Food processing center in Senegal, one of six African countries that has benefited from the IMF's policy support framework. (photo: Georges Gobet/AFP)
Policy Support Instrument
In response, the IMF introduced in 2005 the Policy Support Instrument (PSI). Its main characteristics are two-fold: first, it is a non-financial instrument, meaning no IMF resources are disbursed. Second, however, it is structured to resemble closely the traditional financial facilities of the IMF. In particular, a PSI provides endorsement of a member's policies by the IMF Board and is reviewed twice a year against a number of benchmarks and assessment criteria.
Successful track record
Six countries have since received support under the PSI: Cape Verde, Mozambique, Nigeria, Senegal, Tanzania, and Uganda. In all cases, these countries have a track record of successful policy implementation, strong growth, and no immediate need for IMF financing (see Chart 1).
Inflation remains in single digits.
At the same time, the six countries wished to remain closely engaged with the IMF in designing and supporting their domestic reform programs. In all cases, the PSI is based on a well-articulated national strategy, for example the Nigerian NEEDS program (see box) and the MKUKUTA in Tanzania.
Consolidating progress in Tanzania
Tanzania achieved significant macroeconomic stabilization under PRGF-supported programs during 1995-2006. With economic growth averaging over 5 percent, inflation was brought down from over 20 percent to below 5 percent. Domestic revenue mobilization and increased foreign assistance contributed to a stabilization of public finances, while debt relief and a buoyant export sector led to a comfortable level of foreign reserves.
PSI supports Nigerian gains
The two-year PSI-supported program in Nigeria, approved in October 2005, is based on the economic strategy outlined in the Nigeria Economic Empowerment and Development Strategy (NEEDS).
Among the key objectives supported by the PSI were to consolidate macroeconomic stabilization, notably by reducing double-digit inflation, and achieve a comprehensive debt restructuring, lowering the debt burden on the economy and freeing up resources for priority spending. Important structural reforms aimed to improve macroeconomic management, reinforce public institutions, and redefine the role of government in the economy in support of private sector-led growth.
At the end of the program, macroeconomic performance and sustainability have improved. Non-oil sector growth averaged 8½ percent and inflation fell to 6 percent, exceeding expectations on both counts. The external and fiscal positions strengthened significantly with the reduction of Paris and London Club debt, and the accumulation of public savings and international reserves. Debt-service savings were directed to poverty spending. The improved policies and good macroeconomic performance increased confidence, thereby creating a virtuous cycle.
Buoyant financial market sentiment is reflected in a sovereign rating of BB- and the success of several Nigerian banks in raising capital on international markets. However, while a majority of households saw their economic situation improve or stay the same, poverty remains high and progress toward the Millennium Development Goals needs to accelerate.
The PSI approved in early 2007 seeks to consolidate these gains while providing a framework for raising further economic growth and making decisive progress in poverty reduction. Based on Tanzania's national poverty reduction strategy (MKUKUTA) the PSI-supported program has four main objectives:
1. maintaining macroeconomic stability;
2. durably strengthening public finances;
3. accelerating financial sector reform; and
4. improving the business environment.
Progress in the first year of Tanzania's PSI has been good. Economic growth is averaging over 7 percent, although inflation has remained somewhat above the Bank of Tanzania's medium-term target of 5 percent. The Tanzania Revenue Authority has successfully continued to broaden the revenue base.
At the same time, while the overall quality of public financial management compares favorable with many other countries in the region, progress to improve the quality of public spending processes has remained slow. Financial deepening is continuing at a rapid pace. The challenge looking ahead will be to ensure strong prudential supervision, especially in the fast-growing pension fund sector.
Signaling a commitment
The choice of countries for a PSI represents a commitment to sound policies. Signaling such a commitment can be valuable: to external audiences (donors, investors) to indicate the quality of the policy framework, but also to domestic audiences (politicians, markets). It is best, therefore, to think of the PSI as a commitment device: a way to credibly commit to good policies. Similar to, say, an inflation target or a budgetary objective, such public and transparent commitment has tangible economic benefits in setting priorities and expectations.
This has helped countries in at least three ways:
• It has helped countries develop a macroeconomic policy framework and structural reform agenda;
• It has served the authorities well as an internal discipline mechanism as policy challenges emerged; and
• It has provided a framework for targeted technical assistance and support from the international community, and increasingly from private investors.
Growing importance
Looking ahead, the PSI is likely to grow in importance as a vehicle for the IMF's engagement with Africa. While financing may become a less binding constraint, at least for the leading reformers, many countries will continue to benefit from the IMF's policy advice, especially as they face the new economic challenges of frontier emerging markets.
The PSI provides a unique vehicle for delivering this advice while allowing member countries to demonstrate their commitment to sound policies—critical for both donor support and private sector confidence.
