Friday, July 20, 2007

Q 4: Types of Conditionality

Outline the types of conditionality found in IMF programmes. With reference to country examples, explain why it is important for countries to fulfill programme conditionalities; and outline how IMF conditionality has evolved in recent years.
1.10 Types of IMF Conditionality
We have seen that the IMF adopts a particular approach to stabilisation policy.
But how is this approach actually applied? In practice, the IMF applies its
approach to stabilisation policy by attaching conditions to the use of its financing
facilities. Consequently, member countries that apply for and accept IMF
financing are obliged to fulfil these conditions. This approach is known as the
IMF’s ‘conditionality’ policy. In this section, you will consider two sets of issues
pertaining to conditionality. Firstly, in which specific ways does the IMF apply
its conditionality policy? And secondly, how stringently is conditionality
applied?
1.10.1 Instruments of IMF conditionality
Conditionality is applied in four key ways in Fund-supported financing programmes:
• Performance Criteria (PCs)
• Programme Reviews
• Prior Actions (PAs)
• Structural Benchmarks (SBs).
1. Performance Criteria
The most basic monitoring tool comprises Performance Criteria (PCs). PCs are
conditions that are formally specified in the country’s financing arrangement
with the IMF. These are set when the arrangement commences. At that time, the
country receives a first tranche, or disbursement of financial resources, with the
remaining disbursements made conditional on the fulfilment of a variety of
conditions, including PCs.
PCs are the strongest form of conditionality, and they must be observed if the
country is to be allowed to obtain the next tranche of financing. Where PCs are
not achieved as stipulated in the relevant IMF arrangement, this constitutes a
serious breach of the arrangement. In many cases, the programme can be
suspended, unless the IMF Executive Board grants the country a waiver of the
relevant performance criterion. Applications for waivers are considered during
the periodic Executive Board reviews of the country’s financing arrangement.
Waivers can be granted by the Executive Board in instances where the nonobservance
of the conditionality is minor or temporary; or where the member is
shown to have been prepared to take corrective action.
Performance criteria feature in IMF arrangements in two types. Firstly, quantitative
performance criteria: examples include
• setting a floor or minimum level of net international reserves
• limiting the size of a member’s budget deficit, usually by setting a ceiling
or maximum on the level of net domestic credit extension to the
government by the banking sector
• setting a maximum level of non-concessional external borrowing
permissible in terms of the financing arrangement.
The second feature includes structural performance criteria, such new banking
legislation, or the establishment of a new bankruptcy law.
The International Monetary Fund and Economic Policy
30 University of London
PCs are specified on actions or measures that can be monitored by staff and are
subject to the control of the authorities. These criteria are derived directly from
the financial programming model that the IMF uses to derive quantitative
assessments of the various measures in the financial programme. In Unit 2, you
will see more clearly which types of PCs are most often used in IMF financial
programmes, and why these PCs are important to the IMF’s approach to
stabilisation.
2. Programme Reviews
A second major tool of conditionality is the Programme Review. These represent
the formal condition that all financial programmes with the IMF must be
reviewed at set intervals. After the initial financial disbursement is made,
subsequent tranches are conditional on the successful completion of a Programme
Review and endorsement by the Executive Board.
In 1979, the IMF Executive Board developed guidelines for the staff members of
the IMF. These guidelines were intended to assist IMF staff during their missions
to member countries, by illustrating in what circumstances certain types of
conditionalities would be appropriate. The 1979 Conditionality Guidelines
envisaged that the Programme Reviews would be used for the purpose of
setting PCs in cases where it was impossible to set them sufficiently far ahead at
the outset of the programme, and in cases where an essential feature of a
programme could not be formulated as a PC at the beginning of a programme
year because of substantial uncertainty regarding major economic trends.
The main advantage of the Programme Review is that it provides an opportunity
to update the information on which both the IMF and the country rely,
when assessing the progress of the programme. Programme Reviews enable
both the IMF and the member country to modify a programme as it progresses.
Programme Reviews are also used to establish conditions for future drawings,
and to assess progress toward structural policy objectives that may take time to
come to fruition. For that reason, they have become more prevalent with the
growing structural content of Fund-supported programmes.
3. Prior Actions
Prior Actions (PAs) are additional tools of IMF conditionality that affect the
country’s access to the Fund’s resources. PAs are steps that the authorities agree
to take before a Board decision on the use of Fund’s resources. The use of PAs
has expanded considerably in recent years. In some cases, they are viewed as a
way of signalling the authorities’ commitment to the programme. In general,
PAs are negotiated between the authorities and the staff but they are not
specified in advance and only affect the Board decision on the programme after
they have been implemented.
PAs generally comprise structural measures, which tend to be relied on where
the member country’s past track record is poor. PAs were previously not
considered a formal conditionality, but have recently become a much more
integral part of formal IMF conditionality.
4. Structural Benchmarks
A further major method of applying IMF conditionality is through Structural
Benchmarks (SBs). Structural benchmarks have become increasingly prevalent
since their introduction in the context of IMF structural adjustment programmes
in the 1980s. They have also subsequently been adopted in the more recent IMF
programmes in low-income countries. These programmes are known as Poverty
Reduction and Growth Facility (PRGF) arrangements.
Because the key structural reforms take considerable time to implement, SBs
map out a series of steps towards a desired policy outcome, such as central bank
independence or a broader tax base. Measures that start out as structural
benchmarks, or merely measures listed in a matrix, may become performance
criteria or prior actions for subsequent reviews; other measures may be downgraded
or dropped from the programme. Such shifts often reflect the changing
economic situation as well as the experience with programme implementation,
which may alter the priority attached by the IMF to different measures.
5. Indicative Targets
Indicative targets are utilised where a PC would normally be used, but cannot
be established, due to uncertainty about economic trends.
1.10.2 The importance of fulfilling IMF conditionality
If these are the major tools through which IMF conditionality is applied, how
stringently are these conditions applied? In practice, the IMF attaches very
significant weight to the application of its conditions. For each of the various
types of financing arrangement, the IMF provides its financial support in
tranches. Disbursements of each tranche hinge upon the fulfilment of the
conditions that were set at the point of disbursement of the previous tranche.
When conditions are judged not to have been met, the Executive Board is
informed by the IMF staff.
The Executive Board is empowered to take one of two broad sets of decisions.
Either it can refuse to complete the programme review, pending the completion
of the specified conditions; or it can grant one or more waivers of conditions
that have not been fulfilled. In practice, in each programme there are a host of
conditions. And it is often the case that one or more conditions may not have
been completely fulfilled at the time of a programme review. In the bulk of
cases, the IMF Executive Board grants waivers, the review is completed and the
overall financial arrangement moves to the next stage – the disbursement of a
further tranche and the imposition of a further set of conditions.
In some cases, however, where there have been fundamental breaches of
conditions, or substantial non-achievement of conditions, the Executive Board
decides not to proceed with the review. In such instances, financing programmes
are stalled. In IMF language, these programmes ‘go off-track’.
Sometimes, corrective action by the country authorities results in the programme
coming back on track and proceeding. In some cases, however,
programmes remain off-track for long periods of time. Often in these cases, it is
decided to abandon the original programme and, when appropriate, to commence
a new programme.
For countries seeking to stabilise their economies, this can represent a very
difficult set of circumstances. For once the IMF indicates that its programme
with a member country has gone off-track, other multilateral and bilateral
creditors, including private-sector creditors, invariably also decide to cease new
lending and in some instances call for early repayment of their loans to the
country. You will see later in this course, in Units 4 and 5, that these decisions
can in turn precipitate a serious outflow of capital, causing further adverse
consequences for the economy. For these reasons, IMF member countries that
have taken IMF financing facilities typically ensure that they are fully compliant
with the conditionalities they accepted at the start of an IMF programme.
1.11 The Evolution of IMF Conditionality
The IMF’s policy on conditionality has evolved substantially over the history of
the institution. Some element of policy conditionality has been attached to Fund
financing since the mid-1950s, but the scope of conditionality expanded considerably,
particularly from the early 1980s. In the process, tensions arose between
the desire to cover aspects of policy central to programme objectives and the
importance of minimising intrusion into national decision-making processes.
The expansion in IMF conditionality from the early 1980s is ironic. For in 1979,
the IMF established Guidelines on conditionality, which it issued to its staff. The
purpose of the guidelines was to ensure that IMF staff who negotiated programmes
with IMF member countries understood the parameters within which
the IMF would impose conditions as part of its lending programmes. The 1979
conditionality guidelines underscored the principle that conditionalities should
be limited rather than comprehensive, and that the number and scope of
performance criteria needed to be limited to the minimum needed to evaluate
policy implementation. The Guidelines also stressed that the IMF’s staff should
pay due regard to the country's social and political objectives, economic priorities
and circumstances when deciding what conditions should be imposed.
Notwithstanding the 1979 Guidelines, the period since the approval of the
Guidelines saw a major expansion of conditionality, particularly in the structural
area. While structural measures were rarely an element in Fund-supported
programmes until the 1980s, by the 1990s almost all programmes included some
element of structural conditionality. The expansion of structural conditionality
was also reflected in increasing numbers of performance criteria, structural
benchmarks, and prior actions.
The increasing structural content of Fund-supported programmes and the
changing approach to programme monitoring prompted wide-ranging concerns
that the Fund was overstepping its mandate and core area of expertise. Moreover,
the expansion of conditionality raised issues regarding its effectiveness.
Developing countries asserted that if conditionality were made too comprehensive,
it might undermine the assurances which had been given by the IMF to its
member countries, that these countries could purchase resources from the Fund,
since it would increase the chance of failing to meet all conditions even when
the policies that were critical to programme objectives were actually on track. A
proliferation of conditions also had the potential to blur the Fund’s focus on
what was essential to ensuring that the programme fulfilled its purposes.
Concerns were also raised about whether recent Fund-supported programmes
had taken adequate account of the authorities’ ability to muster political support
for a multitude of policy changes at one time, as well as their capacity to implement
these reforms. Increasingly, the authorities in countries which had entered
Unit I Macroeconomic Stabilisation and the Role of the International Monetary Fund
Centre for Financial and Management Studies 33
into IMF-supported financing arrangements argued that conditionalities had
become too detailed and too intrusive, and had begun to short-circuit national
decision making processes, so undermining the authorities’ ability to muster
public support for policy implementation and thereby debilitating national
ownership of the reform process.
For all these reasons, in particular as a result of growing evidence of the failure
of a number of IMF-supported programmes in achieving their initial objectives,
the IMF embarked on a significant review of its conditionality policy, commencing
in 2000. The review was completed about two years later.
The 2000–2002 Review of IMF Conditionality concluded that the IMF would
need to reduce the number and scope of its conditionalities and would need to
focus more clearly on its core areas of expertise and mandate. In addition, it was
decided to shift away from the approach that had developed up to that point,
with its presumption that conditionality would be comprehensive. Instead, the
dominant presumption now became that conditionality would be limited and
modest.
The most recent conditionality guidelines also introduced the concept of ‘Floating
Tranche Conditionality’. This form of conditionality applies mainly to
structural performance criteria that are important for medium-term external
sustainability and growth and is applied where a structural measure or performance
target is to be implemented during a programme, but not by a specific
date. This enables the relevant member country to control the timeframe for
implementation and in this manner contributes to promoting domestic ownership
of the programme.
The new approach to conditionality also represents a stronger attempt to
coordinate policy advice with other international financial institutions, including
particularly the World Bank. In this instance, the guidelines also introduce
the concept of a ‘Lead Agency’ vis-à-vis the World Bank, in which either the
Bank or the Fund are designated the lead agency in the Bretton Woods Institutions’
overall dealings with the member country.
The IMF’s new approach to conditionality policy has been in operation for
about two years. Initial evidence suggests that fewer conditions are being
applied to IMF-supported programmes and that these tend to be more focused.
It is premature, however, to come to conclusions as to whether or not the new
approach has led to an improvement in programme outcomes.

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