Perspectives on the Conditionality in IMF-Supported Economic Programs1
Amando M. Tetangco, Jr.
Deputy Governor, Bangko Sentral ng Pilipinas
Tokyo, July 10, 2001
At the outset let me express my appreciation to the organizers of this seminar. I believe that this is an important exercise given that there have been many changes since the 1979 Guidelines on Conditionality. After more than two decades, a review indeed seems to be in order.
The Philippines has had a long history of close cooperation with the IMF. In 1962, the Philippines availed itself of its first financing agreement—a Stand-By Arrangement (SBA) with the Fund. Last December 2000, we concluded our last financing agreement, also an SBA. During this almost 40-year span, the Philippines entered into a total of 23 various financing agreements with the Fund. Some of these were classic stand-by's or in the more modern terminology, precautionary; the greater number were active arrangements.
With a long history of constructive interaction with the Fund, one can consider the Philippines a veteran in negotiating, agreeing, and subsequently living with IMF programs and their associated conditionality. Assessing performance and effectiveness of the programs is clearly difficult, as there is no such thing as a straightforward performance attribution technique in an area as complicated as this one. This is so because many factors are in play and not all elements are directly measurable. For instance, not meeting a program objective may be due to external or domestic shocks, policy slippage or to the inappropriateness of the degree or the timing of the policy adjustments prescribed in the program. Having said that, however, I would add that it is undeniable that the Philippine economy has undergone a transformation under these Fund-supported programs, as we adopted a prudent foreign debt management strategy and were able to strengthen the role of competitive forces in the economy, particularly in the external sector. This structural economic metamorphosis has made the domestic economy more resilient to various shocks. One can say that this has been partly the result of policy adjustments made under Fund conditionality. I hope that by sharing our experience and providing some suggestions, we can contribute to the improvement of the Fund's guidelines regarding conditionality attached to its programs.
Fund Conditionality and the Philippine Experience
In many countries, conditionality is commonly viewed as the set of actions that a borrower must take in order to obtain IMF financial assistance. Of course, we know that there are underlying reasons for such conditionality, including that IMF financing must go hand in hand with policy adjustments in addressing external imbalances. Conditionality seeks to ensure the existence of appropriate safeguards that IMF financing is utilized for its intended purpose and the objectives of the program are achieved. On the part of the borrower, adherence to conditionality provides an assurance that financial assistance is forthcoming from the Fund.
Scope of Conditionality
It has been noted that there has been an expansion in conditionality over the years, particularly in the structural area. A number of reasons have been cited as being behind this trend, including the Fund's increasing emphasis on economic growth as a policy objective, its involvement with different groups of countries and the critical dependence of monetary and fiscal policies on structural conditions. These are not bad reasons and to a certain extent, have reflected the evolution of the IMF as it responded to changing conditions and new challenges over the years.
However, the trend carries the risk of the Fund overextending itself, losing its focus and, as it tries to do too much, suffering a reduction in its effectiveness. For the borrowing economies, unnecessarily broad conditionality takes away from the member's feeling of ownership of the program and can distract policymakers from key issues that must be addressed. Moreover, failure to comply with some of the elements in the program can have a negative impact on investor confidence even if the critical elements have been achieved. This last point is particularly important given the Fund's role of helping countries stabilize their economies in an increasingly transparent environment.
Looking at the recent Philippine experience, conditionality has often involved a long menu of structural reform measures. For example, in the 1994 Extended Arrangement, structural conditionality touched on six major areas involving some 40 (43) specific measures.2 In the last Fund-supported program, the 1998 Stand-By Arrangement, structural conditionality covered eight major areas involving over a hundred (110) specific measures.3 Because of the large number, I had to count again and in the process, discovered that there was an error in the numbering of the measures in the structural matrix.
Some of these structural measures, while important, may be considered not crucial to the attainment of macro objectives. In the 1998 SBA, examples of "macro relevant" but not critical to the program are the passage of the Securities Regulation Code, Retail Trade Liberalization, and measures to safeguard local industries against increased imports. Furthermore, the implementation of some of these reforms is not within the time horizon of the assistance as some would involve legislation which normally takes time and is not under the direct control of the executive branch of government. Accelerating the pace of the reform process to meet program targets can also have adverse effects on the vulnerable sectors of the society and induce objections to the program.
Moreover, there is a tendency for conditionality to accumulate over a series of Fund-supported programs. The unfinished measures from previous programs are carried into succeeding programs often in greater detail. Additional measures are also included that may extend to areas over which the Fund does not have core expertise leading to conditionality overload.
To avoid this phenomenon of mission creep,
- the Fund has been advised to instead focus on its core competence which lies in macroeconomic policy-monetary, fiscal, exchange rate and financial sector policies.
The Fund likewise enjoys a comparative advantage in crisis avoidance and in crisis management.
One way of having a more focused set of conditionality is
- to limit structural conditionality to those that are critical for the achievement of the macroeconomic objectives of the program.
Admittedly, laying down rules on how to identify critical measures is difficult. In practice, this exercise may have to proceed on a case-to-case basis. However, there are general principles that can be adopted.
- Aside from the relevance to the program objectives, critical reforms may include those that focus on the problems that led to the economic difficulty or that significantly contribute to a higher probability of a similar crisis occurring in the future.
- Critical reforms may also include those that address serious structural problems, in which case, any failure to resolve such imbalance would have a significant impact on the macroeconomic performance.
- The other measures necessary to ensure sustainable economic growth but not critical to the program can take the form of policy advice and may be handled by other multilateral institutions.
An example of a critical structural reform measure in the Philippine setting is the privatization of the state-owned power company. Its weak financial position is a significant factor behind and is foreseen to continue to weigh on a deteriorating fiscal position. Moreover, its inefficient operation has led to high cost of power, undermining the competitiveness of local industries and may impinge on future export growth. Thus, the privatization of this enterprise is crucial to the attainment of fiscal consolidation and medium-term external viability. An Omnibus Power Sector Law was passed recently which would now allow the sale of this company to the private sector.
An example of a macro relevant reform but not fundamental to the objectives of the program is the strengthening of the Securities and Exchange Commission. The strengthening of this regulatory body will undoubtedly have a major impact on the corporate sector and in the equities market but may not be significant to the attainment of the objectives of the Fund program. Thus, this may form part of the policy advice of the Fund and the reform initiative mainly supported by other multilateral institutions like the World Bank or the Asian Development Bank. In this regard, we agree with the suggestion that there should be a clear delineation of those structural measures which are covered by conditionality and those which are not but would strengthen the broader reform intentions of the member. Such delineation should be understood by all concerned as this will later on form the basis for assessing performance under the program.
There is a suggestion to explore the possibility of the Fund relying more on results-based conditionality. This would make financing contingent on the attainment of the targeted outcomes rather than on the achievement of a specific path. Admittedly, there are limitations to the application of results-based conditionality. Results of macroeconomic policies and reform initiatives usually take considerable time and this may imply that most of the Fund's financing can only be drawn towards the end of the program. Such pacing of drawdowns can be counterproductive as it may be inconsistent with the timing of the financing needs of the borrowing country.
However, we believe that there is a strong argument for a results-based conditionality. This modality provides national authorities flexibility to choose, together with the Fund, the appropriate strategy to attain the agreed objectives. There should be recognition by the Fund that there are alternative ways of achieving the program objectives, something like there is more than one way to skin a cat. National authorities may have a greater understanding of local conditions and are in a better position to judge which path may be more effective. Thus, national authorities must be given reasonable elbowroom within which to maneuver and realize their objectives. We would encourage the Fund to continue looking for ways on how this can be put in place.
On the selection of structural measures that would be covered by conditionality, we find appealing the suggestion that the burden of showing that a particular measure should be included must rest on the proponent. This could be a part of the process that would allow sufficient discussion of the issues involved, both internally in the Fund as well as between the Fund mission and the authorities. This would require flexibility in Fund procedures, including in inter-departmental reviews and possible changes to the mission chief's brief in case a better suggestion comes up during discussion with the authorities.
Design of the Program
Let me say a few words about program design. In the design of economic programs for economies experiencing, say, external payments difficulties, the Fund accords primacy to macroeconomic stability. While there is little dispute that there is a need to restore some degree of macroeconomic stability, it may be the case that this objective can be overemphasized. Excessive focus on closing certain macroeconomic imbalances can lead to an overly restrictive policy stance and heighten economic downturns, thus making the adjustments particularly painful if not socially unpalatable. I recall that during the Asian financial crisis, the initial Fund- supported program of 1998-2000 involved the tightening of fiscal policy to arrest the deterioration of the fiscal account that occurred in 1997 due to the revenue decline associated with the economic slowdown. By 1999, the revised economic program recognized that an important objective under prevailing conditions was to support the nascent recovery of output and that the previous program contained elements that might be restrictive. Thus, the revised program introduced a well-measured shift toward a more expansionary fiscal policy to stimulate domestic demand.
- The point here is that the design of a Fund program should be flexible and take into account specific country circumstances.
There is also the issue of how to deal with situations where objectives of the program are made secondary to the program performance criteria. Should the release of Fund resources be delayed if some of the performance criteria are not met but the objectives are achieved?
In the Philippines, there were instances that macroeconomic objectives were met despite our failing to comply with some of the program performance criteria. For example, there were episodes when base money ceilings were breached but actual inflation and its implied path were within the program targets. These were during the periods of heavy capital inflows. In response to this phenomenon, the central bank introduced key modifications to its then monetary targeting framework. The modification included adjusting the target base money to accommodate productive capital inflows which do not feed into the inflation process. This allowed the central bank to respond to the unexpected rise in the real money demand coming from improvements in the external sector of the economy. Also, in the last SBA, all the macroeconomic objectives were achieved but the fiscal criterion was not met. The SBA was eventually allowed to expire as we shifted to a "Post-Program Monitoring" Framework.
To conclude, let me summarize the recommendations arising from some observations on conditionality attached to the Fund's financial facilities. The Fund must ensure that flexibility continues to be a factor in the design of programs while taking into account country-specific characteristics and circumstances. Efforts towards a more focused and parsimonious conditionality can certainly enhance the effectiveness and facilitate national ownership of the economic program. This can be done by concentrating on conditionality that is critical to the achievement of the macroeconomic objectives. Moreover, national ownership of the program could further be encouraged by allowing national authorities, together with the Fund, to explore policy alternatives to achieve economic objectives.
1 Remarks delivered during the IMF Seminar on Conditionality on 10 July 2001 in Tokyo, Japan
2 Oil deregulation, tax reform, import liberalization, financial sector reform, foreign investment liberalization, privatization
3 Passage of the General Banking Law, amendments to the BSP Charter, banking sector reform, power sector reform, passage of Securities Regulation Code, rationalization of tax holiday incentives, retail trade liberalization, tax administration reform measures, safeguards for local industries against increased imports