1998 IMF Survey Supplement on the Fund / September 1998


Fostering Sustained Policy Implementation

Crowd of people When it provides financial support to a member country, the IMF must be sure the member is pursuing policies that will ameliorate or eliminate its external payments problem. The explicit commitment that members make to implement remedial measures in return for the IMF’s support is known as “conditionality.” This commitment also ensures that members are able to repay the IMF in a timely manner, which in turn allows the IMF’s limited pool of financial resources to revolve and be made available to other members with a balance of payments problem. IMF financing, and the important catalytic effect it has in securing other financing, enables the country to adjust in an orderly fashion, without resort to measures that would be inimical to its own or other countries’ prosperity.

Conditions for IMF financial support may range from general commitments to cooperate with the IMF in setting policies to the formulation of specific, quantified plans for financial policies. IMF financing from its general resources in the “upper credit tranches” (that is, where larger amounts are disbursed in return for implementation of remedial measures) is phased. The IMF requires a “letter of intent,” which outlines a government’s policy intentions during the period of the adjustment program; the policy changes to be taken before approval of the arrangement; performance criteria, which are objective indicators for certain policies that must be satisfied on a quarterly, semiannual, or in some instances a monthly basis for drawings to be made; and periodic reviews that allow the Executive Board to assess the consistency of policies with the objectives of the program.

Conditionality Is Flexible

Although IMF conditionality employs specified performance criteria, it does not rely on a rigid set of operational rules. The Executive Board’s guidelines on conditionality:

  • encourage members to adopt corrective measures at an early stage;
  • stress that the IMF pay due regard to members’ domestic social and political objectives, as well as economic priorities and circumstances;
  • permit flexibility in determining the number and content of performance criteria; and
  • emphasize that IMF arrangements are decisions of the IMF that set out in consultation with members the conditions for its financial assistance.
Conditionality in Practice

The IMF takes a pragmatic approach to helping members formulate economic reform programs, recognizing that no one model suits all members. Each IMF-supported program is designed by the member country in close collaboration with the IMF staff. The process involves a comprehensive review of the member’s economy, including the causes and nature of the balance of payments problems and an analysis of the policies needed to achieve a sustainable balance between the demand for, and the availability of, resources.

IMF-supported programs emphasize certain key aggregate economic variables—domestic credit, the public sector deficit, international reserves, and external debt—and crucial elements of the pricing system, including the exchange rate, interest rates, and, in some cases, wages and commodity prices, that significantly affect the country’s public finances and foreign trade and the economy’s supply response.

During a Stand-By or Extended Fund Arrangement (EFF) or during an arrangement under the Enhanced Structural Adjustment Facility (ESAF), a member’s reform program is monitored by the IMF through performance criteria selected according to the economic and institutional structure of the country, the availability of data, and the desirability of focusing on broad macroeconomic variables, among other considerations. Performance under IMF-supported reform programs is also monitored through periodic reviews by the IMF Executive Board.

Growth-Oriented Adjustment

While macroeconomic policies designed to influence aggregate demand continue to play a key role in IMF-supported adjustment programs, it is widely recognized that measures to strengthen the supply side of the economy are frequently essential to bring about a sustained return of external viability and sound growth. IMF-supported policy adjustments by member countries to enhance the growth potential and flexibility of their economies include measures to remove distortions in the external trade system and in domestic relative prices, measures to improve the efficiency and soundness of the financial system, and measures to foster greater efficiency in government spending. Structural reforms in these areas have been particularly important in programs under the EFF and the ESAF. Given the emphasis on structural reforms in IMF- supported programs, close collaboration with the World Bank has been important.

Trade-Related Conditionality

In October 1997, the Board considered a staff report on trade reform in medium-term IMF-supported programs. Directors felt that trade liberalization should play an increasingly important role in IMF-supported programs. They agreed that, in addition to promoting efficient resource allocation, trade reform was important in fostering transparency and good governance and in reducing the scope for administrative discretion, incentives to lobby for protection, and opportunities for rent seeking. The analysis of countries’ trade policies in the report was based on an index of trade restrictiveness, which Directors generally welcomed as a valuable tool for classifying the relative restrictiveness of trade regimes.

Many Directors supported front-loaded liberalization measures and the use of prior actions, performance criteria, structural benchmarks, and reviews to monitor implementation of trade reforms. Other Directors cautioned that trade-related conditionality should be applied flexibly and should take into account each country’s initial conditions, the degree of political support, and the authorities’ own commitment to reforms. For trade reform to succeed, Directors remarked, it should be broadly based and should initially replace nontariff barriers with tariffs, while eliminating customs duties exemptions and trade-related subsidies, all of which would tend to strengthen the government’s fiscal position or at least avoid revenue losses.

Social Safety Nets

Adjustment programs typically have an impact on income distribution, employment, and social services. While sound macroeconomic policies and effective structural reforms promote sustained growth and employment, the adjustment process itself may involve short-term social costs for vulnerable groups. Measures built into IMF-supported programs address these costs. In collaboration with the World Bank staff, the IMF staff analyzes the social implications of reform measures and advises the authorities on how best to design social safety nets and target them to assist the neediest groups.