The IMF's Enhanced Structural Adjustment Facility (ESAF): Is It Working?

Status Report on Follow-Up to the Reviews of the Enhanced Structural Adjustment Facility, August 30, 1999

Summing Up by the Chairman of the Executive Board on Distilling the Lessons from the ESAF Reviews, Executive Board Meeting 98/73, July 8, 1998

External Evaluation of the ESAF

ESAF Factsheet

Publications on ESAF

Distilling the Lessons from the
ESAF Reviews

July 1998
Executive Summary
I. Introduction
II. Lessons for Program Design
III. Improving Program Preparation and Implementation

A. Fostering Ownership

Fostering Ownership by the Authorities

Fostering Consensus for Reform

B. Selectivity

C. Strengthening Bank-Fund Collaboration

D. Assessing the Social Impact of Adjustment

E. Moving Ahead with Structural Reform
IV. The Architecture of the ESAF

A. Closer Monitoring

B. Post-ESAF Involvement by the Fund
1. Alternative Indicators of External Viability
2. The Scope of Assessments of the Social Impact of Adjustment
3. A Comparison of the Operations Under the Extended and ESAF Arrangements

Distilling the Lessons from the ESAF Reviews

Executive Summary

In discussing the internal review of the ESAF in July 1997 and the external evaluation in March 1998, Executive Directors requested that the staff draw together the conclusions of these evaluations and develop specific proposals for improving future ESAF operations. This paper meets that request.

The paper begins with a brief summary of lessons for program design; the staff and Executive Directors are encouraged to view this as a checklist (Section II) of areas where programs need to be strengthened.

Section III proposes a range of operational changes intended to help governments stay the course of their reform efforts by improving the process of program preparation and implementation:

  • Ownership of a program by the authorities should be fostered by widening the policy debate within government and considering alternative policy mixes that would be consistent with appropriate program objectives. The Fund can also assist governments in their task of building a national consensus for reform.

  • The Fund should be more selective in providing support under the ESAF. Greater use should be made of prior actions, particularly in areas of structural reform fundamental to the success of the program: in the absence of such actions, the Fund should be prepared to withhold financial support. Staff reports for requests for support under the ESAF should include a discussion of the commitment and capacity to implement the program. The staff and the Board might also increase their emphasis on the strength of the program and signs of official commitment in deciding on the level of access.

  • The internal and external evaluations indicated the need for improvements in Bank-Fund collaboration on ESAF countries. To reinvigorate this process and, it is hoped, to demonstrate the potential of closer collaboration to deliver better integrated programs drawing on the combined expertise of the Bank and the Fund, it is proposed to experiment with new modes of collaboration in 5 to 6 low-income countries that would serve as pilot cases. Experience with the pilot cases would be reviewed in 12 to 18 months to draw lessons for improved modes of collaboration for all countries. Bank staff agree with this proposal.

  • In each pilot case, special attention would be paid to three areas that were highlighted in the evaluations: accelerating public enterprise and financial sector reforms; identifying and addressing potential adverse social consequences of the program; and assessing medium-term investment needs and the related capacity to attract and absorb external financing, including from the private sector. Of course, efforts to improve assistance in these areas will continue in other countries as well.
Section IV suggests changes to the existing ESAF framework to facilitate closer monitoring and considers appropriate vehicles for post-ESAF relations with members.
  • The staff proposes modifying the existing ESAF Trust Instrument to permit semi-annual or quarterly reviews and disbursements along the lines of extended arrangements.

  • The staff does not propose the introduction of precautionary ESAF arrangements, primarily because the concessionality of ESAF resources would create incentives (and perhaps domestic pressures) for countries to draw on the facility even in the absence of balance of payments need. An ESAF-eligible country seeking endorsement of its program without a current or prospective balance of payments need could request a precautionary extended arrangement; closer alignment of monitoring for ESAF and extended arrangements would facilitate prompt consideration of an ESAF arrangement if a need were to arise.

Table of Contents

I.  Introduction1

1. The Executive Board’s discussions of the internal and external evaluations of the ESAF reaffirmed the fundamental view that the ESAF is a valuable instrument to assist low-income countries.2 Executive Directors saw these complementary evaluations as providing important lessons which should be used to strengthen the Fund’s ability to foster sustained growth and external viability in poorer member countries. They requested that staff draw together the conclusions of the two reviews, and develop specific proposals for improving future ESAF operations. This paper meets that request.

2. The paper is arranged as follows. Section II summarizes key lessons for program design which the staff are acting upon in individual program cases. Section III proposes steps to improve the process of program preparation and implementation, in the areas of ownership, selectivity in program approval, protecting the vulnerable from the costs of adjustment, accelerating structural reforms, and Bank-Fund collaboration. Section IV suggests changes to the existing ESAF framework to facilitate closer monitoring and considers appropriate vehicles for post-ESAF relations with members.

Table of Contents

II.  Lessons for Program Design

3. In assessing experience with ESAF arrangements to date, the internal review identified policies key to closing the gap in living standards between ESAF and other developing countries while moving toward external viability. For the programs reviewed, it identified policies that were not as strong as had been envisaged at the outset of programs and areas where the programs themselves had been less ambitious than needed to put higher growth on a firm footing. The external review, which focused on a few specific issues, also reached several conclusions on how program design could be improved. The following list summarizes the main conclusions from the reviews on where stronger efforts than realized in the past are needed.3 The staff and Executive Directors are encouraged to view it as a checklist of the areas that warrant especially close scrutiny in individual programs in the future. Subsequent reviews of the ESAF will, inter alia, assess the extent to which these lessons have been acted upon.
  • First, to generate investable resources, ESAF-supported programs should generally target substantial increases in national saving over the three-year period of an arrangement. It is now well established that, in the short run, the direct effect of policy changes on private savings is small.4 Increases in public saving, therefore, provide the best means of immediately increasing national savings. The required fiscal discipline will also enhance growth prospects by providing a solid foundation for a lasting reduction in inflation rates to the single digit range and a strengthening in countries’ external positions.

  • Second, close attention should be paid to the quality of fiscal adjustment designed to achieve higher public savings.5 The balance of adjustment between increases in revenue and cuts in recurrent expenditures should continue to take account of country specific factors, such as the adequacy and efficiency of government spending and the potential for raising revenues efficiently. However, a revenue-GDP ratio in excess of 20 percent is high in the context of the level of development of ESAF countries as a group; this observation could be used as a frame of reference when considering whether the balance of fiscal adjustment should be on cuts in recurrent expenditure or on increases in revenue.

  • Third, programs should aim to shift the composition of revenues over time toward sources that are more robust or less distortionary. As part of trade liberalization, reliance on trade taxes should be reduced and programs should generally seek to strengthen the revenue base through: broad-based consumption taxes, such as a VAT, with no more than two rates and minimal exemptions; simple taxes on income and profits with low marginal rates and a base encompassing (generally through a presumptive tax) small businesses and the informal sector; and strong tax and customs administration.

  • Fourth, the quality and composition of public spending should be improved. Core expenditures—productive capital spending and high-priority spending on health and education—should be protected, and in most cases increased. Savings need to be generated over the medium term, most importantly through civil service and public enterprise reforms. Social safety nets need to be integrated more ambitiously into the design of ESAF-supported programs.6 To support improvements in the quality and composition of expenditure, the quality of expenditure data and the measurement of "outputs" from social spending must be improved.

  • Fifth, the external review advocated programming increases in public investment financed by larger foreign assistance in countries that had achieved stable macroeconomic conditions and structural conditions to ensure the efficient use of such assistance. At this stage, there are few countries that have attained such conditions. The issue, however, is expected to become more important in the future and will receive specific attention in the joint work of the Bank and Fund staffs and in other fora.

  • Sixth, policies that achieve a reduction in inflation to sustained low rates offer the potential for considerable gains in output growth.7 While fiscal restraint must lie at the heart of a program to bring about a durable reduction in inflation, monetary policy is also key to the reduction of inflation. Consideration should therefore be given to the use of more effective nominal anchors-- such as an exchange rate peg, money supply ceilings, or announced inflation targets--as part of a disinflation strategy. The choice of anchor would need to take into account a country's specific circumstances.

  • Seventh, priorities for structural reform should continue to be set on a case-by-case basis to address structural weaknesses across a broad front. Emphasis should be given to structural measures to stimulate private investment and entrepreneurship, so as to foster a quicker and stronger supply response to macroeconomic adjustment. Programs should focus on privatization, the creation of a sound banking system, and measures to improve the regulatory and legal framework for private sector activity—areas where the reviews found progress in past arrangements was slowest.8 Moreover, the experience in the Asian crises underscores the importance of acting preemptively, before countries are highly integrated in global capital markets, to put banking systems, in particular, on a sound footing. The fiscal implications of public enterprise reforms and bank restructuring should, as far as possible, be incorporated into program design at an early stage; in both these areas, the quality of data needs to be improved.

  • Eighth, further trade liberalization should be programmed to improve allocative efficiency. Quantitative restrictions should be removed, import tariff rates should be reduced to moderate or low average levels with a narrow dispersion, and export duties should be avoided.
  • Finally, the experience of ESAF countries has shown that sustained, outward-oriented growth and progress toward external viability are complementary objectives. The staff’s analysis of external viability (e.g., in staff reports) should continue to use export-, GDP-, and revenue-based indicators, all of which convey helpful information. In addition, staff should consider presenting the indicators proposed by the external evaluators (for example the Debt Deepening Index), where they are found to provide a differing perspective on a country’s external debt situation. The merits of alternative measures of external viability are discussed in Box 1. Assessments of external viability should be made using the broadest possible coverage of external obligations. In this connection, and especially in the light of the Asian financial crises, ESAF-supported programs should seek to improve the monitoring of the bank and nonbank private sector’s external obligations.

Table of Contents

III.  Improving Program Preparation and Implementation

4. Experience has shown that the benefits of reform accumulate over time, with the most impressive results arising only after a sustained period of macroeconomic adjustment and structural reform.9 An important aspect of realizing the policy changes summarized in the previous section, therefore, is helping governments to stay the course of their reform efforts. Here, the evaluations offered no panaceas, but they did suggest numerous changes in the manner in which the Fund operates to assist countries in their reform efforts. These include a range of issues—such as the need to address more directly the social costs of adjustment in program design and to develop a more coherent approach to key structural reforms—which will require more effective collaboration between the Fund and the World Bank. The evaluations also emphasized the key role of ownership and commitment in the success of a reform program, noting the implication that the Fund and others should target assistance more selectively toward strong programs with clear national commitment. Proposals on these issues are developed in the remainder of this section.

Box 1: Alternative Indicators of External Viability
The external evaluation proposed the use of two alternative indicators of external viability.

1. The Real External Debt Burden (REDB):

where D is the outstanding foreign debt of the country, Y is GDP, r is the real interest rate paid on the debt, and g is the country’s real rate of growth; and

2. The Debt Deepening Index (DDI):

(r-g)D/Y - T/Y
where T is the current account deficit excluding interest on external debt.

Both of these indicators are intended to provide a summary measure of the dynamics of debt. For example, the DDI (which is an extension of the REDB) shows, for given values of the real interest rate and the growth rate of GDP, the improvement in the current account as a share of GDP (excluding debt service payments) that is required to prevent an increase in the ratio of debt to GDP. As such, these indicators can provide insights into a country’s external viability. In particular, the DDI may be a useful measure to employ in assessing external viability in a very open economy (i.e., where exports and imports are large in relation to GDP), illustrating possible debt dynamics under different long-run assumptions about growth and real interest rates.

However, no single debt indicator can, by itself, provide an adequate measure of external viability. In this vein, the measures suggested by the external evaluators have the disadvantage of relating the debt burden only to GDP; particularly in ESAF countries, the capacity to service debt is likely to be also closely related to export earnings. In addition, the selection of single "steady state" values for both the interest rate and the growth rate in these indicators does not accord well with the circumstances of ESAF countries which are more typically seeking to accelerate growth to a higher path over the medium term, but also are more vulnerable than more-developed countries. Medium-term scenarios, in which the time paths of key variables can incorporate policy effects as well as environmental assumptions, provide a more flexible alternative to this steady state analysis for the assessment of viability using various indicators of the external debt burden over the medium term.


A.  Fostering Ownership

5. There is widespread agreement that national ownership of a program greatly improves the prospects for sustained policy implementation. The external evaluation devoted considerable attention to this issue. Also, bilateral donors are attaching greater significance to program ownership in their relations with recipient countries. Set out below are a number of operational changes aimed at fostering greater ownership, building upon some of the practical suggestions provided by the external evaluation. Before discussing these proposals, however, it is worthwhile to step back and examine what is meant by ownership.10

6. To clarify the Fund’s role, it is useful to distinguish two related levels of ownership. The first and narrower level is ownership of the program by the governing authorities: this is reflected in the authorities’ involvement in all aspects of program design and their determination to implement the policy and institutional changes embodied in the program. Their efforts to communicate to the public their strategy and intentions are equally important indications of their ownership. The second level is ownership in the sense of there being a national consensus in support of the program. Such a consensus is desirable but perhaps not always feasible or essential, especially before the fruits of the reform effort become evident or when some factions of society see the program as impinging upon their short-term interests. The proposals outlined below are framed in recognition that the first priority for the Fund is to strengthen the authorities’ ownership of the program. Lack of ownership at this level brings into question the authorities’ own commitment to the program and hampers the prospects for building a wider consensus that may be required for sustained implementation of the reforms.

Fostering Ownership by the Authorities

7. During program discussions, a mission’s principal interlocutors will continue to be the heads of the authorities’ economic team, typically, for the Fund, the Minister of Finance and the Governor of the Central Bank. However, missions should ensure that—as is often already the case—other relevant ministries are, as far as possible, brought into discussions of structural or sectoral policies. The creation of economic management teams drawn from a wide range of ministries and with senior political leadership has often been useful in fostering wider commitment to the program within government. However, the formation of such a team must remain a matter for the authorities to determine. Missions are also encouraged to experiment further with discussions of key documents as a way to widen the debate within government, fulfilling the intended role of the Policy Framework Paper (PFP).

8. The external evaluation noted a perception among national authorities of inflexibility in the Fund’s negotiating positions and suggested that greater flexibility be afforded to missions to agree on programs that could command broader national support. The scope for such flexibility would need to be reasonably clearly defined ex-ante in briefing papers, so that program objectives would not be diluted, and the principle of uniformity of treatment maintained.11 Attempts to impart greater flexibility need also to guard against the risk that understandings reached between missions and the authorities are subject to significant revisions at headquarters, a process that would be deleterious to national ownership. This risk can be minimized through good communication between headquarters and missions in the field.

9. In recognition of these practical constraints, it is proposed that more attention be paid to considering alternative policy mixes that would be consistent with appropriate program objectives. These alternatives would ideally be incorporated into the mission’s initial thinking on program design and thus elaborated in a negotiating brief. For example, the economy might be able to sustain a larger fiscal deficit at the outset of a reform program if this were accompanied by an acceleration of far-reaching structural reforms and, depending on the circumstances, firm assurances of additional external assistance. Also, there might be different routes to specific structural goals; for example, competition may be fostered either by the initial breakup of a domestic monopoly (say in the banking system) or by opening the market to foreign entrants.

10. Improvements in other areas of ESAF operations would be expected to assist in fostering ownership. For example, the external evaluators noted the importance of improved Bank-Fund collaboration for country ownership, in that "policy choice is not helped when the Fund and the Bank (and donors) pull the country in different directions."

Fostering Consensus for Reform

11. The task of building a national consensus for reform is first and foremost the responsibility of the national authorities. The authorities’ own efforts to explain the program to the public provide the most direct means of developing such a consensus and can, at the same time, illustrate the extent of the authorities’ own commitment to the program. Fund staff can assist the authorities in this endeavor, particularly when the authorities’ own capabilities to mount the needed informational campaigns to explain programs to the population are limited. At the same time, efforts to foster a national consensus cannot involve the Fund in prescribing the nature of the participatory process in member countries.

12. It is already common practice for Fund missions to meet with representatives of civil society including parliamentarians, business leaders, and trade unionists. These efforts to help the authorities explain or discuss policies with social partners should continue and, with the aid of resident representatives, should embrace more frequent contacts with the wider society and participation in national conferences. The publication of the PFP, or a similar document, should be encouraged (or perhaps even required) to engender wider understanding of the government’s reform strategy. Resident representatives, themselves, should do more to explain the role of the Fund in supporting the authorities’ program and help the authorities foster public understanding of the program; these efforts would complement the activities of the External Relations Department in informing the public of the Fund’s role.

13. More generally, it should also be recognized that it may take time to foster ownership for a strong program. Thus, an acceptance of some delay in initiating reform efforts may be desirable in support of the more specific steps to foster ownership described in this section.

B.  Selectivity

14. Both the internal and external evaluations suggested a need for greater selectivity in providing assistance under the ESAF, particularly when the authorities’ commitment to reform or ability to implement the program is in question. This assessment arose partly because a high proportion of program interruptions appeared to reflect a lack of commitment to implement the program. Also, the external evaluation, in particular, concluded that some programs failed to reach growth and other objectives because the authorities’ wishes to delay critical reforms that should have been undertaken early in the process were accommodated. Decisions on whether to provide support under the ESAF should therefore be more selective.

15. Prior actions can be set to provide a strong and tangible indication of the authorities’ commitment to implement a program. In almost all cases, the observance of certain prior actions or quantitative financial targets has been required to establish a track record before Executive Board consideration of a request for support under the ESAF. This practice should continue and be strengthened. In particular, greater use should be made of prior actions where there are structural reforms that are fundamental to the success of the program, but on which progress has not been forthcoming in the past. Where understandings cannot be obtained on suitable prior actions, or these actions are not implemented, the Fund should be prepared to withhold financial support. In line with the earlier discussion of ownership, missions should redouble efforts to help the authorities develop support both within and outside government for needed reforms and to explore alternative policy mixes, where possible, to attain the same objectives.

16. In addition to the use of prior actions to gauge commitment, it is proposed that staff reports for requests for support under the ESAF include sections that describe and assess the environment for program implementation. These discussions would cover the technical capacity to implement the program, the country’s technical assistance needs, and the way in which they will be met; the authorities’ commitment to implement the program; potential roadblocks to the reform efforts; and the authorities’ efforts to foster a consensus for or anticipate opposition to reforms.12 They would be based on discussions with the government and information from other sources and, in the staff appraisal, reflect the staff’s assessment of the environment.

17. Differentiating access according to the strength of programs—already a principle guiding decisions on access—is another aspect of selectivity. The staff and Board might increase their emphasis on the strength of the program and signs of official commitment to the program in deciding on access. This should result in a greater dispersion in access under the ESAF than currently observed. Selectivity of this type would also provide a signal to donors that could assist in informing an improved allocation of their support for reform efforts in ESAF countries.

C.  Strengthening Bank-Fund Collaboration

18. Both the internal and external evaluations indicated the need for improvements in Bank-Fund collaboration to strengthen our joint support for reforms in ESAF countries. The managements of both organizations are committed to improving collaboration on ESAF countries and more generally; efforts are therefore being intensified to strengthen collaboration on all fronts.

19. In the context of these broad-based efforts but, more specifically, to address the concerns raised in the evaluations, it is proposed that the Bank and the Fund staffs experiment with new ways of collaborating on 5 or 6 low-income countries that would serve as pilot cases. Bank staff support this proposal. The motivation behind the pilot project is to foster experimentation and create an environment in which the onus is on the staff teams working on the country to collaborate successfully. The exercise is intended to demonstrate the potential of closer collaboration to deliver better integrated programs, drawing to the fullest extent possible on the combined expertise of the Bank and the Fund. In so doing, it might bring into sharper relief procedural or institutional impediments to collaboration and ways to address them. The following broad principles for the operation of pilots have been agreed with Bank staff.

20. The delineation of responsibilities between the two teams would be guided by the 1989 "Concordat," and Fund staff would retain ultimate responsibility for the ESAF-supported program brought to the Fund’s Executive Board. The work of the teams would also respect the internal review and decision-making processes of each institution. Within this framework, Bank and Fund staff teams on the pilot cases would be asked to establish their own modus operandi with flexibility and open communication. The teams would report jointly to the top managements of both the Bank and the Fund, initially on their organizational approach to each country and subsequently on progress and problems in the reform process. The teams would also report—ideally but not necessarily—in a single joint document to both Executive Boards before approval of an ESAF arrangement or IDA operation and periodically thereafter on program design and developments. The teams would be encouraged to resolve differences in their viewpoints on the design of the program, making use of the procedures set out in the Concordat. However, any such unresolved differences could be explained in the papers prepared for both Boards. Each institution’s operation-specific documents would key off this basic, joint document.

21. The countries selected as pilot cases could be at different stages of the reform process, but would all have to be receptive to an intensified dialogue on reform in the context of this experiment in Bank-Fund collaboration. The teams would be encouraged to draw lessons from the country’s reform experience and the success of collaboration in assisting these efforts. With the country authorities, the teams would jointly build a medium-term plan to establish or preserve macroeconomic stability, move ahead decisively with reform, and build institutions with the help of well-organized technical assistance. While working together in this endeavor, the usual delineation of responsibilities would guide efforts in these areas. The medium-term framework would be elaborated in a document that meets the authorities’ requirements for fostering ownership and coordinates the involvement of the Fund, the Bank, and bilateral creditors. Together with the authorities, the teams would be free to determine the format of this document which could, but need not, be a conventional PFP. The precise focus of these collaborative efforts would depend on the specific circumstances of the country. However, it is expected that in each pilot case, particular attention would be paid to three areas that were highlighted in the evaluations:

  • accelerating public enterprise and financial sector reforms;

  • identifying and addressing potential adverse social consequences of the program; and

  • assessing medium-term investment needs and related capacity to attract and absorb external financing, including from the private sector.
22. Subsequent sections of this paper provide specific proposals related to the first two of these three areas in which teams would have to draw especially heavily on the expertise of the Bank. As regards the third area, in pilot countries that have established a track record of macroeconomic stability, have sufficiently reduced domestic deficit financing, and are implementing policies to bolster domestic saving, the staff teams would be encouraged to investigate the potential for the absorption of greater inflows of aid to finance higher levels of investment without jeopardizing fiscal or external sustainability.13 If this analysis demonstrated significant, unused absorptive capacity that was unlikely to be filled by increased inflows of private capital, efforts could be made to increase access to financing—from the ESAF, World Bank, and most importantly, bilateral sources—in support of a strong medium-term program that targeted early progress in critical areas of reform. An important element of this analysis would be an assessment of the prospects for private capital flows and policy measures that could facilitate such inflows. The objective would be to help countries that are making the boldest efforts to create the conditions for growth to capitalize on these efforts and move to a significantly higher growth rate.

23. The focus on these three areas in the pilot cases is intended to address issues raised in the ESAF evaluations. However, it is expected that the objectives of the pilot project could be widened to take account of policy areas in which the Bank staff sees a similar need to strengthen Bank-Fund collaboration.

24. The experience with the pilot cases would be assessed after 12 to 18 months. The staff of each institution would initially report to their respective managements on the success of all aspects of the experiment. In addition to assessing the experience with collaboration per se, this would gauge the success of program design and implementation (including the identification and organization of technical assistance), particularly in the three areas highlighted. Lessons could be drawn on possible procedural improvements. Recommendations for changes in the guidelines for future work on all countries could then be considered jointly by the Bank and the Fund. Although this experiment would be distinct from other efforts to enhance collaboration, and would not address all concerns in this area, it would complement (both informing and being informed by) these wider efforts.

D.  Assessing the Social Impact of Adjustment

25. In assessing the social impact of adjustment, the external evaluators focused on two routes through which programs affect living standards: changes in private incomes and changes in public social expenditures. On private incomes, they cited evidence, which has been borne out in other studies, that reforms generally have positive effects on income growth and poverty reduction. Moreover, the groups that are likely to suffer economic losses as a direct result of reforms tend to be concentrated among the initially better-off rather than the poor. However, this does not mean that there is no overlap between the poor and those that lose from reforms. The external evaluators therefore advocated detailed country-level work using socioeconomic survey data to elaborate ex-ante assessments of the impact of reforms on the poor; the actual social impact would then be monitored throughout program implementation.

26. On public expenditures, the external evaluation identified four factors that could affect the level of social spending: the level of aggregate GDP; the share of public spending in GDP; the share of social spending in total public expenditure; and relative price changes affecting the volume of public provision from a given amount of public spending. The external evaluators argued that the last of these—relative price effects—were not adequately assessed in the programs they reviewed.

27. To address these two specific concerns of the external evaluators, the Fund will have to rely on the Bank’s expertise to make the needed changes. It is proposed that these social issues be taken up within the broader effort to strengthen the interaction between the Bank and the Fund through the pilot cases. Accordingly, the teams working on the pilot cases would aim to prepare explicit ex-ante assessments of the effects of the program on vulnerable groups and of relative price changes on the volume of social spending. The policy implications of these assessments and requisite social safety nets should be integrated into program design. Understandings would need to be reached with the authorities on how to monitor the success in addressing the problems identified in these assessments. Such monitoring, however, would not become part of conditionality for individual disbursements.

28. Macroeconomic data will continue to be important in designing policies to offset the adverse effects of programs on vulnerable groups. However, significantly advancing assessments of the effects of programs on the poor, particularly along the lines suggested by the external review, will also require analyzing household survey data. Bank staff have cautioned that the availability and comprehensiveness of such data will often not be adequate to identify the relevant vulnerable groups and allow for an ex-ante assessment of the effects of reform. Also, household survey data, which have often been collected to answer longer-term questions about poverty alleviation, may not initially be well-suited to ex-post monitoring of short-term policy impacts. Nevertheless, it should be possible to begin work immediately on the pilot countries, chosen, in part, because of the availability of survey data amenable to the analysis and monitoring required.14 Moreover, it is expected that work on social impact assessments will, in itself, prompt improvements in the quality and availability of the necessary data.

29. Assessing the extent to which social provision to vulnerable and other groups would be affected by changes in relative prices, including those that have their origin in the reform measures, will require a detailed analysis of key components of social spending using relevant deflators. The availability of the appropriate price data is open to question; again, this points to the value of gaining experience in the pilot cases. Where such data are not available, the teams would consider the use of alternative price deflators as proxies for the missing data.

Box 2. The Scope of Assessments of the Social Impact of Adjustment
The Fund’s policy advice can have important social implications; indeed, it was in recognition of this that the external evaluators were asked to focus, inter alia, on the social impact of ESAF-supported programs. The social impacts of adjustment arise in four areas:

1. The fundamental objective of an adjustment program is to raise per capita income, and it is widely accepted that adjustment policies do generally have positive effects on growth and hence per capita incomes.

2. Adjustment programs also tend to reduce poverty, as a result of both rising per capita incomes and the fact that the adverse effects of adjustment generally affect more prosperous groups. However, lower income groups could be adversely affected by particular policy measures. The proposals for program design to take account of the results of social assessments are framed in recognition that the first priority of this work should be to mitigate these potential impacts of adjustment on the poor. This may include the targeting of social spending, including social safety nets, towards vulnerable groups.1

3. Adjustment is also likely to entail changes in the distribution of income as some groups gain or lose more than others as a result of policy changes. In general, the Fund focuses on the consequences of adjustment for the poor, rather than for income distribution per se. However, the adverse effects of adjustment on groups other than the poor may need to be addressed in program design, in part because the task of building political consensus for reforms may entail the provision of compensation for more prosperous and politically vocal groups that lose from reform, such as civil servants facing retrenchment.

4. In addition to these effects on private incomes, an adjustment program may entail changes in priority social spending. Fund advice on program design seeks to increase, or at least protect, such spending. The volume of social provision can, as the external evaluation noted, be strongly influenced by relative price changes. Thus, program design should take into account the implications of price changes, such as civil service wage policies, price liberalization, and exchange rate policies in establishing the desired level of nominal social spending.

The staff has confronted many of these issues in past programs, albeit often without the benefit of social assessments using detailed household data. For example, in general, the rural poor benefited from the pass through of world market prices for cash crops after the CFA franc devaluation. However, programs with countries in the region incorporated policies to alleviate the impact of adjustment on the other vulnerable groups, including measures such as temporary subsidies to safeguard the access of the poor to essential foodstuffs and medicines.

1See Social Safety Nets: Issues and Experience, Ke-Young Chu and Sanjeev Gupta (IMF, 1998).

30. While data may pose a constraint, the feasibility of providing social assessments would be aided by ensuring that the exercise has a precise focus. In particular, it should concentrate on the direct effects of specific reform measures on the poorer segments of the population. Thus, to the extent that analysis of the social impact requires household survey data, the focus would be on a small subset of household data covering particular social groups. Also, the assessments would focus on the direct effects of specific reform measures, rather than on issues of longer-term poverty alleviation or income distribution.

31. The pilot cases would provide the main vehicle for taking account of the specific concerns of the external evaluators about the social impact of adjustment. However, in line with the recommendations of the ESAF evaluations, missions to all ESAF countries should seek to strengthen their analysis of the social content of programs, including the quality of expenditures and the development of output-based measures of social spending, in collaboration with the Bank and other agencies.

E.  Moving Ahead with Structural Reform

32. The internal ESAF review concluded that, although structural reforms continued to move ahead on a broad front in most countries, progress had been uneven. In particular, reforms affecting public enterprises and bank soundness lagged far behind other areas and fell short of program ambitions. The experience with the recent crises in Asia also highlighted the importance of early attention to weaknesses in these areas.

33. This disappointing outcome reflected problems of both design and implementation of public enterprise and banking system reforms. Slow progress in public enterprise reform stemmed, in part, from a failure to divest large enterprises in strategic sectors, while attempts to restructure these enterprises did not meet expectations. In the area of bank soundness, despite the adoption of multi-year bank restructuring programs, reforms were stymied by a lack of both local banking skills and political commitment, as governments failed to expand competition in the banking sector and pressured banks to lend to uncreditworthy enterprises.

34. Accelerating reforms in these two crucial and interlinked areas of structural reform will require sustained efforts on many fronts. Common themes of experience with reforms in these areas, as brought out in the evaluations, are the need for the Bank and Fund staff to work together more effectively in designing the reform strategy and developing institutional capacity to implement it. Better collaboration should aim, for example: to ensure that programs target early reform of those public enterprises that pose a significant threat to the public finances and hence macroeconomic stability; to identify, up front, the likely costs of bank restructuring and the links between the costs and the pace of restructuring, so that these can be incorporated into a program’s macroeconomic framework from the outset; and to help countries plan and execute strategies to build political support for reforms. It will also be important to make the advice and technical support of the Bank, the Fund, and others with the requisite expertise available in a coordinated manner and on a timetable that meets the countries’ needs. These issues will be substantively addressed in the experimental pilot project outlined earlier, although greater attention will be paid to these issues in all ESAF programs. All these efforts will be assisted by the broader initiative underway to strengthen collaboration between the Bank and the Fund on financial sector issues.

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IV.  The Architecture of the ESAF

A. Closer Monitoring

35. The internal review found that ESAF-supported programs were often interrupted, in most cases owing to weaknesses in policy implementation. Evidence from other countries’ experiences suggests that more intensive monitoring, supported by more frequent disbursements, could help sustain program implementation by focusing attention on the evolution of key economic variables and policies and by prompting an early policy response to emerging problems. This would be especially helpful in cases where program performance was highly vulnerable to potential shocks that could not easily be addressed by contingency planning and automatic adjustors. Against this, however, the external evaluators argued that increasing the frequency of monitoring would detract from the authorities’ ownership of programs.

36. In their discussion of the internal review, Executive Directors broadly supported more intensive program monitoring in selected cases in which it was considered that it would aid policy implementation. This section suggests modifications to the existing ESAF framework to allow for closer monitoring in such cases. The changes would entail amendments to the ESAF Trust Instrument, as well as modifications of the borrowing agreements with bilateral creditors to the ESAF Loan Account.

37. The staff proposes modifying the existing ESAF Trust Instrument to permit monitoring and disbursements along the lines of the provisions of extended arrangements. This would entail semi-annual reviews and disbursements (including at the end of each program year) for all ESAF countries and the possibility of quarterly reviews and phasing of disbursements for selected countries. (See Box 3 for a description of the differences between extended arrangements and current provisions for ESAF arrangements.) Semi-annual (or quarterly) reviews and disbursements would provide the benefit of tighter monitoring over the entire program year, especially the latter half.15 Another consideration favoring this approach is the likely increase in the number of ESAF/EFF blend cases, as more countries begin to move from financial support under ESAF arrangements. Bringing ESAF monitoring arrangements in line with those for EFFs would simplify monitoring in blend cases. This move would also partially respond to Directors’ calls to simplify Fund facilities.

Box 3: A Comparison of the Operations Under the Extended and ESAF Arrangements1
There are three main areas of difference between the operations of the ESAF and extended arrangements.

1. A single three-year arrangement vs. a three-year arrangement and three separate annual arrangements

Extended arrangements consist of a single arrangement of up to three years during which purchases can be made. No expiration dates exist for making individual purchases during the entire period of the arrangement. Thus, purchases not made accumulate and can be made during the remaining period of the arrangement, subject to compliance with the latest relevant performance criteria. If the supported program goes off-track, missed purchases can be rephased, conditional on corrective action, over the remainder of the arrangement or through an extension of the arrangement period for up to an additional year.

Under the ESAF, there is a three-year arrangement which specifies the commitment period and overall commitment amounts, and three separate annual arrangements. Disbursements under each annual arrangement must be made before the expiration of that arrangement. In the event of slippages in the program, an annual arrangement may be extended for up to six months to allow for completion of the mid-year review and associated disbursement. The three-year commitment can also be extended for the same reason. A policy framework paper (PFP) for a three-year adjustment program is drawn up collaboratively by the country’s authorities and staff of the Fund and World Bank. The PFP is updated annually and describes the authorities’ economic objectives, macroeconomic and structural policies during the three-year period, and associated external financing needs and major sources of financing.

2. Timing of purchases/disbursements

Under an extended arrangement, provision can be made for either quarterly or semi-annual test dates and purchases; in practice, phasing has typically been set on a quarterly basis, with purchases linked to completion of a review and/or compliance with performance criteria. There is a single purchase at the time at which one annual program ends and the next annual program begins, which is conditional on the completion of a review (including the endorsement of the next year’s annual program) and observance of performance criteria.

Under the ESAF, disbursements are made semi-annually—the first upon approval of the annual arrangement, and the second upon compliance with the performance criteria and completion of the mid-year review. There is no test date or disbursement at the end of the annual arrangement. The approval of, and initial disbursement under, the subsequent annual ESAF arrangement, is subject to an appraisal of progress in implementing policies and meeting the objectives of the program supported by the preceding annual arrangement, as well as agreement on policies for the subsequent arrangement period.

3. Reviews

Under an extended arrangement, reviews can be conducted on either a semi-annual or quarterly basis, depending upon the desired intensity of the monitoring. In addition to establishing that policies are on track to meet program objectives, reviews may also set, on a rolling basis, performance criteria and indicative targets. Normally, performance criteria are specified up to the end of each annual program period or over a period of at least six months.

Under the ESAF, each annual arrangement specifies quarterly benchmarks and a single set of performance criteria for which compliance is to be verified at the time of the mid-term review. At the mid-year review, benchmarks for the remainder of the program can be revised.

1The Enhanced Structural Adjustment Facility (ESAF) was established by the Executive Board on December 18, 1987. In designing the framework, an aim was to retain much of the basic operational structure of the existing Structural Adjustment Facility (SAF) which for a number of years continued to operate concurrently with the ESAF. Like the existing ESAF, the SAF covered a period of three years under three annual arrangements. However, under the SAF, there was only one annual disbursement, upon approval of each annual arrangement, and no mid-year review.

38. The shift to semi-annual disbursements (consisting of one upon approval and one every six months thereafter) would argue in favor of a single three-year arrangement, as under extended arrangements, rather than the system of three separate annual arrangements under the existing ESAF. If this change were not made, a test date at the end of the annual program would almost inevitably require an extension of the annual arrangement to allow the associated disbursement to go ahead, because of the lags in reporting and verifying compliance. As a result, program and arrangement periods would become increasingly out of line. Also, disbursements both at the end of an annual arrangement and upon approval of the next annual arrangement would create an undesirable bunching of disbursements, as compared to extended arrangements, under which a single purchase is scheduled at the time each annual program ends and the next annual program begins. Moving to a single three-year arrangement would obviate these timing problems. Also, in the event of a need to delay a disbursement (owing, for example, to time needed to complete a review or to grant a waiver for a missed performance criterion), the undisbursed amounts could be rephased, conditional on corrective action, avoiding in most cases the need to extend the arrangement period.

39. Under the staff’s proposals, ESAF arrangements would continue to be approved for a period not exceeding three years; where appropriate, the period of an existing arrangement could be lengthened to up to four years. For each of the three annual segments, the country would present to the Fund a detailed statement of the policies to be followed and, as relevant, the progress made during the previous annual segment. Each three-year arrangement would prescribe the total amount, and the annual installments within the total, available in accordance with the terms of the arrangement. These proposals parallel the provisions of the EFF. Performance criteria, reviews, and disbursements would be phased, in most cases, at semi-annual intervals with quarterly benchmarks on selected variables, but they could be phased at quarterly intervals where this was considered helpful for program implementation. Normally, performance criteria would be set for at least the first six months at the outset of the annual program. Indicative targets would cover that part of the annual program for which performance criteria were yet to be established and would be converted to performance criteria at a subsequent review.

40. The choice of which ESAF-supported programs would benefit from monitoring through quarterly performance criteria and disbursements would be made case-by-case, guided by the following factors:

  • Vulnerability of the macroeconomic program: Programs which are considered particularly vulnerable to shocks and policy slippages, taking into account the targeted adjustment and initial conditions (e.g., the existence of high and unstable inflation).

  • Track record under past Fund arrangements or staff-monitored programs: The frequency of slippages and interruptions, and an examination of the contributory factors, would influence the assessment of the track record.
41. On the basis of these considerations, it is expected that quarterly performance criteria would be used in a minority of cases. There would be scope to move from quarterly to semi-annual performance criteria (and vice versa) during the course of the three-year arrangement.

42. In some cases, closer monitoring could include quarterly reviews in conjunction with quarterly performance criteria. Quarterly reviews would be desirable when there is a high degree of uncertainty surrounding the interpretation of economic developments and the administrative capacity of the authorities; where the quality and timeliness of financial data for verifying compliance with performance criteria was in question (for example, in some post-conflict countries); and, more generally, where close and continuous discussion of economic policies and developments with the authorities is needed. Program design would need to include appropriate measures and technical assistance to strengthen data quality within the program period; closer monitoring would also highlight the importance of strengthening data and reporting capabilities.

B. Post-ESAF Involvement by the Fund

43. In considering the possible nature of continuing Fund involvement in countries that have made extensive use of the ESAF and have little or no apparent further need for Fund resources, a number of Directors have expressed interest in the use of precautionary arrangements. In the staff’s assessment and on the basis of experience in other countries, the conclusion of an Article IV consultation would likely not be adequate, by itself, to the meet the perceived need for continuing Fund involvement in some post-ESAF cases. Instead, a precautionary arrangement could provide means of retaining a formal monitoring apparatus, signaling the Fund’s approval of a country’s adjustment and reform program, and thereby catalyzing financial support from other sources. A precautionary arrangement could also provide a form of added assurance, particularly in the early years of "graduation" when the external positions of many post-ESAF countries are likely to remain vulnerable despite successful adjustment and reform efforts.16

44. Stand-by and extended arrangements are described as precautionary when the country indicates its intention not to make purchases. However, the characterization of an arrangement as precautionary is not legally binding and does not bar the country from making purchases, thus providing the country an assurance of the availability of resources in the event of need.

45. The staff considers that the concessionality of ESAF resources would be an obstacle to the use of precautionary ESAF arrangements. The low interest rate and extended maturity applicable to ESAF loans would create incentives (and perhaps domestic pressures) for countries to draw on the facility even in the absence of a balance of payments need. As a matter of policy, it would seem undesirable to build into the architecture of the ESAF features that could place unnecessary pressures on countries to draw on the Fund. Moreover, in view of these incentives, there may be a tendency to limit access in such arrangements, thereby reducing their value as an assurance of financing in the event of need. A further difficulty is that approval of a precautionary ESAF arrangement would entail committing scarce ESAF resources, hence rendering them unavailable to other potential users, even though such resources might not ultimately be needed or used by the member.17

46. In view of these considerations, it is not proposed to introduce precautionary ESAF arrangements. Instead, an ESAF-eligible country seeking the Fund’s approval of its program without a current or prospective balance of payments need could request a precautionary extended arrangement.18 If a balance of payments need were to arise, for example, because of an exogenous shock, the country could either draw upon some or all of the accumulated purchases under the extended arrangement or request an ESAF arrangement. Prompt consideration of a request for an ESAF arrangement would be facilitated by the existence of a parallel extended arrangement which would have established policy commitments for both the short and medium term.19 To facilitate conversions, it is proposed that ESAF-eligible countries with precautionary extended arrangements incorporate a PFP in the precautionary program. More closely aligning monitoring under the two kinds of arrangements, proposed in the previous section of this paper, would also make conversions easier.

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1The principal author of this report was David Andrews. Staff who worked on the internal review of the ESAF included George Abed, Hugh Bredenkamp, Benedict Clements, Sharmini Coorey, Jörg Decressin, Louis Dicks-Mireaux, Liam Ebrill, Zia Ebrahim-zadeh, Sanjeev Gupta, Ali Ibrahim, Kalpana Kochhar, Jean Le Dem, Ronald McMorran, Mauro Mecagni, Anthony Pellechio, Steven Phillips, Susan Schadler, Jerald Schiff, Tsidi Tsikata, and Marijn Verhoeven. The external evaluation was undertaken by Kwesi Botchwey, Paul Collier, Jan Willem Gunning, and Koichi Hamada.
2The ESAF at Ten Years: Economic Adjustment and Reform in Low-Income Countries, Occasional Paper 156 (IMF, 1997); and The External Evaluation of the Enhanced Structural Adjustment Facility (Report by a Group of Independent Experts (IMF, 1998).
3These conclusions are being disseminated through many fora. The external evaluation and the summary report of the internal review have both been published, and internal training sessions and economic fora have been held to highlight the lessons of the ESAF review.
4The evidence is surveyed in Reinvigorating Growth in Developing Countries: Lessons from Adjustment Policies in Eight Economies, Occasional Paper No. 139 (IMF, 1996). The main factor driving private savings appears to be the growth of income, implying that strategies to raise growth will indirectly stimulate private saving, creating a virtuous circle.
5For a fuller discussion, see Fiscal Reforms in Low-Income Countries: Experience Under IMF-Supported Programs, Occasional Paper No. 160 (IMF, 1998).
6Some new proposals in this area are presented in Section III.
7See The ESAF at Ten Years: Economic Adjustment and Reform in Low-Income Countries (op.cit.), "Inflation, Disinflation and Growth" by Atish Ghosh and Steven Phillips (IMF Working Paper 98/68), and The Rise and Fall of Inflation—Lessons from Postwar Experience in the October 1996 World Economic Outlook.
8In the design and implementation of some of these structural reforms, the authorities and the Fund would need to rely on the expertise of the Bank, as discussed in Section III.
9See for example, Reinvigorating Growth in Developing Countries (op.cit.).
10The external evaluation referred to "the genuine difficulties that complicate attempts at giving operational meaning to the concept of ownership" (External Evaluation of the ESAF, op.cit., page 21).
11The external evaluation noted that "each alternative program path would need to satisfy a minimum condition of viability in order not to saddle the Fund with unacceptable risks of program failure..." (External Evaluation of the ESAF, op.cit., page 22).
12The idea would be that this requirement would normally forestall the presentation of a request for an ESAF arrangement in cases where the staff report could not set out a reasonably convincing case.
13The elaboration of medium-term public expenditure frameworks and the provision of related forward-looking aid commitments by donors would facilitate the assessment of the potential for the adsorption of greater external assistance with progress towards external and fiscal viability.
14See Box 2 for a discussion of the scope of these assessments.
15Under the existing ESAF, annual arrangements have no test date or disbursement at the end of the period. Thus, during the second half of each program year, poor policy performance has no immediate consequence in the form of missed disbursements under the annual arrangement, although corrective measures will typically be required to secure approval of the next annual arrangement.
16This may, in practice, be the point at which countries are best able to absorb increased amounts of public and private external financing.
17It should also be noted that the nature of the criterion of balance of payments need also does not lend itself to the use of precautionary ESAF arrangements. The ESAF Instrument requires the Fund to determine that a member has a "protracted balance of payments problem" before approving a three-year ESAF arrangement. This concept was introduced, in part, in recognition that the traditional criterion of need might not be satisfied if the country were suppressing a latent balance of payments need by, inter alia, constraining economic growth. Thus, the requirement of a protracted balance of payments problem can be met without an existing need in the sense applicable in standby or extended arrangements; the country is not required to represent that it has a balance of payments need either at the time of approval or before any disbursements under the ESAF. The introduction of precautionary ESAFs would therefore also require that the ESAF Instrument be amended to bring the criterion of need into line with that applicable for standby and extended arrangements and require a representation of need in support of a request for a disbursement under the ESAF.
18In cases in which actual or prospective balance of payments need has dropped to a very low level, continued Fund involvement could take the form of a low access ESAF arrangement. The ESAF Instrument allows for access to be increased at the time of the approval of an annual arrangement or at a mid-term review to take account of "adverse external contingencies occurring during the period of the arrangement." (ESAF Trust Instrument, Section II, paragraph 2(d).)
19In view of the desirability of establishing a medium-term policy framework for the continuing reforms efforts and to allow a rapid transition to an ESAF arrangement in the event of need, a precautionary standby would not normally be considered an appropriate successor to an ESAF arrangement.