## ppea2023007

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### Exceptionally high uncertainty: definition and motivation for UCT engagement
- Exceptionally high uncertainty is characterized by:
  - Originating in an exogenous shock.
  - Impact depending on events fundamentally outside authorities’ control, at least in the near-term.
  - Severe and continuing balance of payments impacts, making the scale of the BoP challenge difficult to assess with the usual degree of confidence associated with UCT lending.
  - No one scenario sufficiently "central"; significant adverse tail risks where the shock and/or its impacts could continue beyond the usual Fund program timeframe.
  - Impaired ability of official bilateral creditors to ensure debt sustainability through upfront debt write-downs due to lack of a sufficiently "central" scenario and large downside risks, necessitating catalyzing broader financing.

- Motivation for UCT/RFI/RCF use:
  - An RFI/RCF would be the appropriate instrument for urgent BoP needs in the context of exceptionally high uncertainty.
  - Fund UCT financing may be feasible under the proposals in the paper but would involve elevated risks for the Fund.

### Conditions, safeguards, and financing assurances required for UCT financing
- Legal and policy conditions to be met:
  - Fund-supported programs must be designed with the goal to solve the member’s balance of payments (BoP) problem and achieve medium-term external viability.
  - The Fund may only lend under adequate safeguards, including a judgment that the member will be in a position to repay the Fund as required under the Articles.
  - Both conditions require an assessment that debt is sustainable on a forward-looking basis.
  - Where debt is "unsustainable"—i.e., scheduled debt service exceeds the capacity of the member to service it—even with a strong adjustment program and significant Fund support, the Fund is precluded from providing financing unless the member takes steps to restore debt sustainability.

- Financing assurances policy requirements:
  - "firm commitments" of financing for the upcoming 12 months of the arrangement, and
  - "good prospects" that there will be adequate financing for the remaining program period beyond the upcoming 12 months.
  - Official bilateral creditors typically take 6-9 months after program initiation to formally complete needed contractual modifications for debt relief, although some cases involve upfront commitment with later definitive treatment.

- Proposed reforms to allow UCT financing despite exceptionally high uncertainty:
  - Allow upfront commitment to debt relief with a contingent second-stage element (a modified way for a set of official bilateral creditors to deliver upfront credible assurances covering commitments to help restore debt sustainability).
  - Extend the use of a capacity-to-repay assurance from official bilateral creditors/donors from emergency financing to a UCT context (allowing a set of creditors and donors to provide to the Fund a credible assurance about the member’s capacity to repay in a UCT lending context).
  - Procedural safeguard: prior Board consultation on whether exceptionally high uncertainty exists and whether the Fund would accept elevated risks and pursue a UCT program with a requesting member.

### Program design under exceptionally high uncertainty: two-scenario approach
- Rationale:
  - Move away from a single central baseline to establishing that a program can work across a range of scenarios by setting out two sufficiently separated scenarios: baseline and downside.

- Baseline scenario:
  - Built on an assumption about how the exogenous factors evolve (e.g., a large-scale war winding down).
  - Must resolve the BoP problem and restore medium-term external viability.
  - Requires a detailed DSA indicating debt sustainability can be restored over the medium term, together with adequate financing assurances and safeguards on capacity to repay the Fund.

- Downside scenario:
  - Captures significant risk that exogenous factors persist.
  - Should push assumptions to the limit where a Fund-supported program would still meet its objectives.
  - Requires contingent adjustment policies and external financing (including grants/highly concessional financing) to still address the BoP problem and restore medium-term external viability while providing safeguards for capacity to repay the Fund.

- Required elements for the two-scenario approach:
  - Program assumptions on baseline and downside consistent with country context at approval and reviews; staff may draw on other organizations’ expertise.
  - Member capacity and commitment to implement the program, including providing necessary data for monitoring; may require a track record (e.g., staff monitored program or PMB).
  - A program of sufficient length to provide time to adjust and accommodate contingent adjustments.
  - Sufficient donor support on appropriately concessional terms committed to cover the program period and beyond, including contingent donor support for the downside.
  - Financing assurances from donors and creditors regarding debt sustainability (on both baseline and downside).
  - Adequate safeguards for repayment to the Fund, including in tail risk scenarios beyond the downside scenario.
  - If exceptionally high uncertainty dissipates, return to standard Fund approach built around the baseline; if it remains, preserve two-scenario structure at reviews. If uncertainty escalates or persists too long, Fund lending under the arrangement could become infeasible.

### Debt treatment, private sector restructuring, and limitations
- Policy changes proposed for official bilateral creditors:
  1. Modified upfront credible assurances with a second-stage contingent element:
     - i. Upfront “credible and specific” assurance covering what is needed in the baseline to restore debt sustainability (could be cast as a flow then stock treatment).
     - ii. Upfront assurance to provide necessary financial support to restore debt sustainability in a second stage once exceptionally high uncertainty abates within program (or based on best estimate at last program review). Downside scenario provides upfront estimate of possible scale. Assurances updated at each review; given by a recognized creditor forum and/or directly in line with Fund standards.
  2. Extend capacity-to-repay assurance from official creditors/donors for safeguards in a UCT context:
     - Should be extended by a significant group of creditors/donors; group members should be participants in the Fund’s FTP and have a collective history of contributions to multilateral debt relief initiatives commensurate with the scale of their collective assurance.
     - Normally a suitable statement from Executive Directors representing relevant official bilateral creditors/donors, on behalf of their country authorities, in the public domain would suffice.
     - Would confirm creditors’/donors’ recognition of the Fund’s de facto preferred creditor status (PCS) and aim to prevent overdue financial obligations to the Fund, establishing “ex ante” adequate lending safeguards.
     - Management, staff and the Board would need to assess at program outset and each review that scenarios giving rise to overdue obligations are very unlikely and adequate safeguards are in place as required under the Articles.
     - The assurance would cease to be effective upon approval of a new arrangement for the member (unless specifically renewed).

- Private sector restructuring:
  - No policy change proposed for private sector assurances in exceptionally high uncertainty.
  - If private sector contribution is required, lending only feasible if the Fund has assurances that private sector debt will be restructured sufficiently to restore debt sustainability and fully finance the program.
  - In absence of arrears, the Fund must judge a “credible process” for debt restructuring is underway and likely to deliver an outcome in line with program parameters; the two-step arrangement for official creditors would not be extended to private sector processes.
  - In an arrears situation, the Fund’s lending into arrears policy would apply.

### Use of emergency financing and Fund catalytic role
- The Fund should convene donor support and use emergency financing if conditions are met.
- The Fund can catalyze donor support by helping the member implement a policy framework (e.g., program monitoring with Board involvement (PMB)) and can establish and administer trust accounts.
- Where adequate safeguards can be established, the Fund can provide emergency financing; emergency outright purchases do not require the same requirements for resolving BoP problems due to urgent need.
- Past emergency financing safeguards (Ukraine (2022), Iraq (2005), Lebanon (2007)) were established through capacity-to-repay assurances from creditors and donors.

### Enterprise risks, mitigation, and risks of not changing policy
- Major enterprise risks of proceeding with proposed reforms:
  - Financial risks: possibility of more frequent application than expected, unforeseen demand for Fund resources, and attendant increase in financial risks; mitigation via ringfencing, updated lending demand forecasts, and actions to boost the Fund’s lending resources.
  - Operational risks: integration into processes and staff capacity shortfalls (e.g., designing downside scenarios and securing two-stage assurances); mitigation via guidance to staff.
  - Precedent risks: setting precedent for UCT lending with different modalities and higher risks; partially mitigated by procedural safeguard and strong safeguards requirements.
  - Reputational/uniformity risks: perception of policy driven to support a particular member; mitigated by past track record and clarity about framework.
  - Fund decision-making risks: potential divergence among members weakening consensus-based tradition; mitigated by ring-fencing and uniformity measures.
  - Geo-economic fragmentation: risk if Fund perceived as aligning with one side in conflict situations, potentially undermining neutrality.
  - Program misspecification and implementation risks: faster migration towards downside calibration, political fatigue, difficulty securing supplementary commitments, elevated program failure risk.
  - Moral hazard: generous creditor/donor assurances could reduce authorities’ incentives for full implementation; mitigated by program design with reviews and phasing.
  - Creditor/donor failure to act on assurances: entails higher financial risks and capacity-to-repay concerns; partly mitigated by group assurances from creditors/donors with financial strength and track records.
  - Extreme scenarios beyond assurances: cases where the borrowing member cannot exercise rights/obligations (e.g., no government recognized) would render assurances ineffective; after 6 months of protracted overdue obligations, the Fund’s burden sharing mechanism would take effect and could lead to provisioning under International Financial Reporting Standards with impacts on income and precautionary balances.

- Risks of not changing the policy:
  - Reputational risks: perception the Fund is institutionally irrelevant or ineffective if it cannot support members facing exogenous shocks despite strong policies.
  - Spillovers: negative externalities if the affected member is deeply integrated into financial markets or global production/value chains.
  - Financial risks: member could accumulate overdue financial obligations to the Fund if a UCT program would have helped address its BoP problem and restore medium-term external viability.

- Overall assessment:
  - Proposed policy changes involve significant risks that must be weighed against risks of staying with the present approach.
  - Meaningful mitigating factors limit UCT programs to cases where authorities have capacity and commitment and where strong financing assurances are provided.
  - The Fund’s internal review process and application of other relevant Fund policies (e.g., on conditionality) would guard the process.
  - The Board may judge that the benefit of having the option to support members facing exceptional uncertainty outweighs additional risk.

### Procedural safeguards, Board engagement, and decision framework
- Procedural safeguard:
  - Prior Board consultation to determine whether exceptionally high uncertainty exists and whether the Fund would accept higher risks and pursue a UCT arrangement if requested.
  - Initial Board engagement expected when convening creditor/donor support or emergency financing.
  - A dedicated Board meeting could be called if not covered in initial engagements or if a UCT financing request is subsequently received.
  - A Board determination that exceptionally high uncertainty existed in a specific case would not guarantee UCT financing; program design understandings and specific conditions associated with assurances must be met.

- Decision framework and alternatives:
  - Management and staff must judge feasibility and credibility of a UCT program design consistent with legal and policy requirements and adequate safeguards before circulating a UFR request to the Board; the Board must make the same judgment at approval and subsequent reviews.
  - If UCT lending conditions cannot be met, the Fund could still:
    - Convene donors toward direct assistance; and/or
    - Provide emergency financing to the extent conditions are met and adequate safeguards can be secured.

### Questions posed to Directors (Issues for discussion)
- Do Directors agree with the characterization of situations involving exceptionally high uncertainty?
- Do Directors agree that in such circumstances where UCT program engagement is considered, a procedural safeguard as outlined in paragraph 18, should apply?
- Do Directors agree that a modified program design involving two scenarios (instead of one central scenario) can give the Fund sufficient confidence that the member’s BoP problem can be resolved and medium-term external viability will be restored despite such exceptionally high uncertainty?
- Do Directors agree that the Fund should consider a change to the Fund’s financing assurances policy and extension of a capacity-to-repay assurance to a UCT context, as described in paragraphs 23-26?
- Do Directors agree that the capacity-to-repay assurance should complement the Fund’s ex-ante risk management framework (to ensure adequate safeguards and guard against overdue financial obligations to the Fund), taking note of the technical understandings laid out in the paper?

*Source: EXECUTIVE SUMMARY and excerpts from CHANGES TO THE FUND'S FINANCING ASSURANCES POLICY (paragraphs 16, 18–26, 29–31). March 2, 2023.*

### EXECUTIVE SUMMARY

### EXECUTIVE SUMMARY

### Overview
- The Fund may on occasion confront cases of member countries requesting Fund financing while facing "exceptionally high uncertainty."
- Such situations generally involve exogenous shocks beyond the authorities’ control and the reach of their economic policies, at least in the near term.
- Fund engagement in such situations post-2000 has been rare, with three past examples addressed through emergency financing: Ukraine (2022), Iraq (2005), and Lebanon (2007).
- An RFI/RCF would be the appropriate instrument for the Fund to support members with urgent BoP needs in the context of exceptionally high uncertainty.
- Fund UCT financing may be feasible in situations of exceptionally high uncertainty under the proposals in this paper, but such engagement would involve elevated risks for the Fund.

### Conditions for UCT financing and key policy constraints
- Two separate but related conditions under the Fund’s legal and policy frameworks must be met for UCT financing:
  - Fund-supported programs must be designed with the goal to solve the member’s balance of payments (BoP) problem and achieve medium-term external viability.
  - The Fund may only lend under adequate safeguards, including a judgment that the member will be in a position to repay the Fund as required under the Articles.
- Both conditions require an assessment that debt is sustainable on a forward-looking basis.
- Where a member’s debt is assessed as "unsustainable"—i.e., where scheduled debt service exceeds the capacity of the member to service it—even taking into account a strong adjustment program and significant financial support from the Fund, the Fund is precluded from providing financing unless the member takes steps to restore debt sustainability.
- The Fund’s financing assurances policy requires:
  - "firm commitments" of financing for the upcoming 12 months of the arrangement, and
  - "good prospects" that there will be adequate financing for the remaining program period beyond the upcoming 12 months.
- With respect to delivery of debt relief, official bilateral creditors typically take 6-9 months after program initiation to formally complete the needed contractual modifications for debt relief, although some cases involve upfront commitment with later definitive treatment.

### What is "exceptionally high uncertainty" and when would UCT involvement be motivated?
- Exceptionally high uncertainty is characterized by a combination of factors:
  - It originates in an exogenous shock.
  - The impact of the shock on the economy depends on events fundamentally outside of the control of the authorities’ economic policies, at least in the near-term.
  - It involves severe and continuing balance of payments impacts, making the scale of the BoP challenge difficult to assess with the usual degree of confidence associated with UCT lending.
  - No one scenario can be seen as sufficiently "central"; the situation involves significant adverse tail risks where the shock and/or its impacts could continue beyond the usual Fund program timeframe.
  - The ability of official bilateral creditors to ensure debt sustainability through upfront debt write-downs is impaired due to the lack of a sufficiently "central" scenario and the presence of large downside risks, so broader sources of financing must be catalyzed.
- A country experiencing exceptionally high uncertainty could be a fragile state, although not necessarily so. Fragile and conflict affected states may nonetheless often have sufficient confidence in a baseline scenario to guide a UCT program.

### Proposed procedural safeguard and financing assurances policy reforms
- Procedural safeguard:
  - Prior Board consultation on whether the circumstance of exceptionally high uncertainty exists and whether the Fund would be prepared to accept the elevated risks and pursue a UCT program with a requesting member.
- Two proposed reforms to the Fund’s financing assurances policy to allow UCT financing despite exceptionally high uncertainty:
  - Allow upfront commitment to debt relief with a contingent second-stage element (a modified way for a set of official bilateral creditors to deliver upfront credible assurances covering their commitments to help restore debt sustainability).
  - Extend the use of a capacity-to-repay assurance from official bilateral creditors/donors from emergency financing to a UCT context (allowing a set of creditors and donors to provide to the Fund a credible assurance about the member’s capacity to repay in a UCT lending context).
- The two changes together would facilitate adequate safeguards in such situations, in line with the Fund’s legal and policy frameworks.

### Program design and implementation challenges
- Designing a UCT program under exceptionally high uncertainty requires addressing two key challenges:
  - Designing a program that will solve the member’s BoP problem and achieve medium-term external viability despite limited confidence in a central scenario.
  - Securing adequate safeguards, including assessing capacity to repay the Fund and ensuring forward-looking debt sustainability.
- The inability to identify a sufficiently "central" scenario complicates official bilateral creditors’ willingness to commit to upfront debt write-downs, making catalyzing broader financing necessary.

### Use of emergency financing and Fund catalyzing role
- The Fund should handle circumstances of exceptional uncertainty through convening donor support and through emergency financing if conditions are met.
- The Fund can catalyze donor support by helping the member implement a policy framework, e.g., through program monitoring with Board involvement (PMB), and can establish and administer trust accounts.
- Where adequate safeguards can be established, the Fund can provide emergency financing; emergency outright purchases do not involve the same requirements for resolving BoP problems due to the urgent need.
- Safeguards in past emergency financing cases (Ukraine (2022), Iraq (2005), Lebanon (2007)) were established through a capacity-to-repay assurance from creditors and donors.

### Enterprise risks and mitigation
- The proposed policy changes and their application to any specific country case involving exceptionally high uncertainty would result in the Fund taking on material additional enterprise risks.
- These additional risks need to be carefully weighed; identified mitigating factors would only partially reduce them.

*Source: EXECUTIVE SUMMARY, March 2, 2023.*

### 16.      There are no precedents for Fund GRA or PRGT UCT lending under exceptionally high

16.      There are no precedents for Fund GRA or PRGT UCT lending under exceptionally high uncertainty, as defined above.

### Context and risks
- Situation would almost certainly involve large BoP gaps extending for some period and implies a lower degree of confidence than normal that the program will resolve the BoP problems and restore medium-term external viability.
- It is possible that economic policies will not be able to resolve the BoP problems, pointing to very significant safeguards concerns for Fund resources.
- The Fund’s multi-layered risk management framework contains elements that would help mitigate ex-post credit concerns, but the strength of a UCT program is the most critical safeguard for a Fund program and any Fund lending requires that adequate safeguards be in place when new financing is approved and at each program review.

### Procedural safeguards and Board engagement
- A procedural safeguard is proposed for engaging in UCT lending under exceptionally high uncertainty because doing so involves a material increase in risks to the Fund.
- Initial Board engagement would be expected in the context of convening creditor and donor support or emergency financing.
- The Board would need to determine whether exceptionally high uncertainty exists and whether the Fund would be prepared to accept higher risks and pursue a UCT arrangement if requested by the member.
- If not covered in initial engagements or if a UCT financing request is subsequently received, a dedicated Board meeting could be called to consider these issues.
- A Board determination that exceptionally high uncertainty existed in a specific case would not guarantee that the Fund could provide UCT financing; program design understandings and the specific conditions associated with assurances would also need to be met.

### Can a UCT program be specified in situations of exceptionally high uncertainty?
- Fund policies do not rule out UCT lending under exceptionally high uncertainty, but it is inherently difficult to satisfy the necessary conditions: the situation involves a much higher variance around a baseline with a fatter tail risk of adverse outcomes, including a high chance that the program could fail.
- Approval would require the judgment that a program can be designed and implemented to solve the member’s BoP problem and restore medium-term external viability.

### Program design: two sufficiently separated scenarios (baseline and downside)
- Staff propose moving away from a single central baseline to establishing that a program can work in a range of scenarios by setting out two sufficiently separated scenarios:
  - Baseline scenario:
    - Built on an assumption about how the exogenous factors driving the exceptionally high uncertainty evolve (e.g., a large-scale war winding down).
    - This scenario would need to resolve the BoP problem and restore medium-term external viability.
    - Requires, among other things, a detailed DSA that indicates debt sustainability can be restored over the medium term, together with adequate financing assurances to ensure the program is fully financed and that there are adequate safeguards including on the member’s capacity to repay the Fund.
  - Downside scenario:
    - Captures the significant risk that the exogenous factors persist.
    - Should aim to push assumptions to the limit where a Fund-supported program would still be able to meet its objectives.
    - Would require a combination of contingent adjustment policies and external financing that would still address the BoP problem and restore medium-term external viability while providing appropriate safeguards in that scenario, including with respect to capacity to repay the Fund (and taking into account any grants and/or highly concessional financing committed by donors as a backstop).

### Design and implementation challenges for the two-scenario approach
- Required elements:
  - Program assumptions on baseline and downside scenarios consistent with the country context at approval and at subsequent reviews; because shocks typically originate beyond economic policy control, management and staff would draw on expertise of other organizations.
  - The member must be sufficiently committed to and have the capacity to implement the program, including providing necessary data for monitoring; may require a track record (e.g., under a staff monitored program, or PMB).
  - A program of sufficient length to provide time to adjust and room to accommodate a wider range of assumptions and contingent adjustments per the downside contingency plan.
  - Sufficient donor support, on appropriately concessional financial terms, committed to cover the program period and beyond, including contingent donor support to complement stronger policy adjustments under the downside scenario.
  - Financing assurances from donors and creditors regarding debt sustainability (on both baseline and downside scenarios).
  - Adequate safeguards for repayment to the Fund, including in tail risk scenarios beyond the downside scenario.
- If exceptionally high uncertainty dissipates, return to standard Fund approach built around the baseline; if it remains, program reviews must preserve the two-scenario structure and assess continued separation of scenarios. If uncertainty escalates or persists too long, Fund lending under the arrangement could become infeasible.

### Key tensions with existing Fund debt policies
- Two scenarios may help establish credible policy adjustments, but:
  - Fund debt sustainability requirements are designed to work from a baseline with sufficient probability, not two scenarios; creditors may be reluctant to provide relief aligned to a downside scenario they view as overly pessimistic.
  - Tail risk scenarios beyond the downside complicate establishing adequate safeguards for Fund lending because the member could lack capacity to repay despite ex ante design to resolve BoP problems.

### Policy changes proposed to resolve tensions
- Two significant policy changes would be needed:
  1. Modified upfront credible assurances from official bilateral creditors with a second-stage contingent element:
     - i. An upfront “credible and specific” assurance covering what is needed in the baseline scenario to restore debt sustainability. This could be cast as a flow then stock treatment (per HIPC), although the scale of the second stage debt relief commitment would need to be clear to help condition expectations of other creditors expected to restructure in the interim (e.g., the private sector, which would not be eligible for such an approach under Fund policies).
     - ii. An upfront assurance to provide necessary financial support to restore debt sustainability in a second stage once the exceptionally high uncertainty abates within program (or based on a best estimate at the last program review, whichever comes first). The program’s downside scenario would provide an upfront estimate of the possible scale of the needed financial support. Scenarios and financing commitments would be updated at each program review and financing commitments updated if necessary, providing full transparency to creditors and donors and control over their commitment.
     - Assurances would be given by a recognized creditor forum, and/or directly (in line with the Fund’s standards for such assurances).
  2. Extend the existing use of a capacity-to-repay assurance from official creditors/donors for safeguards purposes in an emergency financing context to a UCT context:
     - The assurance would be required in situations of exceptionally high uncertainty to be critical for assessing that the UCT program provides adequate safeguards for Fund lending.
     - Features of the assurance:
       - Should be extended by a significant group of creditors/donors so adverse changes in individual external positions do not undermine credibility; group members should be participants in the Fund’s FTP and have a collective history of contributions to multilateral debt relief initiatives commensurate with the scale of their collective assurance.
       - Normally, a suitable statement from the Executive Directors representing the relevant official bilateral creditors/donors, on behalf of their country authorities would suffice to provide the assurance; the statement would need to be in the public domain.
       - It would confirm creditors’/donors’ recognition of the Fund’s de facto preferred creditor status (PCS) and complement the Fund’s risk management framework with the aim to prevent any overdue financial obligations to the Fund from the borrowing member and thus establish “ex ante” adequate lending safeguards.
       - Management, staff and the Board would need to assess at program outset and each review that scenarios which would give rise to any overdue financial obligations are very unlikely, and adequate safeguards for Fund lending are in place as required under the Articles.
       - The assurance would cease to be effective upon approval of a new arrangement for the member (unless specifically renewed).
- For new highly concessional financing, the requirements for standard financing assurances would apply.

### Private sector restructuring and limitations
- No policy change is proposed regarding assurances about private sector restructuring in cases of exceptionally high uncertainty:
  - If a private sector contribution is required, lending would only be feasible if the Fund has assurances, if relevant, that private sector debt will also be restructured in a manner sufficient to restore debt sustainability and ensure the program is fully financed.
  - In the absence of arrears, this requires the Fund to judge that a “credible process” for debt restructuring is underway and will likely deliver an outcome in line with program parameters; such a judgment would not be possible if the two-step arrangement proposed for official bilateral creditors were allowed for private sector restructuring processes.
  - In an arrears situation, the Fund’s lending into arrears policy would apply.
  - The strong signal from official creditors about their commitment would be expected to guide calibration of authorities’ requests to private creditors and mitigate comparability of treatment problems.

### Decision framework and alternatives
- Management and staff would need to judge feasibility and credibility of a UCT program design consistent with legal and policy requirements and adequate safeguards before circulating a UFR request to the Board; the Board must also make this judgment at approval and at subsequent reviews.
- If the Fund cannot proceed because UCT lending conditions cannot be met, the Fund could still:
  - Convene donors toward direct assistance; and/or
  - Provide emergency financing to the extent conditions are met and adequate safeguards can be secured.

*Source: CHANGES TO THE FUND'S FINANCING ASSURANCES POLICY (excerpts).*

### 29.      Proceeding with the proposed targeted reforms to facilitate engagement through

### 29.      Proceeding with the proposed targeted reforms to facilitate engagement through UCT-quality programs in such situations will raise sizable enterprise risks to the Fund

### Major enterprise risks identified
- Potential high-level consequences:
  - The scope and speed of the envisaged policy changes may not allow for sufficient discussion and reflection of its consequences. There are two dimensions to this:
  - Financial risks. If the policy turns out to be not adequately ring-fenced, then it could be applied more frequently than expected, also leading to unforeseen demand for Fund resources, also with attendant increase in financial risks.  This risk could be mitigated through appropriate ringfencing,  while updated lending demand forecasts and actions underway to boost the Fund’s lending resources would also help.
  - Operational risks. These would include integration of the new policy within the Fund’s current processes, and human capital risks from staff’s lack of expertise in the new policy (e.g.  designing downside scenarios and securing the two-stage financing assurances necessary). These would need to be mitigated by appropriate guidance to staff.
  - Setting a precedent for UCT lending with different modalities and higher risks. The program supported by the Fund’s lending (while being designed to resolve the country’s BoP problem and restore medium-term external viability) would not in itself provide sufficient assurances regarding adequate lending safeguards and capacity to repay the Fund. The proposed credible assurance from official creditors would instead address the safeguards concerns with respect to capacity to repay the Fund in the tail risk scenarios, creating a precedent for other UCT programs. This in turn could raise a broader question regarding potential implications for the Fund’s catalytic role and PCS which have both been linked to the design of such a UCT program. Overall, this implies higher lending risks. This is partly mitigated by the proposed procedural safeguard that helps to ensure that all criteria for UCT lending in exceptionally high uncertainty would be met.
  - Uniformity of treatment. The Fund will incur a reputational risk from the perception that the policy justification and ring-fencing is driven by the desire to support a particular member. Of course, this would be partly mitigated by the Fund’s past track record of emergency financing in situations with features of exceptionally high uncertainty, involving applications across different regions and with different donor groups. The clarity about the framework also can help ensure consistent application going forward.
  - Fund decision making. To the extent that discussion of the policy change surfaces wide divergences amongst Fund members on the merits of proceeding, this could weaken the Fund’s tradition of consensus-based decision making which has been an important factor in the Fund’s ability to respond to evolving needs of its members. This risk, which may be judged to be of very low probability, could be mitigated by the ability of the Fund to ensure adequate ring-fencing and uniformity of treatment of the proposed new policy, as described above.
- Considerable enterprise risks could also arise in actual applications of the policy, and these could also interact (highlighting the Board’s role in assessing this for any individual case):
  - Contributing to geo-economic fragmentation. If the policy is applied in a conflict situation, and the Fund is seen as aligning with one side this would contribute to the risk of geo-economic fragmentation via a dispersed and less cooperative global financial safety net, as members with dissenting political views could be more attracted to alternative financing institutions. This may also place the Fund in a position of being asked by both sides for support and undermining the Fund’s duty of neutrality in disputes between members, which means that it cannot take sides in disputes or conflicts.
  - Program design misspecification. Exceptionally high uncertainty could make it difficult to design program scenarios, as the factors driving exceptional uncertainty would be likely to reduce the quality of information available and raise questions about the capacity of the member to undertake policies. This would tend to manifest itself in a faster migration towards the initial calibration of the downside scenario, giving rise to larger financing gaps exceeding the size of creditor/donor commitments, and in turn leading to political fatigue and difficulties in securing the then required supplementary commitments at reviews, thus creating an elevated risk of program failure.
  - Program implementation affected by higher moral hazard. The extent of the required creditor/donor assurances may also contribute to moral hazard by reducing the authorities’ incentives for full implementation of the Fund-supported program, impacting implementation and amplifying credit risks. The standard design of a Fund program, involving reviews and phasing, can help mitigate this risk.
  - Creditor/donor failure to act on assurances. The debt sustainability assurances involve a potentially evolving commitment and backloaded delivery, while the capacity to repay assurance for safeguards purposes is not a legally binding guarantee. Failure of creditors/donors to act would imply higher financial risks to the Fund and capacity to repay concerns (with possible implications for burden sharing). This is partly mitigated by the need for a group of donors/creditors to provide   the assurances, and by the need for each of them to have sufficient financial strength and track record of previous contributions to support multilateral debt relief initiatives.
  - Extreme scenarios beyond the capacity to repay assurances. There could be instances where the borrowing member could not exercise its rights and obligations in the Fund (e.g., where there is no government recognized for the member by the international community) and in such an extreme case the assurance would cease to be effective. This would involve a critical impact on the Fund. After 6 months, when overdue financial obligations would become protracted, the Fund’s burden sharing mechanism would take effect, and the Fund’s creditor and debtor members would need to contribute financing to cover the amount of unpaid basic charges and surcharges. At some point, concerns about a member’s ultimate repayment could trigger recording a provision for expected credit losses under International Financial Reporting Standards, which would reduce the Fund’s income and (accumulation of) precautionary balances. Management, staff, and the Board would need to assess at the program outset and at each review that the scenarios which could give rise to such impacts are very unlikely, and adequate safeguards for Fund lending are in place as required under the Articles of Agreement. This provides a risk mitigant for all amounts not yet disbursed.  If it is yet assessed that adequate safeguards are not in place at the time of any new purchase under the arrangement, then other means of securing those safeguards for Fund financing would need to be considered in order for the Fund’s financing to continue.

### Risks of not changing the policy
- Reputational risks. Even though such situations are expected to remain rare, when they do arise the Fund could face a situation involving a member with strong policies that is facing an exogenous shock. If the Fund is unable to support such a member in need, it could face a perception that it is institutionally irrelevant or ineffective. Communication could help mitigate this,  but a perception that the Fund would be failing to adapt to the changing needs of its membership would make it more difficult to address.
- Spillovers. The Fund’s wider membership could face spillovers due to inaction. The member in question could be deeply integrated into financial markets or have concentrated enough positions in global production or value chains that not assisting it would have significant negative externalities.
- Financial risks. The Fund could also face financial risks by not going ahead, since the member experiencing exceptionally high uncertainty would not have access to a UCT program to resolve its BoP problem and could accumulate overdue financial obligations to the Fund (where it may have been able to remain current with the support of a UCT program that would help address its BoP problem and restore medium term external viability).

### Overall assessment and mitigants
- The proposed policy changes to facilitate UCT engagement in situations of exceptionally high uncertainty involve significant risks to the Fund that need to be carefully weighed against the risks of remaining in the Fund’s present approach.
- The proposed shift in modalities for UCT lending raises operational and broader issues, and in any particular application would involve many challenges. At the same time, not making such changes may lead to the Fund being perceived as ineffective in delivering its mandate.
- There are meaningful mitigating factors in any specific application of the proposed policy changes, which would limit such UCT programs to cases where the authorities have capacity and sufficient commitment to implement the program, and the need for strong financing assurances from donors and creditors.
- The Fund’s robust internal review process and application of other relevant Fund policies (e.g. on conditionality) would serve to guard the process to ensure that all criteria for UCT lending are met in each specific application.
- The Board may overall judge that the benefit of having the option of supporting members facing exceptional uncertainty outweighs the additional risk of the proposed policy change.

### Issues for discussion (questions posed to Directors)
- Do Directors agree with the characterization of situations involving exceptionally high uncertainty?
- Do Directors agree that in such circumstances where UCT program engagement is considered, a procedural safeguard as outlined in paragraph 18, should apply?
- Do Directors agree that a modified program design involving two scenarios (instead of one central scenario) can give the Fund sufficient confidence that the member’s BoP problem can be resolved and medium-term external viability will be restored despite such exceptionally high uncertainty?
- Do Directors agree that the Fund should consider a change to the Fund’s financing assurances policy and extension of a capacity-to-repay assurance to a UCT context, as described in paragraphs 23-26?
- Do Directors agree about that the capacity-to-repay assurance should complement the Fund’s ex-ante risk management framework (to ensure adequate safeguards and guard against overdue financial obligations to the Fund), taking note of the technical understandings of this laid out in the paper?

*Excerpt from CHANGES TO THE FUND'S FINANCING ASSURANCES POLICY (paragraphs 29–31).*

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_Source: https://www.imf.org/-/media/files/publications/pp/2023/english/ppea2023007.pdf_