## _110915 — Crisis Program Review (selected findings and recommendations) ## Source details **Canonical URL:** [_110915 — Crisis Program Review (selected findings and recommendations)](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2015/_110915.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2015/_110915.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2015/_110915.pdf.json) --- ### Executive summary and scope - Fund support under GRA facilities and instruments during 2008–13: SDR 420 billion. - Arrangements from which members made drawings: SDR 167 billion; nearly SDR 119 billion was drawn during the period. - Outstanding IMF credit (GRA and PRGT): rose from under SDR 10 billion in 2007 to over SDR 90 billion in 2013; declined with repayments to nearly SDR 60 billion as of June 2015. - Review purpose: assess performance of Fund-supported programs since the global financial crisis across 27 countries to draw lessons for future program design. ### Key messages and aggregate assessment - Fund-supported programs helped avoid the most feared global outcomes and smoothed adjustment for program countries. - Program design occurred amid extraordinary uncertainty after the Lehman collapse and during the Euro Area crisis; outcomes informed later program design. - About ¾ of the program countries have regained market access. - A third have substantially reduced reliance on IMF financing. - Even with Fund support, significant adjustment was unavoidable for some countries; underlying vulnerabilities remain and debt is still elevated. - Recovery from financial crises tends to be protracted; unemployment remained high and growth generally tepid. ### External adjustment — findings and implications - Initial conditions: - At program start, currencies were overvalued by an average of about 10 percent; a few currencies overvalued by over 20 percent (Armenia (2009), Greece 2010, Latvia (2008), Seychelles (2008 and 2009)). - Three years before programs, all but one of the 27 countries had fixed or heavily managed exchange rate arrangements. - Exchange rate behavior and competitiveness: - Recent programs featured more rigid exchange rates than in earlier episodes; nominal exchange rate adjustment played a smaller role. - Real effective exchange rate depreciation over program period averaged 12 percent (recent programs) versus 48 percent (earlier programs). - Real effective depreciation averaged 7 percent for currency-union or external-anchor pegs and 20 percent for more flexible arrangements. - Internal devaluation largely failed to deliver desired growth and export recoveries for most countries; where achieved it delivered some nascent growth impact but usually required sustained adjustment beyond typical 3–4 year program horizons. - Financing and burden sharing: - Programs relied on a mix of adjustment and official financing; relative burden sharing varied by case. - For large financing needs, constraints on the Fund’s balance sheet increased need for other creditors; Euro Area cases lent themselves to burden sharing with financing partners. - Practical implications: - Greater exchange rate adjustment helps address external gaps with less adverse impact on output, but where foreign currency liabilities are substantial, measures are needed to mitigate depreciation impacts on balance sheets. - For currency-union members, internal devaluation is very demanding and may require large and sustained reforms and financing. ### Fiscal policy and public debt — findings and outcomes - Program fiscal adjustment objectives: - On average, programs sought to strengthen primary fiscal balances by about 3 percentage points of GDP over a three-year period. - Programmed adjustment larger in the Euro Area (averaging 5½ percentage points of GDP of primary balance adjustment) and smaller in MENA (about 2½ percentage points of GDP). - Realized outcomes: - Primary fiscal balances strengthened by an average of 1¾ percent of GDP during the 3 years after program approval, relative to program goals of about 3 percentage points over three years. - Regional: fiscal outcomes closest to objectives in the Euro Area and MENA; targets fell short in other regions. - Impact on output and debt: - Short-term negative effects on output were larger than envisaged in many cases, in part due to larger-than-expected fiscal multipliers. - Bank recapitalization costs and other factors led in several cases to a larger-than-expected rise in debt-GDP ratios during the program period. - Bank recapitalization costs amounted to 19 percent of GDP on average in the sample noted (or 60 percent of the short-term rise in the debt-GDP ratio). - Restructuring and sustainability: - One in five programs supported public debt restructuring: Of 32 programs, seven included either reprofiling or face-value reductions. - Debt reduction measured by public debt-GDP ratios fell short of medium-term program expectations in three-quarters of programs. - Among countries with high public debt, growth and debt outcomes were generally better where debt restructuring occurred. ### Structural reforms — design, implementation, and payoffs - Conditionality intensity and composition: - Average annual number of structural reform conditions per program year rose during the global crisis; by 2013 the average was close to the 2003–05 peak. - Fiscal reforms accounted for over half of all structural conditionality; supply-side conditions more numerous where exchange rates were rigid. - Implementation: - On average, about 70 percent of structural benchmarks and performance criteria were met without delay; implementation rates highest in small states. - Implementation rates were lower in later program years and in programs with the largest number of structural conditions, indicating possible reform fatigue. - Growth dividends: - Short-term payoffs from structural reforms were generally modest and less than envisaged; programs that assumed large near-term dividends may have overstated short-term impacts. - Empirical example: "0.9 ppt increase in GDP per capita after 10 years due to the change in labor market policies implemented by OECD countries on average between 1996-2006." - "0.3 ppt increase in potential output in the long-run from a 1% tax shift from labor to VAT." ### Private sector balance sheets — diagnosis and policies - Prevalence and diagnostics: - Private balance sheet concerns were identified in 20 out of the 27 program countries (characterized as "high or medium" debt levels). - Key indicators used: Size (debt-to-GDP deviation), Composition (FX share), and Change (pre-crisis increases). - Outcomes and constraints: - Households and corporates deleveraged during the crisis, dampening aggregate demand. - Only modest progress toward accelerated repair of private balance sheets; write-downs and restructuring advanced slowly. - About one-third of programs (12 of 32) experienced a banking crisis. - Policy priorities and recommendations: - Early attention to legal frameworks and out-of-court settlement options. - Prudential measures to incentivize debt write-offs and restructuring (e.g., targets for NPL reductions, time limits on carrying NPLs). - Creation of markets or institutions to handle distressed debt (asset management companies). - Address balance sheet data gaps to inform vulnerability assessments and exchange rate policy decisions. - In crisis circumstances, benefits of debt write-downs may exceed adverse public balance sheet impacts and moral hazard concerns. ### Financial regulation, supervision, and banking outcomes - Supervisory gaps and consequences: - Crisis revealed excessive risk buildup in bank balance sheets and gaps in supervision amid rapid financial integration. - Resolution and recapitalization of systemic banks were often slow, amplifying market volatility and curtailing bank lending. - Delay in establishing a Euro Area banking union was costly; ECB/Eurosystem liquidity support and later policy actions were pivotal. - TA and capacity: - IMF technical assistance nearly doubled on average for program countries compared to the pre-program year (person-years). - TA increased most for Euro Area programs and small states; fiscal TA accounted for most of the increase. - Macroprudential measures: - Macroprudential regulations were not a core feature of recent programs; where adopted, they focused on banks’ foreign currency risks. ### Regional Financing Arrangements (RFAs) and currency unions - RFAs and co-financing: - Programs involving RFAs benefited from regional expertise and expanded financing envelopes. - Clear operational guidance for Fund–RFA interaction is needed to delineate roles (e.g., Fund responsibility for macroeconomic and debt sustainability analysis) and to avoid cumulative overburdening conditionality. - G-20 principles for cooperation with RFAs provide a foundation for updated operational guidelines. - Currency unions: - Program design for currency union members accounted for union-wide policies’ bearing on member economies. - Where program success depended on union-wide policies, the Fund sought assurances via commitments or surveillance advice; alternatives include larger adjustment and financing or postponing Fund involvement. - Euro Area experience: conditionality limited to member-level actions; Fund used formal commitments and surveillance to seek union-level changes (banking union, fiscal backstop, liquidity provisions). ### Instrument experience: FCL, PCL/PLL (Box 1) - Instruments and users: - FCL users: Colombia, Mexico, Poland. - PCL/PLL users: FYR Macedonia, Morocco. - Of these five, only FYR Macedonia drew upon its precautionary facility. - Observed complementarities: - FCL users secured buffers early, pursued counter-cyclical fiscal policy (cyclically adjusted fiscal positions widened by about 3 percent of GDP), and allowed exchange rate adjustment (real exchange rates depreciated peak to trough by 25 percent). - Policy lesson: - Building buffers in good times is important; implementability depends on fundamentals, institutions, and existing imbalances. ### Considerations and recommendations for future program design - External adjustment: - Greater exchange rate adjustment helps address external gaps with less adverse output impact; where FX liabilities are large, mitigate depreciation effects. - Recognize internal devaluation is very demanding and may require sustained reforms and financing beyond typical 3–4 year programs. - Fiscal policy and debt: - Fiscal consolidation remains key; pace and size should reflect macro objectives, financing availability, and debt sustainability. - Where consolidation has large output effects, seek additional financing for more gradual consolidation or consider timely debt restructuring when debt is unsustainable. - Structural reforms: - Structural conditionality remains important but should respect implementation capacity and set prudent near-term growth expectations for supply-side reforms. - Private sector balance sheets: - Do not assume large near-term activity benefits from balance sheet repair; prioritize legal and market frameworks, prudential incentives, and data improvements. - RFAs and currency unions: - Use G-20 principles for IMF-RFA cooperation as a basis for operational guidance; ensure clear roles and parsimonious, macro-critical conditionality. - When union-wide policy changes are material for program success, secure commitments or provide surveillance advice; otherwise, redesign program scale or timing. *Source: CRISIS PROGRAM REVIEW — INTERNATIONAL MONETARY FUND (content unit _110915).* ### 2015. In some cases they may differ, therefore, from the information in more recent ### _110915 - 2015. In some cases they may differ, therefore, from the information in more recent ### Executive Summary — Context and Objectives - The Fund approved support under the GRA facilities and instruments of SDR 420 billion during 2008–13, including both precautionary arrangements and arrangements from which members made drawings. - Nearly SDR 119 billion of these resources was drawn during the period. - Programs responded to differing needs: emerging markets affected by capital flow reversals and credit disruptions after the September 2008 collapse of Lehman Brothers; small countries whose external financing and exports declined during the global crisis; the Euro Area program countries; and a few countries in the MENA region addressing deep-seated structural and fiscal issues amid the global financial crisis. - Objectives at program inception emphasized avoiding severe global outcomes (e.g., fears of a second Great Depression or cascading contagion) and restoring investor confidence through balance of payments support and adjustment. ### Key Messages — Findings - Fund-supported programs helped chart a path through the global financial crisis that avoided the counterfactual scenario many initially feared, involving a cataclysmic meltdown of the global economic system. - Program design occurred amid extraordinary uncertainty after the collapse of Lehman Brothers and during the Euro Area crisis. - Program outcomes informed later program design and contributed to broadening feasible policy choices by strengthening frameworks and reducing contagion risk. - Nominal exchange rate adjustment was less central than in previous episodes; “internal devaluation” relying on domestic price adjustment proved hard to achieve within a short period due to domestic rigidities and weak partner growth and low inflation. - Regional financing played an important role in Euro Area programs; clearer operational guidance for Fund–RFA interaction would be helpful to delineate responsibilities. ### Program Focus and Common Features - Common program objectives included: - Restoring external viability through adjustment in internal or external prices. - Improving competitiveness and productivity by addressing product and labor market rigidities. - Restoring fiscal sustainability through adjustment and restructuring. - Re-capitalizing banks and promoting non-financial private balance sheet restructuring. - Strengthening financial supervisory and regulatory frameworks. ### Outcomes — Aggregate Assessment - At a broad level, Fund-supported programs helped the global economy avoid the most feared outcomes and smoothed adjustment for program countries. - About ¾ of the program countries have regained market access. - A third have substantially reduced their reliance on IMF financing. - Even with Fund support, significant adjustment was unavoidable for some countries; underlying vulnerabilities remain in many cases and debt is still elevated. - Restoration of market access occurred amidst easy global financial conditions; durability remains to be tested. - Unemployment remained high and growth generally tepid, reflecting weak global demand, limited exchange rate adjustment, continuing deleveraging, and a reduction in potential growth. - Recovery from financial crises tends to be protracted; adjustment is particularly difficult in a weak global environment. ### External Adjustment — Findings - External imbalances and currency misalignments in recent crisis programs were at least as large as in previous programs. - Recent programs featured more rigid exchange rates—partly reflecting existing regimes and concerns that large abrupt currency adjustments could destabilize balance sheets with currency mismatches. - Greater exchange rate rigidity implied greater reliance on domestic price adjustment; internal devaluation largely failed to deliver desired growth and export recoveries for most countries. ### Fiscal Policy and Public Debt — Findings - Programs typically sought to reduce fiscal deficits to lower public debt ratios over the medium term, considering available financing. - Deficits were generally reduced in line with program objectives, but short-term negative effects on output were larger than envisaged in programs with large fiscal consolidations, in part due to larger than expected fiscal multipliers. - Bank recapitalization costs and other activity-dampening factors led in several cases to a larger than expected rise in debt-GDP ratios during the program period. - Where public debt significantly exceeded high risk thresholds, it was generally restructured through private sector involvement and, in a few cases, official sector involvement. - Concerns about bank-sovereign linkages and cross-border contagion sometimes delayed or limited public debt restructuring, adversely affecting growth and credit intermediation. ### Structural Reforms — Findings - Many programs featured extensive structural reforms focused on core Fund responsibilities and the structural challenges to growth. - Structural conditionality may have resulted in reform fatigue in some cases. - Near-term growth payoffs from structural reforms were generally modest and less than envisaged. ### Private Sector Balance Sheets — Findings - Households and corporates entered the crisis with debt sustainability challenges. - During the crisis, the private sector increased saving (deleveraged), dampening aggregate demand. - Program design identified balance sheet strains, but the drag on growth and implications for fiscal adjustment were more severe than envisaged. - Only modest progress was made toward accelerated repair of balance sheets, reflecting moral hazard concerns, potential fiscal costs, and gaps in insolvency and foreclosure frameworks. ### Financial Regulation and Supervision — Findings - The crisis revealed excessive risk buildup in bank balance sheets, often due to gaps in supervisory arrangements. - Resolution of insolvent financial institutions and recapitalization of systemic ones was relatively slow, amplifying market volatility, curtailing bank lending, and keeping borrowing costs high. - Delay in establishing a Euro Area banking union with unified supervision, resolution, and safety net was costly. - Macro‑prudential regulations were not a core feature of recent programs and, where adopted, generally focused on banks’ foreign currency risks. ### Regional Financing Arrangements (RFAs) and Currency Unions — Findings - Fund-supported programs that involved RFAs benefited from RFAs’ regional expertise and an expanded financing envelope. - The Euro Area experience is instructive for future Fund–RFA collaboration; operational guidance should recognize differing institutional frameworks across cases. - For members of currency unions, program design accounted for union-wide policies’ bearing on member economies; the Fund sought needed changes through commitments or surveillance advice when warranted. ### Considerations for Future Program Design — Recommendations - External Adjustment: - Greater exchange rate adjustment helps address external gaps with a less adverse impact on output, though with substantial foreign currency liabilities steps are needed to mitigate depreciation impacts on balance sheets. - For countries where nominal devaluation is not realistic (e.g., currency unions), recognize that internal devaluation is very demanding and may require sustained adjustment and structural reforms beyond the standard 3–4 year period of Fund-supported programs. - The policies of the currency union as a whole affect individual members’ prospects for external adjustment; internal devaluation is harder if inflation is very low and external demand is weak. - Fiscal Policy and Public Debt: - Fiscal consolidation is generally key; pace and size should reflect macro objectives, available financing, and debt sustainability. - Program design should account for effects of consolidation on output; where effects are large, seek additional financing for more gradual consolidation. - Where public debt is high, timely debt restructuring may be needed. - Structural Reforms: - Structural conditionality remains important and may need to be more extensive where broad-based reforms support internal devaluation, but should respect authorities’ implementation capacity. - Program assumptions should reflect modest near-term growth dividends from supply-side reforms. - Private Sector Balance Sheets: - Balance sheet strains take time to resolve; program design should not typically anticipate large near-term benefits for activity. - Early priorities: legal frameworks and out-of-court settlement options; prudential measures to incentivize debt write-offs and restructuring; markets or institutions to handle distressed debts. - In crisis circumstances, benefits of debt write-downs may exceed adverse public balance sheet impacts and moral hazard concerns. - Address balance sheet data gaps to inform vulnerability assessments and decisions on exchange rate depreciation. - Strengthen institutional frameworks for regulation and supervision to prevent risk buildup. - RFAs and Currency Unions: - Use the G-20 principles for cooperation with RFAs as a foundation to develop updated operational guidelines. - Guidelines could ensure clear roles (e.g., Fund responsibility for macroeconomic and debt sustainability analysis) and critical, parsimonious conditionality to avoid overburdening implementation capacity. - Where union-wide policy changes are important for program success, the Fund should provide surveillance advice or, when necessary (including for financing assurances), seek commitments on prospective implementation; alternatively, program design would need larger adjustment and financing, or Fund involvement be postponed. *Source: CRISIS PROGRAM REVIEW, INTERNATIONAL MONETARY FUND.* ### 8. Current Account Balances _____________________________________________________________________ 21 ### 8. Current Account Balances ### Overview of the crisis and macroeconomic context - The early 2000s featured strong global growth, loose monetary policy in advanced economies, and a boom in international capital flows; Euro accession eased domestic financing conditions for several Euro Area countries. - Aggregate demand and credit growth boosted property and other asset prices; rapid wage and price inflation in several fast growing countries eroded competitiveness and current account deficits emerged amidst fixed or managed exchange rates. - Three years before their respective programs, all but one of the 27 countries covered in this review had some form of fixed or heavily managed exchange rate arrangement. - Large current account deficits were often financed by foreign saving but frequently supported asset booms (examples: Ireland, Iceland, Latvia, and Portugal) or government consumption (example: Greece). ### Crisis shock and IMF response - The demise of Lehman Brothers in September 2008 triggered a sudden loss of confidence, a spike in counterparty risk, and a collapse in activity; capital inflows stopped or reversed in several economies and financial systems stalled. - The Fund approved financial arrangements under the General Resources Account (GRA) in the amount of SDR 420 billion during 2008–13. - Arrangements from which members made drawings accounted for SDR 167 billion, of which nearly SDR 119 billion was drawn during this period. - Outstanding IMF credit, including both GRA and PRGT resources, rose from under SDR 10 billion in 2007 to over SDR 90 billion in 2013, declining with repayments to nearly SDR 60 billion as of June 2015. ### Purpose and scope of the review - The paper reviews the performance of Fund-supported programs since the outbreak of the global financial crisis to draw lessons for future program design, taking into account prior reviews and the 2014 Independent Evaluation Office (IEO) report on the IMF’s response to the crisis. - Comparisons are made with countries that did not request Fund support and with countries that used Fund resources in earlier programs (largest Fund arrangements between 1995 and 2007 are referenced as context). ### Analytical country groupings used in the review - European emerging markets affected when capital flows dried up in 2008–09: Georgia, Hungary, Iceland, Latvia, Ukraine (2008 and 2010), and Armenia, Belarus, Bosnia and Herzegovina, Mongolia, Romania, Serbia, and Sri Lanka (requests in 2009). Later requests from Moldova (2010) and Kosovo (2012) were similar. - Small highly open economies with vulnerabilities exposed through trade, tourism, and financial linkages: Seychelles (2008), Dominican Republic, Maldives (2009), Antigua and Barbuda, Jamaica (2010), and St. Kitts and Nevis (2011). - Euro Area crisis countries with public and private balance sheet vulnerabilities and large current account imbalances: Greece (2010, 2012), Ireland (2010), Portugal (2011), and Cyprus (2013). - Some MENA countries faced fiscal and structural vulnerabilities heightened by the global crisis (Pakistan, 2008) or strained by the 2011 Arab Spring (Jordan, 2012; Tunisia, 2013). ### Program design considerations and challenges - Initial conditions: many countries had large current account deficits, overvalued exchange rates, and high public and private debt coming out of the Great Moderation. - External adjustment constraints included weak external demand, limited scope for exchange rate adjustment under existing regimes, and balance sheet risks from large foreign exchange liabilities. - Balance sheet adjustment complexity: simultaneous deleveraging by public sector, households, and corporates reduced spending, undercut domestic demand, and raised real debt burdens. - Domestic financial systems as creditors constrained debt restructuring options due to potential impacts on banks’ balance sheets and financial intermediation; low global inflation limited inflation-mediated debt relief. - Where balance sheet risks from exchange rate depreciation were explicit concerns in arrangement requests: Dominican Republic, Georgia, Iceland, Jamaica, Latvia, and Ukraine. - Household balance sheet concerns identified in: Armenia, Cyprus, Georgia, Iceland, Ireland, Latvia, Romania, and Ukraine. - Non-financial corporate balance sheet concerns identified in: Armenia, Cyprus, Hungary, Iceland, Ireland, Jamaica, Latvia, Maldives, Portugal, Romania, and Ukraine. ### Program design approach and trade-offs - Programs leaned toward more gradual approaches compared with earlier programs: modest depreciation or internal devaluation rather than substantial exchange rate correction; strengthen debt sustainability through fiscal consolidation rather than debt restructuring; address banking sector concerns via recapitalization rather than closing insolvent banks. - Large imbalances and limited exchange rate flexibility led to protracted adjustments requiring large financing. - For programs co-financed with Regional Financing Arrangements (RFAs) or under currency unions, design needed to clarify institutional roles (Fund responsibility for macroeconomic framework and debt sustainability analysis) and ensure conditionality remained parsimonious and macro-critical in aggregate. ### Program outcomes and key results - Fund-supported programs during 2008–13 helped avoid a deeper crisis; programs cushioned the decline in output from previous artificially elevated levels, reduced imbalances, and stabilized financial systems. - A range of emerging economies and small states weathered the collapse of trade and financing flows; the Euro Area gained time to build firewalls against contagion; MENA reforms and confidence were shored up after the 2011 Arab Spring. - As of early 2015: - about ¾ of the program countries had regained market access (Figure 2 referenced in source). - a third had substantially reduced their reliance on IMF financing. - only 5 of the 27 program countries required successor arrangements. - Program-specific outcomes highlighted: - Good progress in tackling financial sector strains in Iceland, Ireland, and Latvia. - Effective external adjustment in Armenia, Latvia, Seychelles, and Sri Lanka. - Appropriate fiscal adjustment in Cyprus, Jordan, and Greece (2012). - Broad structural reforms implemented in Armenia, the Dominican Republic, Hungary, Jamaica (2013), and Seychelles. ### Institutional learning and implications for future programs - The Fund used experience from these programs to inform later program design, including: - stronger emphasis on addressing challenges to internal devaluation; - increased focus on restarting credit intermediation. - Experience with Euro Area programs informed the Fund’s recommendations for strengthening firewalls and developing banking union. - The Fund’s engagement across 27 countries enhanced its expertise to inform, advise, and help coordinate a global response. *Source: _110915 - 8. Current Account Balances (excerpt) — Crisis Program Review, International Monetary Fund* ### 12. While a few countries adjusted relatively quickly, in many cases underlying ### 12. While a few countries adjusted relatively quickly, in many cases underlying vulnerabilities remain. ### Macroeconomic outcomes and vulnerabilities - Restoration of market access occurred amidst easy global financial conditions; durability of access remains to be tested and debt is relatively elevated. - Unemployment remains high and growth has generally disappointed, reflecting: - weak global demand, - little exchange rate adjustment, - large fiscal multipliers, - a reduction in potential growth notwithstanding structural reforms. - The pattern reflects the protracted nature of recovery from financial crises and the difficulty of achieving adjustment in a weak global environment. ### Growth projections and forecast errors - Growth projections for the world and key countries were revised down serially over time, as reflected in the WEO and market consensus forecasts. - Growth disappointments reflected: - uncertainty in global demand conditions after the crisis, - drags from private sector deleveraging on demand, - unforeseen downward revisions to potential growth, - larger than expected fiscal multipliers in the context of ambitious fiscal adjustment, - modest short-term dividends from structural reforms, - limited progress in restoring competitiveness, - in some cases, worsening security conditions and political turmoil. - For program countries, growth fell short of projections, especially in the Euro Area programs, although not in the Caribbean and small states. - The 2014 IEO finding: current-year forecasts in exceptional access programs were initially optimistic (see IMF (2014c) Background Paper). ### Inflation outcomes - Inflation outcomes were mixed relative to projections; Fund projections were not consistently too high or low across program and non-program countries. - Inflation turned out: - broadly in line with projections for small states programs, - higher than programmed in the Euro Area, - lower than programmed in other emerging markets cases. ### Social spending and inequality - Social benefit spending was generally protected; traditional indicators (expenditure-based Gini) show some narrowing of inequality. - Proxies based on labor and capital income shares indicate: - For small states and non-European emerging markets: labor income rose relative to capital income during the program period. - In Euro Area programs: capital income shares generally rose during the programs while labor income shares have fallen over time, suggesting some redistribution away from labor. - Many programs safeguarded social expenditures at pre-program levels or increased social spending (Caribbean and small states), while Euro Area programs saw a small decline in social spending-to-GDP ratios amid large fiscal adjustments. *CRISIS PROGRAM REVIEW — INTERNATIONAL MONETARY FUND (excerpt).* ### E. Evenhandedness ### Program design and tailoring - Program design was generally tailored to country circumstances but shared similar features across countries facing similar challenges. - Programs targeted different degrees of fiscal adjustment depending on: - size of initial fiscal imbalances, - strength of economic activity. - Fiscal adjustment was largest in the Euro Area programs. - External current account adjustment objectives were largest in small states, where initial imbalances were large. - Structural reform content varied across programs, measured by the number of structural benchmarks and structural performance criteria; Euro Area programs and successor arrangements had more numerous structural conditions. ### Differences from previous episodes and policy focus - Recent crisis program design differed from previous episodes in response to circumstances and lessons from past experience. - As in the past, programs focused on: - restoring external and fiscal sustainability, - improving competitiveness through structural reforms, - addressing balance sheet problems in the financial sector, - strengthening financial supervision and regulation. ### Access to Fund financing and exceptional access - Access reflected country circumstances; large size of some arrangements, notably in the Euro Area, reflected adjustment challenges, financial development, and close integration with global financial markets. - Access as a percent of GDP was largest in Euro Area programs, commensurate with ambitious fiscal and structural reform objectives. - Over half of the recent programs entailed exceptional access to Fund resources: 19 out of the 32 programs. - Euro Area programs were some of the largest in the Fund’s history, both in SDR terms and as a percent of quotas. ### Programs in currency unions - Program design for currency union members recognized the influence of union-wide policies on member economies. - Where program success depended on union-wide policies, the Fund sought assurances on implementation; this took various forms: - Conditions implemented by the union-wide institution (examples: St. Kitts and Nevis, Antigua and Barbuda), - Financing assurances reflected in Eurogroup press releases and staff reports for Euro Area programs. - Some supportive union-wide policy changes (banking union, monetary policy) were provided as advice in regular surveillance discussions and were not made conditions or safeguards commitments. - Cases using conditions tended to refer to regulatory and supervisory actions within the purview of the union-wide institution that affected the program country but not other members. *CRISIS PROGRAM REVIEW — INTERNATIONAL MONETARY FUND (excerpt).* ### F. Technical Assistance ### Role and magnitude of IMF TA - IMF technical assistance (TA) played an important role in supporting policy implementation in recent programs. - On average, TA delivery to program countries nearly doubled compared to the pre-program year, measured in person-years. - TA increased most significantly for Euro Area programs (up from a very low pre-program base) and for small states. - Largest program TA recipients: Antigua and Barbuda, followed by Greece, Cyprus, and Ukraine. - Ireland was an exception among Euro Area programs, receiving virtually no TA during its Fund-supported program due to strong institutional capacity. ### Composition and focus of TA - Fiscal expertise accounted for most of the increase in TA to Euro Area countries and to small states. - For other emerging markets and MENA countries: - TA rose less markedly, - was refocused on fiscal TA for emerging markets, - and on financial TA for MENA countries. - Overall, delivery of TA was closely related to the ambition of countries’ reform agendas, proxied by the number of conditions per program year. *CRISIS PROGRAM REVIEW — INTERNATIONAL MONETARY FUND (excerpt).* ### Box 1. Recent experience with FCL, PCL, and PLL ### Instruments and usage - Instruments introduced in 2009–10: Flexible Credit Line (FCL) and Precautionary Credit Line (PCL); PCL’s successor is the Precautionary and Liquidity Line (PLL). - Purpose: for countries with very strong (FCL) or “sound” (PCL) fundamentals, to bolster confidence, reduce stigma (reduced or no ex post conditionality), and strengthen crisis prevention. - Users since creation: - FCL: Colombia, Mexico, Poland. - PCL/PLL: FYR Macedonia, Morocco. - Of these five countries, only FYR Macedonia has ever drawn upon its precautionary facility. ### Observed policy complementarities and outcomes in FCL cases - Motivations varied: commodity price shock vulnerability (Colombia, Morocco), significant non-resident portfolio investment (Mexico, Poland), exposure to Euro Area crisis (Morocco, Poland). - During the crisis, Colombia and Poland avoided a contraction; Mexico quickly recovered from a one-year recession. - Elements contributing to outcomes (documented in FCL reviews, IMF (2014d)): - Countries sought additional external buffers (FCL, Central Bank swaps) before a balance of payments need; coming early helped limit contagion. - They had space to pursue counter-cyclical fiscal policy; cyclically adjusted fiscal positions widened by about 3 percent of GDP in all three FCL users. - Despite larger external buffers and smaller imbalances, they allowed exchange rate adjustment; real exchange rates depreciated peak to trough by 25 percent, more than double the adjustment in the CPR sample. ### Policy lesson - The FCL experience underscores the importance of building buffers in good times and the capacity of such buffers to mitigate shocks; implementability depends on fundamentals, institutions, and existing imbalances. *CRISIS PROGRAM REVIEW — INTERNATIONAL MONETARY FUND (excerpt).* ### External adjustment and financing ### Initial external imbalances and exchange rate valuation - Program countries entered the crisis with larger external imbalances than in earlier programs. - Easy global financial conditions had fueled rapid credit growth that widened current account deficits and moved exchange rates away from fundamentals. - Exchange rates were generally fixed or heavily managed and often had overvaluations well over 10 percent. - At program start, currencies were overvalued by an average of about 10 percent, with a few currencies overvalued by over 20 percent (Armenia (2009), Greece 2010, Latvia (2008), and Seychelles (2008 and 2009)); this was similar to the average for earlier programs. - When the crisis hit and global risk aversion rose, most countries experienced a sudden stop in capital flows large compared to earlier programs. ### Adjustment, financing, and burden sharing - Programs relied on a mix of adjustment and official financing to address balance of payments shortfalls; the balance varied significantly across the sample. - The mix reflected: - differing access to exceptional support from partner countries, - whether shocks were expected to be temporary or permanent, - scope for rapid exchange rate adjustment. - Financial support from other official creditors often accompanied Fund financing; relative burden sharing depended on program-specific circumstances. - Euro Area cases lent themselves more directly to burden sharing due to financing partners with reserve currency funding capacity. - Constraints on the Fund’s balance sheet increased the need for other creditors in large financing needs. - Planned program funding components (as presented): IMF financing, other official financing, total other BoP improvement, total CA adjustment — varied across programs. - Access expressed as a share of financing need was comparable between Euro Area and many non-Euro Area programs in percent of financing need. ### Practical implications for program design - Greater exchange rate adjustment helps address external gaps with less adverse impact on output. - Where foreign currency liabilities are substantial, steps are needed to mitigate the impact of currency depreciation on balance sheets. - For members of currency unions, if nominal exchange rate adjustment is not an option, internal devaluation may require: - large macroeconomic adjustment, - deep structural reforms sustained over long periods that can exceed the standard 3–4 year period of Fund-supported programs, - large and continued financing. - Policies of the currency union as a whole can importantly influence the economic situation of individual members. *CRISIS PROGRAM REVIEW — INTERNATIONAL MONETARY FUND (excerpt).* ### 24. The extent of external current ### 24. The extent of external current ### External current account adjustment: extent and cross-country patterns - External current account adjustment varied across programs. - Euro Area and emerging market program cases adjusted by more than projected; small states adjusted by less; adjustment in MENA programs was roughly in line with projections (Figure 12). - Compared to earlier program cases: - External adjustment was larger in Euro Area and emerging market programs. - External adjustment was smaller in small states and MENA programs. - External debt outcomes ran counter to expectations given the current account adjustment: - Despite larger-than-programmed current account adjustment, external debt as a percent of GDP in the Euro Area cases remained higher-than-programmed, largely due to weaker output. - Small states achieved initial objectives of reducing external debt levels: additional borrowing to finance higher-than-programmed current account deficits was offset by substantial debt relief for the Seychelles. - External debt outcomes disappointed in other emerging markets and MENA countries. ### Sustainability of the adjustment - The sustainability of the external current account adjustment remains to be tested. - Even where countries have regained access to financing, current account deficits often remain above debt-stabilizing levels (Figure 13). - Real exchange rates have typically adjusted little; current account adjustments have instead reflected a compression of demand, suggesting external gaps may re-emerge as activity recovers. ### Exchange rate policies: regime choices and recent behavior - Before the crisis, all but one of the recent program countries had some form of fixed or heavily managed exchange rate (Figure 14). - In the years since the crisis broke, about half of the sample moved toward greater flexibility, but actual variation in nominal exchange rates remains far below that of earlier program cases (Figure 15). - Only in Iceland and the Seychelles did the nominal exchange rate depreciate significantly. - Program design observations: - For currency union members, currency union membership was taken as given for program design (Euro Area and East Caribbean Currency Union programs). - Outside unions, most programs sought to maintain pegs close to pre-program levels (Latvia) or pursue managed, gradual depreciation (Jamaica). - Choices to maintain pegs or gradual depreciation reflected recognition of balance sheet risks associated with large or abrupt exchange rate depreciation (Dominican Republic, Georgia, Iceland, Jamaica, Latvia, and Ukraine) and authorities’ strong commitment to the peg (Jordan and Latvia). ### Monetary program design and outcomes - In several cases, exchange rate stability provided a nominal anchor for monetary programs. - Inflation outcomes were close to program projections in a global environment of weak growth, low inflation, and depressed commodity prices in the aftermath of the global financial crisis (Table 1). - Programs designed around pegged exchange rates and inflation targeting regimes saw smaller inflation surprises than regimes based on monetary targets (net domestic asset or base money ceilings). - Operational monetary targets were met more consistently than under earlier programs. - Table 1 (selected figures): - Pegged Exchange Rates: Number of Programs 12; Actual Minus Projected Inflation 0.3 at T, 0.4 at T+1, -0.2 at T+3; Monetary Targets Missed 11 (percent). - Inflation Targeting Regime: Number of Programs 7; Actual Minus Projected Inflation 0.0 at T, -0.5 at T+1, 0.8 at T+3; Monetary Targets Missed 26 (percent). (Armenia, Georgia, Hungary, Iceland, Moldova, Romania, and Serbia.) - Other Monetary Regimes: Number of Programs 13; Actual Minus Projected Inflation 2.1 at T, -2.0 at T+1, 4.8 at T+3; Monetary Targets Missed 27 (percent). - Earlier Programs: Number of Programs 11; Actual Minus Projected Inflation 1.5 at T, 13.6 at T+1, 4.7 at T+3; Monetary Targets Missed 40 (percent). - Exchange rate stability was achieved through monetary tightening and currency intervention: - Several programs saw sizeable increases in real interest rates to stem capital outflows, most notably in floating rate regimes experiencing significant real depreciation pressures (Figure 16). - As global liquidity conditions eased, floating rate regimes often benefited from larger than expected capital inflows; intervention to moderate currency appreciation led to larger reserve accumulation than planned (Figure 17). - Programs featuring soft pegs consistently fell short of program goals for reserve cover, suggesting less success in attracting capital inflows and more prolonged exchange market intervention to support the currency. - The sustained shortfall in reserve cover in soft-peg cases suggests intervention was partly sterilized, limiting associated monetary tightening. ### Outcomes: competitiveness, internal devaluation, and capital flow measures - Relative rigidity in exchange rates led programs to rely on domestic price adjustment to restore competitiveness; internal devaluation proved very hard to achieve. - Recent program cases achieved a real effective exchange rate depreciation of just 12 percent over the program period compared with an average of 48 percent in earlier programs. - Real effective depreciation during the program period averaged: - 7 percent for countries that maintained exchange rate pegs in a currency union or relative to an external anchor currency. - 20 percent for those with more flexible exchange rate arrangements. - Note: A peg relative to an external anchor currency is interpreted as a depreciation of less than 10 percent over the program period. - Limited progress in improving competitiveness: - Labor market reforms were attained ahead of product market reforms; lower labor costs’ benefits were blunted by limited adjustment in producer prices and supply response due to barriers to new entry. - In Euro Area programs, reductions in wage costs relative to trading partners were reflected in ULC-based real exchange rate depreciation, but CPI-based REER depreciations were only small (Figure 18). - Where internal devaluation occurred, there is some evidence of a nascent growth impact: - Trend growth generally declined during recent programs and fell short of end-program projections, but the decline and shortfall were, on average, smaller for countries that made more progress toward internal devaluation (Figures 19 and 20). - This suggests that shortfalls in trend growth owed in part to internal devaluation not being achieved. - Sustained pursuit of internal devaluation over periods longer than the typical program period could deliver growth dividends, provided financing is available to accommodate the slower pace of adjustment. - Capital flow management measures (CFMs): - CFMs on capital outflows were imposed in response to crisis conditions in Iceland (2008) and Cyprus (2013). - CFMs were put in place by the member before the start of the programs to help stem capital outflows when crisis was imminent, with a view to being eliminated as conditions stabilized. - In Cyprus, a roadmap was adopted for relaxation of restrictions on cross-border flows tied to progress in rebuilding domestic financial intermediation; CFMs were eventually removed with little impact on markets and the banking sector. - In Iceland, unwinding CFMs proved more difficult than anticipated owing to the size and complexity of the problem; the liberalization strategy had to be updated successively over the course of the program. - Reserve draw-downs also met market demand in a few other cases (Bosnia and Herzegovina, Moldova). ### Box 2 summary: Promoting internal devaluation (historical experience) - Since the 1990s, only 16 emerging market episodes with fixed exchange rates achieved CPI-based REER depreciations exceeding 15 percent. - Two such cases achieved this through domestic deflation (Antigua and Vietnam); other cases reflected higher partner-country inflation or fortuitous depreciation of the peg currency. - Critical factors for achieving internal devaluation: - Initially small current account imbalances and large exports relative to GDP. - Flexible domestic economy, particularly labor markets. - Supportive global growth and partner inflation dynamics. - Small debt stocks and substantial policy space (especially fiscal). - Where typical conditions do not hold, internal devaluation may only be achievable slowly and requires sustained program ownership, implementation capacity, and access to large continued financing. - Latvia example: - Unit labor costs fell by 25 percent in 1 year; CPI-based REER fell only modestly. - Output contracted substantially at first (24 percent peak to trough), but recovered subsequently due to stronger exports and supply response. - Contributory factors: authorities’ strong commitment, substantial rise in labor productivity, flexible product and labor markets. ### Fiscal adjustment: role and outcomes (summary) - Fiscal consolidation supported external adjustment, responded to financing constraints, and was necessary to support medium-term debt-GDP reduction goals. - Fiscal deficits were generally reduced in line with program objectives. - In some programs with large fiscal consolidations, the negative impact on output in the short term was larger than anticipated and, combined with other factors, raised debt-GDP ratios by more than expected in the short term. - Where near-term output impacts of large fiscal consolidation are likely to be large and protracted with consequences for program sustainability, it is desirable to: - Examine the scope for slower fiscal consolidation—requiring additional financing. - Restructure the debt if it is not deemed sustainable with high probability. ### Fiscal background and objectives (selected figures) - Many program countries were characterized by high levels of public debt. - In some cases, high debt reflected: - Large borrowing prior to the crisis (Greece 2010). - Costs of financial sector interventions (Ireland). - Large cyclical deficits during the crisis (Cyprus, Greece 2012, Ireland, Jordan). - Programs typically sought to reduce fiscal deficits to ease short-term financing pressures and put public finances on a sounder medium-term footing. - Some programs targeted primary fiscal surpluses to help reduce high public debt-GDP ratios. - One in five programs supported public debt restructuring where indebtedness could not realistically be addressed by fiscal adjustment alone. - Programs typically sought to balance benefits of stronger fiscal positions against output impacts: - On average, programs sought to strengthen primary fiscal balances by about 3 percentage points of GDP, in total, over a three-year period. - Programmed fiscal adjustment was larger in the Euro Area (averaging 5½ percentage points of GDP of primary balance adjustment) and smaller in MENA programs (about 2½ percentage points of GDP). - Programs typically sought fiscal consolidations through expenditure cuts. - Many program countries faced public spending ratios exceeding 50 percent of GDP in most Euro Area program countries. - Much spending related to energy subsidies (MENA), wages (Euro Area, MENA, and small states), and social benefits, including pensions (Euro Area). - Weaknesses on the revenue side (e.g., tax administration) made heavy reliance on higher revenue unlikely. - Program design generally mindful of protecting social safety nets: - A quarter of programs had the explicit objective of poverty reduction. - Around half of the programs included some form of social protection in their conditionality. *Source: IMF staff estimates and analysis in the Crisis Program Review chapter excerpt.* ### 37. Fiscal consolidation outcomes were mixed. Primary fiscal balances strengthened by an ### _110915 - 37. Fiscal consolidation outcomes were mixed. Primary fiscal balances strengthened by an ### Fiscal consolidation outcomes - Primary fiscal balances strengthened by an average of 1¾ percent of GDP during the 3 years after program approval, relative to program goals of about 3 percentage points over three years. - Regional outcomes: - Fiscal outcomes were closest to program objectives in the Euro Area and MENA, but fell short in other regions. - In the Euro Area, program fiscal balance targets were met, but typically in the context of disappointingly weak economic activity, implying a much larger than programmed cyclically adjusted fiscal correction. - In small states, original program targets were missed due to expenditure overruns. - Comparative outcomes: - Except for small states, program fiscal consolidation was larger in the crisis program cases, on average, than in non-program countries, where fiscal deficits typically significantly exceeded projected levels. - Composition and protection of spending: - Capital expenditure in relation to GDP rose in the Euro Area cases but was more mixed elsewhere. - Programs were generally effective in protecting social benefit spending, both in relation to total expenditure and relative to pre-program periods, and in contrast to the experience in non-program countries. - Social spending as a share of total expenditure increased across regions. - Social spending was broadly preserved as a percent of GDP, with regional variation: declining slightly in the Euro Area programs and increasing slightly in MENA and the small states. - Structural benchmarks and social protection: - Structural benchmarks on social protection were met in most cases, although the performance on indicative targets was more mixed. ### Impact of fiscal consolidation on output and debt dynamics - Short-run effects: - In some cases, the contractionary effect of fiscal consolidation on output may have contributed along with other factors to raising debt-GDP ratios by more than expected in the short run. - Fiscal consolidation was necessary to reduce debt-GDP ratios over the medium term. - Progress in strengthening fiscal balances reduced the pace of new borrowing, but it did not reduce nominal debt levels. - Causes of larger-than-expected debt-GDP outcomes: - Some countries implementing large fiscal consolidations experienced sizeable declines in activity reflecting larger-than-anticipated fiscal multipliers, reversals of output from artificially inflated levels, weaker activity associated with weak global demand, political uncertainty, and incomplete reform implementation. - Despite fiscal adjustment, debt-GDP ratios rose more than expected over the program period in Armenia, Dominican Republic, Georgia, Jamaica 2013, Maldives, Moldova, and Pakistan. - Bank recapitalization costs amounted to 19 percent of GDP on average, or 60 percent of the short-term rise in the debt-GDP ratio (in the sample noted), and reclassification of public enterprise debt was an additional factor (Portugal). - Program responses: - As the contractionary effect of fiscal consolidation on output became evident, many programs slowed the pace of consolidation (Armenia, Greece, Hungary, Latvia, Portugal, and Ukraine). - In small states, strong initial primary fiscal positions allowed fiscal policy to play a somewhat countercyclical role, financed by earlier-than-expected market access, interest savings from debt operations, and concessional financing provided in successor arrangements. ### Debt sustainability outcomes - General performance: - Debt reduction measured by public debt-GDP ratios fell short of medium-term program expectations in three-quarters of programs. - Shortfalls reflected fiscal adjustment that was somewhat smaller than programmed and disappointing growth outcomes in many cases. - Other contributory factors included upward revisions to baseline primary deficits, currency depreciations (Belarus, Jamaica (2010), Pakistan, Seychelles (2008), and Ukraine (2010)), lower-than-expected asset sales, and higher bank recapitalization costs (Greece). - Large debt surprises and non-restructuring cases: - Debt surprises were particularly large in non-restructuring cases, notably for several countries that needed successor arrangements (Greece (2010), Mongolia, Serbia, Seychelles (2008), and Ukraine (2008, 2010)). In these cases, public debt exceeded medium-term program projections by more than 20 percent of GDP. - Among Euro Area programs, debt-GDP ratios exceeded targeted levels for Greece (2010) and Portugal (2011). - Restructuring incidence: - About one case in five featured sovereign debt restructuring: Of 32 programs, seven included either a debt reprofiling with no face value reduction (Antigua and Barbuda (2010), Cyprus (2013), and Jamaica (2010 and 2013)) or a debt operation with a face value debt reduction (Greece (2012), Seychelles (2010), and St. Kitts and Nevis). - Featured restructuring cases had initial public debt levels exceeding 90 percent of GDP. - In three other advanced economy cases, relatively high debt ratios were assessed to be sustainable with a high degree of probability (Iceland, 2008), or concerns about systemic spillovers precluded consideration of debt restructuring options (Ireland and Portugal). - Comparative outcomes of restructuring vs non-restructuring: - Among countries with high public debt levels, disappointments in growth and public debt outcomes were smaller in cases that included debt restructuring. - Debt-GDP ratios were, on average, higher-than-programmed in the non-restructuring cases, while growth was lower. - Restructuring cases achieved more substantial growth turnarounds and declining debt-GDP ratios, broadly in line with initial program expectations. - Some non-restructuring countries had lower debt ratios ahead of their programs and stronger pre-program growth, limiting scope for improvement during the program period. ### Market access, contagion, and the systemic exemption - Market indicators: - Sovereign ratings deteriorated in all cases during the first program year, suggesting perceptions of debt sustainability were slow to improve; ratings improved subsequently in most program countries. - Sovereign bond spreads in Euro Area program cases remained elevated until mid-2012, before declining helped by decisive policy actions by the ECB. - Narrowing spreads contributed favorably to debt dynamics in most countries, although typically not enough to offset adverse growth disappointments. - Contagion and policy choices: - Concerns about contagion were a critical consideration in decisions about debt restructuring in the Euro Area programs. - For Greece (2010), the Fund could not assess that debt was sustainable with high probability, but the risk of systemic international spillovers provided a justification for not requiring an upfront debt reduction operation as a condition for a Fund arrangement with exceptional access. - A “systemic exemption” clause was added to the exceptional access policy and was invoked for Ireland (2010), Portugal (2011), and again in Greece’s 2012 successor arrangement. - In programs outside the Euro Area, contagion was not seen as a sufficient concern to warrant use of the systemic exemption. - Limitations of the systemic exemption: - The systemic exemption proved critical in avoiding defaults on private claims at the outset and provided breathing space to build firewalls, but it could not on its own prevent contagion. - CDS spreads continued to rise following Euro Area program announcements; market confidence only began to return largely in response to the ECB’s commitment to do “whatever it takes.” - With little evidence that the systemic exemption alone helped prevent contagion, the Fund is considering proposals to reform its exceptional access lending framework, including the systemic exemption, and increase general flexibility to deal with cases where debt is deemed sustainable but not with high probability. ### Timing and costs of debt restructuring - General assessment: - The experience reveals problems for Fund-supported programs when debt sustainability is not secured upfront; debt restructuring, when it came, was often too little too late. - By the time private sector involvement (PSI) was considered in Greece in 2012, the implied haircuts for remaining creditors were large relative to other pre-default cases even though insufficient to restore debt sustainability with high probability. - Country specifics and constraints: - In Jamaica, debt restructuring options were constrained by financial stability considerations; the 2010 and 2013 debt exchanges eschewed principal haircuts, limiting the NPV debt reduction to 15 percent. - In Seychelles (2008) and St. Kitts and Nevis (2011), restructurings involved sizable haircuts but were undertaken several years after staff first assessed debt to be unsustainable. ### Structural reforms (summary link to fiscal and debt outcomes) - Focus and implementation: - Structural conditionality was mainly focused on core areas of the Fund’s responsibilities and was generally important to achieve key program goals. - An extensive reform agenda was motivated by the need to address underlying macroeconomic imbalances, including through internal devaluation, and to boost long-term growth. - Implementation rates of structural conditionality were generally high, although some programs exhibited reform fatigue. - Growth payoffs and design implications: - Growth payoffs from structural reforms in the short term were likely modest and less than programs may have envisaged, suggesting program design should be prudent about expectations. - An analytical framework for assessing prospective payoffs from structural reforms could help inform expectations. - Where reforms are macro-critical but outside the Fund’s traditional responsibilities, further consideration is needed on how to leverage expertise in other institutions. - Where ownership of structural reforms is incomplete, offsetting adjustments in other policies (debt reduction, exchange rate depreciation) may be needed to help address underlying imbalances. *Source: IMF staff analysis as presented in the provided content unit.* ### 47. Structural reforms featured importantly in the recent Fund-supported programs. ### _110915 - 47. Structural reforms featured importantly in the recent Fund-supported programs. ### Overview of structural conditionality - The average annual number of structural reform conditions (prior actions, structural performance criteria, and structural benchmarks) per program year rose throughout the global crisis; by 2013, the average was close to the previous peak in 2003–05. - The use of structural performance criteria under Fund arrangements was abolished in 2009. - The number of structural reform conditions varied across individual countries and program groupings, with particularly high levels in some Euro Area programs (Greece) and in programs outside the Euro Area (Bosnia and Herzegovina, Jamaica, Tunisia, and Ukraine). - Supply-side conditions were more numerous in countries with weaker initial structural conditions and more rigid exchange rates. ### Outcomes: implementation and composition - Implementation rates: - On average, about 70 percent of structural benchmarks and performance criteria were met without delay. - Implementation rates were highest in small states programs. - Implementation rates were lower in the later years of programs and in programs with the largest number of structural conditions, possibly indicating reform fatigue. - Programs with high structural conditionality could still have very strong implementation (example cited: Jamaica, 2013). - Implementation rates were generally lower for structural reforms in the financial sector. - Composition of structural conditionality: - The majority of structural conditionality related to the fiscal and the financial sectors. - Fiscal reforms accounted for over half of all structural conditionality in recent crisis programs. - Fiscal conditionality focus by region: - Tax policy and revenue mobilization most prominent in MENA countries and small states. - Public financial management prominent in other emerging markets. - A range of fiscal issues in Euro Area programs. - Other areas: labor and product market reforms were more prevalent in countries with rigid exchange rate regimes (including Euro Area programs such as Greece, 2012; Portugal), and energy sector reform featured in programs such as Pakistan, 2008; Ukraine, 2008 and 2010. - Conditionality in non-traditional Fund areas: - Where conditionality was applied outside the Fund’s traditional areas of responsibility, implementation delays were about 20 percent longer, on average. - The 2011 Conditionality Review emphasized the need to better scrutinize macro-criticality and justify conditionality in program documents by identifying clear links to program goals. ### Growth dividend from supply-side reforms - Programs with the most supply-side structural conditionality typically projected the largest increases in trend growth relative to historical averages (examples: Dominican Republic, Greece, Jamaica (2010), and Portugal). - Empirical alignment: - The expected medium- to long-term growth dividend assumed in programs appears broadly in line with empirical evidence. - For the short term, literature typically finds supply-side reforms have a very small, possibly even negative, impact on growth, yet several programs implicitly expected a growth dividend as early as the second program year. - Quantitative thresholds and projections: - Where supply-side conditionality exceeded 15 percent of total structural conditionality, program projections for medium-term growth typically exceeded rates in the pre-crisis boom decade. - For more than one-half of such programs, the implied growth dividend was projected to be at least 1 percentage point. - By contrast, for countries with limited or no supply-side conditionality, only one-in-five countries programmed a comparable rise in medium-term growth performance. - Caveat: disappointing growth performance in recent programs cannot be attributed to structural reform dividends alone; other factors include weak global conditions, fiscal consolidation, balance sheet stress, and shrinking bank credit. ### Addressing private sector balance sheet stress — objectives and diagnostics - Private sector debt concerns were prominent in many programs, most notably in Europe. - Cases with identified high debt concerns in corporate and/or household sectors included: Armenia, Cyprus, Georgia, Hungary, Iceland, Ireland, Latvia, Portugal, Romania, Ukraine, Jamaica, and the Maldives. - Comparative observation: Household debt-GDP ratios (Cyprus, Greece, Ireland, Iceland, Jordan, Latvia, and Portugal) and non-financial corporate debt-GDP ratios (Cyprus, Iceland, Ireland, and Portugal) exceeded those in Korea and Thailand in the mid-1990s during their credit booms. - Adverse consequences of excessive private indebtedness: - High debt service ratios relative to disposable income can reduce consumption and investment as households and corporates rebuild balance sheets. - Recoveries were typically slower where financial and non-financial private sector balance sheets were strained, particularly where banks faced high NPLs and limited capital and households and corporates faced elevated debt in relation to GDP. - Over one-third of programs (12 of 32) experienced a banking crisis, defined by a sharp loss of liquidity due to a deposit run, a failure to rollover wholesale borrowing, or a large erosion of capital owing to a collapse in asset quality. ### Importance of balance sheet analysis - Program experience underscored the importance of balance sheet analysis to identify sources of vulnerability and transmission channels of shocks. - The Fund’s balance sheet approach had fallen into abeyance ahead of the global financial crisis, potentially hindering detection of risks (e.g., European banks’ reliance on U.S. wholesale funding). - Addressing balance sheet data gaps would improve assessment of scope for external devaluation by accounting for balance sheet mismatches. ### Policies to address stressed balance sheets - Program priorities to avert or reverse adverse feedback loops included: - Maintaining bank liquidity and solvency. - Facilitating corporate and household debt restructuring. - Initial focus on liquidity support, liability guarantees, and bank recapitalization; bank resolution, asset restructuring, and insolvency framework measures were generally planned for later stages. - Recommended preparatory and preventative measures (to build frameworks and avert future risks): - Early attention to legal frameworks and out-of-court settlement options. - Prudential measures to incentivize debt write-offs and restructuring. - Creation of markets or institutions to handle distressed debts. - Steps to address balance sheet data gaps to identify vulnerabilities and inform policy decisions, including the merits of exchange rate depreciation as part of adjustment. ### Banking sector support and coordination - Liquidity support: - Substantial bank liquidity support helped avoid deposit runs and limit pressures on domestic and foreign exchange liquidity. - The significant presence of foreign banks in eastern European countries provided non-public backup capital and liquidity in some cases. - International coordination (e.g., Vienna Initiative) saw foreign banks commit to avoid sudden stops, inject capital into subsidiaries, and cooperate on stress tests and action plans (examples: Bosnia and Herzegovina, Hungary, Romania, Serbia). - Euro Area specifics: - Euro Area banks benefitted from large liquidity support from the ECB and the Eurosystem. - In the absence of a banking union (single supervisory-regulatory framework, resolution mechanism, and safety net), resolving unviable banks and recapitalizing systemic ones led to higher borrowing costs for sovereigns and private sectors, amplifying financial market volatility and curtailing bank lending and growth. *Source: _110915 - 47. Structural reforms featured importantly in the recent Fund-supported programs.* ### 61. Outside the Euro Area, program conditionality focused on dealing with problem ### _110915 - 61. Outside the Euro Area, program conditionality focused on dealing with problem ### Financial sector outcomes - Program conditionality outside the Euro Area focused on dealing with problem banks and improving regulatory and supervisory frameworks (Georgia, Mongolia, and Pakistan); some programs also sought to strengthen liquidity management practices (Georgia). - In non-banking crisis countries, financial conditionality was used to: - Contain possible adverse impacts of other program components (for instance, from fiscal reforms) and the cycle. - Increase early warning capabilities, including stress tests (St. Kitts and Nevis). - Overall outcomes from financial sector policies were generally mixed: - Capital adequacy improved in most program cases (Figure 47). - NPLs peaked in about half of the banking crises cases, but continued to rise in some: Bosnia and Herzegovina, Greece, Hungary, and Portugal. - Credit had started to grow again in a few cases, but continued to fall in most cases during the life of the program, holding back economic recovery (Figure 48). - Weak credit reflected weaknesses in bank balance sheets and the lingering effect of debt overhang in the corporate and household sector. - Limited progress was made in implementing structural benchmarks and structural performance criteria related to reforms of the financial system (legal framework, capital markets, broker dealers, leasing, and insurance) in Dominican Republic, Moldova, and Seychelles, in part owing to implementation capacity limitations. ### Private debt restructuring - Where high private debt was a concern, conditionality focused on cleaning up non-financial private balance sheets to restore creditor solvency and banks’ long-term viability. - Conditionality was mainly aimed at: - Establishing or amending insolvency frameworks. - Facilitating voluntary out-of-court debt restructurings (Figure 49). - Among the 12 programs featuring high private debt concerns: - 6 programs established frameworks to implement case-by-case debt workouts. - Iceland used a standardized approach for write-downs of mortgages and SME debt. - Capacity constraints implied longer implementation periods for restructuring measures in some cases. - Measures to tackle private nonfinancial balance sheet stress advanced slowly: - On average, about 70 percent of conditionality on private balance sheets was implemented either with delays, or not met. - By contrast, 30 percent for structural conditionality in general was implemented either with delays, or not met. - Slippages reflected: difficulties in getting creditors’ buy-in, lack of political support, delays in advancing legislation, and difficulties in setting up out-of-court frameworks (examples: Cyprus and Ukraine). - Other factors hampering private debt reduction: - Weak economic growth in programs characterized by tight fiscal policies made deleveraging more difficult (Figures 51 and 52). - Write downs of non-financial private debt would have exacerbated banks’ losses and increased public support needed to recapitalize banks, conflicting with fiscal consolidation objectives. - Public sector restructuring and labor market reforms in some programs adversely impacted job security and debt service capacity. - Progress in reducing debt outright was limited: - Only a few countries with high-or medium-debt concerns achieved outright nominal debt reductions for the private sector: Greece, Hungary, Iceland, Ireland, Latvia, Portugal, Romania, and Ukraine. - A larger number achieved deleveraging when stronger economic activity reduced debt-GDP ratios (Figures 53 and 54). - While household sectors in most programs saw a decline in debt-GDP ratios, in about half of programs the non-financial corporate sector saw no debt-GDP improvement. - Recommended priorities to improve prospects for private debt restructuring: - (i) Early emphasis on addressing legal deficiencies and enhancing insolvency and debt enforcement frameworks, including by establishing options for out-of-court restructuring. - (ii) Measures to enhance prudential supervision to incentivize banks to write off or restructure debts, such as targets for NPL reductions (as under the Cyprus program) or time limits on carrying NPLs. - (iii) Establishment of markets or institutions to handle distressed debt, such as asset management companies (examples: Ireland and Latvia). ### Financial supervision and regulation - The crisis revealed excessive buildup of risks in bank balance sheets, often from gaps in supervisory arrangements that did not keep pace with rapid financial integration. - In the run-up to the crisis, banks in Europe increased funding from wholesale markets, including financial centers and off-shore jurisdictions; buildup also reflected relaxation of bank credit standards (Iceland, Romania) and currency mismatches. - Consequences of accumulated foreign liabilities included: - Weakening of domestic monetary transmission channels. - Challenges from weak subsidiaries of parent banks from crisis countries (Greek and Cypriot banks). - Credit market fragmentation as private and sovereign funding costs diverged. - Worsening of the financial-fiscal linkage. - Over time, improved supervision and regulation led to banks’ gradual deleveraging from foreign creditors and to a credit contraction. - Fund-supported program measures: - Increased scrutiny of balance sheets through asset quality reviews and periodic stress testing at national and regional levels to preserve solvency and viability. - Microprudential measures such as provisioning requirements and limits on foreign exchange exposure to unhedged borrowers (Hungary, 2008; Romania, 2009). - Macroprudential measures: - In general, Fund-supported programs did not include adoption of new macroprudential measures. - A few countries adopted macroprudential measures ahead of Fund-supported programs (Armenia and Romania). - Where included in programs, measures aimed to minimize exchange rate risk, e.g. increasing provisioning and risk weighting for banks’ foreign currency loans, raising reserve requirements for foreign liabilities, and establishing tighter limits on net foreign currency open positions (Armenia, Belarus, and Hungary). - Ireland’s program: liquidity assessments included review of loan-to-value levels. - Kosovo’s program: establishment of a macroprudential committee was required to help coordinate and communicate existing macroprudential policies. ### Regional financing arrangements and currency unions: issues for program design - Co-financing with RFAs: - In programs involving co-financing by RFAs, program design needs clarity on roles of various institutions and to consider cumulative extent of conditionality relative to implementation capacity. - The G-20 principles on Fund-RFA cooperation provide a foundation for operational guidance to ensure clear roles and alignment with implementation capacity. - RFAs are playing an expanded role in many regions and can complement the Fund by bringing regional policy understanding and fostering ownership of adjustment programs. - In recent Euro Area programs, financing came from the IMF and a new RFA (EFSF/ESM). Collaboration among IMF, EC, and ECB (“Troika”) extended beyond financing to program design; Fund reviews effectively depended on agreement among the three institutions. - The G-20 endorsed six non-binding principles for IMF-RFA collaboration in 2011 emphasizing early cooperation, recognition of comparative advantages, consistency of lending conditions, flexibility on conditionality and timing, respect for roles and independence, and respect for the Fund’s preferred creditor status. - More operational guidance could clarify roles such as the Fund’s responsibility for assessing macroeconomic frameworks and debt sustainability analysis, and ensure cumulative conditionality aligns with implementation capacity. - Program design in currency unions: - Membership in a currency union can provide benefits (closer integration, credible nominal anchor, regional backstop for sovereign financing) but union-wide policies (monetary, exchange rate, financial) under supranational control may be critical for addressing underlying imbalances in a member. - Program design needs to consider member commitments to other union-wide policies. - The Euro Area experience shows architecture of a currency union impacts crisis prevention and resolution; fiscal union and consolidated supervision and resolution matter for ex-post risk sharing and cross-border vulnerabilities. - A broad set of liquidity tools is important to address market dysfunction, market runs on sovereign issuers, delays or avoidance of necessary debt restructuring, and to allow union-level institutions to recapitalize banks. - Approaches for the Fund when designing programs for members of a currency union: - Conditions on union-wide policies are consistent with the Fund’s Articles of Agreement but are difficult to implement because union-level policy changes may not be acceptable to all members and can involve complex decision-making. - The Fund can take union-wide policies as given and focus on national-level policies (fiscal and structural), though this could increase required program adjustment effort and financing needs. - Alternatively, the Fund could seek commitments from union-wide institutions for necessary union-level policy changes and provide advice through surveillance where warranted. - If these approaches are unworkable, it may be necessary to postpone Fund support until staff can assure the Board that relevant problems are being adequately addressed. *Source: Excerpt from IMF Crisis Program Review (paragraphs 61–75).* ### Box 5. Aligning Union-wide Policies to ### Box 5. Aligning Union-wide Policies to The Needs of Fund-Supported Programs ### Euro Area: conditionality, approaches, and outcomes - Conditionality in Euro Area programs was limited to policies under the effective control of the member; performance criteria and structural benchmarks focused on fiscal, structural, and financial issues. - The Fund used two approaches to obtain changes in policies at the union level: - Formal commitments (for example, financing assurances from the euro group). - Regular surveillance engagement to seek adjustments by union-wide institutions (for example, looser monetary policy, relaxed collateral requirements for liquidity facilities, and measures to strengthen the union’s institutions and architecture). - Specific union-level reforms the Fund advocated in surveillance included: - Establishing a banking union. - Putting in place a common fiscal backstop. - Loosening monetary policy and relaxing collateral requirements for liquidity facilities. - Rationale: The Fund viewed these union-level policy changes as appropriate for the success of Fund-supported programs in the Euro Area and to address underlying vulnerabilities within the Euro Area as a whole. - Outcomes over time: - Euro Area policymakers made substantial changes to the policy mix and the union architecture, radically improving crisis management ability. - Important progress was made on: the stance of monetary policy (including quantitative easing), emergency liquidity provision, balance of payments support, the framework for fiscal governance, and banking union. - These changes were critical to ameliorating undue pressures on sovereign financing, enhancing fiscal discipline, and mitigating contingent liabilities of governments under stress. - In the case of Cyprus, the enhanced supranational firewall allowed for deeper restructuring without fear of contagion. - Conclusion: Europe is now in a far stronger position to prevent and address future imbalances. - Note on supervision responsibilities: At the time the programs were initiated, banking sector and supervision was primarily a national responsibility but this subsequently shifted to the ECB. ### Eastern Caribbean Currency Union (ECCU): program experience and assurances - In stand-by arrangements with Antigua and Barbuda (2010) and with St. Kitts and Nevis (2011), program conditionality included measures within the competence of the Eastern Caribbean Central Bank (ECCB): - Antigua and Barbuda: structural benchmarks. - St. Kitts and Nevis: a prior action (an agreement between the ECCB and St. Kitts and Nevis authorities on commercial banking issues). - ECCB support and safeguards: - The conditionality was supported by the ECCB. - In Antigua and Barbuda, the ECCB provided formal written assurances on the structural benchmarks that were circulated to the Executive Board. - In St. Kitts and Nevis, implementation of the prior action was reported to the Executive Board. - Assessment: In both country cases, the measures were judged not to have broader implications for the currency union as a whole. *Source: Box 5. Aligning Union-wide Policies to The Needs of Fund-Supported Programs (excerpt).* ### 0.9 ppt increase in GDP per capita after 10 years due to the change in labor ### _110915 - 0.9 ppt increase in GDP per capita after 10 years due to the change in labor ### Empirical impact of structural reform on output - "0.9 ppt increase in GDP per capita after 10 years due to the change in labor market policies implemented by OECD countries on average between 1996-2006." - "0.3 ppt increase in potential output in the long-run from a 1% tax shift from labor to VAT." ### Annex III — Classifying private balance sheet concerns (summary) - Purpose: Classify countries with Fund-supported programs by concern level (high/red, medium/orange, low/green) for non financial corporations (NFC) and households (HH) balance sheets to uncover relationships between debt concern and program design/outcomes. ### Data and classification approach - Data sources: - Aggregate NFC and HH debt stocks from BIS. - Individual countries’ central banks. - Classification outcome: - Countries with private balance sheets in 20 out of the 27 program countries were characterized by "high or medium" debt levels. - Overall rating rule: - The overall rating equals the average of three indicator ratings (Size, Composition, Change). - Tie-breaking: When the overall rating is tied between high/medium or medium/low, the higher rating is picked. - When two indicators are high, the overall rating is automatically high. ### Indicators — definitions and intuition - Three indicators employed to measure potential for debt overhang at p=0: - Size: - Measured as the percent deviation of outstanding debt to GDP from a benchmark predicted by a cross-country regression of debt to GDP on GDP per capita and institutional quality. - Intuition: Measures the extent to which a sector’s debt stock may have grown out of proportion with borrowing needs, debt sustainability and risk management. - Composition: - Measured as the percent share of FX debt in total debt. - Intuition: Measures likely debt overhang as a result of exchange rate depreciation. - Change: - Measured in two ways: - The percentage point increase in debt to GDP ratios during the 5-year period preceding the global financial crisis. - The average annual increase in debt to GDP ratio during the same period. - Intuition: Measures the size of a potential pre-crisis credit boom as a proxy for risky borrowing and lax credit standards. ### Indicator thresholds - Size threshold: - Classified as high when the indicator is greater than 50 percent. - Classified as medium when the indicator is greater than 25 percent. - Composition threshold: - For NFCs: high when FX share is greater than 60 percent; medium when greater than 30 percent. - For HHs: high when FX share is greater than 30 percent; medium when greater than 15 percent. - Change threshold: - High when the increase in debt to GDP is larger than 20 percentage points (10 percentage points). - Or amounts to an annual percent increase larger than 20 percent (10 percent). ### Key finding from Annex III - Private debt concern prevalence: - "Private debt was a concern in several program countries with private balance sheets in 20 out of the 27 program countries characterized by “high or medium” debt levels." *Source: _110915 - 0.9 ppt increase in GDP per capita after 10 years due to the change in labor (IMF PDF).* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2015/_110915.pdf_