Signaling by the Fund—A Historical Review
Policy Monitoring Arrangement
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IMF Executive Board Discusses Policy Signaling Instrument
On September 22, 2004, the Executive Board of the International Monetary Fund (IMF) had an initial discussion on a proposed signaling instrument, named the Policy Monitoring Arrangement, in the context of a review of the history of signaling by the Fund.
The demand for close engagement between the Fund and its member countries outside the context of a Fund financial arrangement has arisen repeatedly over the years. The Fund has used various instruments to respond to this demand for high frequency monitoring and delivery of signals on the strength of a member's economic and financial policies, including staff-monitored programs, assessment letters, and various forms of strengthened surveillance.
During the past year, the Fund has paid renewed attention to modalities for policy monitoring and signaling. The issue has arisen in discussions of the Fund's surveillance activities (PIN No. 04/95) the Fund's support of low-income member countries ( PIN No. 04/40), possible use of precautionary arrangements in capital account crisis prevention and some members' request for an intensified surveillance relationship with the Fund.
The staff paper on a Policy Monitoring Arrangement (PMA) sketches an outline of a possible Fund signaling instrument. It describes the potential features of the PMA, such as purpose, legal basis, eligibility, activation criteria, structure of reviews, documentation, and publication regime, and presents a brief analysis of the instrument. The paper was designed to stimulate further discussion by the Executive Board, so as to provide guidance for further work by staff on Fund monitoring and signaling.
The staff paper on Signaling by the Fund-A Historical Review: reviews the Fund's thinking about signaling since its inception and seeks to distill lessons from this experience. It points out that similar themes have recurred over the decades in the Fund's thinking about signaling. The paper concludes that historical experience suggests seven reasons why it has been difficult to design effective signaling mechanisms: (i) the tension between the wish to influence creditors and the wish to let them arrive at their own judgments; (ii) the dislike of giving negative signals; (iii) the risk of misinterpretation of "on/off" signals, depending upon standards for their use; (iv) the credibility of signals, depending upon incentives faced by the Fund including ties to use of Fund resources; (v) the crowding out of multidimensional signals by "on/off" signals; (vi) the dual signaling role of use of Fund resources-a signal of need as well as of policy strength; and (vii) the stigma that, in some countries and circumstances, may be attached to close Fund involvement.
Executive Board Assessment
Executive Directors have had a useful preliminary discussion on a proposed new signaling instrument, tentatively named the Policy Monitoring Arrangement, in the context of the staff's review of the history of the Fund's approach to signaling mechanisms for conveying assessments of members' policies to the international financial community. A number of Directors considered this discussion to be timely, as the question of modalities for policy monitoring and signaling has come up in several recent Board discussions. However, other Directors regretted the short time available to consider the staff paper, and considered that the Fund should give further careful consideration to several aspects of the proposal, including the priority that should be attached to this possible instrument relative to other pressing issues, such as a precautionary facility for capital account crises and a precautionary Poverty Reduction Growth Facility, before deciding upon a new signaling mechanism.
The Fund has returned repeatedly to the issue of signaling mechanisms, as there has been a recurring demand over the years for delivery of signals on the strength of members' economic and financial policies. Directors observed that the Fund has experimented with a variety of instruments to respond to this demand, reflecting not only the diverse circumstances of members but also the evolving experience with the challenge of designing effective mechanisms. Directors stressed that analysis of any new signaling instrument should take careful account of this historical experience, including the fact that some of these instruments were rarely used or discontinued.
Against this background, Directors have had a wide-ranging discussion on whether the Fund's existing instruments are adequate to respond to demands for high-frequency policy monitoring and signaling, or whether new instruments are needed. Many Directors noted that frequent recourse to Fund financial arrangements with low access, or on a precautionary basis, points to a gap in the Fund's toolkit between regular Fund surveillance under Article IV and Fund-supported financial programs. Requests for intensified surveillance by a few Fund members were also seen as further evidence of such a gap.
Many Directors, however, felt that members' needs for Fund signaling can be met through the use of precautionary or low-access arrangements or through existing Article IV surveillance procedures, which, if necessary, may be adapted to provide for assessments more often than once a year. These Directors pointed to successful experiences with precautionary arrangements, the likely confusion from a proliferation of Fund instruments, and the risk of undermining existing surveillance procedures and financing facilities. A few Directors questioned whether Article V, Section 2(b) is an appropriate legal basis for the proposal. All Directors agreed that, should a new instrument be introduced outside the Article IV framework, its use would be entirely voluntary.
Directors expressed a variety of views on the usefulness and modalities of providing "on/off" signals through an instrument such as the PMA. They noted that a key challenge in the design of on/off signaling mechanisms has been the definition of a minimum standard for policies to be endorsed by such a mechanism. Experience with enhanced surveillance and staff-monitored programs shows that the standard is often interpreted as equivalent to upper credit tranche conditionality, even when it is not intended to be. A number of Directors therefore acknowledged the rationale underlying the staff proposal for a PMA based on the same upper credit tranche conditionality. The application of upper credit tranche conditionality, the fixed calendar of reviews, and the commitment to publish PMA-related documents would constitute elements essential for ensuring the PMA's credibility with donors and creditors and adding to its value for potential users. However, it was suggested that a clear signal of policy strength can also be given in support of strong programs, which include macroeconomic targets and structural measures, are fully owned, and are designed to put the economy on a path of sustainable growth and financial stability-without necessarily relying on the standard of upper credit tranche conditionality.
Many Directors were concerned that there may not be sufficient demand for a mechanism with the features outlined in the staff paper, given its stringent conditions-the standard of upper credit tranche conditionality with strict review and transparency conditions -and the absence of automatic access to Fund resources. Doubts about potential demand were also expressed based on concerns that, even as proposed, the PMA would not be seen as an adequate basis for debt restructuring in the Paris Club. These Directors were in favor of retaining greater flexibility in the design of a possible signaling instrument than the staff envisages for the PMA. Some Directors saw greater potential for a mechanism designed to facilitate an intensified surveillance relationship.
Directors generally agreed that any new signaling mechanism, if adopted, should be devised in such a way as to fit appropriately into the Fund's array of instruments ranging from surveillance to Fund-supported programs, which support members and provide signals. In particular, Directors noted that precautionary Stand-By Arrangements and low-access PRGF arrangements have served as useful instruments to support members. A new instrument should not dilute or undermine the positive signals associated with such arrangements. More generally, Directors underscored that Fund financial arrangements will continue to convey a signal of policy strength associated with upper credit tranche conditionality, and signal members' readiness to provide donors and creditors information to assess the strength of their policies through publication of relevant documents in accordance with the established policy on Fund transparency. A number of Directors noted the challenge of ensuring that an appropriate signal is maintained in the absence of a commitment of Fund resources, particularly in cases where the policy stance begins to fall short of the standard of upper credit tranche conditionality, and where this shortfall needs to be signaled. Directors also discussed the pros and cons of a fixed calendar of reviews under the PMA. Those favoring a fixed calendar pointed to the clarity that this would provide to the signals, while other Directors cautioned that a rigid calendar could lead to ill-timed negative signals and further reduce the attractiveness of the instrument.
Directors agreed that use of the PMA will likely entail a similar call on staff resources as a Fund financial arrangement. They noted that the net additional resource costs of the PMA will depend upon whether the PMA largely substitutes for Fund financial arrangements or for lower-cost surveillance relationships. Directors stressed that quantification of resource costs should be an integral part of any further work on the PMA. A few Directors felt that charges for non-PRGF eligible countries would help to avoid financial disincentives to the use of precautionary Stand-By Arrangements. However, others noted that levying a fee for the use of a signaling instrument would not be consistent with the provision of other services by the Fund.
Today's discussion has been very helpful in identifying the considerations Directors feel should be taken into account as we move toward further careful exploration of the merits of a new signaling mechanism and its possible features. Much remains to be done in some areas, and the ideas underlying a potential signaling mechanism need to be further clarified. Directors encouraged the staff to pursue consultations with potential users, donors, and private market participants to ascertain the usefulness and potential demand for a signaling mechanism. Staff will come back to the Board on the basis of these consultations and today's Board discussion. Some Directors suggested that follow-up work in this area should continue to draw a distinction between mechanisms that depend on explicit Board endorsement-and hence give "on/off" signals-and those that call for Board assessments-which by their nature are multidimensional. A number of Directors felt that subsequent work should be carried out together with further analysis of the role of precautionary facilities, including precautionary PRGF arrangements. In addition, as requested at the time of the biennial review of surveillance, a number of Directors asked the staff to pursue work on modalities for intensified monitoring and ways to deliver clearer messages on members' policies through surveillance.
IMF EXTERNAL RELATIONS DEPARTMENT