Transcript of an IMF Book Forum -- Making the IMF's Lending More Effective
September 13, 2006
Edited by Ashoka Mody and Alessandro Rebucci
(Washington, D.C.: International Monetary Fund, 2006)
This transcript was put together from an interview with Alessandro Rebucci on August 7, 2006 and on e-mail exchanges with him and Ashoka Mody between August 28, 2006 and September 8, 2006. (Interviewer: Prakash Loungani.)
Division Chief, External Relations Department, IMF
Assistant Director, European Department, IMF
Economist, Research Department, IMF
LOUNGANI: Your book on the effectiveness of IMF loans comes at a time when borrowing from the IMF is at a low point. How relevant are the book's findings in the present environment?
REBUCCI: They remain quite relevant. For instance, one of the findings is that the Fund's precautionary lending has been more effective than other forms of its lending. When a country is vulnerable but its economic condition has not deteriorated to the point of a crisis, that is where the Fund has been the most effective. I think the demand for that kind of IMF loan remains, though it is true that strong global growth and financial sector reforms undertaken in many countries have reduced borrowing from the IMF, just as they should.
LOUNGANI: Why is it that IMF programs are more effective when a country is vulnerable but not yet in a state of crisis?
REBUCCI: As you know, IMF programs can help a country catalyze private finance, for instance by playing the role of the provider of a 'seal of approval' or through its other roles.
When a country is in the midst of a raging crisis, it is difficult for the IMF to credibly play any of its roles. It is when the country is vulnerable but not in crisis, when its external fundamentals are not very bad, that the presence of the IMF helps to reverse the outflow of foreign capital and improve the country's external fundamentals.
MODY: I should clarify that this does not imply that the IMF has knowledge or information that markets do not have. But an IMF-supported program serves as a joint commitment by the authorities and the Fund to a course of action. Given that commitment, the Fund is then able to play the role of a "delegated monitor". That is, markets value the fact that the Fund's review of the program will help keep the commitment intact.
LOUNGANI: Is the IMF uniquely positioned to provide this kind of financing?
REBUCCI: Though it takes us a little bit outside the realm of the research in the book, it is an interesting question. We know that there is very little private-sector supply of loans of this kind. When a country is vulnerable, the private sector is likely to come in with loans of shorter duration that the country would typically need to resolve a balance-of-payments crisis. And the interest rates on the private sector loans are likely to be higher than what the country can afford. Regional pooling arrangements can help, but not against very large shocks and certainly not against shocks that make the whole region vulnerable. Self-insurance through accumulation of foreign exchange reserves is possible, and is happening as we discussed at the very outset, but it is costly.
MODY: So all these avenues exist, but that the IMF remains an important potential source of finance appears to be indisputable. I think countries, emerging markets in particular, recognize the potential role of the IMF in these cases but of course precautionary programs have to be very carefully designed to meet their needs.
LOUNGANI: What's an example of effective lending along these lines?
REBUCCI: Take the loan to Brazil in 2002 that the Managing Director talked about recently and that former First Deputy Managing Director Anne Krueger has discussed extensively in her speeches (http://www.imf.org/external/np/speeches/2005/
040505a.htm). In the summer of 2002, Brazil was thought of as being vulnerable to a crisis because of anxiety about the macro policies that might be followed after the presidential election in Brazil. The crisis was defused with the help of the IMF. An IMF-supported program was put in place before the election and the major candidates endorsed the key elements of the program, setting the broad thrust of policies to be followed after the election no matter which one of them won. This, together with the financing provided, helped tide Brazil through the difficult period up until the elections; after that, the initial statements and actions of the incoming government calmed the financial markets. It was not a purely precautionary program in the sense that Brazil borrowed from us, but as I mentioned they paid us back well ahead of time.
MODY: I should add that in the papers in our book, the term "precautionary" " is to be understood broadly as lending undertaken to stem or contain a vulnerability.
LOUNGANI: Returning to the findings of the book, what does the research tell us about the appropriate design of conditionality?
REBUCCI: There are a number of views expressed by the authors. For instance, Mohsin Khan and Sunil Sharma discuss the merits of what is called outcomes-based conditionality -- this would require the IMF to make disbursements of loans conditional on the country achieving agreed outcomes. At present, as you know, disbursements are conditional on the country following agreed policies that are expected to produce the desired outcomes. So outcomes-based conditionality recognizes that there many policy paths that can produce a given outcome and gives the country flexibility in choosing the policy path it prefers. One limitation is that the outcomes may not be completely under the control of the country's policymakers.
Another view is that of Olivier Jeanne and Jeromin Zettelmeyer; they argue in favor of ex ante conditionality. Under this system, the conditionality would be established before the country faces a crisis rather than the present system of deciding the conditionality as part of an IMF program when the country is already in crisis. Any precautionary instrument for large-scale insurance provision would quite likely have to depart quite a bit from the traditional framework and incorporate some ex ante conditionality.
So there is not a uniform suggestion other than to suggest that there is some need for experimentation and that the conditionality obviously should be tailored to the type of loan, precautionary versus others.
LOUNGANI: I was surprised to find in a book devoted to program design so much emphasis on forecast accuracy.
REBUCCI: That's true. We tend to associate forecast accuracy with the effectiveness in terms of surveillance; we all know of the studies of the forecast accuracy of the WEO [World Economic Outlook]. But forecast accuracy is very important for program design as well.
REBUCCI: The papers in the book point to a couple of reasons. First, poorly designed programs -- in the sense that the forecasts of key macro variables are far from what can be realistically achieved - are likely to be more difficult to implement. There is obviously a link between policies and macro outcomes; so having the wrong forecasts will imply wrong settings of the policies.
Now it is argued that some forecasts in IMF programs are often not true forecasts; they may, as in the case of growth forecasts, be the product of a negotiation between the country and the IMF or, as in the case of the financing gap, simply be the assumption needed to make the program hold together. Both sides, it is said, understand in such cases that policies need not be set so as to achieve these unrealistic forecasts. But that goes against transparency and it can also, if outside observers don't understand this process, lower the credibility of IMF programs. As you know, our medium-term growth forecasts are often criticized as being too optimistic, and that may reflect the fact that sometimes they are the countries' aspirations, to which the IMF is sympathetic, rather than true forecasts.
LOUNGANI: You said there were some of the other reasons for the importance of forecast accuracy for program design.
MODY: Yes, forecast errors could be a reflection of shortcomings or inconsistencies in the IMF's analytic models. For instance, many Fund economists would agree that the financial programming framework is a very good accounting device. But because that framework treats growth and foreign financing as exogenous, using it to derive forecasts may lead to errors, particularly in the case of capital account crises. That is a point that is made in several of the papers in the book.
LOUNGANI: Any concluding thoughts on the findings of the book?
REBUCCI: As a general comment, both Ashoka and I realized the importance of thinking of an IMF-supported program as a long process. There is a negotiation phase in which a program is put together, and during which there are both internal governance incentives at work, and also political and economic constraints faced by the country. Then eventually this program is brought to the IMF's Executive Board and there is an implementation of this program. Later the program is revised in the light of developments. So effectiveness may be lost along the way in different points in this chain of events. The various chapters of the book can be thought of careful studies of virtually every part of this chain. I think that the contribution of the book is to illustrate this process more clearly than had been done in the literature.
LOUNGANI: I thought the book was very nicely put together. It has both policy relevance and analytic rigor and the findings are interesting. But one last question: Why are the chapters all written by IMF Fund, admittedly with external co-authors in some cases. Was that deliberate?
REBUCCI: Yes, without denying the importance of independent assessments, the idea here was to show the ability of staff to be self-critical and learn from mistakes. In fact, many people, both inside the IMF and outside, told us that perhaps we had ended up being a bit too critical!