a global maximum use. See, for elaboration, Guitián (1981).

22

See Executive Board Decision No. 6056-(79/38) on Guidelines on Conditionality reproduced in Annex I to this paper.

23

Much has been written about the debt crisis since it irrupted onto the international stage in August 1982. A representative sample of volumes on the subject would include Mehran (1985), Frenkel, Dooley, and Wickham (1989), Dornbusch and others (1989), Calvo and others (1989), Husain and Diwan (1989), and Stoll (1990). See also “The International Debt Crisis: What Have We Learned?” Chapter III in Guitián (1992b) and the further references listed there; and Guitián (1992a).

24

For excellent discussions of the role of debtors and creditors in the debt strategy, see de Larosière (1986 and 1987).

25

These stages of the debt strategies were associated with initiatives proposed by United States Treasury Secretaries at the time, James Baker (growth) and Nicholas Brady (debt reduction). See Erb (1990), Ortiz (1989), and Cline (1984 and 1995).

26

See, for further discussion of growth-oriented adjustment programs, Corbo, Goldstein, and Khan (1987). See also Mohammed (1991) for a recent examination of IMF contingency financing and concessional support.

27

The existence and strength of this coincidence and the corresponding support of conditionality were the themes of Michel Camdessus’s (1994) closing remarks at a plenary session of the Annual Meeting on October 6 in Madrid.

28

This point is elaborated fully in Guitián (1996). The convergence of views described in the text has come to be known as the “Washington consensus,” the label given to it by Williamson (1990). It is also behind the “new development paradigm” in development economics; see Summers and Thomas (1993) and Bruno (1995).

29

On the promising prospects owing to the general acceptance of these ideas, see Schultz (1995). And on the growing acceptance of conditionality, see Camdessus’s (1994) closing remarks at the Annual Meetings in Madrid.

30

The focus in the text is on IMF practices. But in addition to these, the coordination linkages with other multilateral institutions, such as the World Bank, the OECD, and the EBRD, have been strengthened. See Guitián (1992b and 1992c), where these issues as well as some other aspects of conditionality in the context of reform are discussed.

31

See Executive Board Decision No. 10348-(93/61) STF, in IMF (1994). See also Annex II to this paper and IMF Survey (May 3, 1993).

32

For a description of the technical assistance services of the IMF, see IMF (1991).

33

See Article VI on Capital Transfers in IMF (1993).

34

See Article XXX on Explanation of Terms in IMF (1993). This Article includes as current transactions payments due in connection with normal short-term banking and credit facilities and payments of moderate amount for amortization of loans or for depreciation of direct investments, which are generally seen as capital transactions.

35

For a more extensive discussion of these issues, see Guitián (1992c and 1993). For a recent examination of capital account convertibility issues and their implications for IMF policies, see IMF (1995).

36

This challenge brings up the close link between the code of conduct and IMF conditionality, which underscores the importance of updating the former to bring it in line with reality in the world economy. In its present version, members may not use IMF general resources to meet “large or sustained” capital outflows. See Article VI, Section 1(a) in IMF (1993).

37

Some of the implications for IMF conditionality and surveillance in a setting of progressively integrated goods, services, and capital markets have been discussed in Guitián (1994c). It should also be pointed out that the IMF has already been considering initiatives in the directions indicated in the text. Thus, a short-term financing facility, currency stabilization funds, and emergency financing mechanisms have been or are being discussed in the Executive Board.

38

An early treatment of methodological questions can be found in Guitián (1981), where three possible standards of comparison were discussed: what is relative to what was; what is compared to what should be; and what is versus what would or might have been.

39

There is too ample a body of literature dealing with conditionality that focuses on the subject of country-specific assessments to pay justice to it in this paper. A selected sample would include Schadler (1995), Schadler and others (1995), Santaella (1995), Polak (1991) and the references it includes, Spraos (1986), Goldstein (1986), Finch (1989), Khan (1990), and Williamson (1983); for a selected list of earlier references, see Guitián (1981).

40

The argument in the text is cast in terms of prospective external deficits, as it is in the context of such deficits that the issue of conditionality and IMF financial support arises. But the reasoning is general. In the absence of restrictions, primary responsibility for policy correction falls on deficit countries; that correction, through its impact on price and quantity variables in the system, will restore balance to it. The surplus countries’ responsibility is to allow those changes to operate within their economies; see Guitián (1992b).

41

See Polak (1991), p. 2, for an elaboration of this argument. Polak attributes the quick resolution of external imbalances, in part, to the rapid expansion of the world economy. But this, in turn, can be attributed to the existence of transparent rules and the instruments available to ensure their observance, key among which was IMF conditionality.

42

Reference should be made here to the institution’s contribution to balance of payments analysis and its linkages with monetary and other policies. See, for example, the collection of articles in IMF (1977).

43

The extent to which the new regime called for judgment to be exercised will be evident when reading, for example, Article IV on the obligations of members regarding exchange arrangements; see IMF (1993).

44

In this context, the relevant question has been posed by Paul Volcker when he asked whether the turbulence and subpar performance that have characterized the world economy since the 1970s are “related to, and aggravated by, the breakdown of the disciplines implied by the Bretton Woods monetary system....” See Volcker and Gyohten (1992), p. 291.

45

Source: IMF (1994).

46

Excerpted from IMF Survey (September 1995).

47

Table A1 in the Appendix lists the various arrangements and resource commitments of the IMF undertaken since its inception.

IMF Staff papers, Volume 42 No. 4
Author: International Monetary Fund. Research Dept.